Business Standard: Towards stakeholder capitalism?

by Deepak Lal, Senior Fellow in Globalization (July 24, 2008)

India can take the path Anglo-American capitalism took over the last 200 years.

In my last column I had examined the travails of Anglo-American managerial capitalism, arguing that it was the success of incumbent managers (the insiders) in using the political process to limit hostile takeovers (by outsiders) which has led to excessive executive compensation at the expense of the shareholder owners of corporations. In the process income distribution also worsened. An important feature of this form of capitalism, providing economic opportunities even for those without their own resources, and enabling outsiders to challenge insiders to impart the dynamism of creative destruction which is involved in the most efficient deployment of an economy's resources, was also attenuated. The US search funds which allow those without collateral or connections to finance their new ideas, is emblematic of the Anglo-American capitalist model.

But since the late 19th century it has faced competition from the corporatist "stakeholder" model pioneered by Germany after its unification in 1871, and adopted by the reformers of the Meiji revolution in Japan. The major differences with the Anglo-American variety were, first, the toleration of cartels, as (following Fredric List) the nation rather than individuals was considered the basic economic unit, with industry required to serve the national weal. Second, there were incestuous relations between the industrial corporations and commercial banks. Third, German corporations had a two-level system of corporate control: a management board for day-to-day management and a supervisory board consisting of various stakeholders: shareholders, banks, cartel members, local politicians and trade unions. Fourth, companies had to provide social insurance to their employees as well as "co-determination", by giving them a formal voice on company boards.

The Japanese chose a variant of this stakeholder capitalism through the zaibatsu. These were conglomerates, which included banks and insurance companies, at whose centre was a family-owned holding company, with other associated firms linked by cross-shareholdings and interlocking directorships.

After the war, the US tried to introduce more features of Anglo-American capitalism in the two countries. But both reverted to their older corporatist forms. The German "social market" recreated Bismarckian corporatism, while Japan saw the zaibatsu reborn as the keiretsu. This model was exported to other Asian countries, most notably South Korea, whose chaebol was another form of corporatist capitalism. This is the so-called Asian model of capitalism.

It was successful as the countries adopting it were latecomers to industrialisation, catching up with the industrial leaders in the UK and the US. Late developers with abundant labour can easily discern the initial industrial structure in line with their comparative advantage. It will consist of small-scale labour intensive industries, which can be financed through the extended family or small partnerships, run by owner-managers. With growth and the shift of comparative advantage to progressively more capital-intensive industries, families would not have the large amounts of capital required to establish such businesses and retain control, avoiding the "agency" problems of managerial capitalism, discussed in my last column. This problem can be overcome by creating large concentrations of wealth or finding ways for some concentrated wealth holders — like rich families — to indirectly control enterprises run by managers. The Indian managing agency system is an example of the latter path. It has resurfaced in a slightly altered from since the 1991 economic reforms.

In the countries of stakeholder capitalism, the financial institutions of the family-owned conglomerates channelled the savings of the general public to their enterprises. This process was directed by the State as a major stakeholder, creating immense moral hazard. Neither the controlling family members, whose financial stake was diluted over time, nor the managers or bankers found it necessary to undertake prudent investments. After the easy "catch-up" stage of capitalist development, many bad investments were made leading to financial crises.

Thus in Japan, Aldo Ando ("On the Japanese Economy and the Japanese National Accounts" NBER wp. 8033, 2000) has calculated that, from 1970 to 1990, because of these bad investments the Japanese corporate sector incurred capital losses of $405 trillion, with non- financial corporations earning a rate of return of about 2.5 per cent and financial ones 1.6 per cent. Japanese households, having cumulatively saved $1,250 trillion (at 1990 prices), found they had suffered a real capital loss of $389 trillion. Thus an ageing population found that its stakeholder capitalism lost 31 per cent of its lifetime savings over 30 years. No wonder the aged Mrs Watanabe continues to save rather than spend to see her through an uncertain old age. A generation which propelled the Japanese miracle, after war-time destruction, finds its hopes along its savings turning to ashes.

What then explains the undoubted economic success of the countries adopting corporatist, stakeholder capitalism? A neglected study of the comparative growth experience of OECD countries by Maurice Scott (A New View of Growth, Oxford, 1989) shows that the Japanese growth rate of 9 per cent between 1960 and 1973 and the German rate of 6 per cent between 1955 and 1962, can be explained entirely by the investment rate, the growth of the quality adjusted labour force, and a catch-up variable. The stakeholder model of capitalism had little to do with it. But their subsequent decline in growth and their continuing economic stagnation is due to the rigidities and inefficiencies in their labour and capital markets caused by the stakeholder model. Reluctantly, along with other adherents of the "Asian model", they are moving towards the shareholder model of the Anglo-Americans.

India has combined "owner-managers" in its large business houses, with its legacy of the institutions of Anglo-American capitalism. But the post-Independence financial repression with the banks being nationalised prevented the free entry into the capital market, which is the hallmark of Anglo-American capitalism. Today, by allowing takeovers, completing the privatisation of banks, and ignoring the proponents of stake-holder capitalism, India can repeat the dynamic capitalist growth which has been a hallmark of the Anglo-American capitalism over the last 200 years.

Published in the Business Standard here


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