The limits of protected oligarchic capitalism

Modern Asia trumps differences in economic and political systems in the web of close relationships running between and within business and politics. These networks facilitate highly transactional interactions yielding significant reciprocal benefits. Networks and connections between businesses and between businesses and governments has bred success in significant parts of Asia with fallibilities. 

This is the thesis in a recent book on the Asian Capitalism titled "The Connections World" by Simon Commander and Saul Estrin (2022). Their empirical construct is based on research on middle-income Asia, including Bangladesh. Their thesis is old wine (read capitalism) in a different (read Asian) bottle. The core structure of their argument on the workings of Asian capitalism is founded on the traditional oligopoly theories of microeconomics applied refreshingly to prognosticate what may be a defining phenomenon of the 21st century.

Engines of growth

Unlike western capitalism, where the market is the primary driver of economic growth, middle income Asia relied on strong state intervention to accelerate growth. This happened through the "connections world" comprising networks and elastic boundaries between governments and businesses. The state directs investment, sets import substituting industrial policies, and promotes exports. Large state-owned enterprises are major players in their respective industries.

High saving and investment rates is the face of middle-income Asia. Their capitalists benefited additionally from western technology transfer and foreign direct investment, often adapting, and improving upon to develop their own technological capabilities. Often family-owned, business groups in Asia are tightly controlled with decision-making centralised by a few individuals or families. Connectedness through family and political ties is more pervasive than expected given the heterogeneity of ethnicity, language, culture, and political discourse across the continent.

Many of the groups trace back to family-run businesses initially focused on a single industry or product. They expanded over time into other industries to diversify their revenue streams and reduce risk. Their businesses are strikingly diversified with companies involved in a wide range of unrelated activities. Diversification occurred through a combination of organic growth, acquisitions, and strategic partnerships to source raw materials or manufacturing capabilities, expand global reach or develop new products or services by leveraging their existing networks and resources. They invested heavily in strategic initiatives to support their long-term success while mutating into the too big to fail category. Their long-term view prioritising strategic planning over short-term profits made them growth leaders.

This connection ecosystem contributed materially to Asia's economic success with mostly extensive (factor driven) growth over the past 40 years, substituting for missing markets and weak formal economic, social, and political institutions at the expense of attenuated competition, rivalry, entry, exit and creative destruction. Offshoring/outsourcing low value activities to neighbouring countries and reallocating resources at home to both technology sourcing foreign direct investment (FDI) and home-based innovation was achieved through collaboration between policy and the private sector, with directed investment in semiconductors. Some (South Korea, Indonesia, Vietnam) did a lot better than others (India, Bangladesh).

Simon and Saul's generous praise for delivering sustained high growth by these oligarchic systems on diversification steroids ignores recent research on the veracity of GDP growth estimates in their countries. Governments of all kinds want to overstate how well their economy is doing, but authoritarian systems are better able to get away with it. Luis R Martínez (University of Chicago 2022) presents a body of evidence based on the comparison of GDP growth and night-time lights suggesting that autocracies overstate economic growth by 35% leading to a more nuanced view on their growth performance in recent decades.

Beyond growth

Focusing single mindedly on economic growth misses jobs, innovation, productivity, and inequality. The dominance of business groups has led to an insider-outsider economy dominated by cross holdings and political connections, benefitting the few and relegating the many to either precarious employment within the formal economy or a very large informal economy. The aggregate concentration of market power is order of magnitude higher in Asia. Dominant firms with such power see little incentive to let others innovate. 

Consequently, they have not delivered on productivity growth and inequality reduction to the same extent as those in the West. Their all-pervasive market power enables suppressing competition, thus removing the incentives for these firms themselves to invest in innovation and productivity growth. Small and medium-sized enterprises often face difficulties in accessing finance and technology. Productivity gap between large business groups and SMEs have widened over time.

Higher levels of aggregate concentration owes in no small portion to strong government patronage of the dominant firms and cultural preferences for working with established, well-connected firms. In some cases, weaker government regulation, say in enforcing antitrust laws or granting exemptions to politically connected firms, allows business groups to have greater monopoly power. What matters is the presence of the transaction motive, not whether the state is weak or strong. Corruption and weak institutional quality have been persistent challenges limiting the ability of governments to implement policies that promote competition, innovation, and productivity growth.

Informal markets and businesses constitute extreme forms of dualism in Asia, especially pervasive in labour markets, a consequence of the exclusivity of connections capitalism. Their long history predates the emergence of large business groups and still accounts for a significant share of economic activity with low productivity and wages. Informality is a way to avoid complex regulatory barriers and reduce costs. They are limited by access to formal financing, such as bank loans or venture capital, to operate in the formal sector. Many firms in Asia have been reluctant to invest in worker training and development, which has limited the building of a skilled and productive workforce. These have contributed to persistent inequality.

Creative destruction on the back seat

Many middle-income Asian countries focused more on replicating existing technologies and products rather than investing in new R&D. Funding constraints and access to technology limit contagion of investment in innovation. The big groups crowd out funding and information access to small players. Their diversified portfolio allows them to be more risk averse. Weak intellectual property protection and regulatory barriers create uncertainties about the appropriability of returns from investment in R&D. Dominance of family dynasties in corporate structures suppress entry of new players. 

Capitalism is supposedly an economic system in which membership of the elite often depends on a high level of economic performance (Acemoglu and Robinson 2012). Failure makes one bankrupt, not kicked out. Market competition provides a mechanism for weeding out those who underperform. Capitalism is less dynamic (János Kornai 2013) when private property is not secure, markets are not competitive, and firms are owned and managed by people who survive because of their connections to the government. 

Family-owned business groups often prioritise maintaining control and stability leading to a reluctance to bring in new outside players. They tend to have stronger relationships with banks and other financial institutions, making it more difficult for new players to secure funding. They have stronger relationships with government officials for kickbacks, the reciprocal part of gaining preferential treatment, such as access to government contracts, licences, or permits. The officials create regulatory barriers for new entrants.

More fallibilities worth reckoning

Asian business groups' close ties to the ruling political elite has been particularly true in countries like, but not limited to, China, where state-owned enterprises and large business groups are closely linked to the ruling party. Alliances with authoritarian regimes provide speedier access to government resources and contracts. Additionally, business groups view such regimes as providing more stability and predictability compared to more apparently chaotic and unpredictable democratic systems.

This creates a system where only a select few firms are able to access government resources and contracts. The groups' social actions prioritise their own club interests over the broader society, thus limiting competition, innovation, accountability, and transparency. The ruling elite and business groups are able to operate with impunity. A small elite holds significant power and wealth, while the rest of society struggles to access basic services and opportunities. 

There is some evidence to suggest rent-seeking activities are more pervasive in Asian capitalism compared to the West. Weak institutions and rule of law create an environment where such behaviour spawn. Individuals and groups often have more to gain spending time and resources to shift the distribution of income in their favour by lobbying and criminal activity. Innovation, essential for the long-term ability to address inequality and productivity simultaneously, gets beholden. 

The Western model of corporate governance may curb the worst excesses as firms seek to internationalise, but in itself may not provide sufficient impetus, particularly when status quo means a large share of a large market (think India). Korea was the forerunner in internationalisation despite group business structures and relationships to the government. They succeeded in innovation and productivity, albeit using their connections across the region. Some firms operating within the Asian structure have successfully internationalised without morphing their traditional structures when faced with Western corporate governance. However, unless globalisation is cannibalised, it may be a mistake to take the current playing field for granted.

Late movers could be less stellar

Bangladesh and India have liberalised policies de jure to attract more trade and foreign investment while maintaining the legacy of import substitution. Differences in the political and institutional contexts of Bangladesh and India from those of the early Asian industrial capitalist economies may bring a different flavour to the nature and trajectory of their capitalist development. The difference may not soothe due to flawed strategic policy choices and neglect of human capital development. The connect between investment and human capital, that is, worker's welfare and skills development is in the shadows.

Large and opaque gap between de jure and de facto policies in Bangladesh and India have not positioned them well to participate in global supply chains. They harbour fears of global integration overlooking the fact that much depends on how a global shock is propagated. Like water, open economies are both more resilient and fragile. Such a common tradeoff between fragility and resilience is surprisingly overlooked. 

Former Reserve Bank of India Governor Raghuram Rajan observed in the context of India that productivity-linked incentives in manufacturing benefit the large well-connected firms rather than the SMEs. PLI elevates tariffs as well as subsidies without which the connected firms cannot stand independently. This produces a permanent situation of using taxpayer money to insure the losers. There is an implicit benefit to scale as the government chooses the beneficiaries. PLIs in sectors where large industrial houses were going to make investments anyway are "pure freebies". The same type of concerns plague Bangladesh.