East Asian Capitalism : Diversity and Dynamism [1 ed.] 9781442674226, 9780802080585

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Hongkong Bank of Canada Papers on Asia Editor A.E. Safarian University of Toronto Managing Editor Wendy Dobson University of Toronto

Editorial Advisory Board David Bond, Hongkong Bank of Canada, Vancouver Edward K.Y. Chen, Lingnan College, Hong Kong Chia Siow Yue, Institute of Southeast Asian Studies, Singapore Farid Harianto, PEFINDO Credit Rating Indonesia Ltd., Jakarta Ralph W. Huenemann, University of Victoria Lawrence B. Krause, University of California, San Diego Karen Minden, Asia Pacific Foundation of Canada, Winnipeg Eleanor Westney, Massachusetts Institute of Technology, Cambridge, Mass. Ippei Yamazawa, Hitotsubashi University, Tokyo Soo Gil Young, The Korea Transport Institute, Seoul

Centre for International Business University of Toronto

Hongkong Bank of Canada

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Hongkong Bank of Canada Papers on Asia, Volume 2

East Asian capitalism: Diversity and dynamism

A.E. Safarian and Wendy Dobson, Editors

UNIVERSITY OF TORONTO PRESS Toronto Buffalo London

ISBN: 0-8020-4201-5 (cloth) 0-8020-8058-8 (paper) www.utppublishing.com © Centre for International Business Faculty of Management University of Toronto Joseph L. Rotman Centre for Management 105' St. George Street, Toronto, Ontario M5S 3E6 Printed and bound in Canada

Canadian Cataloguing in Publication Data Main entry under title: East Asian capitalism (Hongkong Bank of Canada papers on Asia ; v. 2) ISBN 0-8020-4201-5 (bound) ISBN 0-8020-8058-8 (pbk.) 1. Capitalism - East Asia. 2. Industrial organization East Asia. I. Safarian, A.E., 1924- II. Dobson, Wendy. III. University of Toronto. Centre for International Business. IV. Series.

HD70.E37E27 1996 338.095 C96-931897-9

Preface As the pace of technological change increases and new competitors appear, global competition is intensifying in key industries. East Asia is playing two important roles in this transformation of global competition. First, East Asia's rapidly growing economies offer many business opportunities, despite their distance from, and lack of similarity to traditional markets in Europe and North America. Second, many successful new international competitors have their origins in East Asia, and practice what some call "different forms of capitalism." These competitors include the Japanese keiretsu, the Korean chaebol and the ethnic Chinese family networks. These new competitors are actually diverse business systems. This volume discusses how they are organized, why they are organized that way, and how they are changing—information that will be useful to companies trying to enter East Asian markets, or competing with these business systems in other markets. Five internationally-recognized authors explain the origins and prospects of the Japanese keiretsu, the Korean chaebol, business groups and family networks in Southeast Asia and Taiwan, and the evolving industrial structure of China's socialist market economy. This collection of papers makes it clear that it is important to understand the remarkable diversity of these systems, across as well as within economies. And, in order to cooperate or compete with them, it is also important to understand their origins and the dynamics of what might cause them to change. The authors come from a variety of disciplines, including comparative sociology, political economy, management and economics. In organizing these contributions, we have intentionally i

focused on providing the basis for understanding. Other authors in a future volume in this series will present case studies of both successful and unsuccessful business ventures that have involved these business systems as partners and competitors. This is the second volume of the Hongkong Bank of Canada Papers on Asia. The first volume, Benchmarking the Canadian Business Presence in East Asia, established how Canadian business is doing—and is perceived to be doing—in the rapidly-growing economies in the region. It identified a paradox: despite the booming economies and opportunities in East Asia, Canada's economic presence in the region has been small and declining. It also pointed to four factors that companies conducting business in the region need to understand: the evolving global strategies of Japanese multinationals, the strategies of other East Asian firms and governments, the linkages between trade and investment, and the different business systems and how they work. The Hongkong Bank of Canada Papers on Asia has been created to provide information about East Asia to business and government decision makers. The series publishes timely and readable scholarly work in the fields of business and the social sciences, aimed primarily at the Canadian business community, to help increase their knowledge of and familiarity with East Asia's distant markets. The Papers are intended to become an authoritative source of research, in Canada and beyond, on the rapidly-evolving Asian economies. The Hongkong Bank of Canada has provided generous support for this project. Professor A.E. Safarian is the series Editor; he leads a distinguished international Editorial Advisory Board which provides peer review and editorial advice. To stimulate high-quality research, the editors seek out top researchers and encourage them to write on subjects central to the Papers' mission. Manuscripts are commissioned and symposium and conference contributions solicited. In addition, events are organized by the Centre for International Business to ensure timely dissemination to interested audiences. In effect, the Papers are a catalyst in the development of a cadre of scholars. The University of Toronto Press cooperates in this project through its Scholarly Publishing Division. Support is also provided by Heather Munroe-Blum, Vice-President, Research and International Relations and Hugh Arnold, Dean, Faculty of Management at the University ii

of Toronto. This volume was prepared with the assistance of staff of the Centre for International Business, including Birgitta Weitz, Maila Doloroso and Vivien Choy. Catherine Gordon provided expert editorial assistance. Wendy Dobson September 1996

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Contents

Preface

i

The diversity and dynamism of capitalism in East Asia A.E. Safarian and Wendy Dobson Societies, firms and relationships What this book is about Changing relationships among business systems Implications for Canadian business

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The organization of capitalism in South Korea and Taiwan Gary G. Hamilton The misrepresentation of Asian economies Organizational differences among Asian economies South Korea and Taiwan Divergent paths of development Doing business in Asia The paradox of China's industrial reform Gary H. Jefferson and Thomas G. Rawski China's industrial classifications The challenge of China's reform Institutional features of China's industrial economy The process of Chinese economic reform How the different enterprises contribute to industrial refor What reform means to foreign firms in China

3 9 13 14 19 20 21 22 35 39 45 46 49 60 64 70 80

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Southeast Asian business systems: The dynamics of diversity .91 Linda Lim The economic environment 92 The political environment 94 The cultural environment 96 Regional business actors 97 A Southeast Asian business system? 108 Continuing evolution 110 Hidden linkages in Japanese business Richard W. Wright How keiretsu began Characteristics of horizontal keiretsu Integrative mechanisms What this means to foreigners Pressures for change Conclusions

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About the authors

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Centre for International Business

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120 121 126 129 134 137

The diversity and dynamism of capitalism in East Asia A.E. Safarian and Wendy Dobson Until recently, East Asia's forms of business organization were often seen merely as responses to underdeveloped markets. Yet, as East Asian competitors, led by the Japanese, have become formidable global competitors, and as Asian markets have grown in size and dynamism, we have started to take these business organizations—which some say practice "different forms of capitalism"— much more seriously. The first volume of the Hongkong Bank of Canada Papers on Asia explained Canada's relatively modest business presence in East Asia, and outlined the importance of the high and variable costs of entering these dynamic markets. This second volume focuses on the various business systems in the region, since understanding them may help companies reduce entry costs and better appreciate them as global competitors. The meaning and significance of business systems By "business systems" we mean the ways in which firms are organized to carry out production and exchange, both within firms as well as among firms. These systems affect the way in which a country conducts its international commerce, as do other variables such as geographic location, political stability and the regulatory framework. It is important to understand East Asia's business systems in two ways. First, they are different from those we are accustomed to dealing with, and it is important to understand these differences in order to operate successfully in Asia. Second, they may help explain why some 1

countries in the region are growing faster than others, which may provide lessons for our own society. Understanding how business organizations in Asia are different from those in Canada, the United States and Europe is more complicated than it may first appear, because, even though they have many similar characteristics, Asian business systems are strikingly diverse. There are several major differences between business systems in East Asia and those in most industrial countries. Most Asian countries emphasize cooperative business relationships, based most often on family and other informal ties but extending also to cooperation with the state, in ways going well beyond what one observes in many industrial countries. These relationships show up in ownership linkages and in the networks for finance, production and marketing. What comes through even more strongly in this study, however, is the diversity of business systems in East Asia. When we look more closely at the coordination systems involved, the differences stand out sharply. In China, the central and regional governments play a critical role. In the market economies of Korea, Japan and Southeast Asia, interaction between families and the state heavily influences production and exchange. In Taiwan and Hong Kong, relationship-based influences, notably within the family, are key. Within each system, other business organizations such as multinational firms play roles of varying importance. Asian businesses and governments expect people from elsewhere to understand their particular norms. Studying Asia's business systems may also help explain why some of the region's countries grow faster than others. Growth results ultimately from the accumulation of labour and capital which is increasing in quality through skills development and technical change. But skills and technology don't develop without effective incentives. And the creation of effective incentives, in turn, reflects the success of the society's institutions. Studying these business systems may therefore highlight some successes and failures in our own society, although it is always difficult to determine whether organizational changes that work elsewhere will be appropriate at home. Business systems that are successful in some respects can involve costs in others. To throw some light on the origins of these differences and on their implications, we have brought together researchers from four 2

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different disciplines. Professor Gary Hamilton, a comparative sociologist, contrasts the small number of large centrally-directed chaebol in Korea with the many small and medium-sized firms operating in loosely-knit networks in Taiwan. Professor Linda Lim, a political economist, analyses the dominance of family-owned conglomerates in Southeast Asia, which collaborate closely with governments as well as with multinational firms. Professor Richard Wright, a management scholar, notes the advantages the horizontal keiretsu offer Japanese firms competing internationally. Professors Gary Jefferson and Thomas Rawski bring an economics perspective to how some relatively modest reforms in China have led to a much smaller (but also more market-oriented) role for the large state-owned firms, while smaller township and village enterprises have grown rapidly in importance. Each of the authors is careful to note how these and other business forms reflect the complex social settings in which they operate. Before examining their findings in detail, it is useful to consider more fully the different types of business systems and their interaction with other social institutions.

Societies, firms and relationships Business systems are grounded in their home societies, although they may be influenced over time by forms of organization developed elsewhere. Many aspects of a society can affect both the nature and success of any particular business system. We noted earlier some situational aspects, such as geography, which can be critical. There are also three economic aspects of a society that determine the nature and success of its business system: how power is exercised by the state, the conventions or norms of economic behaviour (which can supplement the law and can also be more effective than it), and how these formal and informal constraints are enforced (North, 1994; Matthews, 1986). Each of these aspects influence how relations inside and outside the firm are conducted. The diversity and dynamism of capitalism in East Asia

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How power is exercised by the state There is little question that the state has had an impact on the nature of East Asia's business systems. The economic policies of the rapidlygrowing East Asian economies have differed mostly in the degree of state intervention and timing. All of the East Asian countries have pursued macroeconomic policies conducive to growth. Their economies are characterized by high savings rates and a firm belief in education. Their trade and investment policies have tended to be relatively open, emphasizing exports and a willingness to import foreign technology (though not necessarily through direct investment), and avoiding import substitution (World Bank, 1993). Cooperation between business and government, while it varies by country, has often been central to how particular business forms operate. This cooperation has been especially close in Korea and Japan. The ethnic Chinese, migrants and traders in their host Southeast Asia countries, provide a particular example of cooperating closely with local governments, partly to help assure the security of their businesses. The role of the military has also been an important influence on the nature and organization of business activity in many countries, and is probably understated in these studies. The conventions of economic behaviour For the sake of clarity this analysis concentrates on relations within and among firms and with the state. Much of what is said here about both law and social norms, however, obviously also applies to individuals and non-profit organizations. Firms are organizations that must coordinate a set of internal and external functions efficiently and profitably at a given time, and be able to learn and exploit new challenges over time. These capabilities are central to their success (Chandler, 1992). It is frequently argued that the coordination functions are culturally influenced. In particular, business systems are said to differ in two senses: first, in the degree to which all kinds of contracts are explicit or implicit; and second, in the degree to which enforcement and cooperative behaviour of different kinds is monitored or is based on trust. These differences may extend to relations with the state as well as to relations within and among firms. 4

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We most often assume a contrast between Anglo-American cultural tradition and the Asian "model," which at its extreme is said to exist in Japan (Rohlen, 1989). In the former, individualism is considered to be more highly valued, society more contractualist, enforcement of law and policy more explicit, and social balance and consensus less likely to be overriding concerns. This distinction, however, may be exaggerated. Some European countries resemble the Asian "model" in some respects, and, in other respects, some Asian countries are close to the Anglo-American model. Nevertheless, we can gain insight into the economics of business systems by pursuing these distinctions further. The central issue of intra-organizational relations is the degree of commitment which individuals have to the firm, in terms of accepting its goals, working hard for it and wanting to stay in it. Redding et al (1994) have analysed this concept, concentrating mainly on East Asian systems and drawing from literature from a variety of social sciences. A similar summary of economic approaches to organizations can be found in Journal of Economic Perspectives (1991), and particularly Simon (1991). Relationships within an organization depend in part on the degree of such commitment. For example, individual commitment affects the extent to which hierarchy is recognized, the degree of dependence and trust among different groups of workers and in relation to employers, expectations of reciprocity and mutual obligations of workers and management, and the ease with which collective efforts are undertaken. There is no suggestion, of course, that individual commitment to the firm is the same in all of the rapidly-developing East Asian countries. The primary loyalties of workers in ethnic Chinese firms are likely to be to their own families, while in the larger Japanese firms at least, there is likely to be more of a focus on the organization, even for non-managerial employees (Redding et al, 1994: 668-9, 677). The suggestion, rather, is that the degree of commitment to the firm is stronger in Japan, China, South Korea and the ethnic Chinese communities of East Asia, and that this commitment is an element in the economic performance of these societies. Cooperative relationships among organizations cannot depend to the same degree on individual commitment. Cooperative or The diversity and dynamism of capitalism in East Asia

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interorganizational activity has long prevailed in certain sectors of business for various reasons, such as spreading risk in certain types of environments or activities, reducing competitive uncertainty, securing access to complementary resources not easily secured otherwise (such as knowhow), and reducing costly monitoring activities. Some evidence suggests that cooperative forms of activity have increased very rapidly in recent decades, in part because of shorter product cycles and more rapid technological change. One response is to downsize and to rely more on securing specialized products and services from outside the firm—in other words, to rely more on markets. Another response is to develop more collaborative arrangements with other firms.1 It has long been recognized that these three forms of economic activity—markets, firms and cooperative methods—differ in a variety of ways, for example in their means of communication, methods of conflict resolution, and the amount of commitment between the parties (Powell, 1990: 300). All three forms and many of their variants exist in any society. Intercorporate linkages of production and distribution, which are a focus in this volume, are a feature of any modern or modernizing economy. Some studies of interfirm linkages have found that formal links are found mostly in and between industrialized countries, although it is not clear how the sources used, or forms studied have affected the outcomes (Safarian, 1996). It is the coordination systems which differ, depending on the role of the state, on individual rights as expressed in law, and on a variety of non-state values and relationships. In East Asia, interfirm linkages—not just those within the firm— may require less formal contract or external monitoring than those in the other industrialized or industrializing countries. This can be inferred, for example, from the overlapping of firms in Japanese keiretsu, and their informal contracting with smaller firms. The greater outsourcing in Japanese automobile firms has been ascribed in part to the greater ease of transacting with subcontractors. The rapid interac-

1

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See Powell (1990) for a discussion of network forms of organization contrasted with market and hierarchical forms. Oliver (1990), Auster (1994) and Ring (1994) spell out the different theoretical approaches and determinants for specific forms.

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tion between the smaller family-owned firms in Taiwan and elsewhere is another example. Yet even in East Asia there is a considerable diversity of business systems partly because of differences in forms of coordination. Some are determined by the central or local state, as in China, or are heavily influenced by the interaction between families and the state, as in the more market-oriented economies of Korea, Japan and Southeast Asia. In Taiwan and Hong Kong the relationbased influences, particularly among families, are the key to coordination, even allowing for the role of the state and larger firms in Taiwan. It is also claimed, however, that many costs of coordination are lower in these societies. In particular, costs of business transactions with unrelated parties (as well as those within the firm) are said to be lower because concerns for reputation and mutual obligation are higher. This makes it easier to share resources in the firm or to collaborate between firms in the pursuit of shared objectives. To put it strongly, trust in all its forms is said to depend on culture. Trust either reduces costs of transacting business or, if it raises them, leads to benefits that are more difficult to secure from formal mechanisms, such as more reliable partners. The performance of an economy depends in part on reducing transaction costs and on building more reliable relationships. Conglomerates, after all, exist in most countries—what matters is how they operate. This view of the influence of culture is not uncommon in the social science literature, although there are important exceptions.2 It is not difficult to find another view, however. Informal and continuing interfirm collaboration has been observed in a number of regional contexts elsewhere—for example, in north-central Italy, the Silicon Valley in California, and sectors of the Swedish industry (Powell, 1990). If culture determines how close working relations develop within and between firms, it must be noted that the cultures studied here differ in critical respects. In addition, historical periods of conflict have sometimes played a role, an explanation which is not consistent with one based on cultural differences. Boyer (1992) has noted that bitter conflict between management and workers, along with differences in 2

With some exceptions, such as Casson (1991), economists are far less likely to emphasize cultural influences.

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the power of the two groups, both preceded and played a role in the trust relationships which have developed in such countries as Japan and Germany. Professor Lim emphasizes in this volume that the relationships she studies may reflect fragmented markets for inputs and production, which will change as economic development proceeds. Attempts to establish an empirical relationship between societies with Confucian values and low emphasis on individualism on the one hand, and high economic growth on the other, have been challenged, not least because Confucian dynamism and individualism appear to be highly correlated statistically.3 While one might accept that business systems reflecting a particular social context have an impact on economic performance, they may not have a greater impact than other well-documented variables. For example, the importance of appropriate macroeconomic policies is a matter which is hardly culturally unique.4 We cannot, then, be certain to what extent the differences in business systems affect macroeconomic performance, but we can underline two points. First, business systems are diverse at a microeconomic level. The huge and powerful Korean chaebol are a far cry from the typically small and adaptable Taiwanese firms. Second, there is also diversity within each country (though perhaps less in Korea than elsewhere). Large business groups exist in Taiwan although they do not dominate, there is a very large set of businesses outside Japan's widely-publicized keiretsu, the large state-owned enterprises and the local collectives are both important features in China, and so on.

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3

See the criticism by Yeh and Lawrence (1995) of the well-known study by Hofstede and his associates. In Hofstede's studies, culture was defined along four dimensions: power distance (the degree to which the unequal distribution of power in organizations is accepted); degree of tolerance of uncertainty; importance of individualism (as against collectivism); and the extent to which assertiveness, material acquisition and concern for others prevails.

4

There is a certain amount of circular reasoning here since one can argue that appropriate macroeconomic policies are more likely to be implemented where trust relationships are high. This would not explain why relatively low-trust countries have had such policies in some periods and relatively high trust ones have failed to realize them in others.

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What this book is about

The papers in this volume analyze the main business systems in East Asia—the Korean chaebol, Japanese keiretsu and Chinese business systems. The following is summary of these businesses systems and some implications of their similarities and differences. Business groups in South Korea and Taiwan Professor Gary Hamilton compares the Korean chaebol with Taiwan's business groups. Business groups in the two economies are organized very differently despite similar economic, political and cultural backgrounds. In each country, these groups are stable networks of legally independent firms, in which ownership is shared and entities that carry out the main economic tasks of production, distribution and finance are linked. Korea's large chaebol are family-owned, centrally-controlled, vertically-integrated and active in most industrial sectors. Because of their size, they are the country's main coordinators of production, distribution and capital. Able to achieve economies of scale and scope, they create demand for smaller producers' inputs and promote consumer demand for their final products. In Taiwan, while large business groups exist, they are not vertically-integrated, nor do they organize the economy. They supply intermediate goods and services to networks of small and medium-sized firms (SMEs) which respond in turn to consumers in export markets. As Hamilton documents, these loosely-organized networks of firms may be family-owned or limited partnerships consisting of more distant family members or friends. Their transactions are sometimes arms-length and sometimes based on social relationships and trust, whichever provides more flexibility and speed. Relationships between the large and small firms are segmented so that the large firms do not control downstream production of final goods. Hamilton describes this form of organization of production as "horizontally diversified." The marked differences between the business systems of Korea and Taiwan originate in differences in social structure, particularly the historical transmission and control of family property. The governments reinforced these differences in their development planning. Korea has a lineage or clan-based social structure which allowed for the The diversity and dynamism of capitalism in East Asia

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accumulation of property by "great families" whose power and control were exploited by the Korean government in its post-war industrialization drive in imitation of Japan's traditional zaibatsu family-owned business groups. Taiwan's system, in contrast, was based on partible inheritance, in which land traditionally was split equally among sons, resulting in small landholdings. The Kuomintang government nurtured these practices in its drive to industrialize, which stimulated the creation of the SME networks. Southeast Asian business systems Professor Lim, in her study of Southeast Asia, points out how the main business systems, consisting of ethnic Chinese and indigenous businesses, are rather similar, despite the heterogeneity of the economies in the sub-region. Both are family-owned conglomerates which, similar to those in Korea, China and Taiwan, have tended to be dependent on, and instruments of, governments pursuing rapid industrialization. In both groups, families are the agents of coordination and enterprises have grown into conglomerates, partly because of relationships with governments and partly because of the sub-region's rapid growth, which has thrown off multiple entrepreneurial opportunities, including joint ventures with foreign multinationals. Lim stresses the importance of relationships as core competitive assets which have been leveraged by these firms to create new businesses. She concludes, however that reliance on relationships is a function of the level of economic development. Business groups, she contends, are a rational response to fragmented markets for inputs and production associated with the early stages of economic development. Firms have reduced risks and transaction costs by "internalizing" transactions within a group of firms linked by family ties, friendship and trust. One implication is that such arrangements might wither away with economic maturity. Lim notes, however, that the main features of the traditional system—close business-government cooperation, dynamic partnerships with multinationals, conglomerate forms of enterprise and entrepreneurial mode of operation—fit well with competitive assets required in modern high-tech industry and may become a source of competitive advantage in industries of the future. 10

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Japanese keiretsu The Japanese keiretsu, the subject of Professor Wright's paper, is the best known form of Asian business system. Wright notes that there are two forms of keiretsu—the vertical or production keiretsu and the horizontal keiretsu. While some analysts emphasize the importance of the vertical groups because of their significance as global competitors in new industries, Wright focuses on the horizontal keiretsu, discussing the lack of transparency of their ties to non-Japanese and their dominance in the Japanese economy. Wright estimates that horizontal keiretsu account for between one quarter and one half of Japanese assets and sales (depending on whether financial institutions and smaller associated firms are included). Like other business groups, the horizontal keiretsu are voluntary clusters of independent firms whose economic relationships are informal but stable. Wright stresses the important role of the "main bank" in these groups, which supplies much of the capital, has a strong say in management of customer firms and bears substantial risks, but is not allowed to be a significant shareholder. He emphasizes the forms of cross-shareholding, preferred commercial transactions, flows of people and coordinated strategies as key elements in their success and stability. Their coordination capabilities are seen to be a key competitive asset in international markets since they are able to achieve economies of scale and scope in some of the leading industries in world trade. China's business systems Professors Jefferson and Rawski's study of China's business systems has a different emphasis. Until reforms began in 1980, governments at various levels were the exclusive agents of ownership, coordination, production and distribution. Following the introduction of reforms, considerable diversity has emerged. The share of output by stateowned enterprises has dropped by half since 1980, while enterprises which are collectively-owned by local governments have doubled their share. "Other" enterprises, which include publicly-listed corporations, joint ventures with foreigners and privately-owned firms (all non-existent before 1980), now account for more than a quarter of total output. The remaining state-owned enterprises are adapting to reform, however; they are improving their performance, becoming profitTbe diversity and dynamism of capitalism in East Asia

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oriented, improving their productivity and becoming more exportand consumer-oriented. Jefferson and Rawski stress that the reform process has to be understood as one of "enabling measures" rather than compulsory change, the aim of which is to encourage decentralized responses. The result is a cumulative and mutually reinforcing process of interaction involving market-oriented institutional change, technological innovation and economizing behaviour by enterprises. They see a distinctive value-added hierarchy emerging among Chinese enterprises, in which state-owned enterprises supply raw materials and intermediate goods, and collectively-owned enterprises, particularly the township and village enterprises (TVEs), provide intense competition to the stateowned enterprises in food processing, garments, assembly and machine tools production. At the top of the ladder are firms outside the state and collective sectors—joint ventures with foreigners at the cutting edge of Chinese technology. At the bottom are privatelyowned firms, which are usually SMEs. What do these studies imply? One implication of these analyses is that business groups interact with, and may determine, the industrial structure in an economy. While chaebol dominate all aspects of production in the Korean economy, the large business groups of other economies dominate capital-intensive industries producing intermediate goods. In Taiwan, state-owned enterprises and the large business groups concentrate in these industries. In China these industries are dominated by state-owned enterprises, and Southeast Asia's state-owned enterprises also focus on this sector. In Japan, many of the holdings of the horizontal keiretsu have traditionally been in these industries. Significantly, outside of Korea, the "new" export-oriented industries, including autos and electronics, have attracted the smaller, more flexible entities like Taiwan's SMEs, Southeast Asia's and China's joint ventures between family-owned local firms and foreigners, and Japan's vertical keiretsu (for example, Toshiba, Sony, Toyota and Honda). Following Hamilton's hypothesis, if business groups originate in the social structure, and the coordination of economic tasks is influenced by social factors and political ideology, are business groups and 12

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their capabilities determining factors in an economy's industrial structure? Or are these organizations more likely to evolve in response to industrial demands for flexibility and speed?

Changing relationships among business systems These questions lead to the issue of the stability of business groups and the forces that make them change and evolve. We need to understand not only what goes on in business systems—in order to interact with them and learn from them—but also how they are changing—in order to compete successfully with them and to take advantage of the opportunities that change presents. It is true that business systems evolve slowly, but there are both internal and external pressures for change. Some pressures for change come from within the industry and the firm. For example, intense competition and short product cycles in the auto and electronics industries create a premium for flexibility and speed at all levels of the organization. While their "high end" activities such as management, assembly and R&D are characterized by large barriers to entry, many of the intermediate goods are less sophisticated commodities which provide opportunities for SMEs as suppliers of intermediate goods and services. Cooperation between large assemblers and small suppliers is seen in Japan, Taiwan and in Southeast Asia and is beginning in China. Korea remains an exception. Other pressures for changes are generated externally, and their impacts are difficult to predict. They include changing relationships with government because of privatization and deregulation, and changes in international rules for trade and finance. As firms grow and internationalize, they become less dependent on governments, as in Japan. In Korea, government policy is changing as it seeks to reduce the degree of concentration in the Korean economy, by reducing the diversification in the chaebol and by improving financial and other opportunities for SMEs. In China, efforts to improve the performance of the socialist economy have resulted in "marketization" of the economy and the gradual withdrawal of government from direct production of many final goods and services. Yet the future structure of the Chinese economy is still unclear. For example, Chinese family firms have entered as foreign investors from Hong Kong, Taiwan and Southeast Asia and currently occupy a The diversity and dynamism of capitalism in East Asia

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position between the market and government. Redding (forthcoming) predicts that these firms will become more widespread and formalized. Changing trade rules are also making Southeast Asian economies more attractive to investors relative to China. For example, the World Trade Organization now requires greater transparency in and reduction of trade-related investment subsidies and incentives. Finally, as noted by Professor Lim and others (The Economist, 1996), the ethnic Chinese family and clan relationships partly reflect a response to fragmented and undeveloped market structures. These authors predict that the more informal ways of operating will change as markets develop, and as more formalized management structures become necessary to enter some types of industry.

Implications for Canadian business We have emphasized two points throughout this discussion. There are some broad differences in the ways in which business systems operate in much of East Asia, compared with Canada, the United States and much of Europe. And, more important, there is considerable diversity within East Asia and even within most countries in the region. Business systems are grounded in their social and political contexts. It is helpful to understand these contexts. It is also important to understand the core competencies of particular East Asian business systems, such as the trust relationships, which lead to lower transaction costs or to more reliable partnerships, and the ability to work closely with governments. Understanding these two things can help companies assess whether and how any particular system is changing. In China, for example, the partial and gradual reforms are serving to introduce a decentralized and market-oriented approach in both state-owned enterprises and collectives. However, these changes will be constrained for some time by the absence of well-defined and enforceable property rights, which are a key institution of developed market systems elsewhere. In addition, the fierce competition in many markets is likely to increase as both impediments and incentives to trade and direct investment are reduced in the region. The macroeconomic implications of the business systems studied here are less clear. It makes a difference to a country's economic 14

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performance if resources can be mobilized more quickly or more reliably within and between groups, or if there is sufficient capital for longer-term development. But what we can learn about improving our own systems is complicated by several things. Business systems are embedded in particular social and cultural settings. It is not clear how much difference they make in macroeconomic performance given the documented effects of other determining factors. The benefits of any given business system may be accompanied by economic or non-economic costs that are not acceptable elsewhere. It also may not be possible to improve poor economic performance by borrowing solutions developed in other social and political settings. Comparative analysis may at least help isolate the nature of the problem and encourage a search for solutions consistent with our own setting. The microeconomic implications of the studies in this volume, however, are quite clear. It is essential to understand the diversity and dynamism of East Asian business systems in order to meet them successfully—either as competitors or partners.

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References Auster, Ellen R. 1994. "Macro and Strategic Perspectives on Interorganizational Linkages: A Comparative Analysis and Review with Suggestions for Reorientation." Advances in Strategic Management. 10B: 3-40. Boyer, Robert. 1992. "How to Promote Cooperation within Conflicting and Divided Societies? Some Thoughts about the Transition of Industrial Relations in Europe." Presented at the Conference on Convergence and Divergence in Economic Growth and Technical Change. Maastricht, MERIT: unpublished. Casson, Mark. 1991. The Economics of Business Culture, Game Theory, Transaction Costs and Economic Performance. New York: Oxford University Press. Chandler, Alfred D. 1992. "Organizational Capabilities and the Economic History of the Industrial Enterprise." journal of Economic Perspectives. 6:3- 79-100. Economist, The. 1996. "The Search for the Asian Manager." March 9-126. Matthews, R.C.O. 1986. "The Economics of Institutions and the Sources of Growth." The Economic journal. 96: 903-918. North, Douglass C. 1994. "Economic Performance Through Time." The American Economic Review. 84:3- 359-368. Oliver, Christine. 1990. "Determinants of Interorganizational Relationships: Integration and Future Directions." Academy of Management Review. 15:2. 241-265. Powell, Walter W. 1990. "Neither Markets nor Hierarchy: Network Forms of Organization." Research in Organizational Behavior. 12: 295-336. Redding, S.G. forthcoming. "The Ethnic Chinese Business System of Pacific Asia: Consistencies in its Differentiating and Evolving Forms." ISEAD: unpublished. Redding, S.G., A. Norman and A. Schlander. 1994. "The Nature of Individual Attachment to the Organization: A Review of East Asian Variations." In Harry C. Triandis, Marvin D. Dunnette and Leaetta M. Hough, eds: 647-688. 16

A.E. Safarian and Wendy Dobs on

Ring, Peter Smith and Andrew H. Vandeven. 1994. "Developmental Processes of Cooperative Interorganizational Relationships." Academy of Management Review. 19:1. 90-118. Rohlen, Thomas P. 1989- "Order in Japanese Society: Attachment, Authority and Routine. "Journal of Japanese Studies. 15:1. 5-40. Safarian, A.E. 1996. "Trends in the Forms of International Business Organizations." In Leonard Waverman, et al., eds. Simon, Herbert A. 1991. "Organizations and Markets." Journal of Economic Perspectives. 5:2. 25 -44. Triandis, Harry C., Marvin D. Dunnette and Leaetta M. Hough, eds. 1994. Handbook of Industrial and Organizational Psychology: 4. Palo Alto, California: Consulting Psychologists Press. Waverman, Leonard, et al., eds. 1996 (in press). Competition Policy in a Global Economy. London, UK: Routledge. World Bank. 1993. The East Asia Miracle. Economic Growth and Public Policy. New York: Oxford University Press. Yeh, Ryh-sang and John J. Lawrence. 1995. "Individualism and Confucian Dynamism: A Note on Hofstede's Cultural Root to Economic Growth." Journal of International Business Studies. 26:2. 655-669.

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The organization of capitalism in South Korea and Taiwan Gary G. Hamilton

Like iron filings to a magnet, almost every company of any size and international reputation is drawn to Asia. For the last three decades, Asia's sustained rate of economic growth has been the highest in the world by far, and most analysts believe the same rate of growth will continue. The twenty-first century has already been dubbed "the Asian century." Many European and American corporations worry about this extravagant expansion. They know that if they do not participate in the Asian boom, they will not only lose out on a chance to profit in Asia, but rapidly growing competition from Asian companies may also endanger their position at home. They recognize that the best way to protect their current position is to succeed in Asia, yet this makes them anxious and confused. How does a company enter a market it has had very little experience with and does not fully understand? It may be obvious that to be successful in Asia, companies need to understand Asian economies and Asian firms. But this understanding isn't easy to obtain. Asian economies are very different from western economies, and, like European economies, they are also very different from each other. Perhaps the best way to think about this diversity is to remember a sentence that Perry Anderson wrote over 20 years ago. After a careful comparison of the Marxist concept of "Oriental despotism" and the actual process of development in Asia, Anderson concluded that the Marxist concept was inadequate. "Asian 19

development," he wrote, "cannot in any way be reduced to a uniform residual category, left over after the canons of European evolution have been established.... It is merely in the night of our ignorance that all alien shapes take on the same hue." (Anderson, 1974: 549). Even today, from a western vantage point, Asian economies still seem to resemble each other. Up close, however, Asian economies, as well as the firms that constitute them, are very different from one another. This paper looks at the organization of the South Korean and Taiwanese economies, two of the most economically advanced in the region, to demonstrate that Asian economies must be understood on their own terms, and not as a residual category derived from western economic development.

The misrepresentation of Asian economies When we use Eurocentric economic theories to analyze Asia, we typically see Asian economies and firms as a mirror image of western economies and firms. Consider, for example, the following standard interpretations of Asian economies: European and American economies are composed of "free" markets, while Asian economies are largely made up of "imperfect" markets. For instance, American trade negotiators consistently view the Japanese economy as being unfairly closed to American firms, and hence "unfree" and "imperfect." Relationships among firms in the United States and Europe are defined by "competition," while relationships among firms in Asia are defined by "collusion." For example, many western businessmen in China complain they cannot do business like the locals because they do not have the necessary political and social connections. In Japan, they complain that the large Japanese firms only do business with each other. Such collusion, they argue, results in the "lack of a level playing field," which by implication is what they have in the west. Western firms have "participatory" management structures, which stress due process and contractual relationships, while the management structures of Asian firms are undefined, "arbitrary" procedures and often centralized, authoritarian chains of command. 20

Gary G. Hamilton

These examples show us that we are seeing Asia as a reflection of ourselves. Yet as most recent research reveals (e.g., Granovetter and Swedberg, 1992), economies do not differ on a continuum of set dimensions. They reflect the social organization of the societies in which economic activities occur and in which firms are embedded. We must look closely at Asia itself to understand Asian economies and Asian firms.

Organizational differences among Asian economies Asia is not homogeneous. There are, of course, some similarities among Asian countries, as there are among western countries. For instance, despite considerable differences, western countries all share a respect for contractual, legalistic relations among individuals and among firms. Asian countries, on the other hand, share a respect for status-based social relationships, largely emanating from family roles. Both groups of countries have also developed common solutions to recurring problems of social control. For example, western governments have had to incorporate into the fabric of the state very clear notions about individual rights. In the west, the rights of legal citizens (which include the legal definition of the corporation) normally override the bonds defined by membership in a family. By contrast, family relationships are the core institutional metaphor used to delineate obligations within society and between society and the state in all countries in East Asia, particularly those most influenced by Confucianism (Hamilton, 1994). Businesses must function within the broad matrices imposed by such institutional affinities. Businesses in the west therefore define themselves as legal entities, and relate to each other as legal persons having individual rights and obligations. Businesses in Asia, by contrast, define themselves in terms of their inter-relationships with other businesses, with families, and with various categories of friends and friends of friends. The similarities among Asian economies should not be overstated, however, because they are merely the starting points for diversity. The differences among Asian societies are certainly as great as the differences among European countries. And the variations within Asian countries are even greater than occurs in Europe. For instance, there The organization of capitalism in South Korea and

21

are four major language groups and over 400 dialects in China alone, and the diversity in India is mind-boggling. Since local and national conditions shape the organization of economic activity, it stands to reason that the diversity of economic organization in Asia is considerable. One would, of course, expect differences among economies that differ greatly in their degree of capitalistic development, but the differences are equally obvious when comparing South Korea and Taiwan, two of the most capitalistic economies in Asia.

South Korea and Taiwan1 South Korea and Taiwan are two rapidly industrializing economies, located in the same part of the world about two hours flight time from each other. They have developed in roughly the same years at roughly the same rapid rates, and have had similar historical influences, both having been socially and culturally dominated first by China and then, in the colonial period, by Japan. Both have used similar economic policies to develop, first supporting a strategy of import substitution and then adopting an aggressive strategy of export-led industrialization. Moreover, in both locations, most private firms—even those making up the largest business groups—are family owned and controlled, and, significantly, family authority and practices in both locations draw on Confucian ideology to sustain the patterns of relationships within and among families. In the last decade, both countries have gone through a dramatic process of democratization. Economically, politically, socially, culturally—Taiwan and South Korea are as similar any two countries could be in the world today. Yet, the economies of these two countries are organized in radically different ways. This paper compares the economic organization of the two countries, and then accounts for differences by examining each society's underlying pattern of social relationships. Comparing the two economies The economies of South Korea and Taiwan are both structured, in part, 1

22

The following case studies draw freely on manuscripts that will be published in two forthcoming books (Orru, Biggart and Hamilton, 1996; and Hamilton, 1997).

Gary G. Hamilton

through business groups. Business groups are a global phenomenon and appear in varying degrees of strength in both developed and developing economies (Granovetter, 1994). They are generally defined as more or less stable networks of legally independent firms that are tied together through some form of shared ownership and common economic strategy. Asian business groups, however, are further defined by the normative social relationships that overlay these economic ties. All the major business groups in both South Korea and Taiwan are networks of legally independent, family-controlled firms. The similarities end with family ownership, however, since both sets of business groups are internally very different, and are positioned in their respective economies in very different ways. The best way to understand the differences between the two economies is to compare their business groups. South Korean business groups, called chaebol (or money cliques), are vertically integrated business networks that produce primarily finished products for export, and play prominent and decisive roles in the South Korean economy. Taiwanese business networks, by contrast, are horizontally integrated and made up of primarily small and medium-sized companies that provide intermediate goods and services for export-producing firms. Table 2.1 compares the business groups in the two locations. The statistics clearly show that South Korean chaebol are, on average, many times larger than Taiwanese business groups in terms of sales, assets, total firms per group and total number of workers per firm per group. Table 2.2 shows the relative contribution of these business groups in the manufacturing sectors of their respective economies. Again, it is clear from these figures that the chaebol's share in manufacturing output is much larger than that of the Taiwanese counterpart. These statistical comparisons point to rather substantial differences in the types of interfirm networks represented by South Korean and Taiwanese business groups. The chaebol dominate the South Korean domestic economy, particularly the export sector, but also the intermediate goods and services sectors. The top ten chaebol constitute, as a ratio of their sales to GNP, nearly 70 percent of the South Korean economy. The output of the top 50 chaebol accounts for over 20 percent of the value added component for the entire economy. The organization of capitalism in South Korea and Taiwan

23

The largest chaebol, such as Hyundai, Samsung, Daewoo and Lucky Goldstar, are well known outside of South Korea for their consumer products. They have created vertically integrated networks of firms that manufacture most of the intermediate goods and provide most of the services that go into producing these consumer products. This practice of obtaining goods and services from within the group is called "one-setism" (Gerlach, 1992). An underlying rationale for this practice is the fact that South Korean business groups vigorously compete with each other for dominance in the economy. These are, in fact, family-owned empires that struggle for economic supremacy. Table 2.1: A comparison of South Korean and Taiwanese business groups (US dollars millions)1 Sales2

Assets2 Firms2 Firms per Workers2 Workers per Workers business business per firm3 3 group group3

South Korea (1983)' Top 5 chaebol Top 10 chaebol Top 20 chaebol Top 30 chaebol Top 50 chaebol

35,360 47,317 58,187 64,509 70,772

24,872 33,772 44,078 49,611 56,391

5,084

7

322,876 425,872 550,458 688,385 798,976

64,575 20,599 12,457 13,793 5,530

2,625 1,304 989 1,641 780

90

18

85,719

17,144

952

123 202 328

25 16 13

412

8

552

5,547

Taiwan (1983)b Top 5 business groups Top 10 business groups

7,488

9,660

180

18

164,129

15,682

871

Top 20 business groups

10,444

13,744

283

10

220,413

5,628

546

Top 30 business groups

12,084

16,002

375

9

251,616

3,120

339

Top 50 business groups

14,027

17,902

494

6

289,787

1,908

321

Top 96 business groups

15,842

19,763

743

5

330,098

876

162

1. Exchange rate per US dollar: Japan: 233 Yen South Korea: 772 Won Taiwan: 40 NT$ 2. Cumulative totals. 3. Totals by interval. Source: (a) llbo Hankook. 1985 (b) Zhonghu Zhengxinso (China Credit Information Service). 1985. 24

Gary G. Hamilton

As a consequence, chaebol do not cooperate well with other South Korean businesses, large or small. At least initially, they attempt to create conditions of economic self-sufficiency. In contrast, Taiwan's business groups form economic alliances with other Taiwanese businesses, large and small. This creates diverse, interlinked networks that solicit broad-scale economic cooperation from most Table 2.2: Output shares of business groups in various manufacturing sectors: South Korea (1989) and Taiwan (1988) (percent) Manufacturing sector1 Food products Beverage Textiles Garments and apparel Leather products Lumber and wood products Pulp and paper products Printing and publishing Chemical materials and plastics Chemical products Petroleum and coal products Rubber Products (not footwear) Non-metallic mineral products Basic metals Metal products Machinery Electrical and electronic products Shipbuilding and repairing Transportation equipment Precision machinery Miscellaneous industrial products

South Korean business groups2

Taiwanese business groups3

34.79 31.87 46.73 1.17 4.63 11.21 13.54 7.16 38.62 6.18 91.20 29.05 26.72 36.93 19.05 21.14 63.14 74.16 50.39 13.95 2.43

13.60 0.22 42.26 6.40 0.00 5.20 22.24 0.40 15.80 4.54 0.00 2.80 25.90 4.00 17.10 18.50 11.65 2.40 28.70 0.20 6.14

1. Classification is based on The Report on Industrial and Commercial Census, Taiwan-Fukien Area, 1990 (with minor modifications). 2. 1989 Business Groups data are based on KIS, 1990 Chaebol Analysis Report and 1990 Annual Report of South Korean Companies. 3. Data are based on Zhonghua Zhengxinso (China Credit Information Service), 1990.

The organization of capitalism in South Korea and Taiwan

25

participants. Vertical integration is rare, big businesses do not export finished goods, and there is no evidence of economic self-sufficiency. The chaebol's vertically integrated business networks Chaebol are networks of firms defined by their common ownership which, in its simplest terms, is family ownership. Typically, chaebol are owned and controlled by individuals, haejong, who are the patriarchal heads of powerful families. Either directly or through holding companies, foundations, and other family members, the head of the chaebol normally controls the majority shares of all firms in the group. The haejong have tended to be politically favoured entrepreneurs who borrow money from state banks at favourable rates to establish firms in areas targeted for development by state planners. Because the banks are state-owned, the South Korean government has tightly controlled the financial system, controlled access to capital and carefully allocated it to specific chaebol for specific projects (Zeile, 1993). Recently, however, many of the top chaebol have arranged their own financing from non-state sources, usually from the local equity market and from international loans, and they have also been trying to create their own internal financial institutions, such as tax-exempt foundations. Using their privileged economic position, the families controlling the chaebol have attempted to consolidate their ownership by centralizing their managerial control. The structure of the chaebol is not based on community relations or on pseudo-kinship ties, but rather on the actual ties to the person in charge (Biggart, 1990). The chaebol head himself typically controls the crucial personnel and accounting offices for the group. Middle managers are hired on the basis of their social relationships to the owner and his family. Typically, the owner's family members and his trusted colleagues fill the top managerial positions in all chaebol firms. These colleagues are usually the owner's former classmates or people he grew up with. Put simply, chaebol firms are financed through low-cost loans given to the haejong. As these firms have expanded and prospered with increasing development, the haejong and selected family members have retained both ownership and control over all the firms in the chaebol. Accordingly, chaebol are highly personalized organizations. 26

Gary G. Hamilton

In South Korea, production and distribution are generally carried out by member companies of the chaebol. For example, at the top of the heap, Hyundai and Daewoo are huge networks of firms competing fiercely with one another for the same international markets. Each has sets of firms that make similar export products, such as cars, electronics, ships and clothes. Each has its own construction companies, oil refineries and chemical plants that contribute to the production of those commodities. Each has trading companies to market the products, shipping companies to haul the products and insurance companies to insure the products and the process itself. Unlike the arrangements in Japan or Taiwan, a distinctive feature of this system is the very limited and short-term subcontracting relationships between chaebol and non-chaebol firms. The ownership, production and distribution processes are internalized within the chaebol themselves, and what cannot be internalized is handled through joint ventures with non-South Korean businesses, mainly with US and Japanese firms. In South Korea, as the chaebol expand into new product areas, they start new firms, buy other firms and compete against all comers. This pattern of expansion and ruthless competition has earned the chaebol the label "octopus legs." To compare this practice of one-setism in South Korea with its relative absence in Taiwan, it is useful to measure intragroup vertical integration. This can be viewed as the degree to which firms within the group supply intermediate inputs and essential services required to produce and distribute a finished commodity. The more vertically integrated the interfirm network, the more likely it is that the firms in the group will transact their business with other firms in the same group. One can, therefore, view one-setism as the internalization of transactions within a business group. The average rate of internalization for the South Korea's 43 chaebol is a little over 17 percent.2 This means that 17 percent of the total demand for intermediate inputs and service is supplied by firms within the business groups. The larger the chaebol in total sales and assets, the higher its rate of internalization.

2

These measurements are described in detail in Hamilton and Feenstra, 1995.

The organization of capitalism in South Korea and Taiwan

27

How high is this rate of internalization? A network of firms in which there are no internal sales would be at the low end of the scale, with zero internalization. In this case, each firms sells its products to firms outside the group. At the other extreme, a group of firms that sells all of its intermediate products to other firms in the group, and at the end of the day produces a final commodity that is sold outside the group, would have 100 percent internalization. Clearly, a totally integrated group would be impossible in today's global economy. In relative terms, the 17 percent figure represents a high degree of internalization. First of all, this figure measures only the vertical integration that occurs between firms, not within firms. It is well known, however, that the largest firms in the largest chaebol are themselves highly vertically integrated (Amsden, 1989). The 17 percent figure, therefore, is in addition to vertical integration at the firm level. Recognizing this fact, it is possible to compare South Korea's rate of vertical integration between firms to the rate of internal transfers within American corporations that have multiple internal profit centres. In 1978, Richard Vancil surveyed 237 American corporations that were pricing internal transfers (1978: 176; also cited by Eccles, 1985: 106-113). His study showed that, for over 77 percent of these corporations, 15 percent or less of the total cost (or total sales) for intermediate inputs was accounted for by divisions with their own corporations. It is also possible to compare the vertical integration of Japanese, American and South Korean automobile manufacturing firms. Within Japanese automobile manufacturing groups, Jeffrey Dyer (1993) cites MITI statistics showing that 31 percent of the costs of the product sold were manufactured internally by firms within the group, compared to 45 percent of costs for the more vertically integrated American automobile manufacturing firms. For business groups in Japan as a whole, Gerlach (1992: 143-149) reports that the rate of internal transactions within the intermarket groups has been variously calculated to be around 10 percent or less. If we consider only the interfirm transactions of South Korea's top automobile manufacturer, the Hyundai group, the numbers fall between the Japanese and American cases. However, if we consider both intra- and interfirm sources of vertical integration, the Hyundai group is likely to be even 28

Gary G. Hamilton

more vertically integrated than the American automobile makers are. Based on these rather inexact comparisons, it seems that South Korean chaebol networks rank highly among the world's most vertically integrated business groups. Comparing South Korean and Taiwanese imports into the United States provides additional evidence (Feenstra, Yang and Hamilton, 1993). Data from US Customs show that South Korea imports primarily high volumes of a small number of finished consumer products. The chaebol tend to make automobiles, VCRs, television sets and computers rather than only the components for these products—the firms in the chaebol are the principal upstream suppliers for the big downstream chaebol assembly firms. For example, at Samsung, nearly 25 percent of all intermediate inputs are obtained from Samsung firms, and that number increases to almost 32 percent if the contribution of the Samsung trading company is included.3 Taiwan's horizontally diversified business networks How do the chaebol contrast with Taiwan's business groups? It is difficult to imagine a greater contrast between two nearly equivalent economies. A country with half the population of South Korea, Taiwan produces more, and a wider variety of, quality export products than does South Korea. Taiwan's per capita income is substantially higher than that of South Korea. Like the South Korean economy, the Taiwanese economy consists of large family-owned business groups. Unlike those in South Korea, however, Taiwan's business groups are not vertically integrated, do not produce many finished products for export, and are virtually unknown outside of Taiwan. Chaebol are concentrated in capital-intensive sectors, but are highly diversified—they produce both intermediate products, such as steel and chemicals, and final products, such as cars and TV sets. Taiwan's business groups are also in capital-intensive sectors, but they produce primarily intermediate goods (e.g., plastic, synthetic and cotton thread, iron and steel) and provide services (e.g., containerized shipping, credit services) for export-producing firms. 3

I was also told in interviews that most of the main component parts for Samsung's consumer electronics division are manufactured and assembled in the same compound.

The organization of capitalism in South Korea and Taiwan

29

The fact that Taiwan's big businesses do not produce many export products does not mean that Taiwan is any less exported-oriented than South Korea. In fact, the reverse is true. Until quite recently, Taiwan's exports were 50 percent of GNP, whereas South Korea's were under 40 percent. South Korea's biggest business groups dominate its export sectors, yet, in Taiwan, which has one of the world's highest rates of exports to total output, the biggest businesses produce intermediate goods sold domestically. This difference in roles of the large business groups suggests that the two economies have developed in distinctive ways. In Taiwan's case, small and medium-sized firms have historically played the most important roles. These firms form very flexible production networks, manufacturing consumer goods and component parts that are ordered in batches by large retail chains and product assemblers around the world. Computers, as well as shoes, are produced in this fashion. Although small and medium-sized firms lead the export sector, large firms also succeed in this economy. However, the Taiwanese businesses that have grown are typically the upstream producers, who supply the thousands of small and medium-sized firms that have sprung up around every consumer fashion that has appeared in the last 30 years—everything from trail bikes to semiconductor chip sets. In fact, Taiwan's industrial structure exhibits a "gold rush effect" (Orru, Biggart and Hamilton, 1996). In a gold rush, almost everyone joins the stampede to dig for gold, and although a few people strike it rich, the ones who make the most money are those who supply the miners with what they need. The same process is at work in Taiwan's economy. Merchandisers around the world have discovered that Taiwan's firms can produce almost any product that they need, on demand, and in the quantity and with the quality requested. Over the years, Taiwan's manufacturers have learned how to put together low overhead and very flexible production networks that respond to shifting global demand, and groups of these production networks hotly compete for profits in one consumer fad after another. Although the small and medium-sized firms do not make much money because their profit margins are always being squeezed, the mass producers of intermediate products do reasonably well. 30

Gary G. Hamilton

The clearest demonstration of this gold-rush effect is in textiles and plastics. For nearly three decades, large business groups have maintained a significant percentage of the total sales for these two manufacturing sectors. These business groups do not produce finished products for export, however. Instead, they produce the fabrics, but not the clothes; the plastics, but not the toys. Countless small factories in Taiwan, as well as their off-shore assembly plants located mainly in mainland China, carry out the next steps in the production chain, working on consignments from major retail outlets. This process is repeated in almost every sector and for almost every large business group. Unlike the rigidly controlled, vertically integrated chaebol in South Korea, the entire Taiwanese economy consists of loosely organized networks, some of which are characterized by arms-length transactions and others by relations between families and friends. The production networks are segmented, so that the large firms and governmentowned enterprises do not control the downstream production of manufactured goods; they relate to downstream firms primarily through impersonal transactions. Similarly, the distribution networks for export goods are typically in the hands of non-local firms, such as American brand-name merchandisers and super discount stores that usually have only transactional linkages with the small and mediumsized producers of their goods. The manufacturing capabilities of the small and medium-sized firms provide the key to understanding the Taiwanese economy. Entrepreneurs create flexibility by developing subcontracting linkages with many other firms, so that the size of production networks can be adjusted to fit the order. These loosely coupled networks, often composed of the entrepreneur's friends and colleagues, provide many diverse opportunities for the hard-working Taiwanese. In fact, it appears that nearly everyone wants to be a laoban (a boss), working in one of the networks. And according to the Free China Review (1988), that desire is almost a reality. In Taiwan, which has a population of a little over 20 million, there are 700,000 businesses, which means one laoban for every fifteen persons and, if we count only adults, one laoban for every eight persons. The Taipei business man whom Tyler S. Biggs quotes was exaggerating only slightly when he said, "If you stood in The organization of capitalism in South Korea and Taiwan

31

the middle of this city and tossed a stone in any direction, you'd probably hit a boss" (Biggs, 1988: 3). The ratio of one firm for every eight adults undoubtedly overstates the entrepreneurial fragmentation of the Taiwanese economy, but the general conclusion is certainly valid: the dynamics of the Taiwanese economy produces small firms. This point is brought home by the contrast with South Korea. According to the calculations of Tyler S. Biggs (1988: 3-4), in Taiwan, between 1966-1986, "the number of reported firms increased by 315 percent ... and the average firm size expanded 15 percent." In the same period, the reverse process occurred in South Korea, where "average firm size jumped by 300 percent and its firms grew in number by only 10 percent." The flexibility and dynamism of Taiwan's economy is evident in the capital and ownership networks that are characteristic of Taiwan's family owned businesses, both large and small. Where does the investment capital come from for these businesses? Taiwan's stock market, like South Korea's, is only now developing into a reliable source of investment capital for some of the larger family businesses. Unlike South Korean firms, however, Taiwanese firms are rarely financed through loans from government-owned banks or from international sources, such as the World Bank. Instead, capital investment for all sizes of privately-owned firms comes from two main sources (Semkow, 1994). The largest portion, somewhere around 50 percent, comes from accumulated profits that are reinvested to expand existing firms and to start new firms. The smaller the firm, the more likely it is that the owner supplies the capital himself. The next largest portion, about 30 percent, comes from the unregulated curb market—from family, friends and acquaintances (Semkow, 1994; Biggs, 1988; Lee, 1990). Understanding these two sources of investments helps us understand who owns Taiwan's firms. In Chinese societies, two types of firm ownership are important. First, ownership and control of businesses are in the hands of individuals and heads of households (Wong, 1985). This is certainly the case in Taiwan. Kao Cheng-shu and his colleagues in Taiwan have determined that 83 of the top 97 business groups can be strictly classified as family-owned business groups (Peng, 1989). Sixty-one of those business groups have more than one family member classified among the core people in the group, and most of those 32

Gary G. Hamilton

family members (81 percent, or 53 out of the 67) are either fathers and sons, brothers, or brothers and their sons. A second type of ownership "guanxi ownership," is also important (Hamilton, 1996). All the largest businesses, and most of the small ones, are limited partnerships, which take on a different form in the Chinese context. By long convention (Anonymous, 1887: 41), "every Chinese partnership is represented by one individual, who is solely responsible to the outside world for the solvency of his firm." The Chinese practice of taking on partnerships is similar to having "silent partners" who do not participate actively in making business decisions, but who earn profits on their capital investments. More important in the Chinese context, these silent partners are usually either more distant family members or members of the owners' personal network of acquaintances, which in Chinese would be called a guanxi network. These guanxi owners provide an important source of investment capital that has financed Taiwan's industrialization, but this network clustering of guanxi owners represents more than just capital. It represents a type of capitalism, a form of flexible specialization of the type found in other locations around the world, like Italy and India (Piore and Sabel, 1984; Orru, 1989). The features of this form of capitalism become clear when we look again at the production networks. On the surface, the whole process of production in Taiwan seems to run against western notions of economies of scale. How is it possible for all those small and medium-sized firms to produce so much, and such complex products? The answer is that production sequences are not internalized within firms or within Taiwan's business groups. They are "externalized"; they are an intrinsic part of the horizontally arranged networks linking investors and producers in Taiwan's small firm economy. This externalization is evident in the lack of vertical integration (i.e., internalization) of Taiwan's largest family-owned business groups.4 In contrast with the vertically integrated networks of the chaebol, Taiwan's business groups are highly segmented in distinct

4

These measurements are described in detail in Hamilton and Feenstra, 1995.

The organization of capitalism in South Korea and Taiwan

33

economic niches and show little evidence of vertical integration, even in those niches. Taiwan's top 96 business groups have a rate of internalization of only 0.02 percent. Only six of the 96 business groups have a rate of internalization that equals or exceeds 17 percent (the average rate for the top 50 South Korean chaebol.} Moreover, unlike the South Korean case, there is no relationship between size, as measured in assets or sales, and the rate of internalization (Table 2.1). Nor does the rate of internalization relate to the age or the number of firms in the business group. An analysis of Taiwan's large business groups shows that when the family owners want to reinvest their capital, they do so by diversifying into unrelated businesses, often at the suggestion of friends, colleagues or other family members who alert them to new opportunities to make money. Perhaps the best illustration of externalization—of production as a property of networks—is the so-called "satellite assembly system" (weixing gongchang} (Shieh, 1992). One example is a Taiwanese trading company that specializes in the manufacture of automobile parts.5 The company produces custom-made parts for supply houses and mail-order distributors located primarily in the United States and Europe. The owner employs four people, two for quality control and two for processing orders, and travels to the United States and Europe to take orders from his buyers. His overseas buyers give him the detailed specifications and sometimes a sample part. He then takes the specifications and samples to what he calls "his manufacturing group," which consists of around ten to fifteen independently owned metal working firms. These firms are all small, around 30 employees each, and make about 75 percent of his orders. The team, led by a mechanical engineer, divide each order into a manufacturing process consisting of smaller component parts and necessary steps. They then line up metal working shops to do each component part or step in the manufacturing process, and instruct the owners of the shops on how to do the assigned tasks. Sometimes, for a large and expensive order, the owner may lend money for necessary machinery and supplies to an independent firm he is using in the .

5

34

An automobile parts manufacturer explained this system to me using his own firm as an example.

Gary G. Hamilton

assembly process. Once the process is started and the necessary level of quality reached, the manufacturing proceeds without managerial supervision. Each firm does its own part of the process and delivers the unfinished part to the next firm in the manufacturing sequence. When the product is finished and delivered to the trading company, the two quality control people inspect each part and arrange for its export. Not every commodity, of course, can be produced in this kind of a network, but surprisingly many can. In summary, South Korea's large chaebol are the main organizing nodes in the economy's system of production, distribution and capital. They are tightly owned and centrally controlled. The chaebol create "producer-driven" networks (Gereffi, 1994) and are structured so that the larger firms in the network create the demand for the smaller firms outside the networks. Through research and development, advertising and aggressive merchandising by their own trading companies these large firms also promote, if not create, final consumer demand for their products. In this sense, efficient production in these networks is based on achieving economies of scope and scale, a sort of "network-based Fordism." In economic terms, these are "demand-creating" networks. By contrast, in Taiwan, the large firms and the large business groups are not the organizing nodes in the economy. Big businesses are upstream suppliers of intermediate goods and services, and respond to the demand generated by manufacturing networks of the small and medium-sized firms, which in turn respond to the demand of buyers external to the producing networks. Gary Gereffi (1994) calls this type of network "buyer driven." Production in these networks relies on external markets. The responsiveness to buyers makes Taiwan's smallfirm economy highly integrated in the global economy. These networks, therefore, can be termed "demand-responsive."

Divergent paths of development What factors account for the huge differences in the industrial structures of these two economies? It is clear that the two countries share many similar features. In fact, most observers, bent on explaining the success of Asian economies in general, miss the major differences in industrial structure and economic performance among them. Other analysts, in suggesting an explanation for these differences in general The organization of capitalism in South Korea and Taiwan

35

terms, are inclined to look for some peculiar difference in the timing of industrialization or in the actions of the state. These can certainly be found, but do they account for the divergent paths of development? The differences between the two industrial structures cannot be explained by any set of events or group of people that created a pathdependent trajectory, in part because, internally, the two structures are surprisingly uniform (Orru, Biggart and Hamilton, 1991; Whitley, 1992). A few economists (Levy, 1988 and 1991) have concluded that the South Korean economy is more vertically integrated because transaction costs are lower in Taiwan than in South Korea. But this explanation projects the end result backwards in time, making it the cause of the imputed outcome. In reality, the costs associated with doing business are as much a consequence of administrative hierarchies as the cause of them. The differences in industrial structure can best be explained by differences in social structures that have grown out of the transmission and control of family property. South Korea's lineage-based history In South Korea, kinship institutions support a lineage or clan system that disproportionately favours some lineage segments over others. This institutionalized inequality within lineages allows for the long-term accumulation of economic assets and the creation of a clearly demarcated, hierarchically ranked class structure within South Korean society. This lineage-based social structure can be traced back to the "great families" in the Yi dynasty (1392-1910) (Biggart, 1990). In this period, the property-holding segments of the main clans constituted the rural-based ruling class within South Korean society, the yangbang class. The wealthy families making up this class competed among each other for control of the agrarian society. The lineage was centrally controlled by the eldest son of the dominant segment of the lineage. The clan head inherited from his father all the communal clan landholdings and his own dominant share (about 60 percent) of the father's private estate, and the younger sons divided up the rest. This system preserved the aristocratic clan as the principal unit of political and economic action. These inheritance practices are still in force, a highly privileged lineage-based class hierarchy having 'been reinstituted as a direct 36

Gary G. Hamilton

consequence of South Korea's industrial policy after the South Korean War, especially after the Park Chung Hee coup in 1961 (Kim, 1991; and Kim, forthcoming). At that time, Park aggressively tried to stimulate the economy by selecting certain successful and politically trustworthy businessmen to create large, family-owned business groups similar to the zaibatsu in prewar Japan. Precedents for Park's action are prevalent in South Korea's history. Park acted on an affinity for elites (i.e., deference patterns and class expectations) that existed in South Korean society; it was a logical and rational choice at the time, but in retrospect, it is clear that this choice led to a reincorporation of elite familism, or patrimonialism, as Nicole Biggart (1990) terms it, in the management of the South Korean chaebol. Taiwan's history of patrilineal kinship In Taiwan, the Confucian family was situated in a very different social order. In China's early dynastic period, roughly from 221 BC until the end of the Sung period in 1280 AD, the Chinese social structure also rested on privileged lineage groups. Especially in the middle period, during the Sui (589-618) and the Tang (618-907) Dynasties, the great families controlled the countryside and vied with the emperor's family for aristocratic prestige. After the Mongol victory in 1280, however, the corporate, aristocratic lineages gave way to a segmented patrilineal kinship system in which households, not lineages, were the key building blocks in localized lineage groups (Twitchett, 1959: 131133; Hamilton, 1991). Unlike in South Korea (and in the early Chinese dynasties), where the eldest son inherited the lion's share of the estate and all the lineage's communal holdings, in late imperial China, the Chinese practiced partible inheritance, in which all sons split the father's estate equally. Communal lands of lineages tended to be very small. This set of practices preserved the household and made it, not the lineage itself, the key unit of economic action. Over time, partible inheritance and associated practices of lineage segmentation led to an economy that mirrored the society. Land holdings were divided in small plots and were dispersed in space. Large landowners did not have contiguous holdings. Instead of managing their agricultural resources, they rented their land to tenants, who fully appropriated usage rights to the top soil. The organization of capitalism in South Korea and Taiwan

37

Taiwan was largely settled during the Qing Dynasty (1644-1911) by migrants from Fukien province. The landholding patterns were based on the Southern Chinese model of strong segmented patrilineages, with some households in a lineage having substantial holdings and others in the same lineage being landless or becoming tenants tilling their kinsmen's land. This pattern of landowning continued even after the Japanese takeover of Taiwan in 1895, a concession from the Sino-Japanese War. However, in the 1950s, after Chiang Kai Shek and his Kuomintang forces had taken control of Taiwan, the Kuomintang instituted a comprehensive land reform that distributed the land in small plots to the people who tilled the soil. A similar reform occurred in South Korea, but the South Korean government tried, at the same time, to create an industrial structure based on elite holdings. The Taiwan government, by contrast, tried to stimulate the private sector of the economy by nourishing Chinese family economic practices, a solution that favoured the reinstitutionalization of a household based economy which became filled, in time, with commercially-oriented industrialists. A number of analysts (Fei, 1992; Hwang, 1987; King, 1991) have argued that Chinese patrilineal kinship patterns produce strong pressures on the Chinese to develop enduring working relations with equally ranked people outside of their immediate kinship group. These horizontal ties become the chief vehicle for individuals to marshall resources, including economic resources, for the purposes of household and personal advancement. The strength of these horizontal ties further undermines the influence of the lineage group over its members and enforces the norms that favour the households being the central nodes in extensively organized horizontal networks. Although based on similar Confucian principles, the South Korean and Chinese kinship systems operate in very different ways. In South Korea, kinship norms can be used coercively to incorporate people and groups beyond the household, creating the cohesion necessary to form and maintain large groups. In Taiwan, kinship rules do not apply to people beyond the household, but rigidly apply to members of the household. Outside the household, reciprocal norms based on some form of commonality (guanxi) tie people together normatively in horizontal networks (King, 1991; Fei, 1992). Large, far flung, but 38

Gary G. Hamilton

narrowly cohesive networks result, but these lack the coerciveness of authority possessed by groups organized through patrimonial and bureaucratic means. There is an affinity for economic action in both cases, but these affinities push people to go in very different directions when they organize efficiently to achieve "rational" economic goals. These historical factors provide the sociological background to the period of rapid development experienced by both South Korea and Taiwan. The current shapes of both market structures have, however, been greatly influenced by several decades of success in the global economy. The early and continuing successes of these two economies in the larger economic arena has had a substantial impact on the development of their respective economic structures. The early decisions, however, based on social structural affinities, led not only to a path of development, but also to an organizational environment that feeds back on itself (path-dependence), creating an economic system that has an internal dynamic and institutionalized rules of the game. It is the organizational dynamic, rather than the culture itself, that produces and sustains market structures.

Doing business in Asia Western observers often write about Asian businesses as though they are all essentially alike, or as if they were differentiated only by what they produce or by the personalities of their founders or current managers. Although Asian business people would agree that many situational and industrial factors influence how firms work, they would not lump Asian businesses together. They know that South Korean firms run differently from Taiwanese firms, regardless of who is in charge or what the specialty is. It is, however, often difficult for Asians themselves to account for or even come up with a comprehensive list of differences. Because they themselves lack an understanding of the differences, they often provide rather crude and obscure cultural portrayals of how South Koreans or Chinese do business, as if it were somehow in the very nature of "Chineseness" or "South Koreaness" to do business in a certain way. Their descriptions are, in fact, not much different from the western observer's conclusion that all Asian firms seem pretty much alike. The problem is that most people think about the organization of The organization of capitalism in South Korea and Taiwan

39

firms in the abstract. They mentally pull the firm out of the environment in which it operates and place it on a continuum of set dimensions along which all firms supposedly vary. Businesses, however, are never isolated economic actors; they always operate in complex social settings and always reflect the social and organizational dynamics of those settings. Chinese firms in Taiwan and South Korean firms in South Korea necessarily reflect the institutional medium in which they operate (Whitley, 1992). Many of their organizational characteristics are widely shared with other firms in the same location. How they are organized internally and how they interact with other firms are both shaped by the interfirm systems in which they are embedded. It is, therefore, impossible to understand these firms without also understanding these economic systems. The lessons of western economic development do not apply directly or easily to these economies, and when we try to apply them, they distort our perception of how these economies work. When journalists and trade negotiators magnify these distortions, they create misunderstandings that disrupt trade and undermine goodwill instead of assisting the business people they set out to help. For this reason, if for no other, business people and government officials should understand Asian economies on their own terms before they do business in Asia.

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Gary G. Hamilton

References Amsden, Alice H. 1989. Asia's Next Giant: South Korea and Late Industrialization. New York: Oxford University Press. Anderson, Perry. 1974. Lineages of the Absolutist State. London: New Left Books. Anonymous. 1887. "Chinese Partnerships: Liability of the Individual Members." Journal of the China Branch of the Royal Asiatic Society. New Series. 22: 41. Biggart, Nicole Woolsey. 1990. "Institutionalized Patrimonialism in South Korean Business." Comparative Social Research. 12: 113133. Biggs, Tyler S. 1988. "Financing the Emergence of Small and Medium Enterprise in Taiwan: Heterogeneous Firm Size and Efficient Intermediation." Employment and Enterprise Policy Analysis Project. EEPA Discussion Paper No. 16. China, Republic of. 1990. The Report on Industrial and Commercial Census, Taiwan-Fukien Area. Taipei: Directorate-General of Budget, Accounting and Statistics, Executive Yuan. Dyer, Jeffrey H. 1993. "The Japanese Vertical Keiretsu as a Source of Competitive Advantage." Unpublished Paper. Eccles, Robert G. 1985. The Transfer Pricing Problem: A Theory for Practice. Lexington, MA: Lexington Books. Feenstra, Robert C., Tzu-han Yang and Gary G. Hamilton. 1993. "Market Structure and International Trade: Business Groups in East Asia." Research Program in East Asian Business and Development Working Paper No. 45. Davis: University of California Press. Fei Xiaotong. 1992. From the Soil: The Foundations of Chinese Society. Translation, introduction and epilogue by Gary G. Hamilton and Wang Zheng. Berkeley: University of California Press. Free China Review. 1988. "Restructuring Small and Medium Enterprises". 38:11 (November). 4-17. Gereffi, Gary. 1994. "The International Economy and Economic Development." In Neil Smelser and Richard Swedberg, eds: 206-233. The organization of capitalism in South Korea and Taiwan

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Gerlach, Michael. 1992. Alliance Capitalism: The Strategic Organization of Japanese Business. Berkeley: University of California Press. Granovetter, Mark. 1994. "Business Groups." In Neil Smelser and Richard Swedberg, eds: 453-475. Granovetter, Mark and Richard Swedberg, eds. 1992. The Sociology of Economic Life. Boulder, Colorado: Westview Press. Hamilton, Gary G. 1997. Chinese Capitalism? The Economic Organization of Chinese Societies. London: Routledge. . 1994. "Civilizations and the Organization of Economies." In Neil Smelser and Richard Swedberg, eds: 183-205. . 1991. "The Organizational Foundations of Western and Chinese Commerce: A Historical and Comparative Analysis." In Gary G. Hamilton, ed: 48-65. , ed. 1991. Business Networks and Economic Development in East and Southeast Asia. Hong Kong: Centre of Asian Studies, University of Hong Kong. Hamilton, Gary G. and Robert Feenstra. 1995. "Varieties of Hierarchies and Markets." Industrial and Corporate Change. 4:1. 93-130. Hwang, Kwong-Kao. 1987. "Face and Favor: The Chinese Power Game." American Journal of Sociology. 92: 944-974. Ilbo Hankook. 1985. "Pal Ship O nyndo hankook ui 50 dae jae bul". ("The 50 top chaebol in South Korea"). Seoul, South Korea: Ilbo Hankook. Kim, Eun Mee. 1991. "The Industrial Organization and Growth of the South Korean Chaebol: Integrating Development and Organizational Theories." In Gary G. Hamilton, ed: 272-299, forthcoming. Big Business, Strong State: Collusion and Conflict in South Korean Development. Philadelphia: Temple University Press. King, Ambrose Yeo-chi. 1991. "Kuan-hsi and Network Building: A Sociological Interpretation." Daedalus 120:2. 63-84. South Korea Investors Service, Inc. (KIS). 1990. 1990 Chaebol Analysis Report. Seoul: KIS. . 1990. 1990 Annual Report of South Korean Companies. Seoul: KIS. 42

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Lee, Sheng-Yi. 1990. Money and Finance in the Economic Development of Taiwan. London: Macmillan. Levy, Brian. 1991. "Transactions Costs, the Size of Firms, and Industrial Policy: Lessons from a Comparative Case Study of the Footwear Industry in South Korea and Taiwan." Journal of Development Economics. 34: 151-178. . 1988. "South Korean and Taiwanese Firms as International Competitors: The Challenges Ahead." Columbia Journal of World Business. Spring: 43-51. Nivison, David S. and Arthur F. Wright. 1959- Confucianism in Action. Stanford: Stanford University Press. Orru, Marco. 1989- "Institutional Logic of Small-Firm Economies in Italy and Taiwan." Studies in Comparative International Development. 26:1. 3-28. Orru, Marco, Nicole Biggart and Gary G. Hamilton.1991. "Organizational Isomorphism in East Asia: Broadening the New Institutionalism." In Walter W. Powell and Paul J. DiMaggio, eds: 361-389Orru, Marco, Nicole Biggart and Gary G. Hamilton. 1996. The Economic Organization of East Asian Capitalism. Thousand Hills, California: Sage Publications. Peng, Hwai-jen. 1989- Taiwan qiyeyezhu de 'guanxi' jiqi zhuanbian, yige shehuixue de fenxi. (Relationships among Taiwan business owners and their changes: A sociological analysis). Tunghai University: Unpublished. Piore, Michael J. and Charles F. Sabel. 1984. The Second Industrial Divide: Possibilities for Prosperity. New York: Basic Books. Semkow, Brian W. 1994. Taiwan^ Capital-Market Reform: The Financial and Legal Issues. New York: Oxford University Press. Powell, Walter W. and Paul J. DiMaggio. 1991. The New Institutionalism in Organizational Analysis. Chicago: University of Chicago Press. Shieh, G.S. 1992. "Boss" Island: The Subcontracting Network and Mic Entrepreneurs hip in Taiwan^ Development. New York: Peter Lang. Smelser, Neil and Richard Swedberg, eds. The Handbook of Economic Sociology. Princeton: Princeton University Press. The organization of capitalism in South Korea and Taiwan

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Twitchett, Denis. 1959- "The Fan Clan's Charitable Estate, 10501760." In David S. Nivison and Arthur F. Wright, eds: 97133. Vancil, Richard F. 1978. Decentralization: Managerial Ambiguity by Design. Homewood, IL: Dow Jones- Irwin. Whitley, Richard. 1992. Business Systems in East Asia: Firms, Markets and Societies. London: Sage Publications. Wong, Siu-lun. 1985. "The Chinese Family Firm: A Model." British journal of Sociology. 36: 58-72. Zeile, W. J. 1993. aIndustrial targeting, business organization, and Ind productivity growth in the Republic of South Korea, 1972-1985. Department of Economics, University of California, Davis: Unpublished. Zhonghua Zhengxinso (China Credit Information Service). 1990. Taiwan digu jituan guiye yanjiu. (Business Groups in Taiwan). Taipei: Zhonghua Zhengxinso. . 1985. Taiwan diqu jituan grye yanjiu. (Business Groups in

Taiwan). Taipei: Zhonghua Zhengxinso.

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The paradox of China's industrial reform Gary H. Jefferson and Thomas G. Rawski1

A gradual shift from socialist planning to a market-driven system is propelling China toward the top echelon of global economic powers. China's striking industrial growth has been powered by rural industrialization, foreign investment, a partially reformed state sector and, recently, the emergence of substantial private entrepreneurship. China's reforms combine the gradual exposure of its socialist institutions to market pressures, and the creation of new, market-oriented forms of economic activity. As the economy has shifted toward greater market orientation, the goals of the country's leaders have moved from tinkering with the socialist system, to creating what they call a "socialist market economy with Chinese characteristics." Policy statements call for limiting state responsibility to macroeconomic management, strategic planning and regulation of matters like health and environment, an objective similar to what we observe in many market economies.

1

This paper draws on materials from Jefferson and Rawski (1995), Jefferson, Rawski and Zhen, forthcoming, and Rawski (1995a, 1995B). Our ongoing research in this area has benefited from the support of the Henry Luce Foundation, the William Davidson Institute, the American Council of Learned Societies and the Chiang Ching-Guo Foundation, and the University of Pittsburgh's Central Research Development Fund and the China Studies Endowment.

45

The size of China's market, and the emergence of a middle class, have attracted a host of international entrepreneurs, including many ethnic Chinese operating from bases throughout the Pacific Rim. Navigating successfully through China's complex and unstable business environment, however, requires an appreciation of the subtle dynamics of China's industrial reform process. How has China grown so fast? China's surging growth presents an uncomfortable paradox: How has China "grown so fast when conditions thought to be necessary for growth ... were absent?" (Blanchard and Fischer, 1993). This paper explains this surprising combination of rapid growth and deeply flawed policies and institutions by looking at the dynamics of China's business transition. It focuses first on how several spontaneous changes have reinforced, and eventually overshadowed, Beijing's partial reform efforts. These spontaneous changes are evident in the industrial sector, which is both the largest sector of China's economy and the core of China's reform problem. The paper then addresses three issues as they apply to that sector: How has reform occurred? How has reform affected the behaviour of different kinds of industrial enterprises? How does the on-going reform process affect business prospects for foreign firms?

China's industrial classifications Before analysing China's industrial reform, it is important to understand how China classifies its industrial enterprises. Chinese statisticians distinguish between state-owned enterprises and non-state enterprises. State-owned enterprises, described by Chinese as firms "owned by all the people" (quanmin suoyouzhi), are companies whose initial capital was supplied by the central government. China's state-owned enterprises include the country's largest producers of coal, steel, power generating equipment and other key commodities. Even though all except the largest state-owned enterprises are administered by provincial or municipal authorities, agencies of the central 46

Gary H. Jefferson and Thomas G. Raivski

government and regulations established by Beijing play a much greater role in the operation of the state-owned enterprises than nonstate enterprises. Although the state sector includes a wide range of enterprises, state-owned firms tend to be older, larger and more capital intensive than the average Chinese industrial firm. Non-state enterprises are firms outside the state sector. This category has two components: collectively-owned enterprises that are established and controlled by local governments, and "other" firms that are neither state nor collective, including shareholding corporations, joint ventures and private businesses. The following are brief descriptions of China's non-state enterprises: Collectives Collectives are firms established and controlled by local governments. Prior to 1980, they consisted primarily of urban collectives which, aside from generally lower wages, fringe benefits, capital intensity and productivity levels, closely resembled smaller and less endowed stateowned enterprises. In the reform environment, urban collectives have fared rather poorly, suffering a decline in market share. Rural collectives, by contrast, have enjoyed a massive and protracted boom. Widely known as "township and village enterprises" (TVEs or xiangzhen qiye), they have brought explosive increases in output, employment and exports. Although some TVEs are "red hat" entities—private firms operating under the guise of collective organization—most TVE firms are controlled and closely monitored by local governments, which see local industry as a valuable source of revenues and employment opportunities. Share-holding corporations During the 1990s, substantial numbers of state-owned enterprises and collectives have been reorganized as share-holding companies, and several hundred of them have obtained listings on stock exchanges in Shanghai, Shenzhen, New York, Hong Kong, Singapore and lesser (sometimes unauthorized) domestic share markets. Few are actively traded. In all cases, Chinese government agencies hold large, typically controlling, blocks of shares in these firms. Additional blocks of shares The paradox of China's industrial reform 47

47

are held by corporate insiders, including managers, workers and business partners.

Joint ventures Joint ventures are partnerships between Chinese firms or agencies and international investors. They tend to straddle the public and private sectors, since joint venture partners on the Chinese side typically include state-owned enterprises, TVEs or government agencies. Chinese statisticians classify joint venture firms according to the origin of the foreign partners: "overseas" joint ventures involve ethnic Chinese partners based in Hong Kong, Taiwan or Southeast Asia. "Foreign" joint ventures are partnerships with other foreigners, primarily from the OECD nations and the Republic of Korea. Private businesses Chinese statisticians recognize three types of fully private businesses: "individual enterprises" employing seven or fewer workers, "private enterprises" with eight or more workers, and wholly-owned foreign firms. Table 3.1 shows that there have been rapid changes in the share of output by the various kinds of enterprises since the onset of reforms.2 Although the real growth of state industrial output exceeded 7 percent between 1980 and 1994, the share of output by state-owned enterprises dropped from nearly 80 percent to just one-third. The strongest growth has been in the TVE and "other" sectors, which together accounted for two-thirds of the output in 1994 (up from 20 percent in 1980). Of the spectacular 20 percent increase in the share of industry classified under "other" ownership, 8 percent was contributed by individual enterprises and the balance by the burgeoning number of

2

48

China's economic statistics are compiled by a talented corps of specialists who do their best to record the pulse of China's economy. While official economic data accurately reflect broad economic trends, problems arise because of the incomplete adjustment of statistical methods to reflect new economic structures, because of the limited development of China's information industry and because of occasional falsification of local economic reports. Rawski (1995a) discusses several pitfalls associated with Chinese economic data.

Gary H. Jefferson and Thomas G. Rawski

share-holding corporations, joint ventures, wholly-owned foreign firms and private firms. Statistics on state-owned enterprise output share for various commodities also show striking shifts in the structure of Chinese production (Table 3.2). While the state-owned enterprise share of process and extraction industries such as coal, petroleum and building materials has increased, there has been a dramatic drop in the share of light manufacturing, particularly in textiles and apparel, machinery and chemicals, categories which include the burgeoning electronics and cosmetics industries. It is important to remember that "non-state" and "private" are not synonymous. The steep decline in the share of output contributed by state-owned enterprises does not imply that Chinese industry is dominated by private or semi-private enterprise (Yin and Dong, 1996).

The challenge of China's reform China has experienced fifteen years of rapid change and uninterrupted increases in every plausible measure of economic growth and material welfare. For a developing country, its macroeconomic fluctuations remain mild.

Table 3.1: Industrial output composition by ownership type (percent) 1980

Total

1987

1994

100.00

100.00

100.00

State-owned enterprises

78.69

59.73

34.07

Collectives TVEs

20.72 5.62

34.62 17.73

40.87 30.46

Other Individual

0.59 0.02

5.66 3.64

25.06 11.51

Note: Numbers are percentages of total Gross Value of Industrial Output in current price for indicated ownership types. Source: Yearbook, 1986: 273; Yearbook, 1988: 311; Yearbook, 1995: 375.

The paradox of China's industrial reform

49

This growth spurt coincides with striking qualitative change. The profit motive appears everywhere. Even large state industrial firms have had to adapt to the culture of the market. Despite the continuation of various forms of subsidy, agents throughout China's economy are increasingly forced to live with market-generated financial outcomes. Domestic industries, formerly insulated from international market trends, find themselves buffeted by international as well as domestic market forces. Institutional arrangements bend in the face of competitive pressures. All of these developments continue to reshape individual attitudes, expectations and behaviour at every level of Chinese society.

Table 3.2: Output contributions from state-owned enterprises by industrial branch (percent) 1987

1994

Metallurgy

75.08

68.56

Electricity

94.57

80.26

Coal

74.04

77.47

Petroleum

80.74

93.58

Chemicals

72.47

46.10

Machinery

70.38

37.11

Building materials

33.69

36.06

Forestry and wood processing

39.30

34.08

Food processing

79.17

61.38

Textiles

83.96

39.21

Apparel

18.63

6.78

Leather goods

30.70

10.89

Paper

57.30

36.30

Cultural and art goods

23.13

12.18

Other

73.66

44.83

Note: The 1987 figures are calculated using the branch shares reported in Rawski, 1996. Source: Yearbook, 1988: 318, 319; Yearbook, 1995: 388, 392.

50

Gary H. Jefferson and Thomas G. Rawski

China's industrial achievements during this period reveal four characteristics: rapid growth of non-state enterprises, continued dominance of publicly-owned enterprises, improving performance of stateowned enterprises and persistence of institutional weaknesses. On the surface, these characteristics appear to be contradictory. Taken together, however, they are important pieces in the puzzle of China's economic reform. Rapid growth of non-state enterprises The plunge in the share of output contributed by state-owned enterprises (Table 3.1) reflects dramatic gains in the non-state sector, especially the TVEs whose output during 1996 began to exceed that of state-owned industry. The output share of private domestic firms remains small, rising from 2.8 percent in 1985 to 11.5 percent in 1994 (Industry, 1992; Yearbook 1995). This number would have been larger, however, if private firms masquerading as collectives had been included (Walder, 1994). Rural firms have emerged as a major component of China's drive to penetrate world markets, with foreign sales soaring from US$3.9 billion in 1985 to $40 billion, or one-third of China's total merchandise exports, in 1994 (Lardy, 1992; Chen Chunmei, 1995). The number of small enterprises outside the state sector has proliferated, creating close to 10 million industrial enterprises in China. Large non-state enterprises have also begun to establish a presence. During the 1980s, virtually all of China's large and medium-size enterprises were state-owned—few were classified as collectives or joint ventures. By 1993, however, this had already begun to change dramatically. Among the 18,471 large and medium-size enterprises in that year, one quarter were classified in a non-state category. Approximately 2,800 of these were collectives, and between 350 and 400 were joint stock companies or joint ventures. The dominant role of public enterprise The rapid industrial growth summarized in Table 3-3 has been synonymous with broad-based industrial expansion. The decline in contribution to industrial output by state-owned enterprises is not because of that sector's stagnation—in fact, Table 3.3 shows an The paradox of China's industrial reform

51

average annual rate of growth of 7.9 percent between 1980 and 1994. Rather, the decline in share has come from the spectacular growth of China's non-state sector, principally the TVE sector. The state and TVE sectors, now of comparable magnitude, together account for approximately two-thirds of China's industrial economy (Table 3.1). Urban collectives and domestic joint ventures between collectives and state-owned enterprises account for another 5 to 7 percent. Public-sector entities hold large, often controlling interests in many firms organized under other major ownership forms, including joint stock companies and foreign-invested joint ventures, which account for another 10 to 15 percent of industrial output. The explosive growth of TVE output has aroused intense interest in the way TVEs operate. Use of the term "non-state enterprise" to describe TVEs gives the impression that rural collectives operate independently of government. Some authors speculate that TVE firms "mimic private enterprise" or operate like "loosely-structured cooperatives" (Singh, Ratha and Xiao, 1993; Weitzman and Xu, 1994). In fact, TVE firms, though different in many respects from stateowned enterprises, are public enterprises. Their operations are closely

Table 3.3: Overview of Chinese industrial performance, 1980-1992 (Index of Real Output: 1980 = 100) Ownership type

Real outpu [ 1980

1985

1990

1992

State

100

148

210

257

Collective

100

247

554

Individual1

100

21,752

126,057

100

492

3,530

100

176

328

Other Total

2

1994

Average annual growtn, iyou/94 (percent)

289

7.9

914

1,613

22.0

241,455

642,312

87.1

8,736

27,451

49.3

480

774

15.7

Note: Percentage totals may not check due to rounding error. 1. Privately owned firms employing less than 8 workers. 2. Includes private firms employing 8 or more workers, joint ventures, foreign-owned firms, and other ownership forms. Source: Yearbook, 1993: 409,413; Yearbook, 1993: 377; Rawski, 1996.

52

Gary H. Jefferson

and Thomas G. Rawski

Figure 3.1* Histogram of decision-making authority in Chinese enterprise: Distribution of authority between the enterprise and the state

This research focuses on 11 areas of enterprise decision-making. "Total areas of decision-making authority" represents the number of decision rights (maximum 11) that have been ceded to the enterprise. Source: Jefferson, Lu and Zhao, 1996

monitored and often controlled by "local government entrepreneurs" (Zweig, 1991) who "exhibit characteristics of both de facto owners and senior managers of township corporations" (Whiting, 1993). Similarly, Chang and Wang (1994) emphasize that TVE enterprise is "controlled by the township government ... not by its nominal owners, i.e., the local citizens." The TVE sector is built on the foundation of earlier industrialization efforts undertaken by local governments (Perkins et al, 1977). Like their predecessors, many TVEs of the 1980s and 1990s—but not all—operate "under close supervision from the township or village industrial departments" (Wong, 1993) which contribute start-up funds, appoint managers, and "are intimately involved in major strategic decisions" (Ody, 1991). Local officials tend to have greater control over public firms in the smaller rural jurisdictions (Walder, 1994). Figure 3.1 contrasts the distribution of decision rights in samples of state-owned and TVE enterprises. While the two distributions show that TVEs enjoy more autonomy in eleven areas of decision making, many of them enjoy less autonomy than the more reformed stateowned enterprises (Jefferson, Lu and Zhao, 1996). It is clear that China's collective industries are very different from private firms. Improved performance of state-owned enterprises

No one disputes the scale and significance of the contribution that TVE industries have made to the growth of production, exports, productivity, employment, incomes, and material welfare in China's economy. The success of these public-sector firms shows that prompt dissolution of official influence on enterprise management, preferably via early and comprehensive privatization, is not a necessary near-term ingredient in China's economic reform. But the inconsistency between China's recent industrial experience and free-market orthodoxy runs deeper than this. China's old-line state enterprises have responded to ongoing partial reform by behaving less like passive bureaucratic followers and more like profit-seeking commercial businesses. The impact of reform on objectives, incentives and "corporate culture" within state firms, while neither universal nor complete, has brought substantial improvements in performance. During the late 1980s, state-owned enterprises accounted for over half 54

Gary H. Jefferson and Thomas G. Rawski

of industrial output and absorbed nearly half of the country's aggregate fixed investment. China's recent economic gains could hardly have occurred if they had served only as a drag on economic progress.3 Detailed analyses of the performance of state-owned enterprises support several key propositions (Harrold, 1992; Rawski, 1994b; Jefferson and Rawski, 1994): State-owned enterprises, formerly devoted to plan fulfilment, now take profit as their chief objective (Jefferson, Zhang and Zhao, 1996). Data on the performance of state-owned enterprises generate increasingly strong statistical relationships, like those one would expect from profit-seeking firms operating in a competitive market setting. These include relationships between wages and productivity, bonuses and profitability, and investment activity and profit (Jefferson and Rawski, 1994; Jefferson, Hu, Singh and Wang, 1996). State-owned enterprises have achieved substantial gains in labour productivity and steady but modest increases in total factor productivity amounting to 2.5 percent annually during 1980-92 (Jefferson, Rawski and Zheng 1996). While the growth of total factor productivity, which reflects the combined efficiency of capital, labour and materials, appears to have declined to 1.6 percent during 1988-92, the slowdown is partly cyclical: capacity utilization was lower in 1992 than in 1988 (Jefferson, Rawski and Zheng, 1996).4 State firms have sharply increased the pace of research and development, new product development, and innovation. Enterprises of all types identify state-owned enterprises as the major innovators in their product lines (Jefferson, Rawski and Zheng 1992, 1996). Exports of

3

Data on fixed investment for 1992 are from Yearbook (1993: 145, 150). It is not easy to specify the share of state firms in industrial fixed investment. The 1992 figure for state-owned enterprise industrial investment (ibid.: 150) occupies an impossibly large 97.5 percent share of the combined total of industrial investment outlays under the three subheads of basic construction (jiben jianshe), technical renovation (gengxin gaizao) and "other" (qita - a small category that we assign exclusively to industry even though part should be credited to transport and geology). See ibid.: 159, 181, 199.

4

Wu (1993) and Jefferson, Rawski and Zheng (1996) summarize research on Chinese industrial productivity.

The paradox of China's industrial reform

55

goods manufactured by state-owned enterprises, which appear to have risen at rates of 15-20 percent annually during 1985-1992, reflect the impact of greater attention to quality, variety, customer requirements and quality control (Rawski, 1994a). State-owned enterprises furnish an important and often crucial source of technology, equipment, funds, information, expertise and marketing opportunities essential for the successful development of TVE industry. Table 3.4 compares the performance of the various kinds of enterprises, using state-owned enterprises as the reference. State-owned firms of all sizes are more capital intensive than cooperatives, and firms in the "other" category deploy higher amounts of capital per worker than state-owned enterprises. The profitability of firms in the "other" category surpasses both state-owned enterprises and collectives by a wide margin. State firms achieve higher profits on sales than collectives, but lag behind in terms of returns to capital. State-owned enterprises are a significant source of tax revenue. Data for large and medium firms in 1993 show that while state-owned firms contributed 68 percent of output, they accounted for 72 percent of pre-tax profits, 79 percent of new product sales, 68 percent of new product exports and 76 percent of new product profits earned by all large and medium firms (Science Yearbook, 1994). Persistence of institutional weaknesses China has benefitted from a succession of market-supporting institutional developments, considerable expansion of managerial authority at the enterprise level, and growing pressure to implement the principle that enterprises "should be fully responsible for both profits and losses." However, recognition of these important gains does not mean that partial reforms have transformed China's industrial economy into a full market system. In fact, these advances have occurred without the benefit of features that many economists regard as core ingredients of a market system. Chinese industry, particularly state industry, suffers from three problems: incomplete specification of property rights, a weak financial system and extensive social obligations.

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Gary H. Jefferson and Thomas G. Rawski

Table 3.4: Performance measures for various groups of firms, 1993 (index with average for state enterprises in each category = 100) All state-owned enterprises

Capital intensity

Large & medium state-owned enterprises

Collectives all collectives

townshiplevel collectives

Other firms all "other" enterprises

shareholding enterprises

foreign-funded enterprises

100

94

47

46

167

133

159

100 100

116 96

142 89

226 115

220 176

355 280

220 158

Market responsiveness product inventory/sales interest cost/sales

100 100

93 54

118 71

91 61

92 67

na na

na na

Implicit deflator for industrial output2

100

95

79

78

81

na

na

Profitability profit/capital profit/sales

1, These data exclude village-level enterprises. 2, SOE deflator with 1990 base = 100. Source: Yearbook, 1994; Survey, 1994 and 1995.

Incomplete specification of property rights: Rules of commerce are neither clearly defined nor consistently enforced. Competing firms in the same industry or locality face widely differing legal, fiscal, and regulatory regimes. Neither domestic nor foreign firms can rely on China's legal and regulatory system to consistently uphold trademarks, licensing agreements and other intellectual property rights. Government intervention in business affairs still extends well beyond the boundaries observed in heavily regulated market economies, such as in Japan and Korea. Official involvement in industrial affairs frequently has the effect of softening budget constraints. These difficulties restrict innovation and productivity, particularly in the state sector (although not exclusively). Chinese economists therefore find that the high transactions costs that arise from inadequate contract enforcement and the consequent prevalence of commercial cheating lead to "obvious limitations on specialization outside the state sector" (Jiang et al, 1993). In her study of TVE behaviour, Whiting (1993) comments on "the unwillingness of the courts to enforce loan contracts." She quotes one frustrated enterprise manager who complains that "contracts don't mean anything here" because there is no practical means of forcing customers to settle overdue accounts. A weak financial system: The development of China's financial markets lags behind the proliferation of commodity markets. Banks, long accustomed to a passive and subordinate role in the former planned economy, are moving toward a commercial mode of operations in which profit forecasts and enterprise credit ratings determine the availability of funds. But they are also faced with continuing pressure to prolong the survival of inefficient enterprises and to protect their employees, to manage loan portfolios riddled with bad debts and to divert funds to politically attractive but unprofitable projects and enterprises. Some observers see these banking practices as a threat to China's macroeconomic stability (Sachs and Woo, 1994; Woo et al, 1994; Naughton, 1995). Extensive social obligations: China's state-owned industrial enterprises employ more than 43 million workers. Many state-owned enterprises are different from conventional capitalist firms, however, because they perform the function of a "small society." They guarantee 58

Gary H. Jefferson and Thomas G. Rawski

employment, housing, health, education and pensions. In this respect, many state enterprises are like towns or small cities, some with populations in excess of one-quarter million, where the role of the manager is as much that of mayor as corporate manager. Statistics from the early 1990s indicate that 93 percent of the employees of state-owned enterprises are provided with housing, and 51 percent of urban residents occupy housing furnished by state enterprises (Du and Shang, 1993). The budgets of state firms include massive social outlays that have grown rapidly with rising medical costs and the aging of the work force. These firms must draw on current revenues to support the pensions and medical expenses of retirees. Their schools educate tens of millions of children. Table 3.5 illustrates some of these expenses, as well as the differential burden that state-owned enterprises face. The legacy of central planning and of dual control by managers and Communist party leaders burdens China's state-owned enterprises with ill-defined organizational boundaries and serious principal-agent problems. The mix of corporate enterprise and social purpose, complicated by a system of vaguely defined property rights, confounds the task of making an economic profit. While reform of China's housing and social security systems is beginning to separate the business and social functions of state industry, many state-owned enterprises continue to operate only because closing them would destroy the productive base of whole communities, including most employment opportunities and social services. The cost of these institutional shortcomings, although difficult to quantify, appears large. Specific policies curtail sales and profits, especially in the energy sector. For example, price controls deprive Daqing Oilfield of annual revenues amounting to RMB30 billion (Pei, 1995), a figure equal to 75 percent of 1993 annual earnings for all of collective industry. Many economists would expect such serious institutional deficiencies to smother an economy's forward momentum. Yet China's state-owned enterprises and non-state firms (which face many of the same difficulties) have still managed to perform strongly during the past two decades of economic reform.

The paradox of China's industrial reform

59

Institutional features of China's industrial economy Many researchers view the reform of former socialist economies as a sequence of central policy initiatives, including the abolition of planning, the removal of price controls, the privatization of state enterprises, and other policy changes directed and controlled by the state. They visualize reform as a process of replacing old institutions with new structures, a process that is organized and directed by reformers in a top-down fashion. In this linear view of reform, the self-

Table 3.5: Pensions and welfare costs facing Chinese state enterprises A. Retirees and pensions (shares in percent) Year

Retirees (millions)

State-sector share of Retirees1

Pension Outlays1

Industrial Production

Active workers per retiree

1978

3.1

79.0

88.5

77.6

30.3

1983

12.9

78.6

86.0

73.4

8.9

1988

21.2

72.8

82.4

56.8

6.4

1992

26.0

75.9

83.7

48.1

5.7

1. Includes all units, not just industry.

A. Welfare costs, 1992 (Billions of yuan)

Outlays Industrial output Year-end workforce (millions) Welfare costs per yuan of output per worker

State-owned enterprise industry

Collective units1

Foreign-invested units1

22.140 1,782.420 45.220

8.680 1,410.120 58.340

0.640 206.560 na

0.012 489.600

0.006 148.800

0.003 333.1 OO2

1. Includes all units, not just industry. 2. Figure is for units in the category "other," i.e. other than state or collective entities, a category which includes foreign-invested firms. Source: Labour, 1993: 483-497; Industry, 1993: 3 and 36.

60

Gary H. Jefferson

and Thomas G. Rawski

interested response of agents within the economy is expected to stimulate profit-seeking behaviour and market activity. If progress is inadequate, planners can impose further rounds of reform. Centrally directed reform has played a role in China's economic transition. Central leadership initiated China's economic reforms in the late 1970s, expanding the role of prices and of market allocation, rolling back long-standing barriers to international trade and investment, transferring authority from central planners to enterprise managers and local governments, creating a unique system of dual (plan and market) pricing for industrial goods, and so on. But unlike the post-Communist leaders in countries like Poland and the Czech Republic, China's policy-makers embarked upon a path of reform with no clear vision of what a restructured economy should look like, and with no consensus about the policy mix or institutional arrangements that would best meet their objectives of political continuity and accelerated economic growth (Hua, Zhang and Luo, 1993; Shirk, 1993; and Naughton, 1994). Not surprisingly, policy announcements from the centre were partial and tentative. The centre ratified but did not direct the momentous shift from collective to household farming. Central initiatives in the reform of industry focused on incremental relaxation of controls over state-owned enterprises. Even the revolutionary "open door" strategy, reflected in a sequence of central decisions that shattered long-standing barriers to China's participation in the world economy, concentrated on expanding trade and investment activity in a small number of provinces and special zones along China's southeast coast. Many factors contributed to the outcome of China's industrial reform efforts. Developments in the industrial sector reflect the influence of external events, including the progress of agricultural reforms, China's relative macroeconomic stability, and the arrival of complementary skills and resources from Hong Kong and Taiwan (Hussain and Stern, 1994). But the core dynamics of industrial change have arisen from initial conditions specific to China's domestic industrial system. China's industrial reform began with partial relaxation of institutional constraints associated with socialist planning, thus initiating competition in the markets for industrial products. Competition created financial The paradox of China's industrial reform

61

pressures that induced technical innovations, more efficient operations, and fresh rounds of market-leaning institutional change. Four institutional features of China's industrial economy have been key to this process: decentralized supervision, incipient competition, fiscal dependence on industrial profits and the hierarchy of heterogenous enterprises. Decentralized supervision Central control of China's industrial enterprises was never as tight as it was in Eastern Europe and the Soviet Union (Granick, 1990). Decentralization increased during the late 1960s and 1970s as the central government transferred the supervision of many firms to provincial and municipal governments. This system of decentralized supervision encouraged provinces and localities to create and pursue their own industrial development strategies. When reform began, decentralized decision-making also made it possible to introduce piecemeal reforms and to conduct local policy experiments without disrupting the whole economy. Successful local reforms inspired widespread emulation. Incipient competition The term "incipient competition" aptly describes domestic Chinese industrial markets on the eve of reform. Actual competition was sharply limited by policies that created strong barriers to entry. Removal of these barriers, however, quickly revealed that there were already many competitors in nearly every product line. In China, deregulation has led to industrial competition—not monopoly, as in Russia and other former republics of the Soviet Union and Eastern Europe. Once liberalization began, competitive pressures came from several sources. Rural industry developed widely in the decades before reform, but was largely confined to fabricating local materials into goods for local buyers (Perkins et al, 1977). Entrepreneurial leaders in hundreds of counties and thousands of production brigades were poised to take advantage of deregulation by bursting into markets they had coveted for years. China's southern regions, excluded from large-scale industrial investment during three decades of central planning, took advantage of the new "open door policy" to promote 62

Gary H. Jefferson and Thomas G. Rawski

industrial growth with the aid of capital, skill and commercial contacts from overseas Chinese, most of whom trace their ancestry to the southern coastal provinces of Guangdong and Fujian. Defense conversion brought strong new entrants into a number of civilian industries; by the early 1990s, at least two-thirds of output from defense industries consisted of civilian products (Blasko, 1994). Finally, China's long-standing policy of building complete sets of state-owned industries in most provinces provided a ready-made source of competition. Fiscal dependence on industrial profits Industrial profit deliveries and tax payments are a key component of fiscal revenue at every level of government. State enterprises contributed 80 percent or more of "adjusted budgetary revenues" in every year during the 1978-87 period; by 1988, state industry accounted for 73 percent of profits and profit taxes from all enterprises (Sicular, 1992), implying a share in total revenue of about 60 percent. By 1994, state industry share had fallen but remained substantial at nearly 40 percent of revenue (Yearbook, 1995). The fiscal reforms of the 1980s created a system in which each level of government collected taxes from enterprises under its jurisdiction. It then "turned over a contractually specified amount to the next higher level of government, and could keep the residual." The result was "a shift toward local fiscal power at the expense of the centre, as the centre's proportion of total government revenue fell" from 50 percent in the 1970s to less than 30 percent in the 1980s (Walder, 1994). The hierarchy of heterogeneous enterprises The universe of domestic industrial enterprises in China is heterogeneous; there is a hierarchy of domestic firms: foreign-linked firms, state enterprises, urban and rural (TVE) collectives and private businesses. These groups of firms exhibit systematic differences in technological capabilities, cost structures and institutional arrangements. There is an inverse relationship between innovative capability and labour costs: state-owned enterprises suffer the greatest restriction from institutional constraints, and TVEs are least affected by institutional limitations. Interaction between different kinds of enterprises The paradox of China's industrial reform

63

creates a kind of innovation and competition ladder, in which innovations initiated by more technologically sophisticated enterprises are imitated by less advanced firms, whose lower labour costs allow them to undersell products from the initial innovators, creating financial pressures that motivate successive rounds of innovation, imitation, and competition. Our analysis combines these institutional conditions—which created a backdrop of incentive structures, organizational and technological diversity, and incipient competition—with the concept of international product cycles and quality ladders developed by Vernon (1966), Krugman (1979) and Grossman and Helpman (1991). Their models focus on interactions between innovative firms in the "North" and imitators in the "South." Northern firms rely on product innovations to support their high-cost manufacturing operations. Southern firms, with lower production costs, capture markets by imitating Northern products. The North retaliates with a fresh round of innovation. Rivalry among different types of producers leads to an ongoing evolution of product characteristics, while the locus of manufacturing activity may shift back and forth between firms located in the "industrial" North and in the "developing" South. This approach fits nicely with China's recent industrial history. Chinese industrial goods rarely match the quality and characteristics of products manufactured by global leaders. But Chinese firms, either on their own or with the cooperation of foreign partners, can produce reasonable substitutes at low cost. Rapidly growing exports of textiles, garments, footwear, machinery and consumer durables illustrate the extension of the international quality ladder and China's industrial economy. Before describing the categories that comprise the ladder, it is important to understand how the reform process unfolded.

The process of Chinese economic reform Conventional policy advice pictures economic reform as a series of changes imposed by decree, much in the style of central planning. Orthodox recommendations take the creation of US-style market arrangements as the objective of reform. But reform in China did not follow this path. In China, the idea of a "socialist market economy" 64

Gary H. Jefferson and Thomas G. Rawski

received little consideration during the initial decade of reform, emerging only in the 1990s. Even Deng Xiaoping's slogan moshitou guohe (crossing the river by stepping from stone to stone) exaggerates the systematic component of China's early reforms by suggesting a clear objective—the far bank of the river—when none existed. China's reforms typically involve what might be termed "enabling measures" rather than compulsory changes. Instead of eliminating price controls, reform is gradually raising the share of sales transacted at market prices. Instead of privatizing, a growing range of firms are issuing shares. Production planning has not vanished, but its span of control is gradually shrinking. This open-ended approach invites decentralized reactions that the centre can neither anticipate nor control. Governments at all levels become participants, sometimes even followers, as well as leaders of reform. Reform unfolds as a process replete with interactions among governments, enterprises, workers and consumers rather than a sequence of events in which the state makes decisions to which businesses and individuals react. The steep decline in the ratio of government revenue, especially central revenue, to national product illustrates the importance of unforeseen outcomes. The nature of the reform process is perhaps best seen by looking at a schematic representation for the industrial sector, the largest sector of China's economy and the source of the most intractable policy dilemmas. What emerges is a picture of economic momentum arising from a virtuous circle of reform, a cumulative and mutually reinforcing process of interaction among market-leaning institutional change, technical innovation and improved efficiency. The sequence of responses that transforms partial reform into improved performance is simple and direct: government initiates partial reform measures, partial reform destabilizes outcomes and intensifies competition, competition reduces profitability, enterprises respond to financial pressures, governments react to financial pressures and lobbying, feedback accelerates the impact of reform, and experience changes attitudes and expectations as well as behaviour.

The paradox of China's industrial reform

65

Government initiates partial reform measures As we have indicated, Chinese industry includes several types of firms—state-owned enterprises, urban collectives, township-village enterprises, share-holding enterprises, joint ventures, and private businesses. There is a distinct hierarchy of capabilities, product quality and labour costs, all of which are highest in joint ventures and state-owned firms. Competition occurs within a framework of "product cycles" in which low-wage firms increase sales and profits by imitating goods introduced at higher levels of the hierarchy; advanced firms strive to maintain their advantage by upgrading the quality and variety of their products. Reform begins when the government implements partial reform measures that reduce entry barriers and lower the cost of many types of transactions. These initiatives have a differential impact on the opportunity sets available to various groups of firms. Partial reform accelerates the domestic product cycle by facilitating the transmission of cost pressures and technologies up and down the hierarchy of industrial enterprises. Partial reform destabilizes outcomes and intensifies competition The unequal impact of reform efforts destabilizes the existing division of industrial resources and product markets among different types of firms (Table 3.2). Competition in industrial product markets intensifies, as suggested by the rapid proliferation of industrial enterprises, whose numbers have more than doubled to over 10 million since the late 1970s. Competition reduces profitability Stronger competition diminishes flows of profits created by entry barriers and market segmentation. At the micro-level, reduced profitability limits the growth of wages and bonuses for some firms, while others are thrown into a position of financial loss. At the macro-level, erosion of profits limits the growth of revenues accruing to local and provincial authorities and to the central government. Statistics in Table 3.6 show how reform brought dramatic reductions in industrial profits. The dominance of the public sector made governments the chief victim. Tax and profit revenues from industry lagged far behind the growth of output. The ratio of industrial tax 66

Gary H. Jefferson and Thomas G. Rawski

revenues to total industrial output tumbled from 20 to 4 percent between 1978 and 1993 (Yearbook, 1994). Widespread tax evasion exacerbated the fiscal consequences of falling profits. This decline in earnings affected all segments of domestic industry. Profit rates for township-village enterprises fell even faster than for state industry. The decline in earnings increased the number of unprofitable firms, with losses concentrated primarily, but by no means exclusively, in the state sector. Table 3.6: Trends in profitability for different segments of Chinese industry (net of tax profit per unit of fixed and working capital in percent) Year

Collectives

State firms all state-owned enterprises

1980

16.0

1981

15.0

1982

14.4

1983

14.4

1984

14.9

1985

13.2

1986

10.6

1987

me

1988

10.4

1989

7.2

1990

3.2

1991

2^8

1992

2.7

1993

3.1

1994

na

large and mediumsized state-owned enterprises

na na na na na na na 9.9 na na na na na 3.6 3.9

all collectives

TVEs

18.5

26.7'

15.2

22.3'

118

20^2'

15.3

18.51

13.9

15.21

15.3

14.51

11.1

10.6'

na

9.0'

11.3 na na na na 4.4

9.3

na

1

7.1' 5^9'

na 6.4 7.0

na

Other ownership

na na na na na na na 15.22 na na na na na 6.8 na

rate of return = 100*P/K where P = sum of profit figures (positive or negative) for all firms K = net (of depreciation) value of fixed assets plus average amount of working capital in use 1. Data for all TVEs, not just for industry TVEs. 2. Data for large and medium Sino-foreign joint ventures. Sources: Rawski, 1996; Yearbook, various years; Industry, various years; Survey, various years; Large Scale, 1989; Rural Enterprise, 1993.

The paradox of China's industrial reform

67

Enterprises respond to financial pressures Firms react to financial stress by choosing one or more strategies. They restructure operations, lobby for further deregulation to facilitate profit-seeking, or lobby for subsidies or official intervention to restore the initial financial position. The market opportunities and the scale and accessibility of official subsidies influence micro-level decisions to emphasize one or another of these responses to financial pressures. Governments react to financial pressures and lobbying Governments also face financial pressures that reduce their share of total output and destabilize the distribution of fiscal revenue across regions, missions and administrative levels. Officials face conflicting enterprise lobbying efforts, some demanding further autonomy and deregulation, others seeking protection from the effects of earlier reforms. Government's declining share of economic output is a key link in Chinese reform dynamics. Lacking funds to provide all firms with "soft budget constraints," central officials repeatedly faced an unwelcome choice: allow fiscal deficits to escalate or force market discipline on state enterprises. Central officials frequently, though not always, chose the latter. Provincial and local governments, whose share of revenues rose at the expense of the centre, also restricted subsidies. Again, competition provides an explanation. Provincial and local governments compete for foreign and domestic investment. With little access to credit markets, local governments fear that large subsidy payments will cripple local competitive strength by delaying vital infrastructure projects. Feedback accelerates the impact of reform The induced responses of firms and governments further erode entry barriers and reduce transaction costs. Beneficial feedback accelerates every dimension of the reform process by intensifying competition, further diminishing profits and motivating additional reform efforts on the part of enterprises and governments. These changes initiate further rounds of technical development, improved efficiency and reform increments.

68

Gary H. Jefferson and Thomas G. Rawski

Experience changes attitudes and expectations as well as behaviour This entire process affects the attitudes of enterprise personnel and government officials toward the direction and outcome of reform. Changing attitudes affect the objectives and strategies of all participants. For example, the experience of partial reform created pro-market sentiment among former advocates of central planning (Shirk, 1993; Rawski, 1994b). The thinking of government officials and political leaders experienced similar changes. The rise of pro-market sentiments among the political and administrative elite represents the biggest feedback of all. In the early 1990s, these reactions coalesced into a stunning reversal of deep-seated attitudes. Ideas that only ten years earlier stood outside the limits of permissible discussion now took centre stage. Ambitious bureaucrats began to resign their official posts to pursue private business careers (Chen, 1994). China's Communist party formally announced a national goal of creating a decentralized market economy (Decision, 1993). This remarkable change in outlook, combined with intense fiscal pressures, has sparked a series of policy innovations aimed at relieving governments of the burden of supporting loss-making enterprises. Although official documents avoid terms like "ownership reform" or "privatization" to describe these changes, recent initiatives amount to a policy of gradual and induced privatization. Ministries, provinces and localities have begun to lease state-owned industrial firms to private agents (including foreign companies). Some loss-making firms are forced to merge with stronger enterprises, with substantial loss of jobs (Huang, 1994). Others are auctioned off to the highest bidder. The government has also begun to support the reorganization of state enterprises into limited-liability entities owned by government, corporate and private share-holders. Although this analysis focuses attention on the endogenous or bottom-up aspects of the reform process, China's mix of top-down initiative and bottom-up reaction is itself a variable element within the reform mechanism. In the 1980s, when the centre lacked clear objectives, initiative gravitated to lower levels. In the 1990s, a new elite consensus favouring market outcomes stimulated a volley of centrallydirected reforms affecting taxation, banking and corporate governance. The paradox of China's industrial reform

69

China offers a shifting array of forces in which many policy changes, such as the partial commercialization of bank lending and the reduction of budgetary appropriations for industrial research, probably represent a combination of bottom-up response and independent central initiative.

How the different enterprises contribute to industrial reform The dynamics of China's industrial reform arise from policy initiatives that generally relax constraints on entrepreneurial initiative and market activity. It is hardly surprising, therefore, to find major shifts in the distribution of industrial activity among different types of enterprises. This section describes the specific contributions various kinds of firms make to the operations of China's industrial innovation ladder. State-owned enterprises Despite their falling share of industrial output, state-owned enterprises retain a central position in China's industrial economy because they provide essential inputs, are converted to other forms of ownership, provide a valuable source of fiscal revenues, and offer social insurance against disruptions during the transition. They provide essential inputs to the growing periphery Interaction with state firms provides essential resource inputs and market outlets for other types of firms, especially collectives and joint ventures. The robust growth of China's industrial periphery, particularly its rural TVEs, required the import of intermediate inputs, including machinery and equipment, steel and other producer goods that, during the 1980s, were the purview of state industry. The introduction during the early 1980s of "dual track" pricing, which partitioned supplies of nearly all commodities into distinct segments to be sold at plan and market prices, and the continuous expansion of dualtrack pricing after 1985 were critical ingredients in the growth of China's non-state sector. At the outset of reform, in the late 1970s, most of the technical capabilities of China's industrial sector resided in the equipment, 70

Gary H. Jefferson and Thomas G. Raivski

facilities and personnel controlled by large and medium-sized state enterprises. The flow of technologies, including equipment, product designs, engineering skills and marketing opportunities, are critical to the technological development of China's fast-growing rural collectives. Through the sale of second-hand equipment and the provision of technical services and "Sunday engineers" to the collective sector, state-owned enterprises have become an important conduit for the diffusion of technology within China's industrial economy. China's "open door" policy, initiated in the late 1970s, has created expanding opportunities for these state enterprises, most of which were isolated from the world economy during China's period of socialist planning. These enterprises have upgraded their operations by accessing production technologies, management systems, designs and technical knowhow through increased participation in international markets. This ongoing process of upgrading occurs partly through independent initiatives and partly through joint ventures with overseas businesses. It contributes to growing diversity and technological sophistication within the state sector, because some firms move their operations toward international frontiers of quality and technology, while others fail to do so. This process of upgrading is allowing many state-owned enterprises to retain their technological advantage and continue to transmit newer techniques down the industrial ladder. They are converted into new ownership types

In addition to continued support for China's smaller, less technically sophisticated enterprises, state enterprises are contributing to the growth of the non-state sector in more direct ways, through their conversion to other forms of ownership. Thousands of state-owned enterprises have been converted to joint ventures. In motor vehicles, electronics and many other industries, joint ventures involving former state-owned enterprises have replaced state industry at the pinnacle of China's domestic quality ladder. Studies of these firms focus on the technical, managerial and financial contributions of the international partners, which range from giant multi-nationals like Hitachi and Chrysler to family firms operated by Chinese entrepreneurs from around the Pacific Rim. The contributions state-owned enterprises make to labour, equipment and technical personnel also provide an The paradox of China's industrial reform

71

important component of joint venture operations. Beijing Jeep illustrates the capacity of joint venture firms to make profitable use of equipment and designs contributed by the Chinese partners even in sectors in which domestic firms operate far below international technical frontiers. A growing number of state-owned enterprises have reorganized themselves into joint-stock companies, some of which are now listed on stock exchanges in Shenzhen, Shanghai, Hong Kong, Singapore and New York. These restructurings, which typically begin with various Chinese government agencies holding a controlling interest, have the potential to evolve in many directions. Unanticipated changes have already begun. In some cases, government holdings have fallen below 50 percent, and in other cases, incumbent management has been ousted following poor financial results. The conversion of state enterprises into joint ventures and jointstock companies involve the departure of successful firms from the ranks of state-owned enterprises. This intensifies the competitive pressures facing the remaining state-owned firms. It also artificially Table 3.7: Productivity of large and medium state enterprises by performance category: Conversions and loss-makers Category

Year

Labour Productivity1

Capital Productivity2

1988-1992 balanced sample of large & medium state enterprises (N=2345)

1988 1992 change

43,380 11.56%

2.08 2.14 0.93%

Firms exiting SOE classification during 1988-1992 (N=105) and entering a new classification (N=73)

1988

44,701

3.35

Persistent losers: firms with negative profit throughout 1988-1992

1988

15,800 13,464 -3.98%

1.49 0.99

1992

change

29,079

-10.50%

Note: The total number of large and medium industrial enterprises in 1992 was 16,903 (Yearbook, 1993:417). 1. Q/L: gross output in current prices divided by year-end employment. 2. Q/K: gross output in current prices divided by year-end net fixed assets. Source: Jefferson, Rawski and Zheng, 1996.

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Gary H. Jefferson

and Thomas G. Rawski

depresses measures of overall state industry performance, and elevates performance measures for the emerging joint venture and corporate sectors. These effects are visible in Table 3.7, which summarizes output per man-year and annual output per unit of fixed assets for a significant number of China's large and medium-sized industrial firms. Data for 73 firms classified as state enterprises in 1988 and subsequently reclassified as joint ventures or shareholding corporations show that 1988 output per worker and per unit of fixed assets surpassed the sample averages by 50 percent. This process of reallocating state industrial assets to the non-state sector appears to have accelerated in recent years. In 1995, the State Council estimated that on average, approximately 250 million yuan of fixed assets were moved out of state industry each day. Their profits represent a vital source of fiscal revenues Throughout the two decades preceding the reforms, China's stateowned enterprises served as the economy's main revenue generator. By controlling agricultural and raw material prices to the industrial sector, the Government was able to generate surpluses which it captured and recycled into industrial investment and public expenditure. Reliance on state industry as the principal source of public revenue has continued into the present. State-owned enterprises have, however, become increasingly squeezed by price reform (which has generally driven up input prices relative to product prices) and by competition from the burgeoning nonstate sector. Nonetheless, state industry continues to provide a substantial share of central and local government revenues. In 1994, 65 percent of industrial taxes were paid by state industry; these in turn represented approximately 40 percent of total government revenues. They provide social insurance against disruptions during the transition State-owned enterprises provide social insurance against the worst disruptions of transition while a publicly managed system of unemployment, health, and pensions is put in place.

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Collective firms China's cycle of reform and innovation is not an automatic consequence of partial reform efforts. Its existence depends on specific aspects of the country's institutional set-up and economic structure. Rural collective industry is one of the most important ingredients in China's reform achievements (urban collectives are comparatively insignificant). The expansion of collective industry intensifies competitive pressures and encourages growing numbers of firms and government agencies to adopt market-oriented business strategies, pursue technical change and explore new rounds of institutional reforms. The collective sector makes two main contributions. Collectives contribute to the diversity of corporate ownership, organization, management and incentives that provides the foundations for a dynamic selection process. More specifically, the presence of collective operations energizes the state sector. Coddled by official favouritism and accustomed to monopolistic control over product markets, stateowned enterprises in a growing range of industries found their market dominance shattered by rambunctious competition from collective rivals who began with a 1978 base of 3 million firms and 28 million workers. These rural firms have begun to challenge state-owned enterprises in a range of industries including food processing, garments, and labour-intensive assembly manufacturing, cement (one-third produced by TVEs) and machine tools. China's second-largest cement producer is a TVE firm; by 1994, 30 of China's top 500 firms (ranked by sales) came from the TVE sector (Liu, 1994; China Daily, September 6, 1995). The expansion of collectives has served as a lever forcing state firms toward market-oriented behaviour. The consequences are measurable. World Bank researchers use provincial data to obtain statistical relationships showing that high growth of industry outside the state sector is associated with reduced profit rates in the state sector and that a low share of provincial output by state-owned enterprises is associated with high levels of multi-factor productivity (Singh, Ratha and Xiao, 1993). That is, the rapid growth of non-state industry tends to erode the monopoly profits of state enterprises. Moreover, when non-state industries come to dominate regional economies, they motivate greater efficiency, or eliminate the least efficient of the state-owned enterprises. 74

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An important factor in the success of collectives is the relative freedom of collective firms from the controls and obligations that burden their state-owned rivals. Rural firms pay lower taxes than state-owned enterprises. Redundant workers can be dismissed and whole enterprises closed down as market circumstances change. Collectives rarely provide housing for employees; their youthful workers require little in the way of pension outlays. Altering the product mix, shifting among suppliers or market outlets, changing prices, entertaining or even bribing customers—these and many other business manoeuvers are much easier for collectives than for their state-sector rivals. Despite their success, it is too soon to conclude that China's collectives represent an enduring organizational innovation. Their dependence on resources from the state sector, the tendency for collectives to cluster at the low end of the scale and technology spectrum, and the somewhat artificial nature of their domestic cost advantages all suggest that the rapid gains of the collectives owe much to specific circumstances of China's economy in the 1980s. Problems arising from vaguely defined property rights are no easier to resolve locally than nationally. Tight controls strangle enterprise initiative, but loose controls invite abuses: news reports complain that "illegal diversion of administrative funds to [collective] businesses" is rampant in rural China, with annual losses amounting to nearly US$1 billion in Guangdong province alone (Wu, 1995). Another issue concerns "triangle" or "chain" debts, which arise when firms continue to supply important customers despite their failure to pay for earlier shipments, and then seek to protect cash-flow by delaying payments to their own suppliers. Debt chains, formerly confined to the urban sector, have now spread to rural industry. The growing responsiveness of state firms to market forces, attributable in no small part to the pain inflicted by collective intrusions into formerly sheltered markets, presents new difficulties for collective expansion. State-owned enterprises, joint ventures, domestic enterprise groups and sellers of imports have begun to use brand names, advertising, full product lines and interregional distribution networks to develop marketing strength that neither individual collectives nor newly-formed groups of collectives can easily match. Rising incomes and growing demand for quality will erode the The paradox of China's industrial reform

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market for inferior goods, to which much of the production of collectives is directed. Improved transport networks and the declining scope of local barriers against "imports" from outside jurisdictions have exposed rural-based collectives to unprecedented competition in their own home markets. The growing importance of collectives has also encouraged the government to eliminate some of their special cost advantages. New regulations equalize the tax burdens on all types of enterprise—a big change from previous rules that placed the largest tax burdens on state-owned enterprises. Shanghai and many other jurisdictions now collect pension contributions on an equal basis from all firms, easing another big cost burden on the state sector. The pressure of competition, coupled with these institutional difficulties, has brought growing financial strains. Widespread discussion of falling profits in the state sector has obscured the equally rapid decline in the earnings of collectives (Table 3.6). Falling profits threaten the survival of firms and the stability of local banks. A 1995 report from the Shining County (Jiangsu) branch of the Agricultural Bank of China states that many rural industries are partly or entirely closed down, that two-thirds of the branch's loans to TVE firms are overdue and that 20 percent of outstanding industrial loans were extended to firms that have ceased production (Xia Hongwei, 1995). These reports indicate the beginning of a shake-out in collective industry. Rising labour costs are undercutting the economic basis for manufacture of garments and other labour-intensive products in China's coastal cities. Growing demand for high-quality products, fuelled by rising incomes and successful advertising from producers of brand-name goods (e.g., Proctor & Gamble), is squeezing the market for inferior goods, the mainstay of many collectives. Firms in the upper tier of collective production are pushing toward nationally and internationally competitive industrial production that draws on modern management methods and science-based techniques to stabilize quality and upgrade the product mix. These trends are most notable in the suburbs of China's largest cities and in the lower Yangzi region adjacent to Shanghai, where successful firms now pursue business links with universities and research institutes. This behaviour represents a decisive break with the agricultural origins of the collectives. Firms 76

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that fail to make this transition will be left to compete for a share of China's vast, but declining market for inferior goods. Firms outside the state and collective sectors Firms outside the state and collective sectors, now contributing onequarter of China's industrial output, occupy the top rungs of China's industrial innovation ladder. In many industries, joint ventures represent the cutting edge of China's technological advance. At the opposite end of the spectrum, privately-owned firms, often small and illequipped, add a new element of diversity to China's industrial sector. Joint ventures Joint ventures, which scarcely existed before 1980, have emerged as a major force in China's international trade. They include a variety of organizational forms, but typically involve a cooperative manufacturing effort in which an overseas firm (defined here to include firms based in Hong Kong, Macao and Taiwan) joins forces with one or more Chinese entities, typically a state-owned manufacturer. They create an independent producer that is directed, funded and managed under working arrangements determined by the parent firms. Since the Chinese government provides joint ventures with substantial tax and regulatory relief, Chinese firms eagerly seek out joint venture partners. Recent publications report a total of more than 20,000 joint ventures employing over 1.5 million workers and contributing roughly seven percent of national industrial output. Joint-venture activity is tightly clustered along China's east coast, with three-quarters of this output coming from the southern coastal provinces of Guangdong, Fujian and Jiangsu and the three province-level metropolises of Beijing, Tianjin and Shanghai. Many joint ventures operate in dutyfree export zones and produce mainly for foreign markets. As a result, their economic impact is most notable in China's export trade, where these firms now contribute over one-fourth of overseas sales. The rapid growth (Table 3.4) and export success of joint ventures has led some observers to trumpet their achievements as evidence favouring accelerated privatization of state and collective firms. This overlooks several important matters. China's government has showered joint ventures with tax and regulatory concessions. Foreign The paradox of China's industrial reform

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participants no doubt select the most capable and well-connected domestic firms as joint-venture partners. The export accomplishments of joint ventures suggest that the upper stratum of domestic firms is rather close to attaining international competitiveness, needing only an injection of funds, equipment, designs, marketing, or management from foreign partners to break into world markets. Given the large ownership role of public-sector entities—state firms, collectives and even Chinese government bodies—on the Chinese side, it is not entirely accurate to describe the typical joint venture as a private enterprise. With extensive ties to the domestic public sector, joint ventures are not immune from the political pressures, regulatory snares and cultural practices that impede modernization efforts in domestic (especially state-owned) firms. It is not unusual for Chinese managers to lead both a joint-venture firm and its Communist party branch! Despite a favourable policy environment, many joint ventures lose money. Reports of joint-venture losses, some no doubt fabricated to reduce tax liabilities, are sufficiently numerous to prompt Chinese officials to issue occasional statements denying that more than a "very few of them are in the red" (China Daily Business Weekly, August 30, 1993). Despite these weaknesses and their generally modest scale of operations, joint ventures have strongly influenced the process of industrial reform. Joint ventures bring foreign firms with their access to offshore pools of funds and their intimate knowledge of advanced technology, market intelligence and management systems into partnership with Chinese domestic enterprises. The impact of novel product designs, manufacturing processes, marketing techniques, information systems and management styles has begun to ripple through China's business community through supplier networks, competitive pressures and the rotation of Chinese personnel to and from foreign-linked enterprises. Along with their direct impact on partners, rivals, suppliers and employees, expansion of the Chinese operations of overseas firms contributes to China's ongoing information revolution, and to the absorption of new concepts, standards and organizational structures into China's domestic economy. Building codes, environmental standards, 78

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packaging standards, labour-relations practices, distribution systems, chain stores, market research, mass advertising and job-safety standards are among many areas in which joint ventures provide a transmission belt between international business practice and China's domestic economy. Private enterprise

Private enterprise, long the bane of socialist propagandists, is booming in China today. Chinese industry includes 8 million "individual enterprises" employing fewer than 8 workers. There are also a few thousand "private enterprises" employing 8 or more workers. The impact of these firms on output is small. The individual units account for 80 percent of industrial enterprises, but only 8 percent of 1993 production. Private-sector urban manufacturers employed 1.7 million workers in 1993, most no doubt in 680,000 individual proprietorships. Most private firms are tiny entities on the fringe of China's industrial economy. Only one of 9,447 large and medium-sized industrial firms is owned by domestic private interests (Science Yearbook, 1994). In 1993, exports of private domestic firms amounted to US$182 million, a mere 0.2 percent of the national total (China Daily, March 3, 1994). Private industry and commerce account for only 0.05 percent of all bank loans. Private industry also operates at the margin of China's polity. Although China's leaders often endorse the expansion of private business, individual entrepreneurs are easy targets for informal tax levies. With little hope of support from the legal system, entrepreneurs seek the shelter of protective arrangements with powerful officials or agencies. Some private businesses masquerade as collectives; others obtain a measure of protection by making what amount to insurance payments in appropriate places. Under socialist planning, no industrial manager could fulfil his obligations without violating the law. The same is true of today's private entrepreneurs, who build their fortunes on intricate arrangements that inevitably contain elements of evasion, deceit and graft. China's ranks of entrepreneurs include many dynamic personalities who aspire to imitate the well-publicized achievements of Jimmy Lai and others The paradox of China's industrial reform

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who have risen from humble origins to become business magnates in Hong Kong or Taiwan. Some will undoubtedly succeed. Until China's government acts to regulate the legal and regulatory atmosphere surrounding private business, the future of private industry is very difficult to forecast.

What reform means to foreign firms in China What does China's ongoing reform mean to foreign firms contemplating entry into the China market or expansion of current China-related activities? The sheer size of China's economy, the obvious potential for continued expansion and the consequent significance of China as a market or production site for globally-oriented businesses all argue for an expanded commitment of resources and effort to China-related business activity. At the same time, the long history of exaggerated hopes for the "China market" requires that enthusiasm be tempered by sober appraisal of costs and risks as well as opportunities and benefits. Several features of China's political economy deserve careful attention from the international business community. Do not expect quick success Dreams of easy profits in China have fascinated generations of entrepreneurs. Reality, however, is quite different. As we have seen, reform has intensified market competition in virtually every sector of China's economy. As a result, business in China is difficult. 1993 statistics showed over 40 percent of foreign-linked firms in various provinces and cities reporting losses, including 486 of 1,089 firms in Shenzhen; claims of losses among 100 percent of foreign-linked firms in some districts of Guangdong province suggest that some firms conceal profits to avoid taxes (Sun, 1993). A year earlier, another survey found 64 percent of individual foreign ventures and 44 percent of multi-nationals' operations earning profits (Xu, 1995). A 1995 survey of 147 USand European-linked firms in Beijing, Shanghai, and Guangdong found that 61 percent of managers describe their operations as "okay," 35 percent reported higher profit in 1995 than in 1994, 51 percent reported higher turnover in the same period and 53 percent expected to increase staff (Gao, 1996). Furthermore, the favourable treatment applied to foreign-linked 80

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firms is fading, partly because of the requirements of international organizations and partly because of rising confidence in China's capacity to attract overseas funds without policy concessions. Thus preferential policies applied to special economic zones "are gradually being eliminated." Provisions allowing "duty-free imports for foreignfunded enterprises" were scrapped in April 1996 (China Daily, December 19, 1995; Tong, 1996). The trend is clear: Vice Premier Li Lanqing says that "preferential policies will be phased out" (Kahn, 1995).

Prepare for fierce competition China's economy has a rich history of strenuous competition. In the decades prior to World War II, Chinese firms mastered a variety of technologies pioneered by overseas producers and "successfully competed with foreign rivals in textiles, food processing, light engineering, acid and soda products" and many other items that "did not require block investments or sophisticated technology" (Rawski, 1989). Today, the same competitive instinct is very much alive. Many foreign companies indicate that profit margins are lower than in mature markets and in other developing economies (Xu, 1995). Furthermore, growing integration with global markets now means that domestic firms are no longer excluded from producing goods that require large investments or advanced technologies. Although some Chinese firms receive direct or indirect subsidies, and thus escape the full force of market pressures, most do not. Fifteen years of rising costs and declining profits have turned large numbers of domestic firms into hardened competitors that stand fully prepared to offer tough competition to foreign rivals at home and in overseas markets. Recent tariff reductions signal China's willingness to increase financial pressures on domestic firms in order to gain admission to the World Trade Organization; they also signal Beijing's confidence in the capacity for domestic businesses to meet intensified competition from overseas producers as well as foreign-linked local suppliers.

Appreciate China's economic dynamism A survey of the reform process shows that China's economy is truly dynamic, and not simply because of rapid output growth. There have The paradox of China's industrial reform

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been big changes in relative prices, in the composition of output, in the balance of regional advantage, in consumer preferences, in the lending practices of Chinese banks, in regulatory procedures and in institutional arrangements. The nature of China's reform, which has progressed through competition among firms and local governments as well as through initiatives from Beijing, ensures that institutional and regulatory uncertainty will continue. Business arrangements that perform well today may quickly lose their effectiveness without constant efforts to anticipate the impact of economic and institutional changes on costs and profit margins. These changes are sometimes beneficial to foreign business, as when local leaders relax national requirements in order to attract joint venture investments (Zhou, 1996), but they can also hurt, as when the Bank of China slows the growth of loans to foreign-funded ventures (Ren, 1995). The following policy and institutional changes are likely to occur during the remainder of the 1990s: further commercialization of banking continued withdrawal of administrative limitations on layoffs and bankruptcy gradual erosion of subsidies and other supports to loss-making enterprises expanded efforts to lease, merge, auction or otherwise dispose of money-losing state enterprises continued decline in the contribution of state-owned industries to output and employment emergence of powerful corporate groups continued liberalization of imports increasing efforts to attract foreign investment to China's central and western provinces, and expanded enforcement of environmental laws and regulations. Do not underestimate costs Low costs attract foreign firms to China. But "low wages do not translate into cheap labour costs," because of the cost of training and rapid employee turnover (Xu, 1995). In the coastal regions where foreign ventures cluster, however, "wages are increasing and the standard of living is increasing, so costs are increasing" and many firms are 82

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moving to interior regions, which promise lower labour costs, but only after costly investment in new facilities, new marketing and procurement channels, and coming to terms with new sets of regulators (Kalathil, 1995). Business in China involves unusual costs and risks. Protection against default, patent and trademark infringement, theft of technology and other forms of commercial misconduct leave much to be desired, despite continuing reform efforts (Brauchli, 1995; Smith, 1995). The uncertainty surrounding property rights makes it difficult to formulate and execute clearly defined contracts. Negotiation costs are substantial. Flexibility, good will, and close personal ties often emerge as crucial ingredients in successful business arrangements. Expatriate managers rank China (along with India and Indonesia) "among the three most corrupt countries in Asia" (Economist, 1995). Chinese officials recognize that "collection of illicit fees from foreignfunded firms has become a problem" (Liaoning, 1996). Chinese authorities show a growing tendency to use regulation of foreign-linked firms as a signalling device that in effect announces their priorities and concerns to the domestic business community. This is particularly clear in the realm of labour relations, where a desire to "boost the rights of workers" and to "publicize labour laws" leads to special efforts to dramatize labour disputes involving overseas firms and to secure "better protection for workers ... in foreign-funded firms" (Cao, 1994). Issues involving environmental concerns, workplace safety, product liability, fringe benefits and pension contributions invite similar treatment. In all these areas, foreign businesses should anticipate costs appropriate to the standards sought by Chinese officials rather than those currently applied to the average domestic enterprise.

Remember that market economy practices and beliefs remain fragile Until very recently, Chinese schoolchildren were taught that, prior to 1949, foreign trade and investment had "sucked the blood of the Chinese people." Hovering close to the surface of many Chinese discussions of the "open door" policy is the idea that international business is a zero-sum proposition, and that the existence of profits or high The paradox of China's industrial reform

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salaries on the foreign side demonstrates that domestic participants suffer losses. Signs of resurgent nationalism among Chinese youth increase the probability that foreign-linked economic activity in China will become a target for political assault in much the same way it has in Canada and the United States. The Chinese government has taken forceful action to curb foreign enterprise when it sees a threat to domestic business interests. For example, it has consolidated the home telecommunications industry, and it has required overseas firms to register their financial news organizations with their Chinese competitor, the New China News Agency (Xinhua). Laws and regulations designed to protect proprietary technologies and other forms of intellectual property rights are only gradually taking shape, and enforcement remains erratic. Maintain a broad, informed perspective on China's economy Broad and deep institutional forces are driving China's industrial transformation. This means that changes in any specific industrial branch may be in response to developments in other sectors of the economy. The lesson for business executives is therefore clear. In addition to mastery of one's own line of business, success in China's complex and dynamic economy also depends on an appreciation of the links between wider processes of economic and social change and conditions in particular industries and markets. Careful consideration of the broad contours of China's ongoing reform will help entrepreneurs prepare for the surprises both large and small, pleasant and unpleasant, that are certain to confront any China-related business.

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References Blanchard, Olivier Jean and Stanley Fischer. 1993. NBER Macroeconomics Annual, 1993. Cambridge: MIT Press. Blasko, Dennis J. 1994. "Review of Paul Folta, 'From Swords to Plowshares? Defense Industry Reform in the PRC." Far Eastern Economic Review. March 3. Brauchli, Marcus W. 1995. "China's New Economy Spurs Legal Reforms, Hopes for Democracy." Wall Street Journal. June 20: 1. Cao Min. 1994. "Jobs Probe to Boost the Rights of Workers." China Daily. February 19: 1. Chang, Chung and Yijiang Wang. 1994. "The Nature of the Township-Village Enterprise" Journal of Comparative Economies. 19:3. 434-452. Chen Chunmei. 1995. "Rural Firms Do One-Third of State Exports." China Daily. May 6: 5. Chen, Kathy Chen. 1994. "Chinese Bureaucrats Take Hopes Private." Wall Street Journal. January 26: A10. China Daily. 1995. "SEZs to Swap Tax Breaks for Reforms." December 19:4. . 1995. September 6: 5. . 1994. "Private Economy Continues Growth." March 3: 1. China Daily Business Weekly. 1993. August 30. Decision. 1993. "China's Central Government Decision on Resolving Several Problems Concerning the Establishment a Socialist Market Economic System." Renmin ribao (People's Daily). November 17: 1. Du Haiyan and Shang Lie. 1993. "Distribution of Fringe Benefits for Employees of State-owned Enterprises." Zhongguo gongye jingji yanjiu (Research on Chinese Industrial Economics) 2: 30. 46-52. Economist, The. 1995. "Hard Graft in Asia." May 27: 61. Gao, Bianhua. 1996. "JVs Operating Well - Survey." China Daily. February 26: 2. Granick, David. 1990. Chinese State Enterprises: A Regional Property Rights Analysis. Chicago: University of Chicago Press.

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Grossman, Gene M. and Elhanan Helpman. 1991. "Quality Ladders and Product Cycles." Quarterly Journal of Economics. 106: 557586. Harrold, Peter. 1992. "China's Reform Experience to Date." World Bank Discussion Paper No. 180. Washington DC: World Bank. Hirschman, Albert O. 1958. The Strategy of Economic Development. New Haven: Yale University Press. Hua, Sheng, Xuejun Zhang and Xiaopeng Luo. 1993. China: From Revolution to Reform. Houndsmills: Macmillan, 1993. Huang, Zhiling. 1994. "Mergers Revive Loss-making Firms." China Daily. April 16: 4. Hussain, Athar and Nicholas H. Stern. 1994. "Comment on 'How Industrial Reform Worked in China: The Role of Innovation, Competition, and Property Rights' by Jefferson and Rawski." Proceedings of the World Bank Annual Conference on Development Economics 1994. Washington, D.C: World Bank. 157-162. Industry. Zhongguo gongye jingji tongji nianjian (Statistical Yearbook of China's Industrial Economy). Annual since 1988. Beijing: Zhongguo tongji chubanshe. Jefferson, Gary H., Albert G.Z. Hu, Inderjit Singh and Benzhou Wang. 1996. "Wage and Employment Behavior in Chinese Industry." In G. Jefferson and I. Singh, eds. Jefferson, Gary H., Mai Lu and John Z.Q. Zhao. 1996. "The Reform of Property Rights in China's Industrial Enterprises." In G. Jefferson and I. Singh, eds. Jefferson, Gary H., Ping Zhang and John Z.Q. Zhao. 1996. "An Overview of Survey Results from Chinese Industry." In G. Jefferson and I. Singh, eds. Jefferson, Gary H. and Thomas G. Rawski. 1995. "How Industrial Reform Worked in China: The Role of Innovation, Competition and Property Rights." Proceedings of the World Bank: Annual Conference on Development Economics 1994. Washington, D.C.: World Bank. 129-156. . 1994. "Enterprise Reform in Chinese Industry." Journal of Economic Perspectives. 8:2 (Spring). 47-70.

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Jefferson, Gary H., Thomas G. Rawski and Yuxin Zheng. 1996. "Innovation and Reform in Chinese Industry." In Jefferson and Singh, eds. . 1992. "Growth, Efficiency, and Convergence in China's State and Collective Industry." Economic Development and Cultural Change. 40:2. 239-266. , forthcoming. "Chinese Industrial Productivity: Trends, Measurement Issues, and Recent Developments." To appear in journal of Comparative Economics. Jefferson, Gary H. and Inderjit Singh, eds. 1996. Reform, Ownership, and Performance in Chinese Industry. Washington, DC: World Bank (manuscript). Jiang Xiaojuan, et al. 1993. "New Features of China's Industrial Growth and Structural Change." Zhongguo gongye jingji yanjiu. (Research on Chinese Industrial Economics). 8: 32-40. Kahn, Joseph. 1995. "China May Cut Foreign Firms' Incentives." Wall Street Journal. October 30: A17. Kalathil, Shanthi. 1995. "In China, Investors Flock Inland from Costly Coast." Wall Street Journal. October 25: A17. Krugman, Paul. 1979. "A Model of Innovation, Technology Transfer, and the World Distribution of Income." Journal of Political Economy. 87:21. 253-266. Labour. Zhongguo laodong gongzi tongji nianjian (Yearbook of China Labor and Wage Statistics). Annual since 1989- Beijing: Zhongguo tongji chubanshe. Lardy, Nicholas R. 1992. "Chinese Foreign Trade." China Quarterly. 131:691-720. Large scale. 1989- Zhongguo dazhongxing gongyeqiye, zongheben (China's Large and Medium-scale Industrial Enterprises, summary volume). Beijing: Zhongguo chengshi jingji shehui chubanshe. Liaoning. 1996. "Liaoning Challenges Illicit Fee Collection." China Daily. May 4: 2. Liu, Baogen. 1994. "Cement Firm has Big Aspirations." China Daily. December 12: 2. Naughton, Barry. 1995. "China's Macroeconomy in Transition." China Quarterly. 144 (December): 1083-1104.

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. 1994. Growing Out of the Plan: Chinese Economic Reform, 19781993. NY: Cambridge University Press. Ody, Anthony J. 1991. "China: Rural Enterprise, Rural Industry, 1986-1990." Unpublished paper. Washington DC: World Bank. Pei, Jianfeng. 1995. "Daqing Field Offers More Black Gold." China Daily. July 2: 5. Perkins, Dwight H., et al. 1977. Rural Small-Scale Industry in the People's Republic of China. Berkeley: University of California Press. Rawski, Thomas G. 1996. "An Overview of Chinese Industry in the 1980s." In Jefferson and Singh, eds. . 1995a. "The PRC's Industrial System: Reform, Obstacles, and Opportunities." The Economy of the PRC: Analysis and Forecasts. Studies by the Salomon Brothers Panel of PRC Experts. Report No. 1 November. 25-43. . 1995b. "Implications of China's Reform Experience." China Quarterly. 144: 108-131. . 1994a. "Export Performance of China's State Industries." Unpublished. . 1994b. "Progress Without Privatization: The Reform of China's State Industries." In Vedat Milor, ed. The Political Economy of Privatization and Public Enterprise in Post-Communist and Reforming Communist States. Boulder: Lynne Rienner. 2752. . 1989- Economic Growth in Prewar China. Berkeley: University of California Press. Ren, Kan 1995. "BOC Hikes Loans to Foreign-Funded Firms." China Daily Business Weekly. April 29: 1. Rural Enterprise. 1993. Zhongguo xiangzhen qiye nianjian 1993 (Yearbook of Chinese Rural Enterprises, 1993). Beijing: Nongye chubanshe. Sachs, Jeffrey and Wing Thye Woo. 1994. "Reform in China and Russia." Economic Policy. April: 101-145. Science Yearbook. 1994. Zhongguo keji tongji nianjian 1994 (1994 China Statistical Yearbook on Science and Technology). Beijing: Zhongguo tongji chubanshe. 88

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Woo, Wing Thye, et al. 1993. "The Efficiency and Macroeconomic Consequences of Chinese Enterprise Reform." China Economic Review. 4:2. 153-168. Wu, Yanrui. 1993. "Productive Efficiency in Chinese Industry." AsiaPacific Economic Literature. 7:2. 58-66. Wu, Yunhe. 1995. "State Tries to Curb Collective Asset Loss." China Daily. July 4: 1. Xia Hongwei. 1995. "Where Have All the Bank Funds Gone?" Sunan Rural Enterprise. 5:34. Xu Binglan. 1995. "It Can Take Years to Earn Profits." China Daily. October 3:2. Yearbook. Zhongguo tongji nianjian (China Statistical Yearbook). Annual since 1981, except for 1982. Beijing: Zhongguo tongji chubanshe. Yin Wenquan and Dong Yanbin. 1996. "State Sector and Non-State Sector: Reform Orientation and Development Policy." Jingji yanjiu (Economic Research). 3: 43-50. Zhou Fuquan. 1996. "Problems and analysis dealing with the use of foreign direct investment." Touzi yanjiu (Investment Research). 1: 39-42. Zweig, David. 1991- "Internationalizing China's Countryside: The Political Economy of Exports from Rural Industry." China Quarterly128: 716-741.

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Southeast Asian business systems:

The dynamics of diversity Linda Lim

The outstanding characteristic of Southeast Asia is its diversity— diversity of cultures and political structures, diversity of economic development and diversity of business actors. Because of a history of openness to such external forces as immigration, investment and trade, Southeast Asia's indigenous business system is a complex hybrid consisting of ethnic Chinese and indigenous capitalists who have relied on family networks and close links with rulers and governments. Southeast Asian business systems will continue to evolve in response to the dynamic economic and political environment in the region. This dynamism and diversity may be of particular interest to Canadian business since the country's own immigrant communities from East Asia are making Canada an increasingly cosmopolitan business environment. Despite the diversity, however, the different national business systems in Southeast Asia are systematically similar in many ways. These characteristics suggest a potentially more representative model of business system development for other developing regions of the world than either western or East Asian models. The area's extremely rapid growth sustained over many decades suggests that conformity to either set of established models is not necessary for economic and business success. Southeast Asia's already significant and rapidly increasing integration into both "western" and "East Asian" business systems 91

makes the continued development of its own business systems of growing global as well as regional importance. This paper describes and explains existing business systems in the developing capitalist market economies of Southeast Asia,1 and suggests the directions that their future evolution is likely to take. First, it reviews the regional economic, political and cultural environments, and the evolving roles of different regional business actors, and then integrates these factors. It then considers whether and why Southeast Asian business systems may or may not distinctively differ from western and East Asian systems, and if any distinctiveness is likely to persist over time as economies, enterprises and political systems mature, global business linkages proliferate, and the influence of internationalization on local cultures intensifies.2

The economic environment The economic environment facing businesses in Singapore, Malaysia, Thailand and Indonesia over the past thirty years has been one of rapid export-led growth with relatively low inflation, and high savings and investment rates (Hill, 1994; World Bank, 1993). Dependence on foreign investment has also been high, while reliance on the export of primary commodities is declining. The economic structure has diversified with rapid economic growth as firms have moved up the value chain and technology ladder, encouraged by both market adjustments and government policies. There has been a developmental progression from subsistence level production of primary products through export-oriented primary production, to labour-intensive export manufacturing, capital-intensive and high-tech manufacturing, and labour and skill-intensive services,

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1

Southeast Asia consists of six market economies—Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand—with a total population of 330 million, and four reforming socialist economies of Myanmar (Burma), Vietnam, Cambodia and Laos, with a total population of 120 million. Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand and recently Vietnam are members of the Association of Southeast Asian Nations (ASEAN).

2

This work draws on Lim, 1996.

Linda Lim

for both world and domestic markets. Such sectors coexist within given countries, with newer sectors displacing older ones only when resource constraints are reached. The regional division of labour in Southeast Asia is based on differences in national comparative advantages and on the special role of Singapore. Singapore is a commercial and financial intermediary; it provides capital, skilled labour and infrastructure services for its neighbours. Through the internal division of labour within multinational corporations based on comparative advantage, and facilitated by the existence of free trade zones, Singapore is also the location of many "high-end" manufacturing functions linked to "lower-level" activities in neighbouring economies (Lim and Pang, 1991; Lim, 1994b). As national comparative advantages change, trade and investment also shift activities among different Southeast Asian countries. For example, labour-intensive manufacturing has been relocated from Singapore to Indonesia and land- and labour-intensive agriculture from Malaysia to Vietnam (Lee, 1994; Lim, 1995a). Trade and investment flows also link Southeast Asia with Northeast Asia. Japan is the region's largest trade partner, foreign investor and aid donor, with Taiwan, Hong Kong and Korea ranking close behind as sources of foreign investment (Doner, 1993; Wells, 1993). Except for Singapore, the countries of Southeast Asia are still developing, though Malaysia, and sometimes Thailand, are occasionally classified as newly-industrializing. They are thus characterized by market imperfections and institutions that are still being developed. Business actors respond to these obstacles in certain ways in order to access resources and information, assess and reduce risks and minimize transaction costs. At the same time, abundant natural resources, the rapid growth of markets and the appearance of new market opportunities encourage and reward opportunistic, entrepreneurial and risktaking business behaviours. Such behaviour contrasts with that in rather slower-growing industrial economies like those of the west and Japan, where greater emphasis is placed on productivity enhancement. Underdevelopment and rapid export-led growth in Southeast Asia mirror conditions in Northeast Asia at an equivalent stage of development. One might expect to see similar organizational and behavioural responses from the business community. But two other aspects— Southeast Asian business systems: The dynamics of diversity

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resource abundance3 and the active, often dominant, participation of foreign business actors—distinguish the Southeast Asian cases from their Northeast Asian neighbours. They introduce different forms and stronger external influences into local business systems. Thus, for example, resource-extracting foreign multinationals like oil-and-gas companies and plantation-based agribusinesses are two prominent forms of business enterprise in Southeast Asia that are generally not found in Northeast Asia. Both regions began industrializing under protective trade and investment regimes and then liberalized over time but Southeast Asia has received much larger flows of foreign direct investment. Among domestic entities, the dominant commercial role of the ethnic Chinese immigrant minority in Southeast Asia has no parallel in Northeast Asia.

The political environment National political systems in the capitalist market economies of Southeast Asia have been for the most part authoritarian, although there is considerable diversity among countries and over time. Most states adopted nationalist ideologies in the aftermath of western colonialism. Military-backed regimes dominated most of the post-colonial era in Indonesia, the Philippines and Thailand, while dominant-party governments characterized the electoral systems in Malaysia and Singapore. Authoritarianism and militarism have been legitimated on grounds of national security concerns, given internal political tensions caused by ethnic diversity, the widespread existence of communist insurgencies and ethnic separatist movements in the immediate postcolonial period as well as the triumph of socialist regimes in nearby Indochina and Myanmar. The Vietnam War also provided the motivation for national economic development and for regional cooperation

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Southeast Asia has a greater relative abundance of labour than Northeast Asia and, unlike Northeast Asia, also has an abundance of land and natural resources. Capital has been readily available through domestic savings and foreign investment, to the extent that it has even been argued that the region may be receiving "too much" in the way of foreign capital inflows (Brauchli, 1995).

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within the ASEAN grouping to provide political stability. For this reason, too, external economic, political and military links with western powers were maintained long after colonialism ended. In Southeast Asia there is the additional element of indigenism, which differentiates between immigrant-origin ethnic Chinese and peoples of heterogeneous indigenous origins, called bumiputra in Malaysia and pribumt in Indonesia, for example. The Chinese are now locally-born and -domiciled, and are partially culturally-assimilated. In most places, however, they are a small minority.4 Despite these characteristics they dominate local private business, particularly the modern urban-industrial sector. This is a source of internal political tension which has been managed in part by discriminatory policies designed to restrict Chinese business activities and/or to advantage their indigenous counterparts through affirmative action (Golay et al, 1969). In response, segments of the Southeast Asian Chinese business community have developed personal "clientelistic" relationships with politically powerful individuals or the military in order to protect, maintain and advance their business interests, most notably with the Suharto regime in Indonesia. Chinese business interests thus benefit both from the political stability engendered by, and their connections with, authoritarian regimes. In more democratic countries, they organized collectively to achieve the same end, most notably in ethnic business associations such as the Chinese Chamber of Commerce and in political parties such as the Malaysian Chinese Association in Malaysia. In both cases, political involvement has been necessary to Chinese business success, if not survival. Recently, democratic regimes have begun to emerge. Improved information flows and popular demands for more transparency and fairness in government and business actions (relating, for example, to issues of corruption and to the environment) may induce some changes in local business practices. The position of the Chinese makes the implications for business of democratization more complex. On the

4

Apart from Singapore, which is 75 percent Chinese, their relative numbers are 2 percent in the Philippines, 4 percent in Indonesia, 10 percent in Thailand and 30 percent in Malaysia.

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one hand, their slight representation among Southeast Asian electorates suggests that the Chinese political influence is likely to decline with the rise of democratically elected governments. On the other hand, their economic power and established clientelistic relationships might enhance their political influence through the funding of sympathetic political parties or candidates (Lim and Gosling, forthcoming).

The cultural environment Southeast Asia's cultural diversity contrasts vividly with Northeast Asia's ethnic and cultural homogeneity. This contrast occasionally has been advanced as one of the reasons for the latter's economic success, in that intergroup conflicts are minimized and a "sense of common purpose" is easier to marshall among people with a common heritage. High savings and investment rates, high levels of education, and tolerance of and high standards for bureaucratic intervention are associated with Northeast Asia's Confucian culture. Yet the Southeast Asian countries have virtually matched the economic achievements of Northeast Asia without such cultural homogeneity. Indonesia, for example, has more than 300 ethno-linguistic groups and is the world's largest Islamic country, with Chinese accounting for only 4 percent of its population, yet for more than two decades it has had savings and investment rates of around 35 percent of GDP and annual GDP growth rates of over 6 percent. Thailand, where Theravada Buddhism is the major religion and cultural influence, has enjoyed even more rapid growth for a longer period of time. Malaysia's three ethnic groups—Muslim Malays, Confucian Chinese and predominantly Hindu Indians—have achieved social harmony as well as rapid economic growth over many decades.5 Only in the Catholic Philippines has economic performance been lagging until recently. One may argue from these success stories that capitalist economic development is compatible with many different cultures or that all Asian cultures contain elements that are conducive to

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Widely-publicized race riots linked to election results in May 1969 have not been repeated since.

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capitalism.6 Our interest here is in whether culture shapes aspects of the business system. Certainly the political ramifications of cultural diversity play a role, as noted in the case of ethnic Chinese business dominance. Certain elements common to all Asian cultures, such as the importance of family, gift-giving, relationships and respect for age and education, are also reflected in regional business behaviours. But do specific cultural attributes result in distinctive business systems and practices in different ethnic and cultural groups?

Regional business actors National governments National governments have arguably been the dominant players in the evolution of modern Southeast Asian business systems to date (Maclntyre, 1994). Many differences exist among countries and over time in government economic policies. Yet the early adoption and maintenance of sound macroeconomic management and realistic exchange rates by Malaysia, Singapore and Thailand have been emulated in Indonesia and the Philippines. In the microeconomic area, policies have been more varied and variable. Like most other developing countries, Southeast Asian governments pursued policies of import-substituting industrialization in the post-independence period, motivated economically by latecomer disadvantages and politically by nationalist aspirations. While such goals required trade barriers like occasionally overvalued exchange rates, the market distortions were relatively mild by developing country standards. In most periods and places (the Philippines being the most notable exception), the export competitiveness of primary commodities was never seriously threatened. Later, the push to export manufactures in the 1970s resulted in partial trade liberalization. Economic reforms in the wake of external debt problems and recession in the mid-1980s included more unilateral trade liberalization that 6

Malaysia's Deputy Prime Minister Datuk Seri Anwar Ibrahim has even argued that "collaboration between Muslim-Malay and Confucian-Chinese communities has made Southeast Asia into a prosperous region" (Straits Times, March 14, 1995).

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continues to this day, bolstered by similar initiatives at the regional, sub-regional and multilateral levels.7 Most countries imposed at least some restrictions on foreign investment (Singapore being the exception), mostly by requiring majority local ownership in resource exploitation and domestic market-oriented sectors, and/or phase-ins to increase local ownership over time (most notably in Indonesia). By the 1970s, 100 percent foreign ownership was permitted in export-oriented manufacturing. Investment liberalization, which began in the 1980s, has continued. In May 1994, for example, Indonesia lifted local ownership requirements, which was followed by a record US$24 billion of new foreign investment commitments in that year. Some governments in the region have been open to foreign direct investment not only for the usual reasons of access to capital, technology and foreign markets, but also because of their desire to secure a counterweight to the private sector dominance of local ethnic Chinese business. This was most clearly the case in Malaysia, where employment created in multinational subsidiaries for bumiputra and equity ownership for them in foreign-owned companies helped achieve the ethnic redistribution objectives of the Malay-dominated government's New Economic Policy (Brauchli, 1995). In Indonesia, joint ventures with foreigners provided a channel of entry into business for aspiring pribumi businessmen, particularly the politically well-connected. The dominant business presence of minority ethnic Chinese helps explain the relatively weak support by Southeast Asian governments for local private business (Jesudason, 1989). State-owned enterprises were developed, largely in infrastructure and resource-based industry, for political (nationalism, indigenism) as well as economic (public goods, externalities, contribution to government budget) reasons.

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Regional policy initiatives include the ASEAN Free Trade Area (AFTA) to be completed by 2003 and the Asia Pacific Economic Cooperation (APEC) free trade area to be completed by 2020; the sub-regional policy development is the "growth triangle" linking contiguous territories of neighbouring countries in limited local freedom of goods, capital, services and labour flows; and the multilateral influence is the GATT Uruguay Round agreement and the establishment of the World Trade Organization.

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Such enterprises provided alternate economic opportunities for indigenous bureaucrat-managers and, in the case of Malaysia, for economic assets explicitly held "in trust" for the bumiputra community at large. Privatization, when it came in the 1980s and 1990s, often involved privileged distributions of such state-owned assets to politically wellconnected members of this community.8 A somewhat similar situation prevails in Indonesia, where privatization is much less advanced than in Malaysia, while in Thailand more limited state enterprises remain in the hands of the Thai bureaucracy. Beyond policies to attract foreign investment and promote exports generally, the governments of Singapore, Malaysia and Indonesia have also undertaken strategic industrial policies to channel resources into specific industrial sectors or industries, most notably electronics and other high-tech activities in Singapore; automobiles, steel and other heavy industry in Malaysia; and aircraft in Indonesia (Jomo, 1995). Foreign multinationals have played key roles in these strategic ventures, primarily as suppliers of technology, but also as joint-venture partners with state-owned enterprises. Similar policies have not been enacted in Thailand or the Philippines. Western multinationals Western multinationals are the oldest-established modern enterprises in Southeast Asia, beginning with colonial-era multinational trading companies and export plantations. Some of the original enterprises, such as the Dole pineapple plantations in the Philippines, survive today, but most have been taken over by nationals in both ownership and management. Some are being transformed from trading companies into manufacturers, and from plantations into property development companies. Other western multinationals include oil and gas companies, import-substituting "brand name" industrial enterprises established in the 1960s and 1970s, export-manufacturing enterprises established since the 1970s, financial services companies and, most

8

This lack of support for, and in some cases even antagonism toward, local Chinese private business existed even in Singapore, where an English-educated bureaucracy held the reins of political power.

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recently, manufacturing ventures oriented simultaneously at both domestic and foreign markets. Thus, even before the investment liberalizations of the late 1980s and 1990s, western multinationals occupied a major, if not dominant, role in the modern sectors of Southeast Asian economies. They included both wholly 100 percent foreign-owned and joint-venture companies, and in Malaysia and Singapore many were publicly listed on the local stock exchanges. Since the 1970s, the presence of western multinationals has steadily increased as these economies have grown and developed new sectors, and barriers to foreign trade and investment have been progressively reduced (Lim, 1994a; Jomo, 1993; Bowie, 1991; and Lim, 1995c). Until the 1990s, western investment in Southeast Asia was most attracted by the region's abundant physical resources and cheap labour and the possibilities they provided for competitive exports to world markets. In resource-based activities such as oil and gas extraction, partnership with state-owned enterprises was required, and production-sharing agreements took the place of foreign ownership. In export-oriented manufacturing, 100 percent foreign ownership was allowed, in part because foreign technology and global sourcing and marketing networks were essential. Western enterprises were least represented in manufacturing for protected local markets, where joint ventures with local partners, often with only a minority foreign stake, were usually required. In consumer products, however, licensing to local manufacturers was common. The surge of western multinationals into Southeast Asia in the 1990s is accounted for by enterprises still pursuing resource extraction, but also export manufacturing projects which are more capitalintensive and often regionally-integrated (Lim, 1995b). There is new interest in production for the rapidly growing local and regional markets which are now either of a sufficient size to attract the interest of global companies in their own right, or are perceived as "strategic" in companies' struggle for global market shares. Most such projects still involve the participation of local joint-venture partners, whose contributions of capital, manpower, local market knowledge and government and business connections balance the technological, managerial and global market access contributions of the foreign investors. 100

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Japanesemultinationals9 If western companies were the earliest foreign investors in Southeast Asia, they were soon overtaken by Japanese multinationals who supplied protected local markets through minority joint-venture partnerships or who exported labour-intensive manufactures to world markets from their wholly-owned subsidiaries. The relocation of Japanese export industry to Southeast Asia accelerated in the 1980s and 1990s with the appreciation of the yen. Much more so than in the case of western firms, manufacturing investments by major Japanese multinationals were accompanied or followed by investments by other, smaller, firms in their home-country supplier networks. This helped to multiply and integrate Japanese investments, which are in the process of integrating Southeast Asia into the Japanese multinationals' global production networks. The Japanese influence on Southeast Asian business systems is spread through their local joint-venture partnerships with ethnic Chinese businesses and indigenous state-owned enterprises as well as their growing relationships with local suppliers. Ethnic Chinese capitalists™ Ethnic Chinese account for only a small proportion of Southeast Asia's population as a whole, but they dominate its private business sector."

9

Companies increasingly practise a regional division of labour, locating different stages of production, or producing different products, in different countries according to their respective comparative advantages. There exists a voluminous literature on this subject. A selection of more recent works includes: Phongpaichit, 1990; Yamashita, 1991; Tokunaga, 1992; Dobson, 1993; Doner, 1993.

10

The literature on Overseas Chinese business is extensive, but generally tends to focus more on East than Southeast Asia. Works focussing on the latter region include: Wu and Wu, 1980; Lim and Gosling, 1983; Limlingan, 1986; McVey, 1992; Chan and Chiang, 1994. My own most recent work on the subject is Lim and Gosling, forthcoming.

11

Estimates typically have the Chinese accounting for roughly 4 percent of Indonesia's population but 75 percent of its modern private sector, with equivalent figures for the Philippines of 2 percent (40 percent), for Thailand of 10 percent (85 percent) and for Malaysia of 30 percent (65 percent) (Lim and Gosling, forthcoming).

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This phenomenon has its roots in the pre-colonial and European colonial era, when trade-oriented immigrants from southeastern coastal China came to Southeast Asia. They were favoured by both local rulers and European colonialists as tax-collectors and commercial intermediaries ("compradors") to indigenous peasant populations because, being a small immigrant minority, they did not constitute a political threat to their patrons. Their status as "outsiders" and their political vulnerability also led the Chinese to cultivate relationships with those in power as a means of assuring political protection, accessing business opportunities in a controlled environment, and reducing risk. Besides the sponsorship of local authorities, the Chinese had several other advantages over indigenous populations in entering into trading ventures. They were not subject to existing local cultural sanctions against trade, or indeed to any discouragement posed by the low status of the merchant in the Confucian social hierarchy in China itself. As migrants, they were not only self-selected for risk-taking, ambition and entrepreneurism, but also maintained international links with their home country and with fellow countrymen who had migrated to other countries in the region. These links facilitated trade. In their host countries, the Chinese immigrants were not tied to conservative established social orders, but were rather excluded from traditional modes of livelihood such as agriculture. Trade was thus often their only means of subsistence and upward mobility, and one which fit in with the migrant's short-term horizon and preference for liquid investments and quick returns. In addition, many of the early Chinese migrants to Southeast Asia had been traders at home and were motivated by trade to emigrate. Chinese migrants set up clan-, village-, occupational-, school-, temple- and other associational networks for mutual assistance in Southeast Asian host countries. These ethnic networks, which often had cross-national extensions, provided them with privileged access to scarce capital and information, and cheap loyal labour from within the Chinese community itself. The networks also helped them find business opportunities, assess and reduce risks, minimize transaction costs and ensure collective security to advance their business interests in economies with underdeveloped markets and institutions and imperfect information and price signals. Migrants also tended to save a lot 102

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of their income for repatriation to the mother country as well as for reinvestment in the host economy. After independence, Chinese communities in some Southeast Asian countries were subject to nationalist government policies which discriminated against them on the basis of race, in some cases reducing the scope of their business activities (Golay et al, 1969). Such practices reinforced the need to develop clientelistic relationships with politically powerful local patrons, who often included the military. The erection of trade and investment barriers by new nation states in Southeast Asia, and the isolation of China after the communist revolution in 1949, further restricted the previously "borderless" reach of Chinese businesses in the region. Chinese communities lost their migrant or "sojourner" characteristics but not their minority status in their adopted lands. Even before this, permanent settlement had increased and with it, varying degrees of assimilation to indigenous Southeast Asian cultures. With the assistance or at least tolerance of indigenous patrons, Chinese businesses took advantage of import-substituting policies (which otherwise hurt their import trade) to enter the industrial sector. This was sometimes done at the behest of national governments seeking to develop particular key industries who relied on their Chinese clients for risk-taking and initiative (e.g. in steel and cement in Indonesia). In import-substituting industries, the external relationships that Chinese traders had with foreign suppliers helped provide the foreign joint venture capital, technology and expertise required in modern manufacturing for the domestic market. Chinese businesses themselves contributed some capital, local political connections and market knowledge, and distribution networks. Chinese businesses in Southeast Asia had long been involved in the export of primary commodities. But export manufacturing to industrial country markets in the west (since regional markets were themselves protected) required different skills and connections. These had been developed by the Chinese in Hong Kong and Taiwan, who established themselves as subcontractors to, and original equipment manufacturers for, foreign buyers. As foreign investors escaping third-country import quotas (as in textiles and garments), or chasing cheaper local labour and tax incentives, they were the first to bring such Southeast Asian business systems: The dynamics of diversity

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labour-intensive export manufacturing to Southeast Asia in the 1970s. Some of them entered into partnerships with Southeast Asian Chinese, more because they were often the only local partners available, rather than because they were Chinese.12 Western and Japanese multinationals also invested in export manufacturing, but since 100 percent foreign ownership was allowed in this sector, they rarely took on local partners. However, they played a major role in developing local suppliers, who were overwhelmingly drawn from the ranks of Chinese entrepreneurs.13 Two developments since the late 1980s have increased the public profile of ethnic Chinese capitalists in Southeast Asia. The first is the increased presence of foreign Chinese investors from Taiwan, Hong Kong and Singapore as shifting comparative advantage has caused them to relocate labour-intensive export manufacturing to the cheaper ASEAN countries. The second is the economic rise of China, which has attracted large investments from Chinese business domiciled in Southeast Asia. The Sino-Thai Charoen Pokphand (CP) Group of Thailand, as is well known, is considered to be the largest single foreign investor in China. CP was founded by a Chinese immigrant who specialized in supplying chicken feed, who then branched out into distribution of day-old chicks and feed, followed by exporting grown chickens. CP expanded these activities into China in the early 1980s and had an important impact on China's subsequent agrarian reforms. CP has also entered into a variety of joint ventures in China with foreign firms producing a variety of products including motorbikes and telecom services. Other cumulatively large investments in China have been made by Chinese-Indonesian business groups such as Lippo and Salim, one of the best-known conglomerates linked to the Suharto

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For example, dialect-group differences existed between Chinese from Taiwan and Hong Kong, on the one hand, and those in Southeast Asia on the other (some of whom by now speak little or no Chinese of any kind).

13

The most prominent Thai company neither founded nor primarily owned by Sino-Thai capital is the Siam Cement group, which was established by the Thai government and whose main shareholder is the Thai royal family through its Crown Properties Bureau. For more on the relationship between Sino-Thai capital and the Thai state, see Hewison, 1989.

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family. Chinese-Malaysian and Chinese-Filipino groups as well as Singaporeans have also made investments. These two developments have arguably led to a "re-Sinification" of otherwise partially-locallyassimilated Chinese business groups in Southeast Asia. The "typical" Chinese business enterprise in Southeast Asia today is a diversified family-owned conglomerate headed by the founderpatriarch or his immediate descendants. It is tempting to see ethnic cultural characteristics embedded in this enterprise form—particularly the Confucian family system and the inclination toward individual entrepreneurship resulting in the proliferation of autonomous business units. But it is at least equally likely that this form is dictated by environmental conditions— specifically the underdevelopment of markets and the consequential importance of relationships. These relationships then become the core competitive asset of the firm which is leveraged to provide new business that is likely to be in different sectors, given relatively small markets and rapid growth. The minority status of the Chinese, rather than their ethnic cultural characteristics (which are diluted in the Southeast Asian context), may make relationships both within and outside the group more important to them. Similarly, the family nature of the enterprise and the use of family members to manage its different branches may simply reflect the youthful stage of enterprise development, the inadequacy of capital markets, the scarcity of skilled labour in fast-growing economies and underdeveloped human resource management systems. Indigenous capitalists This discussion refers only to indigenous capitalists in Malaysia and Indonesia. Thailand is excluded not only because of the overwhelming dominance of ethnic Chinese and Sino-Thai business at the mediumand large-scale enterprise levels, but also because the Sino-Thai ethnic admixture makes separate identification of an indigenous capitalist class difficult (Lim, 1983; Lim and Pang, 1982; Lee and Low, 1990; Doner and Ramsay, 1993). In the case of the Philippines, most nonChinese local capital is of Spanish-Chinese-mestizo, rather than indigenous Malay, origin (Yoshihara, 1985). In Malaysia and Indonesia, on the other hand, the development of bumiputra and pribumi business communities has been promoted by Southeast Asian business systems: The dynamics of diversity

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indigenous-dominated governments which have given them privileged access to government contracts and credit allocations, for example. Malaysia's New Economic Policy (NEP) from 1970-1990 also included ethnic quotas favouring Malays in higher education, employment and equity ownership in larger companies, and provided scholarships to train Malays in business skills. State-owned enterprises were set up that were run by Malay managers, and subsequently privatized into the hands of privileged members of the Malay business elite. Some of these enterprises, particularly agribusiness plantations and mining companies, were taken over from foreign shareholders in "market nationalization" moves by the Malaysian government in the 1970s. The Malay ruling party UMNO was also active in business, generating further opportunities for its members. The result of these developments has been the rapid emergence of a class of Malay capitalists. Malay-Chinese joint business ventures are another evolving aspect of this development. Access to higher education has been a crucial element of the success of Malay business leaders in Malaysia (in the pre-NEP era, access to education was dominated by non-Malays). Political connections have been important to both groups, but for the Chinese these have tended to be connections with Chinese political leaders who exist because of Malaysia's electoral democracy, its racially-based parties and the large proportion (about one-third) of the electorate who are ethnic Chinese. Despite their common educational background, senior Malay business leaders are themselves a heterogeneous group. They include "products of the conservative boardroom" in publicly-listed diversified conglomerates like Sime Darby and Golden Hope, which retain a "western organizational face" (Tsuruoka, 1994); entrepreneurial managers of state-owned corporations like Petronas (Asiaweek, September 3, 1994); UMNO party members or supporters involved in partybased "money politics"; politically well-connected private entrepreneurs; as well as other independent entrepreneurs who have made little use of political connections (Jayasankaran, 1994). Malays are also not the only non-Chinese local businessmen—there are also prominent Indian business leaders who, like the Chinese and Malays, may also make use of political connections. Political connections are even more important to pribumi business 106

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in Indonesia, which has a less-developed, more heavily-regulated and less-transparent market economy than Malaysia and is not an electoral democracy. In Indonesia, strategic alliances between Chinese conglomerates and President Suharto's family members and associates are often seen as a source of monopolization of lucrative sectors of the Indonesian economy (Schwarz, 1992; McBeth, 1994). Suharto himself has defended his children's involvement in business as both their individual right and a means of increasing pribumi participation in the otherwise Chinese-dominated private sector. More recently, some observers argue that Suharto is beginning to distance himself from the Chinese, whose unpopularity is a political liability in a potentially liberalizing political environment. At the same time, non-Suhartolinked, non-Chinese-linked pribumi groups are on the ascendancy and will provide more competition for the Chinese, particularly as economic liberalization proceeds. Even so, pribumi firms account for only 5 of the 25 largest conglomerates in the country (Budiman, 1994). In terms of their structure and operations, indigenous Southeast Asian businesses resemble the ethnic Chinese enterprises which operate in the same country. They are family-based enterprises which rely heavily on personal relationships, including political connections, to access business opportunities. Using these relationships as their core competitive asset to attract foreign and local Chinese partners, they can thus access external sources of capital, technology, managerial and marketing expertise. As in the case of Chinese business, a diversified conglomerate enterprise form is the natural result. The major differences between Chinese businesses and indigenous Southeast Asian businesses are that the latter are more likely to be directly involved in politics or state-owned enterprises and more likely to rely on education and previous occupational experience as secondary or even primary assets in launching and expanding their business ventures. Ethnic and village-based networks, while they exist, are probably less significant for the indigenous Southeast Asian capitalist than for the Chinese one. International connections are also weaker. But the "minority" effect may be similar. Ethnic minorities have traditionally had an advantage in indigenous Southeast Asian trade (Foster, 1974), and many pribumi businesses in Indonesia are drawn not from the majority Javanese community but from outer island Southeast Asian business systems: The dynamics of diversity

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minority groups, such as the Malay, the Bugis and the Minahasa. Since Chinese dominate the business community, indigenous enterprises operate as a minority within the private sector, a characteristic which encourages them to seek a competitive edge through privileged access to state resources and to form strategic alliances with the "majority" community and with foreigners to bolster their own position. Their minority position also encourages them to network among themselves.

A Southeast Asian business system? Several distinctive features of Southeast Asian business systems have been outlined above. Their location in underdeveloped economies encourages the development of private institutional mechanisms such as networks and relationships to access information and reduce costs and risks. Rapid economic growth additionally rewards risk-taking behaviour, thereby encouraging an entrepreneurial mode of operation. Entrepreneurial behaviour together with the development of relationships as core competitive assets leads to a conglomerate form of enterprise. The development of market economies is recent, and the youthfulness of most firms makes family enterprises the most common form of enterprise. In addition, for historical reasons, the state's role in economic development is that of a major initiator and regulator of economic activity and of a participant in such activity in its own right. Thus far, there would seem to be little to distinguish business systems in Southeast Asia from those in Northeast Asia. Distinctiveness comes from the presence of an important natural resource and agricultural exporting sector, from long-established openness to international trade and foreign business participants, and from the dominant presence of an ethnic Chinese minority business community. Control of the natural resources sector has strengthened the economically interventionist role of the state. The Southeast Asian countries' long-established involvement in international trade and with foreign traders also began with the export of natural resources and agricultural products. Locally-domiciled ethnic Chinese played an important role in this trade as middlemen or agents of European colonial import-export houses. In the post-colonial period, many foreignowned companies in the agricultural and mining sectors were taken over by the state, creating a base of western-derived organizations run 108

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by indigenous bureaucrat-managers who themselves eventually formed the nucleus of an indigenous business class. New state-owned enterprises were also set up to develop newly discovered natural resources like oil and natural gas, and these have remained in state hands. Western business organizations are prevalent in the modern manufacturing and services sectors too. Western organizational forms and business practices are disseminated through their hiring of local employees and managers and their active development of local suppliers—both of which encourage local, particularly ethnic Chinese, business entrepreneurs. Japanese enterprises, in contrast, have frequently been criticized for inadequate development of local managers and suppliers. While inadequate localization and lower turnover of local managers in Japanese subsidiaries might be expected to limit the dissemination of Japanese business practices, in fact a strong Japanese influence exists because of numerous joint ventures with local partners and because industrial firms of all nationalities are dependent on Japanese suppliers. Southeast Asian Chinese enterprises are differentiated from those in Chinese-majority territories like Hong Kong, Taiwan and Singapore by the specific nature of their relationships with the indigenous state and with both western and Japanese business organizations which supply them with technology and contacts in world market. Southeast Asian Chinese enterprises are more likely to include both conglomerates and very large firms; they are concentrated in trade, services and property development while their Northeast Asian cousins are active in manufacturing on their own account (without foreign joint venture partners). Southeast Asian Chinese are less likely to develop internal firm competitive advantages based on technology or marketing assets, and more likely to rely on privileged external relationships. Ethnic Chinese are small in number and many prefer to be entrepreneurs rather than employees in the dynamic economic environment because of ethnic quotas in existing organizations. Thus Southeast Asian Chinese companies must employ many non-Chinese, who also form the bulk of their customers and must develop ethnically-neutral business practices. I have argued that the differences between local Chinese and Southeast Asian business systems: The dynamics of diversity

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indigenous business enterprises in Southeast Asia are relatively minor and historically-specific. Rather, their considerable similarities are based on adaptations to similar environmental conditions, particularly the abundant opportunities for entrepreneurship, the utility of networks and relationships, and the natural evolution of family-based enterprises in fast-growing underdeveloped, but newly industrializing economies. Both groups also share a common need for state support or patronage as a response to government regulation and minority status. These politically-based relationships then become part of their competitive asset base and may be leveraged to obtain technology from foreign partners in many different sectors. This gives rise to the diversified conglomerate, which is also a means of economizing on scarce entrepreneurial and managerial skills. Cultural differences between local Chinese and indigenous business enterprises are also minimal and smaller than the differences between Southeast Asian and western cultural systems. Even so, the diversity of business cultures found in Southeast Asia, and their close interaction with each other over long periods of time, makes it difficult to argue that a single ethnic business culture is regionally dominant beyond certain sector-specific cases such as the dominance of indigenous state enterprises in petroleum in Malaysia and Indonesia. Rather, there is mutual adaptation by the various business actors, both to each other and, more fundamentally, to shared underlying economic and political conditions. This readiness to adapt to and include foreign and minority participants in the local business system has been characteristic of Southeast Asia throughout its long and very active trading history. It has also contributed to the region's openness to foreign trade and investment, which in turn has contributed substantially to its rapid economic growth and may deliver a particular advantage in competing in the increasingly liberalized, diverse and "globalized" business world of the future.

Continuing evolution As described in this paper, Southeast Asian business systems are characterized by a diversity of business actors operating in rapidly-growing, underdeveloped and politically-controlled market economies. Among local private—as distinct from foreign and state—enterprises, 110

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there is a preponderance of family firms which operate in an entrepreneurial and opportunistic mode, with many ending up as large diversified conglomerates. Closely linked to government and politics, these enterprises are heavily networked and dependent on personal relationships which extend to all ethnic groups and foreigners. Southeast Asian Chinese enterprises rely more heavily on ethnic and familial networks, while indigenous enterprises rely more heavily on education and the state. For both groups of firms, government and private sector connections comprise a key competitive asset that enables them to access information, capital and specific business opportunities, and to reduce risks and transaction costs. This business system is continuing to evolve in response to major changes that are under way in the Southeast Asian environment. Market liberalization policies (including deregulation and privatization) adopted since the 1980s are both increasing competition from new foreign and domestic entrants and reducing the importance of government connections. With economic development, market imperfections decline and new legal and financial institutions are established, which further reduce the need to resort to non-market institutions such as relationships and networks to access capital or to guarantee contracts. Some countries are also experiencing shifts in comparative advantage which, together with the emergence of new investment locations in other developing countries such as China, India, Vietnam and Myanmar, have reduced their international competitiveness in labourintensive industry and agriculture. Labour scarcity makes retaining workers and increasing their productivity a matter of high priority. New business opportunities are enticing them to invest abroad. These developments make it necessary to compete on the basis of competitive advantages familiar to the western firm—based on technology, management and marketing skills. Because these skills can be obtained from foreign companies, the value of such alliances relative to those with local governments and ethnic networks increases. Slow but steady movements toward political liberalization such as participatory democracy, a free press and free labour organization also increase popular demands for greater transparency in business operations and reduce tolerance of close business-government relationships Southeast Asian business systems: The dynamics of diversity

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which are perceived to be anti-competitive and rent-seeking. Such democratization is also likely to reduce the influence of the ethnic Chinese minority business community on government and politics. At the same time, the growing size and complexity of Southeast Asian enterprises increases their need for public sources of capital— e.g. through emerging local equity and bond markets, and participation in global financial markets—and professional management, both of which will lead to a loss of family ownership and control. Outside capital providers especially will demand more transparency in business practices and better management, just as family-based businesses face the challenge of succession from their founder-entrepreneurs to a new generation. Whether the new company leaders come from the ranks of family members or from unrelated professional managers, their ways of doing business are likely to differ from those of the founder-patriarchs. For both groups, and even for new-generation entrepreneurs, these ways are perhaps more likely to resemble those of the west due to the spread of western managerial training and experience (Far Eastern Economic Review, 1994; Asiaweek, December 14, 1994). Education is likely to become a more important competitive asset to the firm. In short, the maturing of enterprises, economies, and political and legal systems is already initiating significant changes in Southeast Asian business systems. Significantly, such change may occur more rapidly than in Northeast Asia because established systems are less entrenched than they are in Japan and Korea. Change is likely to encounter both less resistance and fewer problems of transition, especially with continued rapid growth. The already high degree of market and foreign penetration of the Southeast Asian systems, their cultural diversity, the presence of many different cooperating and competing business actors and the political weakness of the ethnic Chinese commercial minority also weaken resistance to change. At the same time, change is unlikely to occur overnight, or to be complete for several reasons. First, except in Singapore, Southeast Asian economies have a long way to go before they become developed. Thus established ways of doing business will retain utility for some time to come. Second, established practices will also continue to be useful in the neighbouring developing economies of China and 112

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Vietnam, in which Southeast Asian companies are increasingly involved. Third, market liberalization is unlikely to be complete. Indigenist policies are unlikely to be completely eliminated because of lingering concerns about business domination by the ethnic Chinese minority and/or foreigners. Fourth, established practices have considerable utility in an advanced modern economy. For example, the high-tech industry is characterized by rapid growth, the proliferation of multiple new opportunities, imperfect information, high risk and uncertainty, short product-cycles and first-mover advantages which reward speed to market. Trust based on long-term relationships can help in accessing information and patient capital, encouraging risk-taking and permitting flexibility and speed in operations. The entrepreneurial mode of operation, conglomerate form of enterprise and international strategic alliance so familiar in Southeast Asian business systems all retain their utility under these circumstances. But a high-tech industry of this type, already increasingly common in East Asia, particularly Taiwan (and to a lesser extent Singapore where companies produce computer sound cards invented by ethnic Chinese entrepreneurs), has yet to make its appearance in Southeast Asia outside of Singapore.

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References Asiaweek. 1994. "Lefty Visions." September 3. Asiaweek. 1994. "Into the Big Time." December 14. Bowie, Alsadair. 1991. Crossing the Industrial Divide. New York: Columbia University Press. Budiman, Ariel. 1994. "Suharto's Revised New Order." Far Eastern Economic Review. December 22. Brauchli, Marcus. 1995. "Foreign Capital Holds Key in Southeast Asia." Wall Street Journal. January 23: 1. Chan, Kwok-Bun and Claire Chiang. 1994. Stepping Out: The Making of Chinese Entrepreneurs. Singapore: Simon and Schuster. Dobson, Wendy. 1993. Japan and East Asia: Trading and Investment Strategies. Singapore: Institute for Southeast Asian Studies. Doner, Richard F. 1993. "Japanese Foreign Investment and the Creation of a Pacific Asian Region." In Jeffrey A. Frankel and Miles Kahler, eds. Regionalism and Rivalry-.Japan and the United States in Pacific Asia. Chicago: University of Chicago Press. and Ansil Ramsay. 1993. "Postimperialism and Development in Thailand/' World Development 21:5. 691-704. Far Eastern Economic Review. 1994. "Family Ties—Asia's Corporate Dynasties." November 17. Foster, Brian L. 1974. "Ethnicity and Commerce." American Ethnologist. 1:3. 437-448. Golay, Frank et al. 1969- Underdevelopment and Nationalism in Southeast Asia. Ithaca, NY: Cornell University Press. . Ralph Anspach, Ruth Pfanner and Eliezer Ayal. 1969Underdevelopment and Economic Nationalism in Southeast Asia. Ithaca, New York: Cornell University Press. Hewison, Kevin. 1989. Bankers and Bureaucrats, Capital and the Role of the State in Thailand. New Haven: Yale University Southeast Asia Studies Monograph Series 34. Hill, Hal. 1994. "ASEAN Economic Development: An Analytical Survey—the State of the Field." The Journal of Asian Studies.

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Jayasankaran, S. 1994. "You Gotta Believe." Far Eastern Economic Review. December 1. Jesudason, James V. 1989- Ethnicity and the Economy: The State, Chinese Business, and Multinationals in Malaysia. Singapore: Oxford University Press. Jomo, K.S., ed. 1995. Privatizing Malaysia: Rents, Rhetoric, Realities. Boulder, Colorado: Westview Press. , ed. 1993- Industrialising Malaysia. London and New York: Routledge. Lee, Tsao Yuan. 1994. "Overseas Investment: Experience of Singapore Manufacturing Companies." McGraw-Hill for the Institute for Policy Studies. Singapore: McGraw-Hill. and Linda Low. 1990. Local Entrepreneur ship in Singapore, Private and State. Singapore: Times Academic Press for the Institute of Policy Studies. Lim, Linda Y.C. 1996. "The Evolution of Southeast Asian Business Systems." Journal of Asian Business. 12:1. 51-74. . 1995a. "Models and. Partners: Malaysia and Singapore in Vietnam's Economic Reforms." In Scott Christensen and Manuel Montes, eds. Marketization in Southeast Asia. Palo Alto: Stanford University Press for the East-West Center. . 1995b. "Southeast Asia: Success Through International Openness." In Barbara Stalling, ed. The New International Context of Development. Cambridge, U.K.: Cambridge University Press. . 1995c. "Technology Policy and Export Development: The Electronics Industry in Singapore and Malaysia." In Charles Cooper, ed. Technology Policy in Developing Countries. London and New York: Routledge. . 1994a. "Foreign Investment, the State and Industrial Policy in Singapore." In Howard Stein, ed. Asian Industrialization and Africa. New York: St. Martin's Press. . 1994b. "The role of the Private Sector in ASEAN Regional Economic Co-operation." In Lynn Mytelka, ed. South-South Cooperation in a Global Perspective. Paris: OECD Development Centre.

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. 1993. "Chinese Business, Multinationals and the State: Manufacturing for Export in Malaysia and Singapore." In Linda Y.C. Lim and L.A. Peter Gosling. Volume 1. and Pang Eng Fong. 1991. Foreign Direct Investment and Industrialisation in Malaysia, Singapore, Taiwan and Thailand. Paris: OECD Development Centre. . 1982. "Vertical Linkages and Multinational Enterprises in Developing Countries." World Development 10:7. 582-595. Lim, Linda Y.C. and L.A. Peter Gosling, eds. 1993. The Chinese in Southeast Asia: Ethnicity and Economic Activity. Volume 1. Singapore: Maruzen International. , forthcoming. "Economic Growth, Liberalization and the Chinese in Southeast Asia." In Daniel Chirot and Anthony Reid, eds. Insiders and Outsiders: Chinese and jews in the Modern Transformation of Southeast Asia and Eastern Europe. Seattle: University of Washington Press. Limlingan, Victor Simpao. 1986. The Overseas Chinese in ASEAN: Business Strategies and Management Practices. Manila, Philippines: Vita Development Corp. Maclntyre, Andrew, ed. 1994. Business and Government in Industrialising Asia. Australia: Allen and Unwin. McBeth, John. 1994. "To Market, To Market." Far Eastern Economic Review. August 25. McVey, Ruth, ed. 1992. Southeast Asian Capitalists. Ithaca, New York: Southeast Asia Program, Cornell University. Phongpaichit, Pasuk. 1990. The New Wave of Japanese Investment in ASEAN. Singapore: Institute of Southeast Asian Studies. Schwarz, Adam. 1992. "All is relative." Far Eastern Economic Review. April 20. Straits Times. 1995. Singapore: March 14. Tokunaga, Shojiro, ed. 1992. Japanese Foreign Investment and Asian Economic Interdependence. Tokyo, Japan: University of Tokyo Press. Tsuruoka, Doug. 1994. "Wake-Up Call." Far Eastern Economic Review. March 3.

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Wells, Louis T. 1993. "Mobile Exporters: New Foreign Investors in East Asia." In Kenneth A. Froot, ed. Foreign Direct Investment. Chicago: University of Chicago Press. World Bank. 1993. The East Asian Miracle: Economic Growth and Public Policy. New York: Oxford University Press. Wu, Yuan-Li and Chun-Hsi Wu. 1980. Economic Development in Southeast Asia, the Chinese Dimension. Stanford, California: Hoover Institution Press. Yamashita, Schoichi, ed. 1991. Transfer of Japanese Technology and Management to the ASEAN Countries. Tokyo, Japan: University of Tokyo Press. Yoshihara, Kumio. 1985. Philippine Industrialization, Foreign and Domestic Capital. Manila, Philippines: Ateneo de Manila University Press.

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Hidden linkages in Japanese business Richard W. Wright

Japan's business system is dominated by keiretsu, powerful business groups that are probably the best known of the Asian business systems. Yet, in some ways, keiretsu are also the least understood by nonJapanese. Japan's business system is significantly different from the business systems of most western countries. Long-term employment practices, collective decision-making approaches, close collaboration between business and government are obvious differences, even to a foreign business person only casually involved with Japan. Many people have written about the management processes and internal relationships within Japanese companies (Kono, 1984; McMillan, 1985; Pascale and Athos, 1981; Ouchi, 1981; Whitehill, 1991). Many have also studied the close working relationship between Japanese companies and the Japanese government (Abegglen and Stalk, 1987; Gibney, 1975; Johnson, 1982; Nakatani, 1984; Patrick and Rosovsky, 1976). Detailed analyses of keiretsu, however, are fewer in number (Gerlach, 1987 and 1992; Imai, 1994; Wright, 1989), even though the implicit relationships among companies that belong to a keiretsu can have major consequences for foreigners doing business in Japan or competing with Japanese firms in world markets. While keiretsu have many much-vaunted strengths, they also have important weaknesses which may provide opportunities for Canadians 119

competing or cooperating with Japanese business groups. This paper focuses on the unique, cross-industry group relationships among companies in Japan, emphasizing aspects which may not be evident to the foreign business person. It first explains how these huge but informal clusters of companies came into being. Then it reviews the nature and characteristics of the keiretsu groups, and identifies some of the key mechanisms which integrate the apparently autonomous member firms. Finally, it explores the significance of these powerful relationships for Canadians and other foreigners, using examples from several different groups.

How keiretsu began The origin of Japanese industrial groups dates back to the closing decades of the 19th century, when the so-called "Meiji Restoration" propelled Japan from a feudal society toward a modern military and industrial power. In its haste to build a modern economy from technology and skills acquired abroad, the Japanese government founded companies in many new industries, then sold them off to the private sector. However, only a handful of wealthy merchant families had the financial resources and business acumen to buy and manage them. By the turn of the century, several groups of widely diversified companies had evolved, each owned and operated by a single family. As their wealth continued to expand, these families became the nation's new aristocracy, and their companies became the new "financial cliques" or zaibatsu (Genay, 1991; Miyashita and Russell, 1994: 22). A number of these groups grew and prospered in the early decades of the present century, particularly around the time of World War I. By the 1930s, four of them had achieved positions of dominance: Mitsui, Mitsubishi, Sumitomo and Yasuda. The formal zaibatsu clusters were officially dissolved by the American military occupation after the war, in part because of their central role in Japan's military efforts and in part because they conflicted with American antimonopoly ideals. As soon as the Americans left, however, the companies began to cluster back together again in true Japanese fashion. The main difference was that members of the new groups were no longer centrally controlled by holding companies or interlocking directorships. Rather, they were ostensibly indepen120

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dent, stand-alone companies, cooperating voluntarily with each other for important financial, commercial and strategic reasons. Today's keiretsu are much less centralized and much more flexible than their zaibatsu counterparts were. Eight of these horizontal groups dominate the Japanese economy today. Four are essentially re-groupings of the pre-war "Big Four" zaibatsu'. Mitsui, Mitsubishi, Sumitomo and Fuyo (Fuyo is based on remnants of the old Yasuda group). Four newer groups, each centred on a large bank, have formed from remnants of other pre-war groups and by attracting new members: the Sanwa group, the DKB (Dai-Ichi Kangyo Bank) group, the Tokai group and the IBJ (Industrial Bank of Japan) group. Sanwa and DKG, together with the earlier "Big Four" zaibatsu descendants, comprise today's "Big Six" keiretsu groups. These so-called "financial" keiretsu spread horizontally across industry lines. There are also two basic kinds of vertical keiretsu in Japan: production keiretsu, in which a number of parts suppliers and assemblers put together products for a single end-product manufacturer, as in the auto or electronics industries; and distribution keiretsu, in which a single parent firm, usually a manufacturer, moves products out to market through a network of wholesalers and retailers that depend on the parent firm for goods (Miyashita and Russell, 1994: 115-125). Although they are controversial for their alleged role in constraining foreign access to Japanese markets, the vertical keiretsu correspond to strategies of vertical integration elsewhere. Their structures and consequences are reasonably transparent to foreigners. In contrast, the relationships of the horizontal keiretsu are much less transparent, and their full implications are harder for foreigners to understand. The following discussion focuses on the horizontal or financial keiretsu.

Characteristics of horizontal keiretsu The complex relationship networks of horizontal keiretsu are best illustrated graphically. Figure 5.1 shows the principal members of one of the largest keiretsu groups, the Mitsui group. The characteristics of Mitsui described here also apply generally to the other major groups.

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Figure 5.1: Mitsui Group

Source: Industrial Groupings in Japan, 1995.

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Size and industry range The most striking characteristic of the contemporary groups is their massive size and scope. They reach across industry lines to encompass virtually every productive economic sector. Each of these modern keiretsu groups has at its core a commercial bank, a trading company and usually one or two major industrial firms. The commercial bank in each group now plays, in an informal sense, the central coordinating role formerly held by the holding companies of the old zaibatsu. Clustered closely around this core are large firms from nearly every sector of the economy. The Mitsui group, for example, includes companies in fibre and textiles, foodstuffs, construction, retailing, finance and insurance, chemicals, pulp and paper, mining, steel and metals, transportation and warehousing, electrical goods and machinery, automobiles, and so on. Farther afield are scores or even hundreds of other companies more loosely affiliated with the group—too many to include in Figure 5.1. The colossal size and influence of these groups is impossible to measure or even estimate accurately. Japan's Fair Trade Commission (FTC), which conducts a periodic survey of the groups, estimates that the Big Six horizontal keiretsu alone account for roughly one-third of the paid-in capital of Japanese enterprises and one-fourth of both assets and sales (Miyashita and Russell, 1994: 74). Mind-boggling as these numbers may seem, they are deceptively low, since the FTC numbers exclude financial institutions and thousands of smaller companies that may be directly associated with the major keiretsu firms. It is probably a fair guess that the six major keiretsu, with all of their component firms, comprise close to half of the Japanese economy. Autonomous members Unlike the older, pre-war zaibatsu groups, modern keiretsu consist ostensibly of independent, stand-alone firms, voluntarily clustered together. Most of the larger firms in the groups are listed independently on the Japanese stock exchanges, and each appears to have a large, diversified set of shareholders. This apparent autonomy, however, is qualified significantly in the discussion of cross-shareholdings that follows.

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Nebulous boundaries For the most part, the relationships within keiretsu groups are implicit and informal. This tends to make them largely opaque from the perspective of outsiders, particularly for westerners accustomed to clear, explicit organizational relationships. It is not clear, for example, where the influence of one keiretsu group ends and that of another begins. Some companies, such as those near the centre of the Mitsui group in Figure 5.1, are clearly members of the Mitsui group. Others are more loosely affiliated, and some companies near the periphery may even be associated with more than one group. Although the relationships tend to be very stable, they can and do evolve over time. It is interesting, for example, that Dodwell Marketing Consultants, the leading foreign analyst of the groups and the source of the diagram in Figure 5.1, continues to place Mitsui & Co. (the group's trading company) at the very centre of the Mitsui group diagram. Yet the key coordinating role of Mitsui & Co. was supplanted years ago by Mitsui Bank when reliable financing for growth became more important to Japanese companies than developing distribution channels.1 Similarly, as Toyota Motors and Toshiba Corp. have grown larger and more international, their dependence on the other companies in the group has waned. While they still are still affiliated with the group, they are no longer mutually interdependent, and their working relationships with the other companies in the group are weaker than they have been in the past, which is why their names appear in parentheses in Figure 5.1. The central role of commercial banks At the core of every major keiretsu group is a large commercial bank, which serves as the coordinator or, as one commentator put it, the spider at the centre of the web. It is only in the context of these keiretsu groupings that a foreigner can understand the intensely supportive nature of banks in Japan. Unlike the arms-length relationships that banks in most other

1

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Mitsui Bank was recently re-named Sakura Bank after a merger with TaiyoKobe Bank.

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countries have with their corporate clients, bank-client relationships in Japan are very broad and very deep. The bank at the centre of each group guarantees, in effect, the long-term viability of the companies closely affiliated with its group. Although Japanese companies appear to be extremely highly leveraged, the "main-bank" relationship ensures that loans are rolled over to constitute what amounts to permanent financing.2 If a company is unable to meet its interest payments, the main bank will usually continue to supply additional funds, while allowing the borrower to defer the interest payments. If a borrower gets into a situation where its long-term viability is threatened, the main bank is expected to take the initiative to engineer a smooth restructuring or folding of the borrower into some other company, usually one belonging to the same group. In return for that extraordinary support, Japanese banks exercise tremendous influence over the companies to which they lend. They have full proprietary access to the operations and plans of the companies in their group, and they exercise an implicit veto power over many management decisions. The main bank may even inject senior bank personnel directly into the top management of the company when such "guidance" is deemed appropriate. The relationship between banks and industrial firms is, therefore, a far more intimate, supportive one in Japan than in most other countries. In fact, the meanings which westerners attach to debt and equity are fundamentally different in Japan. Creditors—primarily the main bank—supply most of the corporate capital. They have a strong voice in management and participate directly in the earnings of the company (through changes in the borrower's compensating bank balances). They also bear substantial risk, as Japanese companies have been known to meet dividend obligations while deferring interest payments. In other countries, these characteristics are more closely associated with equity positions.

2

Close bank relationships exist outside the groups as well, but the intensive "main bank" relationships are facilitated in the broader collaborative context of the keiretsu groups.

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On the other hand, shareholders of large Japanese companies provide a relatively small proportion of corporate funds. They hold a largely fixed-return obligation since dividends tend to be a fixed percentage of the par value of the stock. They have practically no direct voice in the management policies of the firm, and they bear minimal risk, since the main bank implicitly guarantees the company's viability. In other countries, these characteristics are associated more closely with creditor positions. Given the supportive keiretsu structure and the strength of the main bank relationships, commercial banks in Japan really should be seen as principal shareholders of many large industrial firms, even though they are precluded by law from owning more than 5 percent of the shares of a company (Ballon and Tomita, 1988: 197ff).

Integrative mechanisms If the keiretsu groups are composed of independent, autonomous firms, what is it that holds them together in these clusters or families? There are several important integrative forces. Cross shareholdings

Although central holding companies no longer directly own the shares of keiretsu members, financial control is nevertheless held closely within the "family." Companies affiliated with a group may borrow from a variety of banks, but their main bank relationship is invariably with the bank at the group's core. The bank and other firms within each group own shares of the other member firms. Shareholdings by any one firm seldom exceed two to three percent of the total shares of other member firms. Adding together all of the bits and pieces, however, reveals that effective control of each member company is held by other companies within the group. Figure 5.2 illustrates the ownership interrelations among four firms at the centre of another of the large keiretsu, the Mitsubishi group. Mitsubishi Bank owns 4.7 percent of the shares of Mitsubishi Trading Corp. (the group's trading company), 4.1 percent of Mitsubishi Heavy Industries and 5.0 percent of Tokio Marine & Fire Insurance. Tokio Marine & Fire Insurance owns 4.6 percent of the shares of Mitsubishi Bank, and so on. The important point here is that 126

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Figure 5.2: Crossholding of shares among four major Mitsubishi Group firms (percent of paid up capital)

SourceJapan Company Handbook, 1995.

while most large Japanese corporations are independently listed on the stock exchanges and appear to have a large number of diversified shareholders, the controlling shares are held collectively by the other companies of the same group. In the Mitsubishi group, for example, on average about 35 percent of the shares of the major member companies are held directly by other companies within the group. Perhaps as much again is held by financial institutions and other "stable" shareholders that hold onto each other's shares indefinitely as a symbol of their long-term business relationship, rather than as holdings to be traded or sold on the open market. 3 One vitally important

3

The Mitsubishi group, illustrated here, is the most cohesive of the groups, with the highest ratio of internal shareholdings. The groups that have developed since World War II are organized more loosely than those that descended from the earlier zaibatsu.

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consequence of these hidden relationships is, of course, that Japanese managers are free from the threat of hostile takeovers and can focus their attention on long-term competitive positioning. Commercial transactions The members of each group tend to favour other related firms in their commercial transactions. A member of the Mitsubishi group, for example, will invariably have its main banking relationship with Mitsubishi Bank. It will likely procure many of its inputs and distribute its products at least partially through the group's trading company. Other things being equal, it is likely to procure other supplies and materials from other members of the same group. For many firms in keiretsu groups, the bulk of their business transactions may well be with other affiliates of the same group. This commercial favouritism is weakening today with the increasingly competitive business environment, but it remains a strong unifying force. Personnel movements The cohesiveness of the group is reinforced by the frequent movement of personnel among member firms. If, for example, a particular firm in a group is seeking to launch a new product, or to expand into overseas markets, it is not uncommon for other member firms to lend managerial or technical personnel, typically for a two-year period. Cohesion is further reinforced by the movement of "assigned directors." The powerful companies at the core of a group—the main bank, the trading company or another core firm—have their executives serve on the boards of directors of other firms in the group. The most important player in this is the main bank. They send directors for several years, and sometimes permanently, to sit on the boards of companies whose welfare is important to them—especially companies that owe the bank money. Miyashita and Russell (1994: 73) estimate that in 1992 the Big Six keiretsu had posted over 4,000 board members to other companies, including over 400 presidents or CEOs. Strategic coordination Perhaps most important, keiretsu coordinate the business strategies of their member firms. Although the firms span a wide range of 128

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industries and each is ostensibly owned and managed independently, there is ongoing communication and coordination at all levels. In particular, the CEOs of the companies near the core of each group meet periodically to discuss matters of common concern and to coordinate their business strategies (Smith, 1990). In the case of the Mitsui group, for example, the presidents of the 25 or so most strategically important firms (those included within the lined area of Figure 5.1) meet together on the second Thursday of each month, hence the group is referred to as Nimoku-kai, or the "Second-Thursday Group." The importance of these meetings can't be overemphasized. CEOs may discuss new product developments, competitive strategies and governmental policies. They may also decide to provide subtle but powerful assistance to member companies that are launching new products, entering new markets, or are otherwise in strategically sensitive positions. Assume, for example, that a member of a group is attempting new market penetration abroad, the success of which is felt to be strategically important to the entire group. In such a case the group's bank can make funds more easily and cheaply available to the firm, compensating for its reduced income by raising slightly the cost of capital to the other members of the group. In effect, the entire group is subsidizing the cost of capital to firms they consider to be of particular strategic importance at any given time. Other member firms may help by lending managerial or technical personnel, or by extending their intercompany accounts for a year or more to provide additional liquidity (Wright, 1989).

What this means to foreigners Not having an adequate understanding of these important but largely unseen relationships can spell misfortune for foreign companies trying to relate to Japanese firms in a number of contexts. The following examples briefly illustrate some areas of potential misunderstanding, from the perspective of a foreign creditor, a foreign investor, a foreign partner and a foreign competitor. Creditor perspective The first example of how foreign firms may be confused by these relationships is the case of a Canadian bank considering a commercial Hidden linkages in Japanese business

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loan to a major Japanese corporation. This example uses yet another of the major groups, Sumitomo. Table 5.1 shows financial and operating data for one of its leading members, Sumitomo Chemical. In a country like Japan where there are no established credit rating agencies, lending institutions must rely on their own analysis of published financial data. At first glance, Sumitomo Chemical's credentials seem impeccable: it is one of the world's largest comprehensive chemical manufacturers, with annual sales exceeding 500 trillion yen. But when the bank examines the firm's financial structure more closely, it discovers disquieting information: the company has an equity ratio of only 18 percent. In other words, more than 80 percent of Sumitomo Chemical's assets are financed by borrowed funds (and most of this in the form of short-term bank loans). By financial standards prevailing elsewhere, Sumitomo's high leverage poses an extraordinary level of financial risk, so the bank refuses the loan. If the bank had understood keiretsu relationships, however, it would have understood that while the company's financing is mostly in the form of debt, much of this debt is internally-provided, rolled over indefinitely and guaranteed by the main bank. In other words, much of what seems to be debt is really the western equivalent of equity. Even in the unlikely event of a default or bankruptcy, the main bank would likely subordinate its own debt to that of external creditors, dramatically reducing the real risk to outside creditors. Investor perspective An individual or company considering investing in the shares of a Japanese company may also easily misinterpret published financial data if they don't understand how keiretsu relationships work. Continuing our example of Sumitomo Chemical, a potential investor will note that while current earnings are around 4 yen per share, the share price is 440 yen, yielding a price/earnings multiple of nearly 100! Why would it make sense to invest in a company if it will take 100 years to recover the investment? A partial answer is that keiretsu relationships provide companies with value that is not reflected in financial statements. This includes, of course, financial stability and risk diversification. But there is often additional hidden value in the portfolio of shares the company holds 130

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Table 5.1: Sumitomo Chemical

Source:Japa/J Company Handbook, 1995.

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in other member firms, most of which is recorded at book value rather than at current market value. Investing in the shares of a Japanese company belonging to a keiretsu is therefore not only an investment in the cash flow the firm is expected to generate. For all practical purposes it is also an investment in a closed-end mutual fund consisting of shares of other firms, the value of which is almost never reflected fully in the firm's published financial data. Partner perspective There are many examples of foreign-owned companies stumbling in Japan, partly because they don't understand these hidden relationships. The influence of the keiretsu groups is so pervasive that foreign firms in Japan may have no choice but to deal with or through them. But working with them can present a minefield of hidden hazards to the uninitiated. For example, foreign companies entering into joint ventures with Japanese firms typically assume that a core objective of the Japanese parent company, like that of its foreign counterparts, is to maximize the profitability of its joint-venture affiliates and therefore to maximize dividends flowing back to the parent companies. But foreign managers often find the profits of their joint-ventures with Japanese companies sapped by the unexpectedly high cost of procurement, financing, distribution, and other transactions. (Wright, 1979a and 1979b). While often unacknowledged, the fact may be that the Japanese parent company is content to allow some of its profits to leak to other firms in the group, even if that means lowering the profitability of the joint venture company. The profit taken in fees and commissions by other related firms stays, after all, within the keiretsu "family," rather than flowing in part to the foreign parent—and the Japanese parent can probably rest assured that its favours to the rest of the family will at some point be reciprocated. This does not mean that the Japanese parent company is dishonest, or that a foreign firm cannot operate a successful joint venture in Japan. It does suggest, however, that foreign companies operating in Japan may need to take a more holistic approach than they might elsewhere. It can be a costly error to assume they are dealing with standalone partners that are seeking only to maximize direct profits. 132

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Competitor perspective Japan's system of intercompany coordination and support gives Japanese businesses powerful competitive advantages, both at home and abroad. One of these advantages is the degree of effective business diversification that it provides. Like firms elsewhere, Japanese companies typically compete in a narrow industry segment. But Japanese companies have the safety net of the broadly-diversified keiretsu conglomerate behind them, giving them substantially greater security and stability (Wright and Pauli, 1988). The system also gives its member firms a large and stable in-house market base in which to develop and consolidate new products before attacking new markets abroad. The individual firm in a keiretsu group can rely on other members of the "family" to provide it with supplies, to purchase its products and to be a source of introductions in Japan or abroad. The keiretsu system also facilitates very rapid fertilization of new technology across industry lines. For example, Mitsui (Sakura) Bank has direct access to new telecommunications technology developed by Toshiba and other firms within its group. Non-Japanese competitors, by contrast, must shop for comparable technology on the open market. Another strength of the group system that is often overlooked is the degree to which it phases out business activities that are no longer competitive. It is extremely rare for a Japanese company near the core of a keiretsu group to go bankrupt. Rather, unprofitable activities can usually be phased out, and the resources—both physical and human— incorporated into more productive uses elsewhere within the family of companies.4 It is largely these stable networks of business and financial relationships that enable Japanese firms to benefit from the long-term planning and extended profit horizons for which they are so celebrated (Anderson, 1991; Jacobs, 1991: 69). Unlike competitors elsewhere, 4

Another possibility, of course, is to sustain inefficient activities. Some observers argue that excessive competition exists in traditional Japanese industries such as chemicals and steel because each group continues to support the existence of its group representatives long after they have lost competitiveness.

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Japanese managers do not need to pay excessive attention to shortterm earnings. In a study that asked American and Japanese managers how their performance was measured, 59 percent of American managers said their performance was measured in periods of less than one year. Only two percent of the Japanese managers said their performance was measured over one year or less (Wall Street Journal, 1988). Keiretsu relationships give Japanese companies significant competitive advantages in world markets. The competitive strengths of American and European firms stem largely from production or marketing economies of scale, with each firm focusing its energies on the narrow range of products or services which it can best supply. But in an increasingly interdependent world, economies of scope—the coordination of diverse but related business activities across industry lines— are assuming growing importance. A current example is the trend towards the integration of the computer, communications and entertainment industries. Keiretsu groups are well equipped to integrate activities of related companies across industry lines. Non-Japanese firms seeking similar linkages must integrate unrelated units with different corporate cultures, which is a much more difficult process.

Pressures for change Pressure to change the Japanese keiretsu network system is coming from several directions. Capital market developments In the years after World War II, Japanese companies, having no significant capital to invest, had no choice but to borrow money. Financial markets were immature, and the government encouraged banks to be the primary intermediaries between savers and investors and to set interest rates low to enable businesses to borrow money. Recent financial deregulation and the growing sophistication of Japanese capital markets are now stimulating large Japanese companies to go directly to the financial markets, bypassing their traditional reliance on bank borrowing (Anderson, 1991- 52; Holyoke, Spindle and Gross, 1994). As this trend continues, the key role of main-bank relationships in keiretsu is bound to weaken.

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Changes in cross-shareholdings Significant changes are also taking place in the motives and patterns of corporate cross-shareholdings. Managers of keiretsu-based firms, traditionally content to hold low-yielding shares of related companies, are becoming much less willing to tie up scarce capital in the shares of related firms. Japanese managers would rather invest their funds more productively and are beginning to make cross-shareholding arrangements with companies outside their groups for reasons of business strategy and access to new technology, rather than for historical ties. An example of this is the recent acquisition of Mazda shares by Ford. Technological and engineering perspectives, rather than keiretsu relationships, appear increasingly to influence interfirm linkages (Mori, 1994b: 22). Competitive pressure The intensely competitive environment is forcing Japanese firms to source their inputs from the lowest-cost suppliers, even if they are not related firms. Giving preferential treatment to related firms is a luxury most of them can no longer afford. More and more, Japanese companies are looking for business deals that will contribute directly to bottom-line profits, instead of paying higher prices to favour a longterm relationship. Foreign pressure There is intense foreign pressure on Japan to allow foreign firms greater access to the Japanese market, especially from the United States in bilateral trade negotiations. However, the Structural Impediments Initiative talks in 1989, followed up by the Clinton administration's "framework" talks, have produced few tangible results in terms of modifying traditional keiretsu relationships. Indeed, there is probably little that the Japanese government itself can do beyond stepping up the enforcement capabilities of the Fair Trade Commission. Giving the FTC greater powers to implement existing antitrust laws may constrain some of the more collusive keiretsu practices. Market pressures resulting from the recent severe recession and the strong yen have also forced some changes in traditional sourcing and human resource practices. Hidden linkages in Japanese business

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The impact of these pressures has been felt so far mostly by vertical keiretsu, where attention to profit and loss and to changes in economic conditions are most intense (Mori, 1994b; Westney, 1995 and 1996). With weakened demand for automobiles and other Japanese manufactures, the large producers have cut back on prices and volumes in their orders from suppliers, forcing many of them to seek other customers, loosening the traditional bonds of the production keiretsu. The distribution keiretsu are weakening at an even faster pace, as priceconscious Japanese consumers turn toward large discount stores rather than the higher-priced manufacturer-controlled outlets (Miyashita and Russell, 1994: 199-205). Change is being felt less quickly in the horizontal keiretsu, whose main objectives are to spread risk rather than to maximize profit. Studies by Nakatani (1984) and others have shown that the major benefit of membership in a horizontal keiretsu is not profit. Keiretsu members are, in fact, slower to grow and slower to increase profits than are independent firms. The major benefit is a kind of large-scale insurance policy: to stabilize corporate performance and to share risks and profits. Miyashita and Russell (1994: 198) conclude: The answer to why keiretsu still exist is that they provide security in the broadest sense. The big groups guarantee that (1) member firms have a much larger voice in the business community than they would if they were independent; (2) members have access to greater political leverage when necessary; (3) members will not be taken over by a hostile raider; (4) members will have easy access to credit; (5) members have a small but significant safety net for their sales figures—whether the merchandise is beer, autos, or securities; and (6) in a worstcase scenario, no member firm will ever fail. That kind of security alone is enough to keep keiretsu in business for some time to come. The underlying supportive, long-term relationships within the groups appear to remain firmly entrenched. Nevertheless, a combination of forces are likely to erode even the horizontal groups over time.5

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The gradual weakening of keiretsu ties may actually provide some new opportunities for Canadian businesses in Japan (Wright, 1994). Japanese companies that felt obligated in the past to purchase from related companies, even at higher cost, are increasingly seeking out the best deals as costs loom larger in their purchasing decisions. Canadian capital goods manufacturers offering quality products at competitive prices may discover new market opportunities that were previously prevented by tight keiretsu ties. And the freeing up of shares as crossshareholding ties weaken may provide new opportunities for Canadian firms to establish a greater direct presence in Japan through joint ventures or other linkages with Japanese companies, particularly with the share prices of many Japanese firms now well below their earlier cost.

Conclusions It is very important for Canadians and other foreigners to understand the forces and relationships operating beneath the surface of the Japanese business system. Canadians, to compete effectively in global markets, must see the Japanese business system as it really is: not as a multitude of independent entities standing and competing on their own, but rather as clusters of complex, nurturing and closely-knit families of firms. Doing business in Japan or with Japanese companies requires research into these hidden linkages—research that might not be necessary elsewhere. It is also necessary to commit to full-time, on-thespot monitoring of operational details. While such commitment may be relatively easy for large firms to make, it poses a particular hurdle for small and medium-sized Canadian companies. The public sector can, and is, playing a constructive role by informing Canadian

5

A recent study (JEI, 1995) notes that the Big Six financial keiretsu employed 4.6 percent of all workers in 1984, 4 percent in 1989 and 3.8 percent in 1994. Similarly, a 1992 study by Japan's Fair Trade Commission (see JEI, 1995) found that sales by group members in manufacturing industries to trading companies and other members of the same keiretsu groups represented an average of 16.4 percent of their total sales in fiscal year 1989, down from 20.4 percent in fiscal year 1981.

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business people about these complexities, and by facilitating contacts for smaller Canadian companies in Japan and between Japanese companies and potential partners based in Canada. Even on the surface, Japan's business system is markedly different from that of western countries. Hidden linkages lie beneath the surface, linkages which bind Japanese firms in subtle but very powerful relationships. Regulations in many other countries prevent similar combinations, especially the relationships between financial and nonfinancial institutions that are so central to the Japanese system. Most non-Japanese business cultures probably would not lean toward such formalized cross-industry groupings even if they were permitted. Significant competitive strength can, nonetheless, be derived from close and stable collaborative working relationships among like-minded firms across industry lines, even where those relationships are informal and implicit. This, in fact, may be the central lesson that innovative western business leaders can take from the Japanese example. The author acknowledges the research assistance of Lalitha Jonnavithula and Pascal Beaudoin.

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References Abegglen, James C. and J. G. Stalk. 1987. Kaisha. The Japanese Corporation. Tokyo: Charles E. Tuttle Company. Anderson, Gerald H. 1991. "Why U. S. Managers may be more ShortRun Oriented than the Japanese." Federal Reserve Bank of Chicago. November. Ballon, Robert J. and Iwao Tomita. 1988. The Financial Behavior of Japanese Corporations. Tokyo and New York: Kodansha International. Dodwell & Co. 1992. Industrial Groupings in Japan. Tokyo: Dodwell Management Consultants. Genay, Hesna. 1991. "Japan's Corporate Groups." Economic Perspectives. January-February: 20-30. Gerlach, Michael. 1992. Alliance Capitalism: The Strategic Organization of Japanese Business. Berkeley: University of California Press. . 1987. "Business Alliances and the Strategy of the Japanese Firm." California Management Review. Fall. Gibney, Frank. 1975. Japan, the Fragile Superpower. New York: W.W. Norton and Company. Holyoke, Larry, William Spindle and Neil Gross. 1994. "Doing the Unthinkable." Business Week. January 10: 52-53Imai, Kenichi. 1994. "Enterprise Groups." In Kenichi Imai and Yutaro Komiya, eds. Business Enterprise in Japan: Views of Leading Japanese Economists. Cambridge, MA: MIT Press. Jacobs, Michael T. 1991. Short-Term America: The Causes and Cures of our Business Myopia. Boston: Harvard Business School Press. Johnson, Chalmers. 1982. MIT1 and the Japanese Miracle. Stanford: Stanford University Press. Kono, Toyohiro. 1984. Strategy and Structure of Japanese Enterprises. London: MacMillan Press Limited. McMillan, Charles. J. 1985. The Japanese Industrial System. New York: Walter de Gruyter Publishers. Miyashita, Kenichi and David Russell. 1994. Keiretsu. Inside the Hidden Japanese Conglomerates. New York: McGraw-Hill Inc.

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Mori, Kiyoshi. 1994a. "An Appropriate Corporate and Financial Strategy for Successful Investing in the Japanese Market." Business Economics. July: 50-55. . 1994b. "Industrial Sea Change: How Changes in Keiretsu Are Opening the Japanese Market." The Brookings Review. Fall: 2023. Nakatani, Iwao. 1984. "The Economic Role of Financial Corporate Groupings." In Masahiko Aoki, ed. The Economic Analysis of the Japanese Firm. Amsterdam: Elsevier Science Publishers. Ostrom, Douglas. 1995. "Competitive Conditions and Competition Policy in the Japanese Economy."y£7 Report. 9A: March 10. Ouchi, William. 1981. Theory Z: How American Business Can Meet the Japanese Challenge. Reading: Addison-Wesley Publishers. Pascale, Richard Tanner and Anthony G. Athos. 1981. The Art of Japanese Management. New York: Simon and Schuster. Patrick, Hugh and Henry Rosovsky. 1976. Asia's New Giant. How the Japanese Economy Works. Washington: The Brookings Institution. Toyo Keizai Inc. 1.995. Japan Company Handbook. Tokyo: Toyo Keizai Inc. Wall Street Journal. 1988. "The Final Frontier: Japan Assaults the Last Bastion: America's Lead in Innovation." November 14: Rl. Westney, Eleanor. 1996. "The Japanese Business System: Key Features and Prospects for Change." Journal of Asian Business. 12:1. 21-50. Westney, Eleanor. 1995. "The Japanese Keiretsu in Transition." CIB Perspectives, University of Toronto. 3:2. 4. Whitehill, Arthur M. 1991. Japanese Management. Tradition and Transition. London: Routledge Publishers. Wright, Richard W. 1994. "Head for the Rising Sun." Business Quarterly.'59\2. 94-98. . 1989. "Networking: Japanese Style." Business Quarterly. 54:2. 20-25.

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. 1979a. "Canadian Joint Ventures in Japan." Business Quarterly. 42:3. 42-53. . 1979b. "Joint Venture Problems in Japan." Columbia Journal of World Business. Spring: 25-31. Wright, Richard W. and Gunter A. Pauli. 1988. The Second Wave: Japan's Global Assault on Financial Services. New York: St. Martin's Press.

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About the authors Wendy Dobson is Professor and Director, Centre for International Business, University of Toronto. She has served as Associate Deputy Minister of Finance in the Canadian government and President of the CD Howe Institute. Her most recent publications include Managing US-Japanese Trade Disputes: Are There Better Ways? (edited with Hideo Sato). Gary G. Hamilton is Professor of Sociology, University of Washington, Seattle. His areas of interest include East Asian business networks, Chinese societies, economic sociology and historical comparative sociology with an emphasis on East Asia. His forthcoming publications include Organization of Chinese Economies (Routledge) and The Economic Organization of East Asian Capitalism (Sage), with Nicole Biggart and Marco Orru. He has been awarded a Fulbright Fellowship, a Guggenheim Fellowship and a Fellowship to attend The Advanced Center for the Behavioral Sciences at Palo Alto, California. Gary H. Jefferson is Associate Professor of Economics, Graduate School of International Economics and Finance, Brandeis University. He has lived in Hong Kong, Taiwan and China and has worked extensively with the World Bank. His publications include "Lessons of China's Economic Reforms" (Journal of Comparative Economics, 1992), "Enterprise Reform in Chinese Industry" (Journal of Economic Perspectives, 1994) among others. Linda Lim is Associate Professor of International Business, Director of the Southeast Asia Business Program at the University of Michigan and Editor of the Journal of Asian Business. She teaches Asian business in the MBA and executive programs and carries out extensive research into international trade and investment in the region as well as ethnic Chinese business. In addition to her many publications on these subjects, forthcoming publications include "Economic Growth, Liberalization and the Chinese in Southeast Asia" and a volume of Business Cases on Southeast Asia.

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A. E. Safarian is Professor of Business Economics at the Faculty of Management, University of Toronto and an Associate of the Canadian Institute of Advanced Research. He has served as Dean of the University's School of Graduate Studies and as President of the Canadian Economics Association. He was elected a fellow of the Royal Society of Canada in 1973- He is author of Multinational Enterprise and Public Policy (1993) and Foreign Ownership of Canadian Industry (1966). Thomas G. Rawski is Professor of Economics, University of Pittsburgh. He specializes in research on the history and development of China's economy. He taught at the University of Toronto before moving to the University of Pittsburgh in 1985. His recent publications include Chinese History in Economic Perspective (1992), co-edited with Lillian M. Li; "Implications of China's Reform Experience (China Quarterly, 1995:144); and a number of joint papers with Gary H. Jefferson and Yuxin Zheng. Richard W. Wright is Professor and Chair of International Business at the Faculty of Management, McGill University. He has lived and worked in Japan on several occasions. He writes extensively on Canada-Japan business relations, and he serves as Economic Advisor to the Canada-Japan Trade Council. His book, The Second Wave: Japan's Global Assault on Financial Services (co-authored with Gunter Pauli) has been published in seven languages.

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Centre for International Business Mission Founded in 1993, the Centre's mission is to focus the University of Toronto's expertise in international economics and strategic management in ways that assist Canadian businesses to increase their international competitiveness and to develop strategies to become world leaders in their fields. Strategic Direction The Centre's research has two aims: 1.

To analyse global economic trends and assist executives in understanding the risks and opportunities inherent in those trends that are beyond their control.

2.

To study trends in international business and provide executives with knowledge applied to building lean, innovative and internationally competitive organizations.

The research strategy is formulated in consultation with an Advisory Committee, and is carried out in collaboration with members of the global research networks of the Centre's Associates. Ongoing direction is carried out by Wendy Dobson, Director, in consultation with a Steering Committee which includes Professors Joseph D'Cruz (strategic management), Jack Mintz (tax policy and public finance), Peter Pauly (international economics), Alan Rugman (international business) and Tom Wilson (business economics, fiscal and tax policy).

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Key research issues Global research on international business, focusing on firm competitiveness, behaviour and strategies. Global research on the economic environment for international business, including policies that affect trade and investment. International environmental research that recognizes that, in a globally-integrated business environment, both the economic and environmental effects of environmental policies must be examined in a cross-national perspective. Programs and services International Business Perspectives Published quarterly and disseminated widely to the business and policy communities, Perspectives presents concise analyses and interpretations of current developments in the global economic environment and anticipates future trends that will have an impact on North American businesses. Particular attention is paid to anticipating developments in the G-7 economies and in East Asia. The CIB Roundtable Roundtables, held monthly, provide a forum where CEOs can focus on and discuss developments in international business and in the global economic environment. In sessions led by Associates and invited speakers, the focus is on anticipating, interpreting and responding to these developments. The International Business Conference Organized annually by the Centre and the Faculty of Management in collaboration with the Globe and Mail, the Faculty brings together senior private and public sector leaders in "sleeves-up" sessions addressed to challenges faced by Canadian businesses seeking to become world leaders in their sectors and to translate these into "take-away" benefits.

Centre for International Business Faculty of Management University of Toronto Joseph L. Rotman Centre for Management 105 St. George Street Toronto, Ontario, Canada M5S 3E6 Tel: 416-978-2451 Fax: 416-978-0002

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