The post was written by Simon Commander, Visiting Professor of Economics at IE Business School and Managing Partner of Altura Partners, and Saul Estrin, Emeritus Professor of Managerial Economics and Strategy at the London School of Economics and Political Science.
The mutually beneficial ties between Asia’s business dynasties and its political elites have been important drivers of Asia’s remarkable renaissance. But as we argue in our new book ‘The Connections World: The Future of Asian Capitalism’, just published by Cambridge University Press, those close ties now threaten the continent’s future economic growth.
This is because the ubiquitous Asian corporate structures of Business Groups systematically cooperate with politicians in Asia to create excessive monopoly power and market concentration.
Dynastic business groups have proven incredibly adept at digging in. However, by concentrating resources in a relatively small number of hands, they have limited competition and stalled innovation, which will threaten future progress.
Pervasive and highly resilient networks of ties between business and politicians provided a common backbone for Asian development and cut across political systems.
The ‘world of connections’ in the title of our book is a world made up of a network of interactions between businesses and politicians or political parties. All these interactions are highly transactional and usually contain significant degrees of reciprocity. Politicians, for example, ask companies to make campaign or personal contributions; pay a bribe; provide work for your family or colleagues and create jobs in politically favorable moments. In return, companies ask politicians for protection from foreign or domestic competition; to provide subsidies, loans and/or contracts with the public sector. All parties benefit from these interactions, creating a stable political-economic balance.
A far less stable foundation for future growth
Connections World has served Asia well over the past half century – the continent’s share of the world economy has grown from 9% in the 1970s to almost 40% in 2021. However, it will provide less of a supportive foundation for growth in the future when innovation will have to be the main driver. . This Connections World means that neither politicians nor business groups have enough interest in encouraging competition and innovation, either through the entry of domestic or foreign multinationals as competitors.
Asian business groups are also often highly diversified, with oligarch or dynasty control reinforced by cross-holdings and ownership pyramids. To understand how significant they are, it is best to look at overall concentration levels. Our analysis shows that while in the US the revenues of the five largest companies do not amount to more than 3% of the country’s GDP, in China and India they account for 11%. High levels of concentration are common throughout Asia. The findings are even starker when we calculate the revenues of the 10 largest companies. In the USA it is only about 4%, but in South Korea it exceeds 40%, and in India and China it exceeds 15%.
As access to cheap labor and capital becomes increasingly problematic, future economic growth across Asia will need to increasingly rely on innovation. In other parts of the world, innovation thrives in an open ecosystem where there is a willingness to risk and lose.
In Asia, Connections World is pushing out new entrants, absorbing capital, skilled workers and managers. Furthermore, it undermines the competitive environment that is so essential to the trial-and-error process that is at the heart of many successful innovations. Even when business groups themselves are innovative, relatively little innovation occurs in the wider economy.
The need for urgent reforms
What policies and other measures should be required that could address the shortcomings of Connections World?
Central to the political agenda to loosen the grip of entrenched business groups will have to be measures to transform them into more transparent and better-governed businesses, with a radical weakening of the ties between politicians and businesses.
This will not happen naturally because the mutual benefit of market consolidation and political connections outweighs any gains for the current players from the reform. The necessary policies will have to include changes in corporate governance that undermine pyramidal ownership structures, mergers and cross-holdings. There will need to be additional tax obligations imposed on established business groups, as well as the adoption of an inheritance tax and a transition to new types – and objectives – of competition policy.
Some of these policies were successfully introduced in the US under Roosevelt. More recently, Israel has adopted competition policy criteria for overall as well as market-specific levels of concentration, while South Korea has used high inheritance taxes to weaken the grip of its giant business groups. It is also necessary to adopt measures aimed at limiting the scope of discretion and incentives for politicians to use their connections for personal or family benefit. Although difficult to achieve, incremental improvements, such as revised interest registries, can begin to influence behavior.
Many commentators declared the 21stSt century to be Asian. It is far from predetermined. Unless the kinds of policies we suggest are put in place to reduce the tentacles of the Connections World, many Asian economies will find themselves at a disadvantage in realizing their potential in the coming decades.