STRATEGY & POLICY

Critique of Legal Origins Theory

• No actual system fits platonic ideal of types.

• Does not allow for evolution • Representing a broader market orientation.

Orientation

• Free Market vs. Government Coordination • Developmental vs. Welfare • Nationalist vs. Globalized vs. Regional • Business vs. Labor • Consumption vs. Investment • Open vs. Closed

Read

• Hayek, Friedrich A., 1945, “ The Use of Knowledge in Society ,” American Economic Review. XXXV, No. 4. pp. 519-30. • Hall, Peter A. and David Soskice, 2001, Varieties of capitalism : the institutional foundations of comparative “An Introduction to Varieties of Capitalism,” pp. 1-70,: Oxford [England] ; New York : Oxford University Press, 2001 • Polanyi, Karl, 1994 The great transformation Chap 3, “The Self Regulating Market and the Fictitious Commodities: Labor, Land and Money,” p.68-76, foreword by Robert M. MacIver Imprint Boston : Beacon Press.

Hayek: 1945

• Economy made up of millions of humans in wildly varying quickly changing circumstances.

• Allocating resources to match the demands of particular places and time has great value. • Eliciting the subjective value of those opportunities is uncertain. • No single individual or institution could possibly process that much information.

Prices as Information

• Centralized planning cannot provide an efficient co ordination mechanism.

• Market system provides decentralized means to allocate resources to time and place. • “The most significant fact about this system is … how little the individual participants need to know in order to be able to take the right action. …., only the most essential information is passed on and passed on only to those concerned .” • All necessary information is contained in prices.

Prices solve allocation problem

• Assume either: 1) new use of tin appears; 2) source of tin goes offline. • Doesn’t matter which and most people don’t need to know which. All that matters is prices will rise.

• This gives information to users of tin to shift toward substitutes and users of substitutes for tin to shifts to substitutes and so on. • Everyone automatically gets info on a need to know basis.

Link •

I am a Pencil

I am a lead pencil —the ordinary wooden pencil familiar to all … who can read and write…I am seemingly so simple… Yet,

not a single person on the face of this earth knows how to make me.

Price Gouging

Polanyi: Great Transformation

• During 19 th century, self-regulating markets dominated society. In 20 th century, free market ran its course, ending in depression and war. • Market society was justified under the rubric of “Laissez faire” essentially “leave it alone” masking its true nature.

• As if self-regulating markets were a natural outcome i.e. what would happen without society.

• Ahistorical

Historical Economic Structure

• Traditionally, economy was

embedded

within social structure and fell into three basic forms.

1.

2.

3.

Autarky – Household production and Subsistence Centralized – Allocation by chief/lord/headman Gift Giving – Ritualized voluntary exchange of value. • Markets existed but were strictly limited by society, served as a tool of society.

Industrial Revolution: First Transformation

• Disruptions of 17 th Century, led to construction of philosophy and legal system necessary for market system. • Self regulating markets are necessarily part of a system of interacting markets allocating all of the commodities in the economy. • Inevitably, markets must include those for

false commodities

: 1) Money; 2) Labor; 3) Land.

False Commodities

• Labor and land are false commodities in that their production cannot respond to market signals.

• Labor and land are the essential elements of society itself. Subjecting them to self-regulating markets means disembedding economy from society.

• Inevitably society will push back against market dominance of society for self-protection.

Varieties of Capitalism,

• Orientation and the Firm • Four spheres in which firm interacts with society. 1.

2.

Financial Markets (corporate governance); Industrial Relations (regulating wages and working conditions); 3.

4.

Intrafirm relations (access to inputs and technology & institutional customers) Education and Training

Education & Training Corporate Governance

Internal Structure Of the Firm

Labor Relations Interfirm Relations

Two types

• LME – Liberal Market Economies • External relations are typically governed by arms-length, competitive markets • CME – Coordinated Market Economies • External relations often governed by modes of co-operation. • Institutions of co-operation have more specific nature.

USA Prototypical LME

1.

2.

3.

4.

Corporate Ownership – Management teams represent atomized shareholders; disciplined by buyouts.

Labor relations – Fluid labor relations, right to hire and fire; limited unions or firm level negotiations.

Training – Formal education, general skills. Inter-firm Relations – Anti-trust legislation, reputation based relationships. No technology transfer.

Germany Prototypical CME

1.

2.

3.

4.

Corporate Governance – Patient capital, large or institutional shareholders. Rules & institutions prohibit takeovers. Stakeholder governance. Labor relations – Work councils, national and industry level negotiations; employment protection. Training – Apprenticeship systems; job or firm specific skills. Inter-firm Relations – Research consortia; supplier relationship. Anti-trust legislation, reputation based relationships. No technology savings

External Relations and Internal Structure

• LME’s give rise to firms with strong hierarchies. Managerial decisions unencumbered by non-market factors. Market pressure requires focus on immediate profitability. • CME’s have consensus decision making with stakeholder relations in all directions impacting choices.

Institutional Complementarities

• Cooperative relationships in one area make cooperation in other areas more advantageous. • Ex. Workers with more job stability more likely to invest in specific skills.

• Ex. Systems of cross-holdings of securities creates a greater likelihood of long-lasting relationships with suppliers.

• Ex. Firms that co-operate with technology sharing more likely to form groups to train new workers .

• Ex. Consensus model of corporate governance more likely to lead to cooperative model of labor relations.

Labor and Product Markets 2008

3,5 3 2,5 NLD NOR GER ITA SWE FRA SPA DNK 2 BEL 1,5 UK IRE JPN AUS NZD 1 CAN 0,5 0 0,5 0,6 0,7 0,8 USA 0,9 1 1,1

Product Market Regulation

1,2 1,3 1,4 1,5

Labor and Capital Markets 2007-2008

3,5 3 2,5 2 1,5 1 0,5 0 0,5 NZD ITA GER IRE BEL NOR DNK FRA NLD SPA SWE JPN UK AUS CAN 20,5 40,5 60,5 80,5 100,5

Market Capitalization % of Incom

120,5 140,5 USA 160,5 180,5

Varieties and Comparative Advantage

• Many varieties may co-exist in symbiotic relationship. • Institutional structure may offer comparative advantage which can lead to specialization in particular goods.

• CME’s advantage in producing goods requiring long-term investment, continuous upgrading, specific skills.

• LME’s advantage in producing goods requiring radical innovation.

Examples from

Link • Varieties of Capitalism and Innovation: Patenting in LME concentrated in industries (pharma, infotech) typified by radical shifts, patents cite deep research; patenting in CME concentrated (auto, machine tools) typified by continuous improvement, patents cite previous patents. • Industry Standardization – German industry organization able to enforce specific detailed standards [A4 paradigmatic example]; UK standards focus on process principles.

• BA vs. Lufthansa. BA thrives during periods of radical market disruption. Lufthansa thrives at more stable periods.

Measuring Coordination

• Big Picture Measure • Objective Measures

Link

Bank Directed Economy vs. Financial Markets

Capital Markets

140 120 100 80 60 40 20 0 Germany USA Bank Loans/GDP Market capitalization of listed companies (% of GDP)

Capital Markets

150 100 50 0 300 250 200 Germany Deposit money bank assets to GDP USA Stock Market Turnover to GDP

Buyouts

2 1 0 7 4 3 6 5 Germany M&A transaction value to GDP USA

Regulation of Firm Production Activities

6 5 4 3 2 1 0 Germany USA State Control Product Markets (0-5) Cost of Starting a New Business (% of Income)

50 45 40 10 5 0 35 30 25 20 15

Regulated, Low Turnover Workforce

Labor Relations

Germany Weeks of severance pay for redundancy of experienced workers USA % of Work Force: 10 years tenure or More

Job Separation Rates

4,00% 3,50% 3,00% 2,50% 2,00% 1,50% 1,00% 0,50% 0,00% Germany US Japan

Job Finding Rates

30% 20% 10% 0% 70% 60% 50% 40% Germany US Japan

Labor Orientation

World Bank Jobs Database Notice period for redundancy dismissal (for a worker with 5 years of tenure, in salary weeks) Minimum wage for a 19-year old worker or an apprentice (US$/month) Paid annual leave for a worker with 5 years of tenure (in working days) Retraining or reassignment obligation before redundancy?

Weeks of severance pay for redundancy of experienced workers

Hong Kong Singapore Germany Spain

4.33

0.00

10.00

0.00

5.80

4.00

0.00

11.00

0.00

0.00

8.67

1145.47

24.00

1.00

43.33

2.14

1043.96 1242.58

22.00

0.00

52.00

USA

0.00

0.00

0.00

0.00

30 20 10 0 80 70 60 50 40

Dataset: Trade Union Density

http://stats.oecd.org/

80,00% 70,00% 60,00% 50,00% 40,00% 30,00% 20,00% 10,00% 0,00%

% Employees 5 Years Tenure or More

15 10 5 0 20 25

Technically Oriented Education

Technical Training

4 Germany USA Technical/vocational enrolment in secondary (ISCED 2 and 3) as % of total On-the-Job Training, Global Competitiveness Ranking (in World) 13

5 0 15 10 25 20 35 30 Social Welfare (% of GDP)

Criticism: All countries deregulating

Product Market Regulation

4.5

4 3.5

3 2.5

2 1.5

1 0.5

0 A ust ra lia A ust ria B el gi C um C ze an ch ad R a ep ub D lic en m ar Fi k nl an d Fr an G ce er m an G y re ece H un ga ry Ice la nd Ire la nd Ita ly Ja pa n K or ea M N exi et co he N rla ew nd Z s ea la nd N or w ay P ol an P d or tu ga l S pa in S w S ed w en itze U rla ni nd Tu te d rke Ki U y ng ni do te d m St at es

OECD Countries

1998 2003 2008

Nature of Japanese Competition, 2000

Porter, Michael E., and Mariko Sakakibara. 2004. "Competition in Japan " Journal of Economic Perspectives, 18(1): 27-50.

• Inter-firm Relations: • Large Japanese business groups, Horizontal Keiretsu, organized around small number of city banks, share financing, personnel, distribution networks. • • Vertical Keiretsu: LT relationship between industrial firms and family of suppliers. Gov’t encourages research consortia and sometimes cartels. Anti trust weak. • Corporate Governance: • System of cross-shareholdings within business groups make it difficult for equity investors to replace management. • Bank financing more important than bond financing.

Japan, cont.

• Labor Relations • Legally, socially difficult to fire long-term workers • Company unions play a role in corporate management • Training • Firm specific human capital • Seniority based compensation

Competitive Outcomes

• Low returns on capital • Firms emphasize market share, maintenance of employment • Intense domestic competition in some sectors especially those internationally successful ones. • Sectors with government sponsored cartels or planning, low competition, low success

Credibility Main Bank System Corporate Cross-Holding Anti-Takeover Legislation Banks support & Coordinate group Group cross-holding supports management Firm Specific On-the-Job Training Keiretsu, Limited Anti-trust Research Consortia Incentives to Specialized Workers acquire training Lifetime Employment Firm level unions Talent sharing Knowledge Sharing through consortia & councils Japanese Variety of Capitalism

Can Japan Compete?

Link • Japanese companies dominated a number of advanced industries from the 1980’s and experienced high growth up to that period with slower subsequent growth.

• Japan: Known for industrial policy activism through Ministry for Industry, Trade and Investment. MITI approach was to • • encourage cooperation by companies in key industries. allow cartels and even encourage formation. • Limit foreign trade & investment

Japanese GDP per capita (constant Yen) Growth Rate

15.00% 10.00% 5.00% 0.00% 19 61 19 63 19 65 19 67 19 69 19 71 19 73 19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 20 09 -5.00% -10.00%

120,000 100,000 80,000 60,000 40,000 20,000 0,000

Share Ownership Tokyo Stock Exchange

Individuals Foreigners Cross-Ownership Other FI Banks Govt

http://www.mhlw.go.jp/english/policy/affairs/dl/04.pdf

Link

Changing Structure of Economy

• Lifetime employment still exists but many firms reluctant to hire long-term employees.

• Declining cross-ownership, limited corporate take-over.

• Decline in Keiretsu system. Increased anti-trust, decline in main bank system has diminished horizontal Keiretsu

Employment to population ratio, 15+, total (%) (modeled ILO estimate) 66 64 62 60 58 56 54 52 50 2000 [YR2000] 2001 [YR2001] 2002 [YR2002] 2003 [YR2003] 2004 [YR2004] Germany 2005 [YR2005] 2006 [YR2006] United States 2007 [YR2007] Japan 2008 [YR2008] Denmark 2009 [YR2009] 2010 [YR2010] 2011 [YR2011] 2012 [YR2012]