Connections that threaten Asian growth

The interactions of business and politicians/political parties in the “Connections World” are transactional and reciprocal. (James Goldie and Chris Bartlett, 360info). Credits CCBY4.0

Many Asian economies may not realise their full potential unless they roll back the mutually beneficial links between business and politics.

There’s no doubt that Asia is a rising economic force — its share of the world economy has risen from nine percent in the 1970s to nearly 40 percent now.

However Asia’s economic growth has been driven by mutually beneficial links between dynastic business houses and political elites, or what experts call the Connections World.

These arrangements, which have been advantageous until now, have begun to threaten future Asian economic growth.  This may have a direct bearing on whether the 21st century will belong to Asia, or whether its economies will falter as major fragilities are exposed.

Asian countries have many differences but they share common features, notably the ubiquitous and embedded political and economic networks that exert a massive influence on how these economies are structured and perform. This has implications far wider than particular acts of cronyism and preferential behaviour.

Gaining advantage through connections

The interactions of business and politicians/political parties in the ‘Connections World’ are transactional and reciprocal. Politicians look to firms to make campaign or personal contributions, pay bribes and provide jobs for family or associates while also providing favours, such as creating jobs in regions or at moments that are politically advantageous.

At the same time, businesses look to politicians for protection from foreign or domestic competition, and to supply subsidies, loans and/or public sector contracts. By such means, they commonly manage to acquire very substantial market power and profitability. Reciprocity ensures that all parties derive advantage.

Development policy in Asia has usually placed emphasis on the role of the state. Activist industrial policy has tended to focus on providing infrastructure, finance and support for priority sectors and businesses (‘national champions’), including through protection from competition from foreign firms.

On the other side of these informal coordination arrangements sit Asia’s powerful and ubiquitous business groups. These groups cut across political systems, being as important in Vietnam, say, as they are in Thailand or Indonesia. They are large, diversified firms, but they also have organisational structures that have long been outlawed or rarely used in advanced economies.

Keeping it in the family

These business groups are marked by their extent of crossholdings, as well as pyramidal structures. The aim of such opaque ownership arrangements is to keep control ‘in the family’. Share pyramids, for instance, allow the family to own a smaller proportion of shares than would be implied by the extent of control that they possess.

Such arrangements facilitate tunnelling which can involve non-transparent, inter-group loans, as well as non-transparent capital flows between different parts of the group. Business groups are also exceptionally suitable for transacting with political elites in legal and illegal ways as they provide concentrated points of contact for the political class, thereby reducing complexity in their relationships.

However, it seems the ‘Connections World’ will be far less supportive of economic growth than in the past. This is because of several factors.

The reduction of competition. Neither politicians nor business groups have an interest in stimulating competition whether domestic firms or foreign multinationals, except when the latter bring critical technologies. As a consequence, business groups entrench themselves and often are in a position to exert major market power.

While this will translate into profits, it also high levels of concentration (indicated by the share of total revenues for the largest five firms relative to GDP), which reach levels of around 30 percent in South Korea and exceed 10 percent in the much larger economies of India and China. Most of these firms are either business groups or state-owned companies and this concentration measure shows far higher levels than, for example, in the United States where it is around 3.3 percent.

Limiting ‘good’ job creation. Although Asia has grown rapidly, jobs – particularly high productivity ones – have not followed. Indeed, labour productivity mostly remains unimpressive. Relative to the US productivity level, only South Korea has reached more than 50 percent; a few others hover around 30 percent and, on average, GDP per worker in Asia is only 10-15 percent.

Asia faces serious challenges. Just to keep the share of employment stable, it has had to generate over two million jobs a month.  Whilst business groups do create jobs with high wages, security and productivity, the problem lies with their limited numbers. As a result, most job creation occurs in Asia’s massive informal sector, where fragile, low wage, low productivity jobs abound. These informal economies tend to account for over two thirds of employment but barely a fifth of GDP on average.

Rising inequality. The ‘Connections World’ breeds income inequality, not least through the wage differentials that come from these dual labour markets. But even more striking is the extraordinary expansion of wealth and the proliferation of ultra-wealthy families. In China alone, the number of billionaires has shot up from zero in 2000 to nearly 400 by 2020.

However, the biggest concern for future Asian growth relates to the nature and evolution of the development model. The margins for further extensive growth – the application of more capital and labour – are shrinking and some countries – notably China — already need to pivot towards more intensive growth based on technology, knowledge and skills as drivers of innovation. What does the ‘Connections World’ look like through that lens?

In fact, the business groups are quite efficient at identifying and allocating resources, and evidence suggests their  affiliates innovate more than non-affiliates.  However, we also find business groups often focus on making short term profits through their connections and can act as a brake on innovation by crowding out non-business-group firms from innovating, not least by restricting access to markets and limiting the availability of external financing. Business groups also suppress the levels of entry and exit of firms in general which restricts the capacity of the economy to shift from lower to higher value-added activities.

The solutions

For Asian economies to raise productivity and enhance innovation they must come to grips with the entrenched power of the ‘Connections World’.

To achieve that they’ll need measures designed to transform business groups into more transparent and better governed business organisations, while also radically weakening the links between politicians and business. This will not happen naturally because the mutual benefits from market entrenchment and political connections outweigh any gains from reform.

It will require policies to accelerate the disappearance of business groups, including changes in corporate governance, undercutting pyramidal ownership structures, mergers and cross-holdings, imposing inheritance taxes and shifting to new types of, and the targets for, competition policy. At the same time, measures are needed to limit the discretionary scope and incentives for politicians to leverage their connections for personal or family benefit.

The proclamations of the 21st century being the ‘Asian Century’ are premature. Unless policies are introduced to roll back the tentacles of the ‘Connections World’, many Asian economies will be far less well placed to exploit their potential in the coming decades.

*Analysis and examples in this article can be sourced in Connections World, Commander and Estrin (2020).

Simon Commander is Visiting Professor of Economics at IE Business School in Madrid & Managing Partner, Altura Partners, London. He previously worked at the European Bank for Reconstruction & Development and the World Bank. 

Saul Estrin was the founding Head of the Department of Management at LSE & formerly a Professor of Economics & Associate Dean at London Business School.  

Originally published under Creative Commons by 360info™.

*London School of Economics in London.

Published 11:47 08/05/2023

By Simon Commander, IE Business School, Madrid, Spain and Saul Estrin*

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