towards a more resilient macroeconomy
with 2 comments
In previous posts (1,2), I explained how crony capitalism and rent-seeking can explain many of our current economic problems. Although I drew parallels with the experiences with cronyism in developing economies, there are some important differences that I neglected to mention.
Financing Constraints and Cronyism
Earlier, I highlighted the role that financing constraints faced by new firms can play in inhibiting exploratory investment. As Raghuram Rajan and Luigi Zingales have explained in great detail, financing constraints have caused and helped support cronyism throughout economic history. Incumbent corporates feel especially threatened by free financial markets “because they provide resources to newcomers, who then can make other markets competitive.”
Banks may be reluctant to lend to new entrants for entirely rational reasons such as lack of collateral or uncertainty-aversion. Moreover, many developing economies are capital-poor at the early stages of their economic development and their governments often choose to play an active part in allocating scarce capital to chosen industries and firms. In his book on the origins of cronyism in Japan, Richard Katz laid out the extent to which Japanese capital-intensive firms were dependent upon state patronage and approval for their financing needs in the 50s and 60s. Katz takes the example of Kawasaki Steel which struggled to raise capital for Japan’s first modern integrated steel facility due to the objections of the BoJ and only succeeded due to the patronage of another government agency, the Japan Development bank (JDB).
Inefficient Crony Capitalism vs Efficient Crony Capitalism
Although there are some similarities (e.g. collateral constraints), it is a stretch to compare the cronyism of capital-poor developing economies with financing constraints faced by new firms in the developed world (especially the United States) today. There are fundamental differences between the crony capitalism faced by the United States and the experience of economies such as India or Japan. As I have highlighted before, our malaise is caused by insufficiently exploratory incumbent firms. However, our economy is sufficiently internally competitive that incumbent corporates are efficient. Crony capitalism in most developing economies and in Japan has been characterised by a distinctly inefficient and uncompetitive corporate sector. Katz describes the high costs and overemployment that are endemic to many of Japan’s domestic industries which can only remain solvent due to a myriad of implicit and explicit collusive and protectionist measures. In other words, the protected incumbents in most developing economies not only fail to explore but are exploitatively inefficient.
The exploitatively inefficient crony capitalism of most developing economies is easy to identify. For example, Katz documents the abysmal productivity of Japan’s protected domestic sectors. On the other hand, a systemic failure to explore and innovate is more subtle and harder to detect – in fact, the drive towards exploitative efficiency is likely to increase measured productivity in the short run. When Katz argues that America’s problems have few similarities to the problems of Japan’s dual economy he is only half right.
The most significant difference between inefficient and efficient crony capitalism is in its impact on unemployment and prices. Paradoxically, efficient crony capitalism goes hand in hand with higher unemployment and lower prices. Incumbent corporates are efficient enough to shed workers during the inevitable deleveraging cycle but are unwilling to explore and create the new jobs that will take their place. Intense exploitative competition between the incumbents also reduces price levels in the short run. On the other hand, inefficient crony economies have lower unemployment at the cost of lower economic output and higher prices. Richard Katz’s observations on Japan’s hidden social safety net are worth repeating in full: “Whereas in Europe, the social safety net is woven out of overt government programs, in Japan it occurs in hidden form. Anticompetitive activities allow moribund companies and flagging companies to sustain themselves so that unemployment is disguised….”Japan is organized so that society’s losers don’t feel like losers,” is how it is described by Takashi Kiuchi, chief economist at the Long-Term Credit Bank.”
Written by Ashwin
December 15th, 2010 at 5:53 am
Posted in Cronyism
Might I suggest that this also applies to Intellectual Property “protection”? Certainly the competition problem is more difficult, because foreign companies might be able to work more cheaply, but other than that IP is just as bad for innovation (and might actually be one of the reasons why banks will become more unwilling over time to lend money to newcomers, because they feel they don’t stand a chance).
Foppe
15 Dec 10 at 6:50 am
This is a good article delineating the costs of corruption relative to the competitive dynamics at various levels of an economy. The competitive internal dynamics, intra-industry and how they facilitate economic advancement and innovation are deeply unexplored in economics.
Most economists and analysts just look at the economy as a simple set of interlocking pieces instead of each economy as slightly different set of competitive ecological niches behaving with differing rules to deliver or not deliver the goods.
The argument you put forward is good and addresses structural variation and adapted behaviors. Most policy and economic debate assumes that finding the right interest rate policy or some other crude lever will solve all problems.
This present a crude mechanistic treatment of economy like a machine that overheats or cools down relative to “money” fuel running through it.
Poor Structural dynamics and competitive behaviors hurt Japan leading to stagnant growth. Rate policy, “missing demand”, demographics etc. most likely have less to do with the “lost” decades, than poor competitive structures allowing for innovation and creative destruction.
nick gogerty
15 Dec 10 at 9:39 am
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John Kay on Regulatory Capture.
John Kay’s rightly notes that a regulator who regulates from the position of a distant judge is better placed to avoid regulatory capture. This reminds me of the advice that Lester Bangs gives to William in the movie ‘Almost Famous’. Bangs insists that a rock journalist ”cannot make friends with the rock stars” if he is to remain unbiased and true to his profession.
Regulatory capture is good for the regulated in the short run but it is fatal in the long run. Eventually, cronyism kills the crony as well as the system. Again, Lester Bangs’ advice is as relevant to financial regulation as it is to rock journalism when he says: “ I know you think those guys are your friends. You wanna be a true friend to them? Be honest, and unmerciful.”
11/04/10
Geoffrey West on Why Cities Survive and Companies Die .
My take: Organisations and Living Beings are the unit of selection whereas cities, economies and ecosystems are emergent entities comprising of these units. In a complex adaptive system that needs to innovate just to maintain the status quo, the unit of selection is usually fragile as it competes with all other units.
In fact, if the micro-unit is more resilient, then it leads to fragility at the macro-level. In other words, micro-resilience is incompatible with macro-resilience in many complex adaptive systems as I explain here.
11/03/10
Price controls are like crack to an addict. You can't live without them, but they will be the death of you.
http://american.com/archive/2010/october/confessions-of-a-price-controller
Cronyism ultimately kills the crony as well as the system.
11/01/10
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