Tag Archives: varieties of capitalism

Economies Dependent on Outside Investment

26 Wednesday Oct 2022

Posted by in Economics, Finance, Politics, Politics for Worldbuilders, State Formation

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One of the most trafficked posts on this blog is a brief discussion of “Varieties of Capitalism” theory, pointing out how some capitalist economies feature a set of institutions that foster a more dynamic economy and radical innovation, and others have institutions that foster a more sedate, “managed” economy featuring more incremental innovation. (As far as I can surmise from web traffic stats, some comparative-politics professor at San Francisco State University must have noticed the post and included it in a course syllabus. I’m flattered!)

But in the years since I left grad school, the field has marched on. Apparently, scholars have identified at least one other “variety” of capitalism that fills in a bunch of empirical gaps of prior theory. This is the dependent market economy (DME), whose distinguishing feature is that it relies heavily on the foreign investment of outsiders for capital—typically transnational corporations. In this post, I’ll briefly discuss the key features of the DME that would be useful for worldbuilders.

The first economies to be designated as DMEs were found in Eastern and Central Europe, countries that had formerly been dominated by the Soviet Union. They featured an unusual combination of factors: a populace that was reasonably well educated and technically skilled, yet still had low wages, and where the countries’ economic institutions had been totally wiped away and could be built afresh according to the preferences of anyone with enough clout. These were the transnational corporations, who are always on the lookout for skilled, cheap labor. They used the lure of their massive investment to induce the former Warsaw Pact countries to establish institutions that were favorable to company interests—and turned these countries into favored sites for the assembly of “semistandardized industrial goods.”

What are the features of the DME, and the institutions that develop there?

  • A population that had reasonable technical skill—but not too much, or they could develop their own indigenous industries and not be dependent on outside investment.
  • Low wages.
  • A massively disproportionate level of foreign direct investment that dominates the economy, usually because of the lack of domestic capital. (For example, in 2007 Hungary and the Czech Republic both had FDI equal roughly half of their entire gross domestic product.)
  • Governance that is largely controlled by transnational corporate hierarchies, so local company subsidiaries take orders from the parent companies back home. (They also receive funding from back home, rather than relying on local banks or the stock market.)
  • Weak labor laws and no national labor unions.
  • On the other hand, individual companies typically treat their workers well in relative terms, because they don’t want their supply chains disrupted; so management and labor tend to work closely together, company by company. (But companies try to avoid simply paying higher wages, which defeats the point of the exercise!)
  • Little investment in worker training or a public education system, and the education system’s reorientation to the specific skill needs of the transnational companies, because companies don’t want to spend a lot of money or make it easy for their workers to leave, and because the DME is not meant to develop new technology—only to implement the technologies developed elsewhere.
  • Sectors of the economy where the country has a clear comparative advantage, such as the assembly of automobiles or electronics, are dominated by foreign ownership. The same is often true of the banking system, which needs a lot of capital. Meanwhile, less competitive segments of the economy remain in domestic hands, but languish. If left unchecked, this division could lead to tensions between wealthier and poorer worker groups in society.

We thus have another model for what an economy could look like, and why it would look that way. True, few worldbuilders will be working with a direct analogue to something like the collapse of the Iron Curtain; but if you’re thoughtful, you can extract useful principles from the foregoing for use in your work.

There are additional types of economies—chiefly the typical “dependency” economy (or supply region) that is exploited for basic commodities; the “patrimonialist” society with high corruption, patron-client networks, informal arrangements, and pervasive insecurity; and the incoherent mishmash that borrows features from several other economies which don’t necessarily work well in combination. I hope to explore some of these more in later writing.

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(This post is part of Politics for Worldbuilders, an occasional series. Many of the previous posts in this series eventually became grist for my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders. The topic of this post belongs in the planned second book in this series, working title Wealth for Worldbuilders. No idea when it will be finished, but it should be fun!)

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Concerning Cooperatives

25 Sunday Nov 2012

Posted by in Economics, Politics

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Thinking about how to make an economic system that is more humane, and less riven by class struggles, many social reformers have advocated for workers’ cooperatives (the Distributists being one example). Cooperatives differ from the traditional capitalist firm in that workers share ownership and management of the company, as opposed to being salaried employees with no participation in the profits besides what management feels like giving them. They differ from a socialist commune in that there is still private property, and individuals can benefit directly from the success of the firm, which tends to mitigate the typical Socialist tendency of “They pretend to pay us, and we pretend to work” and lead to more creativity and enterprise.

With these advantages, why hasn’t the cooperative become more popular in the United States? In part, because cooperatives come with some drawbacks. First, if workers share ownership in the company, what happens when you hire new people? Does that mean that you’ve just diluted the ownership of the existing employees? If so, then there will be a tendency of the owner-employees to delay hiring more people, even if it means sacrificing business opportunities. Or do different classes of employees have different shares of ownership? If so, then the cooperative differs from a typical capitalist firm only by degrees.

How much of the ownership of the firm accrues to the investors, as opposed to the employees? After all, without the initial investment, there would likely be no business in the first place. And asking employees themselves to buy in, as some cooperatives do, places a high bar in front of poor job-seekers.

Additionally, there will always be a place in a large-sized firm for experts of some kind, who will be paid more for their expertise. Should such experts, be they management or whoever, also get a disproportionate share of the company?

All of these questions have answers, and the answers will vary depending on the particular needs of each cooperative. But even if you could come up with an ideal structure for your own situation, it is far from clear that existing law could support the ownership structure you want. To my knowledge, in the United States the most common means for employee ownership of their company is the ESOP, or Employer Stock Option Plan, and these are typically structured so that employees have partial ownership without true control. While American law has well-understood prototypes for traditional capitalist firms, like the C-Corporation or the S-Corp, there are few prototypes for worker-owned cooperatives.

If such prototypes existed, then new insights could be gained as people experimented with them and figured out what works and what does not in different contexts. And cooperatives could become more accepted in modern industrial economies—which is not to say that they would displace the typical capitalist firm entirely, or even mostly. Each firm structure solves different problems. The best structure depends on your own situation, and the imperatives of your industry. Still, more options are good.

One handicap of your typical utopian social reformers is that they tend to focus on parapolitics, action outside the system, rather than trying to work within the system. True, such parapolitics often has an effect, but you only get mass adoption of your ideas in the face of total collapse of the system you are opposing. In this case, those who seek to have the cooperative form catch on in society ought to be lobbying for its inclusion in the tax code, the same way that a C-Corp or S-Corp is. With an off-the-shelf model to work with, with well-understood procedures for sharing ownership and profits, more entrepreneurs may elect the cooperative model without any political or social goal at all—which is how you win.

Coordinated versus Liberal Market Economies

11 Monday Jun 2012

Posted by in Credit, Economics, Finance

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[Welcome! If you enjoy worldbuilding, check out my handbook for authors and game designers, Beyond Kings and Princesses: Governments for Worldbuilders.]

Capitalist economies (not the same thing as free-market economies, necessarily) depend on those with money providing capital to firms that need it. For most of human history, most actual investment was done by a small number of people, those with the skills and inclination to form relationships with businesses. Vast amounts of money was economically sterile, being hoarded as gold or silver treasures in the vault of some nobleman or other (just as today one might stuff hundred-dollar bills into a mattress). For the economy to grow and develop, somehow a mechanism needed to be set up to allow savings to be automatically channeled into investment.

This mechanism was the banks. When you deposit money in a bank account, the bank then turns around and lends it to someone who wishes to borrow. The bank serves as an intermediary between you, the saver who wants nothing more than a safe place to store your money (with maybe a little interest on top), and the borrower. Thus, savings that were previously useless to the economy are now being recirculated. (This can lead to systemic fragilities, of course, but those must wait for another post.)

Most bank-dominated systems work in a style called relationship banking. A company forms a long-term exclusive relationship with a bank, that will provide access to capital in exchange for a large degree of control over the company’s decisions—the bank wants to make sure that the company isn’t going to waste the money, after all. This sort of system relies on personal relationships and insider knowledge more than on things like a credit score, which only came into common use in the 1980s or so.

Some economies, such as those in much of Europe, take this logic even further and structure their entire economy around such long-term relationships between firms. Business contracts, decisions on who to hire and how to train them, and access to capital are all made through a close-knit network of powerful executives; insider knowledge and relationships are the key factors here. This is called a coordinated market economy, and you can read a fuller description of it in Hall and Soskice’s Varieties of Capitalism. (Amazon link here.)

Coordinated market economies have some advantages over the American/British system of comparatively liberal market economies. The system in general is more stable; you don’t get the day-to-day disruptions common in the US economy, for example, because everything is based on long-term relationships. In particular, new upstarts find it very difficult to break into such a system, because they can’t get access to capital and they can’t win contracts from existing businesses. While this may seem bad to the American ear, it has the advantage that firms in such an economy can specialize in extremely narrow niches of production, leading to incremental innovation. This is why German companies are known for their precision manufacturing, for example: because they have the luxury of intense specialization in their particular areas.

On the other hand, because it is so difficult for new firms to compete, a continuing hazard of such economies is that the whole system begins to stagnate. Disruptive innovations find it hard to survive in such systems, and instead gravitate to the more open liberal market economies like the United States.

In a liberal market economy, access to capital for big firms is usually gained via the public markets: the stock market and bond market. This means that the long-term relationships typical of Continental economies are less important here. Instead, decisions about who to invest in are driven by the release of public data, for example in annual reports or tax filings. Using such data, market participants decide who to channel their capital to.

There are drawbacks to this system. Particularly in the last thirty years, company executives can be driven to chase quarterly targets at the expense of long-term viability. The business environment is volatile and always changing, making it extremely difficult to plot long-term strategy and to pursue incremental improvement.

On the other hand, this system is much more hospitable to disruptive innovation, as we can see just in the last decade or two. While it can be gut-wrenching while you’re in the middle of it, overall it leads to a more dynamic and healthy economic system over time; stagnation is less of a threat here.

The main difference between these two systems is in the ability to get investment capital without sucking up to a bank. From that relatively minor difference, massive differences in total economic structure can develop. (More details in the Hall/Soskice link.)

Again, institutions matter. And seemingly small differences in institutions can lead to major differences in outcomes.