PS 11/Econ 11 –Reading Response Assignments Instructions: Please answer BOTH questions to the best of your ability. Each answer should no less than half a page single-spaced, but will probably require more than this. Your entire reading response should be anywhere from 1-2 pages single-spaced (500-1000 words). You are required to use your textbook but are also welcome to use outside sources as well. Please be sure to put things into your own words, do not write phrases directly from the text. Some questions will require you to simply summarize the information. Other questions will require you to think critically and present your own critique, argument, or opinion. Be sure to explain your answers and opinion, providing extensive evidence. Rubric: A good paper will have the following • A clear and original argument (this means going beyond just summarizing what the text says, take a stance on the issue and defend your stance) • A detailed introduction paragraph that provides a roadmap to your paper. I should be able to read your introduction and know exactly what you will argue/talk about in the rest of the paper. • Evidence that supports your argument (quantitative like statistics or data or qualitative like your own life experiences, work, or historical examples) • The paper has thoroughly answered ALL of the questions • The paper uses citations from the text and possibly outside sources • No grammatical or syntax errors- make sure you read and edit your paper. Citations: If you cite something directly from the book please put the pg. number in parentheses at the end of the sentence as such: (pg. # ). You do not need to provide a bibliography or works cited pg. if you only use the textbook. If you use outside sources (internet, books, etc.) please use APSA format and include a works cited/bibliography. You can find APSA format instructions here: http://citesource.trincoll.edu/apsa/apsaconfpaper_000.pdf or https://www.tamiu.edu/uc/writingcenter/documents/APSAformatanddocumentation_7-3012_JM.pdf ***MUST SUBMIT TO TURNITIN BEFORE CLASS BEGINS TO RECEIVE FULL CREDIT 1) Reading Response 1- DUE August 30th Describe the 3 main perspectives (also called “ideologies”) of International Political Economy. Which perspective do you find most convincing—that is, which one offers the most accurate description of politics and economics? Use evidence from the history and current events to support your argument. 2) Reading Response 2- DUE September 13th Explain the arguments for free trade. Why do so many people still oppose free trade policies? Is your country more protectionist or liberal when it comes to trade? Make 3 trade policy recommendations for your country. 3) Reading Response 3- DUE October 2nd What causes financial crises? What caused the 2008 global financial crisis? Who is to blame for 2008 and what lessons should be learned? How should U.S. policy reflect those lessons? 4) Reading Response 4- DUE October 18th What are the primary differences between liberal and coordinated market economies? What are some of the consequences of each system (i.e. employment, wages, commodities produced, policies concerning regulation, vocational training etc.) What is your country? Which system would you prefer and why? Is there anything that the author’s are missingdo you have any criticism for their explanations? 5) Reading Response 5- DUE October 30th What are the explanations for Africa’s economic stagnation and extreme poverty? What are the solutions? Is it foreign aid? More trade? What do you think? Be sure to defend your argument. 1111 211 3 4 5 6 7 8 9 10111 1 211 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 1 An Introduction to Varieties of Capitalism Peter A. Hall and David Soskice 1.1 Introduction Political economists have always been interested in the differences in economic and political institutions that occur across countries. Some regard these differences as deviations from ‘best practice’ that will dissolve as nations catch up to a technological or organizational leader. Others see them as the distillation of more durable historical choices for a specific kind of society, since economic institutions condition levels of social protection, the distribution of income, and the availability of collective goods—features of the social solidarity of a nation. In each case, comparative political economy revolves around the conceptual frameworks used to understand institutional variation across nations. On such frameworks depend the answers to a range of important questions. Some are policy-related. What kind of economic policies will improve the performance of the economy? What will governments do in the face of economic challenges? What defines a state’s capacities to meet such challenges? Other questions are firm-related. Do companies located in different nations display systematic differences in their structure and strategies? If so, what inspires such differences? How can national differences in the pace or character of innovation be explained? Some are issues about economic performance. Do some sets of institutions provide lower rates of inflation and unemployment or higher rates of growth than others? What are the trade-offs in terms of economic performance to developing one type of political economy rather than another? Finally, second-order questions about institutional change and stability are of special significance today. Can we expect technological progress and the competitive pressures of globalization to inspire institutional convergence? What factors condition the adjustment paths a political economy takes in the face of such challenges? The object of this book is to elaborate a new framework for understanding the institutional similarities and differences among the developed economies, one that offers a new and intriguing set of answer to 2 Peter A. Hall and David Soskice such questions.1 We outline the basic approach in this Introduction. Subsequent chapters extend and apply it to a wide range of issues. In many respects, this approach is still a work-in-progress. We see it as a set of contentions that open up new research agendas rather than settled wisdom to be accepted uncritically, but, as the contributions to this volume indicate, it opens up new perspectives on an unusually broad set of topics, ranging from issues in innovation, vocational training, and corporate strategy to those associated with legal systems, the development of social policy, and the stance nations take in international negotiations. As any work on this topic must be, ours is deeply indebted to prior scholarship in the field. The ‘varieties of capitalism’ approach developed here can be seen as an effort to go beyond three perspectives on institutional variation that have dominated the study of comparative capitalism in the preceding thirty years.2 In important respects, like ours, each of these perspectives was a response to the economic problems of its time. The first of these perspectives offers a modernization approach to comparative capitalism nicely elucidated in Shonfield’s magisterial treatise of 1965. Devised in the post-war decades, this approach saw the principal challenge confronting the developed economies as one of modernizing industries still dominated by pre-war practices in order to secure high rates of national growth. Analysts tried to identify a set of actors with the strategic capacity to devise plans for industry and to impress them on specific sectors. Occasionally, this capacity was said to reside in the banks but more often in public officials. Accordingly, those taking this approach focused on the institutional structures that gave states leverage over the private sector, such as planning systems and public influence over the flows of funds in the financial system (Cohen 1977; Estrin and Holmes 1983; Zysman 1983; Cox 1986). Countries were often categorized, according to the structure of their state, into those with ‘strong’ and ‘weak’ states (Katzenstein 1978b; Sacks 1980; Nordlinger 1981; Skocpol and Amenta 1985). France and Japan emerged from this perspective as models of economic success, while Britain was generally seen as a laggard (Shonfield 1965; Johnson 1982). 1 We concentrate here on economies at relatively high levels of development because we know them best and think the framework applies well to many problems there. However, the basic approach should also have relevance for understanding developing economies as well (cf. Bates 1997). 2 Of necessity, this summary is brief and slightly stylized. As a result, it does not do full justice to the variety of analyses found within of these literatures and neglects some discussions that fall outside them. Note that some of our own prior work can be said to fall within them. For more extensive reviews, see Hall (1999, 2001). Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 3 During the 1970s, when inflation became the preeminent problem facing the developed economies, a number of analysts developed a second approach to comparative capitalism based on the concept of neocorporatism (Schmitter and Lehmbruch 1979; Berger 1981; Goldthorpe 1984; Alvarez et al. 1991). Although defined in various ways, neocorporatism was generally associated with the capacity of a state to negotiate durable bargains with employers and the trade union movement regarding wages, working conditions, and social or economic policy.3 Accordingly, a nation’s capacity for neo-corporatism was generally said to depend on the centralization or concentration of the trade union movement, following an Olsonian logic of collective action which specifies that more encompassing unions can better internalize the economic effects of their wage settlements (Olson 1965; Cameron 1984; Calmfors and Driffill 1988; Golden 1993). Those who saw neo-corporatist bargains as a ‘political exchange’ emphasized the ability of states to offer inducements as well as the capacity of unions to discipline their members (Pizzorno 1978; Regini 1984; Scharpf 1987, 1991; cf. Przeworski and Wallerstein 1982). Those working from this perspective categorized countries largely by reference to the organization of their trade union movement; and the success stories of this literature were the small, open economies of northern Europe. During the 1980s and 1990s, a new approach to comparative capitalism that we will term a social systems of production approach gained currency. Under this rubric, we group analyses of sectoral governance, national innovation systems, and flexible production regimes that are diverse in some respects but united by several key analytic features. Responding to the reorganization of production in response to technological change, these works devote more attention to the behavior of firms. Influenced by the French regulation school, they emphasize the movement of firms away from mass production toward new production regimes that depend on collective institutions at the regional, sectoral, or national level (Piore and Sabel 1984; Dore 1986; Streeck and Schmitter 1986; Dosi et al. 1988; Boyer 1990; Lazonick 1991; Campbell et al. 1991; Nelson 1993; Hollingsworth et al. 1994; Herrigel 1996; Hollingsworth and Boyer 1997; Edquist 1997; Whitley 1999). These works bring a wider range of institutions into the analysis and adopt a more sociological approach to their operation, stressing the ways in which institutions 3 An alternative approach to neo-corporatism, closer to our own, which puts less emphasis on the trade union movement and more on the organization of business was also developed by Katzenstein (1985a, 1985b) among others (Offe 1981). 4 Peter A. Hall and David Soskice generate trust or enhance learning within economic communities. As a result, some of these works resist national categories in favor of an emphasis on regional success of the sort found in Baden-Württemberg and the Third Italy. Each of these bodies of work explains important aspects of the economic world. However, we seek to go beyond them in several respects. Although those who wrote within it characterized national differences in the early post-war era well, for instance, some versions of the modernization approach tend to overstate what governments can accomplish, especially in contexts of economic openness where adjustment is firmled. We will argue that features of states once seen as attributes of strength actually make the implementation of many economics policies more difficult; and we seek a basis for comparison more deeply rooted in the organization of the private sector. Neo-corporatist analysis directs our attention to the organization of society, but its emphasis on the trade union movement underplays the role that firms and employer organizations play in the coordination of the economy (cf. Soskice 1990a; Swenson 1991). We want to bring firms back into the center of the analysis of comparative capitalism and, without neglecting trade unions, highlight the role that business associations and other types of relationships among firms play in the political economy. The literature on social systems of production accords firms a central role and links the organization of production to the support provided by external institutions at many levels of the political economy. However, without denying that regional or sectoral institutions matter to firm behavior, we focus on variation among national political economies. Our premiss is that many of the most important institutional structures— notably systems of labor market regulation, of education and training, and of corporate governance—depend on the presence of regulatory regimes that are the preserve of the nation-state. Accordingly, we look for national-level differences and terms in which to characterize them that are more general or parsimonious than this literature has generated.4 Where we break most fundamentally from these approaches, however, is in our conception of how behavior is affected by the institutions of the political economy. Three frameworks for understanding this relationship 4 One of the pioneering works that some will want to compare is Albert (1993), who develops a contrast between the models of the Rhine and America that parallels ours in some respects. Other valuable efforts to identify varieties of capitalism that have influenced us include Hollingsworth and Boyer (1997), Crouch and Streeck (1997b), and Whitley (1999). Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 5 dominate the analysis of comparative capitalism. One sees institutions as socializing agencies that instill a particular set of norms or attitudes in those who operate within them. French civil servants, for instance, are said to acquire a particular concern for the public interest by virtue of their training or the ethos of their agencies. A second suggests that the effects of an institution follow from the power it confers on particular actors through the formal sanctions that hierarchy supplies or the resources an institution provides for mobilization. Industrial policy-makers and trade union leaders are often said to have such forms of power. A third framework construes the institutions of the political economy as a matrix of sanctions and incentives to which the relevant actors respond such that behavior can be predicted more or less automatically from the presence of specific institutions, as, for instance, when individuals refuse to provide public goods in the absence of selective incentives. This kind of logic is often cited to explain the willingness of encompassing trade unions to moderate wages in order to reduce inflation. Each of these formulations captures important ways in which the institutions of the political economy affect economic behavior and we make use of them. However, we think these approaches tend to miss or model too incompletely the strategic interactions central to the behavior of economic actors. The importance of strategic interaction is increasingly appreciated by economists but still neglected in studies of comparative capitalism.5 If interaction of this sort is central to economic and political outcomes, the most important institutions distinguishing one political economy from another will be those conditioning such interaction, and it is these that we seek to capture in this analysis. For this purpose, we construe the key relationships in the political economy in game-theoretic terms and focus on the kinds of institutions that alter the outcomes of strategic interaction. This approach generates an analysis that focuses on some of the same institutions others have identified as important but construes the impact of those institutions differently as well as one that highlights other institutions not yet given enough attention in studies of comparative capitalism. By locating the firm at the center of the analysis, we hope to build bridges between business studies and comparative political economy, two disciplines that are all too often disconnected. By integrating gametheoretical perspectives on the firm of the sort that are now central to microeconomics into an analysis of the macroeconomy, we attempt to connect the new microeconomics to important issues in macroeconomics 5 There are a few notable exceptions that influence our analysis, including the work of Scharpf (1987, 1997a) and Przeworski and Wallerstein (1982). 6 Peter A. Hall and David Soskice Ours is a framework that should be of interest to economists, scholars of business, and political scientists alike. We turn now to an elucidation of its basic elements. 1.2 The Basic Elements of the Approach This varieties of capitalism approach to the political economy is actorcentered, which is to say we see the political economy as a terrain populated by multiple actors, each of whom seeks to advance his interests in a rational way in strategic interaction with others (Scharpf 1997a). The relevant actors may be individuals, firms, producer groups, or governments. However, this is a firm-centered political economy that regards companies as the crucial actors in a capitalist economy. They are the key agents of adjustment in the face of technological change or international competition whose activities aggregate into overall levels of economic performance. 1.2.1 A Relational View of the Firm Our conception of the firm is relational. Following recent work in economics, we see firms as actors seeking to develop and exploit core competencies or dynamic capabilities understood as capacities for developing, producing, and distributing goods and services profitably (Teece and Pisano 1998). We take the view that critical to these is the quality of the relationships the firm is able to establish, both internally, with its own employees, and externally, with a range of other actors that include suppliers, clients, collaborators, stakeholders, trade unions, business associations, and governments. As the work on transactions costs and principal– agent relationships in the economics of organization has underlined, these are problematic relationships (Milgrom and Roberts 1992). Even where hierarchies can be used to secure the cooperation of actors, firms encounter problems of moral hazard, adverse selection, and shirking. In many cases, effective operation even within a hierarchical environment may entail the formation of implicit contracts among the actors; and many of a firm’s relationships with outside actors involve incomplete contracting (cf. Williamson 1985). In short, because its capabilities are ultimately relational, a firm encounters many coordination problems. Its success depends substantially on its ability to coordinate effectively with a wide range of actors. For the purposes of this inquiry, we focus on five spheres in which firms must develop relationships to resolve coordination problems central Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 7 to their core competencies. The first is the sphere of industrial relations where the problem facing companies is how to coordinate bargaining over wages and working conditions with their labor force, the organizations that represent labor, and other employers. At stake here are wage and productivity levels that condition the success of the firm and rates of unemployment or inflation in the economy as a whole. In the sphere of vocational training and education, firms face the problem of securing a workforce with suitable skills, while workers face the problem of deciding how much to invest in what skills. On the outcomes of this coordination problem turn not only the fortunes of individual companies and workers but the skill levels and competitiveness of the overall economy. Issues of coordination also arise in the sphere of corporate governance, to which firms turn for access to finance and in which investors seek assurances of returns on their investments. The solutions devised to these problems affect both the availability of finance for particular types of projects and the terms on which firms can secure funds. The fourth sphere in which coordination problems crucial to the core competencies of an enterprise appear is the broad one of inter-firm relations, a term we use to cover the relationships a company forms with other enterprises, and notably its suppliers or clients, with a view to securing a stable demand for its products, appropriate supplies of inputs, and access to technology. These are endeavors that may entail standard-setting, technology transfer, and collaborative research and development. Here, coordination problems stem from the sharing of proprietary information and the risk of exploitation in joint ventures. On the development of appropriate relationships in this sphere, however, depend the capacities of firms to remain competitive and technological progress in the economy as a whole. Finally, firms face a set of coordination problems vis-à-vis their own employees. Their central problem is to ensure that employees have the requisite competencies and cooperate well with others to advance the objectives of the firm. In this context, familiar problems of adverse selection and moral hazard arise, and issues of information-sharing become important (see Milgrom and Roberts 1992). Workers develop reservoirs of specialized information about the firm’s operations that can be of value to management, but they also have the capacity to withhold information or effort. The relationships firms develop to resolve these problems condition their own competencies and the character of an economy’s production regimes. 8 Peter A. Hall and David Soskice 1.2.2 Liberal Market Economies and Coordinated Market Economies From this perspective, it follows that national political economies can be compared by reference to the way in which firms resolve the coordination problems they face in these five spheres. The core distinction we draw is between two types of political economies, liberal market economies and coordinated market economies, which constitute ideal types at the poles of a spectrum along which many nations can be arrayed.6 In liberal market economies, firms coordinate their activities primarily via hierarchies and competitive market arrangements. These forms of coordination are well described by a classic literature (Williamson 1985). Market relationships are characterized by the arm’s length exchange of goods or services in a context of competition and formal contracting. In response to the price signals generated by such markets, the actors adjust their willingness to supply and demand goods or services, often on the basis of the marginal calculations stressed by neoclassical economics.7 In many respects, market institutions provide a highly effective means for coordinating the endeavors of economic actors. In coordinated market economies, firms depend more heavily on nonmarket relationships to coordinate their endeavors with other actors and to construct their core competencies. These non-market modes of coordination generally entail more extensive relational or incomplete contracting, network monitoring based on the exchange of private information inside networks, and more reliance on collaborative, as opposed to competitive, relationships to build the competencies of the firm. In contrast to liberal market economies (LMEs), where the equilibrium outcomes of firm behavior are usually given by demand and supply conditions in competitive markets, the equilibria on which firms coordinate in coordinated market economies (CMEs) are more often the result of strategic interaction among firms and other actors. Market relations and hierarchies are important to firms in all capitalist economies, of course, and, even in liberal market economies, firms enter 6 In other works by the contributors to this volume, ‘organized market economy’ is sometimes used as a term synonymous with ‘coordinated market economy.’ Although all of the economies we discuss are ‘coordinated’ in the general sense of the term, by markets if not by other institutions, the term reflects the prominence of strategic interaction and hence of coordination in the game-theoretic sense in CMEs. 7 Although we do not emphasize it here, this is not meant to deny the observation of Granovetter (1985) and others that market relations are usually underpinned by personal relationships of familiarity and trust. Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40111 1 9 into some relationships that are not fully mediated by market forces.8 But this typology is based on the contention that the incidence of different types of firm relationships varies systematically across nations. In some nations, for instance, firms rely primarily on formal contracts and highly competitive markets to organize relationships with their employees and suppliers of finance, while, in others, firms coordinate these endeavors differently. In any national economy, firms will gravitate toward the mode of coordination for which there is institutional support. 1.2.3 The Role of Institutions and Organizations Institutions, organizations, and culture enter this analysis because of the support they provide for the relationships firms develop to resolve coordination problems. Following North (1990: 3), we define institutions as a set of rules, formal or informal, that actors generally follow, whether for normative, cognitive, or material reasons, and organizations as durable entities with formally recognized members, whose rules also contribute to the institutions of the political economy.9 From this perspective, markets are institutions that support relationships of particular types, marked by arm’s-length relations and high levels of competition. Their concomitant is a legal system that supports formal contracting and encourages relatively complete contracts, as the chapters by Teubner and Casper indicate. All capitalist economies also contain the hierarchies that firms construct to resolve the problems that cannot be addressed by markets (Williamson 1985). In liberal market economies, these are the principal institutions on which firms rely to coordinate their endeavors. Although markets and hierarchies are also important elements of coordinated market economies, firms in this type of economy draw on a further set of organizations and institutions for support in coordinating their endeavors. What types of organizations and institutions support the distinctive strategies of economic actors in such economies? Because the latter rely more heavily on forms of coordination secured through 8 This point applies with particular force to market relationships in which one or more of the participants has substantially more market power than the others, as in cases of oligopoly, oligopsony, and the relations found in some supplier chains. We are not arguing that all markets in LMEs are perfectly competitive. 9 Note that, from time to time, we refer loosely to the ‘institutions’ or ‘organization’ of the political economy to refer to both the organizations and institutions found within it. 10 Peter A. Hall and David Soskice strategic interaction to resolve the problems they face, the relevant institutions will be those that allow them to coordinate on equilibrium strategies that offer higher returns to all concerned. In general, these will be institutions that reduce the uncertainty actors have about the behavior of others and allow them to make credible commitments to each other. A standard literature suggests that these are institutions providing capacities for (i) the exchange of information among the actors, (ii) the monitoring of behavior, and (iii) the sanctioning of defection from cooperative endeavor (see Ostrom 1990). Typically, these institutions include powerful business or employer associations, strong trade unions, extensive networks of cross-shareholding, and legal or regulatory systems designed to facilitate information-sharing and collaboration. Where these are present, firms can coordinate on strategies to which they would not have been led by market relations alone. The problem of operating collaborative vocational training schemes provides a classic example. Here, the willingness of firms to participate depends on the security of their beliefs that workers will learn useful skills and that firms not investing in training will not poach extensively from those who do, while the participation of workers depends on assurances that training will lead to remunerative employment. As Culpepper’s chapter in this volume indicates, it is easier for actors to secure these assurances where there are institutions providing reliable flows of information about appropriate skill levels, the incidence of training, and the employment prospects of apprentices (Finegold and Soskice 1988; Culpepper and Finegold 1999). Similarly, the terms on which finance is provided to firms will depend on the monitoring capacities present in the economy. Where potential investors have little access to inside information about the progress of the firms they fund, access to capital is likely to depend on highly public criteria about the assets of a firm of the sort commonly found on balance sheets. Where investors are linked to the firms they fund through networks that allow for the development of reputations based on extensive access to information about the internal operations of the firm, however, investors will be more willing to supply capital to firms on terms that do not depend entirely on their balance sheets. The presence of institutions providing network reputational monitoring can have substantial effects on the terms on which firms can secure finance. In short, this approach to comparative capitalism emphasizes the presence of institutions providing capacities for the exchange of information, monitoring, and the sanctioning of defections relevant to cooperative Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 11 behavior among firms and other actors; and it is for the presence of such institutions that we look when comparing nations. In addition, examination of coordinated market economies leads us to emphasize the importance of another kind of institution that is not normally on the list of those crucial to the formation of credible commitments, namely institutions that provide actors potentially able to cooperate with one another with a capacity for deliberation. By this, we simply mean institutions that encourage the relevant actors to engage in collective discussion and to reach agreements with each other.10 Deliberative institutions are important for several reasons. Deliberative proceedings in which the participants engage in extensive sharing of information about their interests and beliefs can improve the confidence of each in the strategies likely to be taken by the others. Many game-theoretic analyses assume a level of common knowledge that is relatively thin, barely stretching past a shared language and familiarity with the relevant payoffs. When multiple equilibria are available, however, coordination on one (especially one that exchanges higher payoffs for higher risks) can be greatly facilitated by the presence of a thicker common knowledge, one that extends beyond the basic situation to a knowledge of the other players sufficiently intimate to provide confidence that each will coordinate on a specific equilibrium (Eichengreen 1997). Deliberation can substantially thicken the common knowledge of the group. As Scharpf (1987: ch. 4) has pointed out, although many think only of a ‘prisoner’s dilemma’ game when they consider problems of cooperation, in the political economy many such problems take quite different forms, including ‘battle of the sexes’ games in which joint gains are available from more than one strategy but are distributed differently depending on the equilibrium chosen. Distributive dilemmas of this sort are endemic to political economies, and agreement on the distribution of the relevant gains is often the prerequisite to effective cooperation (Knight 1992). In some cases, such as those of collaborative research and development, the problem is not simply to distribute the gains but also the risks attendant on the enterprise. Deliberation provides the actors with an opportunity to establish the risks and gains attendant on cooperation and to resolve the distributive issues associated with them. In some cases, the actors may simply be negotiating from positions of 10 One political economist who has consistently drawn attention to the importance of deliberation is Sabel (1992, 1994) and the issue is now the subject of a growing gametheoretic literature (see Elster 1998). 12 Peter A. Hall and David Soskice relative power, but extensive deliberation over time may build up specific conceptions of distributive justice that can be used to facilitate agreement in subsequent exchanges. Finally, deliberative institutions can enhance the capacity of actors in the political economy for strategic action when faced with new or unfamiliar challenges. This is far from irrelevant since economies are frequently subject to exogenous shocks that force the actors within them to respond to situations to which they are unaccustomed. The history of wage negotiations in Europe is replete with examples. In such instances, developments may outrun common knowledge, and deliberation can be instrumental to devising an effective and coordinated response, allowing the actors to develop a common diagnosis of the situation and an agreed response. In short, deliberative institutions can provide the actors in a political economy with strategic capacities they would not otherwise enjoy; and we think cross-national comparison should be attentive to the presence of facilities for deliberation as well as institutions that provide for the exchange of information in other forms, monitoring, and the enforcement of agreements. 1.2.4 The Role of Culture, Informal Rules, and History Our approach departs from previous works on comparative capitalism in another respect.11 Many analyses take the view that the relevant outcomes in economic performance or policy follow more or less directly from differences in the formal organization of the political economy. Particular types of wage settlements or rates of inflation and unemployment are often said to follow, for instance, from the organizational structure of the union movement. Because we believe such outcomes are the products of efforts to coordinate in contexts of strategic interaction, however, we reject the contention that they follow from the presence of a particular set of institutions alone, at least if the latter are defined entirely in terms of formal rules or organizations. As we have noted, the presence of a set of formal institutions is often a necessary precondition for attaining the relevant equilibrium in contexts of coordination. But formal institutions are rarely sufficient to guarantee that equilibrium. In multi-player games with multiple iterations of the sort that characterize most of the cases in which we are 11 Here we depart from some of our own previous formulations as well (cf. Hall 1986; Soskice 1990b). Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 13 interested, it is well known that there exist multiple equilibria, any one of which could be chosen by the actors even in the presence of institutions conducive to the formation of credible commitments (Fudenberg and Maskin 1986). Something else is needed to lead the actors to coordinate on a specific equilibrium and, notably, on equilibria offering high returns in a non-coooperative context.12 In many instances, what leads the actors to a specific equilibrium is a set of shared understandings about what other actors are likely to do, often rooted in a sense of what it is appropriate to do in such circumstances (March and Olsen 1989). Accordingly, taking a step beyond many accounts, we emphasize the importance of informal rules and understandings to securing the equilibria in the many strategic interactions of the political economy. These shared understandings are important elements of the ‘common knowledge’ that lead participants to coordinate on one outcome, rather than another, when both are feasible in the presence of a specific set of formal institutions. By considering them a component of the institutions making up the political economy, we expand the concept of institutions beyond the purely formal connotations given to it in some analyses. This is an entry point in the analysis for history and culture. Many actors learn to follow a set of informal rules by virtue of experience with a familiar set of actors and the shared understandings that accumulate from this experience constitute something like a common culture. This concept of culture as a set of shared understandings or available ‘strategies for action’ developed from experience of operating in a particular environment is analogous to those developed in the ‘cognitive turn’ taken by sociology (Swidler 1986; DiMaggio and Powell 1991). Our view of the role that culture can play in the strategic interactions of the political economy is similar to the one Kreps (1990) accords it in organizations faced with problems of incomplete contracting. The implication is that the institutions of a nation’s political economy are inextricably bound up with its history in two respects. On the one hand, they are created by actions, statutory or otherwise, that establish formal institutions and their operating procedures. On the other, repeated historical experience builds up a set of common expectations that allows the actors to coordinate effectively with each other. Among other things, this implies that the institutions central to the operation of the political economy should not be seen as entities that are created at one point in time and can then be assumed to operate effectively afterwards. 12 Culpepper documents this problem and explores some solutions to it in this volume and Culpepper (1998). 14 Peter A. Hall and David Soskice To remain viable, the shared understandings associated with them must be reaffirmed periodically by appropriate historical experience. As Thelen emphasizes in this volume, the operative force of many institutions cannot be taken for granted but must be reinforced by the active endeavors of the participants. 1.2.5 Institutional Infrastructure and Corporate Strategy This varieties of capitalism approach draws its basic conceptions of how institutions operate from the new economics of organization. We apply a set of concepts commonly used to explain behavior at the micro level of the economy to problems of understanding the macroeconomy (Milgrom and Roberts 1992). One of the advantages is an analysis with robust and consistent postulates about what kind of institutions matter and how they affect behavior. Another is the capacity of the approach to integrate analysis of firm behavior with analysis of the political economy as a whole. However, there are at least two respects in which our account deviates from mainstream views in the new economics of organization. First, although we make use of the influential dichotomy between ‘markets’ and ‘hierarchies’ that Williamson (1975) has impressed on the field, we do not think this exhausts the relevant variation. Markets and hierarchies are features of LMEs and CMEs but we stress the systematic variation found in the character of corporate structure (or hierarchies) across different types of economies and the presence of coordination problems even within hierarchical settings (Milgrom and Roberts 1992). Even more important, we do not see these two institutional forms as the only ones firms can employ to resolve the challenges they confront. In coordinated market economies in particular, many firms develop relationships with other firms, outside actors, and their employees that are not well described as either market-based or hierarchical relations but better seen as efforts to secure cooperative outcomes among the actors using a range of institutional devices that underpin credible commitments. Variation in the incidence and character of this ‘third’ type of relationship is central to the distinctions we draw between various types of political economies.13 Second, it is conventional in much of the new economics of organization to assume that the core institutional structures of the economy, 13 Williamson (1985) himself acknowledges the presence of institutionalized relationships extending beyond markets or hierarchies, albeit without characterizing them precisely as we do here. Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 15 whether markets, hierarchies, or networks, are erected by firms seeking the most efficient institutions for performing certain tasks. The postulate is that (institutional) structure follows (firm) strategy (cf. Chandler 1974; Williamson 1975, 1985; Chandler and Daems 1980). In a restricted sense, this is certainly true: firms can choose whether to contract out an endeavor or perform it in-house, for instance, and they enjoy some control over their own corporate form. However, we think it unrealistic to regard the overarching institutional structures of the political economy, and especially those coordinating the endeavors of many actors (such as markets, institutional networks, and the organizations supporting collaborative endeavor), as constructs created or controlled by a particular firm. Because they are collective institutions, a single firm cannot create them; and, because they have multifarious effects, it may be difficult for a group of firms to agree on them.14 Instead, as Calvert (1995) observes, the construction of coordinating institutions should be seen as a second-order coordination problem of considerable magnitude. Even when firms can agree, the project may entail regulatory action by the government and the formation of coalitions among political parties and labor organizations motivated by considerations well beyond efficiency (Swenson 1991, 1997). As a result, the firms located within any political economy face a set of coordinating institutions whose character is not fully under their control. These institutions offer firms a particular set of opportunities; and companies can be expected to gravitate toward strategies that take advantage of these opportunities. In short, there are important respects in which strategy follows structure. For this reason, our approach predicts systematic differences in corporate strategy across nations, and differences that parallel the overarching institutional structures of the political economy. This is one of the most important implications of the analysis. Let us stress that we refer here to broad differences. Of course, there will be additional variation in corporate strategies inside all economies in keeping with differences in the resource endowments and market settings of individual firms. The capabilities of management also matter, since firms are actors with considerable autonomy. Our point is that (institutional) structure conditions (corporate) strategy, not that it fully determines it. We also agree that differences in corporate strategy can be conditioned by the institutional support available to firms at the regional or sectoral levels (Campbell et al. 1991; Hollingsworth et al. 1994; Herrigel 14 At the sectoral or regional level, of course, large firms may be able to exercise substantial influence over the development of these institutions, as Hancké shows in this volume (see also Hancké forthcoming). 16 Peter A. Hall and David Soskice 1996). Many of the works making this point are congruent with our own in that they stress the importance of the institutional environment to firm strategy, even though there has been fruitful disagreement about which features of that environment matter most (cf. Streeck 1992b).15 However, we emphasize variations in corporate strategy evident at the national level. We think this justified by the fact that so many of the institutional factors conditioning the behavior of firms remain nationspecific. There are good reasons why that should be the case. Some of the relevant institutions were deeply conditioned by nationally specific processes of development, as are most trade unions and employers’ associations. In others, the relevant institutions depend heavily on statutes or regulations promulgated by national states, as do many institutions in the financial arena and labor market, not to mention the sphere of contract law. In sum, we contend that differences in the institutional framework of the political economy generate systematic differences in corporate strategy across LMEs and CMEs. There is already some evidence for this. For instance, the data that Knetter (1989) has gathered are especially interesting. He finds that the firms of Britain, a typical LME, and those of Germany, a CME, respond very differently to a similar shock, in this case an appreciation of the exchange rate that renders the nation’s goods more expensive in foreign markets. British firms tend to pass the price increase along to customers in order to maintain their profitability, while German firms maintain their prices and accept lower returns in order to preserve market share. Our approach predicts differences of precisely this sort. We would argue that British firms must sustain their profitability because the structure of financial markets in a liberal market economy links the firm’s access to capital and ability to resist takeover to its current profitability; and they can sustain the loss of market share because fluid labor markets allow them to lay off workers readily. By contrast, German firms can sustain a decline in returns because the financial system of a coordinated market economy provides firms with access to capital independent of current profitability; and they attempt to retain market share because the labor institutions in such an economy militate in favor of long-term employment strategies and render lay offs difficult. 15 It is possible to apply the general analytical framework of this volume to variations at the regional or sectoral level, as the chapter by Hancké does in some respects. From the perspective of this volume, institutional variation at the regional or sectoral level provides an additional layer of support for particular types of coordination and one that enhances a nation’s capacity to support a range of corporate strategies and production regimes. Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 17 These are only some of the ways in which the institutional arrangements of a nation’s political economy tend to push its firms toward particular kinds of corporate strategies. We explore more of these below with special emphasis on innovation. To put the point in the most general terms, however, firms and other actors in coordinated market economies should be more willing to invest in specific and co-specific assets (i.e. assets that cannot readily be turned to another purpose and assets whose returns depend heavily on the active cooperation of others), while those in liberal market economies should invest more extensively in switchable assets (i.e. assets whose value can be realized if diverted to other purposes). This follows from the fact that CMEs provide more institutional support for the strategic interactions required to realize the value of co-specific assets, whether in the form of industry-specific training, collaborative research and development, or the like, while the more fluid markets of LMEs provide economic actors with greater opportunities to move their resources around in search of higher returns, encouraging them to acquire switchable assets, such as general skills or multi-purpose technologies.16 1.2.6 Institutional Complementarities The presence of institutional complementarities reinforces the differences between liberal and coordinated market economies. The concept of ‘complementary goods’ is a familiar one: two goods, such as bread and butter, are described as complementary if an increase in the price of one depresses demand for the other. However, complementarities may also exist among the operations of a firm: marketing arrangements that offer customized products, for instance, may offer higher returns when coupled to the use of flexible machine tools on the shop floor (Jaikumar 1986; Milgrom and Roberts 1990, 1995). Following Aoki (1994), we extend this line of reasoning to the institutions of the political economy. Here, two institutions can be said to be complementary if the presence (or efficiency) of one increases the returns from (or efficiency of) the other.17 The returns from a stock market trading 16 For examples in one sphere, see the essay by Estevez-Abe, Iversen, and Soskice in this volume. 17 Conversely, two institutions can be said to be ‘substitutable’ if the absence or inefficiency of one increases the returns to using the other. Note that we refer to total returns, leaving aside the question of to whom they accrue, which is a matter of property rights, and we define efficiency as the net returns to the use of an institution given its costs. 18 Peter A. Hall and David Soskice in corporate securities, for instance, may be increased by regulations mandating a fuller exchange of information about companies. Of particular interest are complementarities between institutions located in different spheres of the political economy. Aoki (1994) has argued that long-term employment is more feasible where the financial system provides capital on terms that are not sensitive to current profitability. Conversely, fluid labor markets may be more effective at sustaining employment in the presence of financial markets that transfer resources readily among endeavors thereby maintaining a demand for labor (cf. Caballero and Hamour 1998; Fehn 1998). Casper explores complementarities between national systems of contract law and modes of inter-firm collaboration, and we identify others in the sections that follow. This point about institutional complementarities has special relevance for the study of comparative capitalism. It suggests that nations with a particular type of coordination in one sphere of the economy should tend to develop complementary practices in other spheres as well.18 Several logics may be operative here. In some cases, the institutions sustaining coordination in one sphere can be used to support analogous forms of coordination in others. Where dense networks of business associations support collaborative systems of vocational training, for instance, those same networks may be used to operate collective standard-setting. Similarly, firms may pressure governments to foster the development of institutions complementary to those already present in the economy in order to secure the efficiency gains they provide. If this is correct, institutional practices of various types should not be distributed randomly across nations. Instead, we should see some clustering along on the dimensions that divide liberal from coordinated market economies, as nations converge on complementary practices across different spheres. Fig. 1.1 presents some support for these propositions. It locates OECD nations on two axes that provide indicators for the character of institutions in the spheres of corporate finance and labor markets respectively. A highly developed stock market indicates greater reliance on market modes of coordination in the financial 18 Of course, there are limits to the institutional isomorphism that can be expected across spheres of the economy. Although efficiency considerations may press in this direction, the presence of functional equivalents for particular arrangements will limit the institutional homology even across similar types of political economies, and the importance to institutional development of historical processes driven by considerations other than efficiency will limit the number of complementarities found in any economy. Introduction 1 ITL Employment/protection 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40111 1 19 AUT GER NTH JAP FRA FIN BEL DEN 0.5 AUS CAN UK US 0 0.04 Stock market capitalization 209.72 FIG. 1.1 Institutions across sub-spheres of the political economy Note: Employment protection refers to the index of employment protection developed by EstevezAbe, Iversen, and Soskice in this volume. Stock market capitalization is the market value of listed domestic companies as a percentage of GDP. Source: International Federation of Stock Exchanges, Annual Report. sphere, and high levels of employment protection tend to reflect higher levels of non-market coordination in the sphere of industrial relations.19 Although there is some variation within each group, a pronounced clustering is evident. Nations with liberal market economies tend to rely on markets to coordinate endeavors in both the financial and industrial relations systems, while those with coordinated market economies have institutions in both spheres that reflect higher levels of non-market coordination. Among the large OECD nations, six can be classified as liberal market economies (the USA, Britain, Australia, Canada, New Zealand, Ireland) and another ten as coordinated market economies (Germany, Japan, Switzerland, the Netherlands, Belgium, Sweden, Norway, Denmark, 19 The employment protection index developed by Estevez-Abe, Iversen, and Soskice in their chapter for this volume is a composite measure of the relative stringency of legislation or collective agreements dealing with hiring and firing, the level of restraint embedded in collective dismissal rules, and the extent of firm-level employment protection. Stock market capitalization is the market value of listed domestic companies as a percentage of GDP. 20 Peter A. Hall and David Soskice Table 1.1 The economic performance of liberal and coordinated market economies Liberal market economies Growth rate of GDP GDP per capita Unemployment rate 61–73 74–84 85–98 74–84 85–97 60–73 74–84 85–98 Australia Canada Ireland New Zealand UK United States 5.2 5.3 4.4 4.0 3.1 4.0 2.8 3.0 3.9 1.8 1.3 2.2 3.3 2.3 6.5 1.7 2.4 2.9 7932 9160 4751 7378 7359 11055 16701 18835 12830 14172 15942 22862 1.9 5.1 5.0 0.2 2.0 4.9 6.2 8.4 9.1 2.2 6.7 7.5 8.5 9.5 14.1 6.9 8.7 6.0 LME average 4.3 2.5 3.2 7939 16890 3.2 6.7 8.9 Coordinated market economies Growth rate of GDP GDP per capita Unemployment rate 61–73 74–84 85–98 74–84 85–97 60–73 74–84 85–98 Austriaa Belgium Denmark Finland Iceland Germany Japan Netherlandsb Norway Sweden Switzerland 4.9 4.9 4.4 5.0 5.7 4.3 9.7 4.9 4.3 4.2 4.4 2.3 2.0 1.8 2.7 4.1 1.8 3.3 1.9 4.0 1.8 0.58 2.5 2.2 2.2 2.2 2.7 2.2 2.6 2.8 2.9 1.5 1.3 7852 8007 8354 7219 8319 7542 7437 7872 8181 8450 10680 17414 17576 18618 15619 18285 16933 18475 16579 19325 16710 21398 1.6 2.2 1.4 2.0 0.6 0.8 1.3 1.5 1.6 1.9 0.01 2.2 8.2 7.1 4.8 0.6 4.6 2.1 5.6 2.1 2.3 0.4 5.3 11.3 9.3 9.4 2.5 8.5 2.8 6.8 4.3 4.8 2.5 CME average 5.1 2.4 2.3 8174 17902 1.3 3.6 6.1 Notes: Growth rate of GDP: average annual growth in GDP, averaged for the time-periods indicated. GDP per capita: per capita GDP at purchasing power parity, averaged for the time-periods indicated. Unemployment rate: annual unemployment rate. a b Unemployment series begins in 1964. Unemployment series begins in 1969. Sources: Growth rate of GDP: World Bank, World Development Indicators CD-ROM (2000); except for Germany, for which data were taken from OECD, Historical Statistics (1997), for 1960–91, and WDI for years thereafter. GDP per capita: OECD, OECD Statistical Compendium CD-ROM (2000). Unemployment rate: OECD, OECD Statistical Compendium CD-ROM (2000). Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 21 Finland, and Austria) leaving six in more ambiguous positions (France, Italy, Spain, Portugal, Greece, and Turkey).20 However, the latter show some signs of institutional clustering as well, indicating that they may constitute another type of capitalism, sometimes described as ‘Mediterranean’, marked by a large agrarian sector and recent histories of extensive state intervention that have left them with specific kinds of capacities for non-market coordination in the sphere of corporate finance but more liberal arrangements in the sphere of labor relations (see Rhodes 1997). Although each type of capitalism has its partisans, we are not arguing here that one is superior to another. Despite some variation over specific periods, both liberal and coordinated market economies seem capable of providing satisfactory levels of long-run economic performance, as the major indicators of national well-being displayed in Table 1.1 indicate. Where there is systematic variation between these types of political economies, it is on other dimensions of performance. We argue below that the two types of economies have quite different capacities for innovation. In addition, they tend to distribute income and employment differently. As Fig. 1.2 indicates, in liberal market economies, the adult population tends to be engaged more extensively in paid employment and levels of income inequality are high.21 In coordinated market economies, working hours tend to be shorter for more of the population and incomes more equal. With regard to the distribution of well-being, of course, these differences are important. To make this analytical framework more concrete, we now look more closely at coordination in the principal spheres of firm endeavor in coordinated and liberal market economies, drawing on the cases of Germany and the United States for examples and emphasizing the institutional complementarities present in each political economy. 1.3 Coordinated Market Economies: The German Case As we have noted, we regard capitalist economies as systems in which companies and individuals invest, not only in machines and material 20 Luxembourg and Iceland have been omitted from this list because of their small size and Mexico because it is still a developing nation. 21 The Gini Index used in Fig. 1.2 is a standard measure for income inequality, measured here as post-tax, post-transfer income, reported in the Luxembourg Income Study for the mid- to late 1980s. Full-time equivalent employment is reported as a percentage of potential employment and measured as the total number of hours worked per year divided by full-time equivalent hours per person (37.5 hours at 50 weeks) times the working-age population. It is reported for the latest available of 1993 or 1994. 22 Peter A. Hall and David Soskice JPN Full-time equivalent employment 77.8 US AUS CAN UK NZ SWE FIN NOR GER FRA ITL ESP 44.9 20.7 GINI 36.8 Fig. 1.2 Distributional outcomes across political economies Note: Full-time equivalent employment is defined as the total number of hours worked per year divided by full-time equivalent hours per year per person times working age population. GINI refers to the gini coeffficient measuring post-tax, post-transfer income inequality. Sources: For full-time equivalent unemployment: OECD (1996a). For GINI: Spain, Portugal, Japan, New Zealand are from Deiniger and Squire (1996); the remaining countries are from OECD (1996a). technologies, but in competencies based on relations with others that entail coordination problems. In coordinated market economies, firms resolve many of these problems through strategic interaction. The resulting equilibria depend, in part, on the presence of supportive institutions. Here, we use the case of Germany to illustrate how non-market coordination is achieved in each of the principal spheres of firm endeavor. Of course, the institutions used to secure coordination in other CMEs may differ to some extent from those of Germany. (i) The financial system or market for corporate governance in coordinated market economies typically provides companies with access to finance that is not entirely dependent on publicly available financial data or current returns. Access to this kind of ‘patient capital’ makes it possible for firms to retain a skilled workforce through economic downturns and to invest in projects generating returns only in the long run. The core problem here is that, if finance is not to be dependent on balance-sheet criteria, investors must have other ways of monitoring the performance Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 23 of companies in order to ensure the value of their investments. In general, that means they must have access to what would normally be considered ‘private’ or ‘inside’ information about the operation of the company. This problem is generally resolved in CMEs by the presence of dense networks linking the managers and technical personnel inside a company to their counterparts in other firms on terms that provide for the sharing of reliable information about the progress of the firm. Reliability is secured in a number of ways. Firms may share information with third parties in a position to monitor the firm and sanction it for misleading them, such as business associations whose officials have an intimate knowledge of the industry. Reputation is also a key factor: where membership in a network is of continuing value, the participants will be deterred from providing false information lest their reputation in the network and access to it suffer. CMEs usually have extensive systems for what might be termed ‘network reputational monitoring’ (Vitols et al. 1997). In Germany, information about the reputation and operation of a company is available to investors by virtue of (a) the close relationships that companies cultivate with major suppliers and clients, (b) the knowledge secured from extensive networks of cross-shareholding, and (c) joint membership in active industry associations that gather information about companies in the course of coordinating standard-setting, technology transfer, and vocational training. Other companies are not only represented on the supervisory boards of firms but typically engaged closely with them in joint research, product development, and the like. In short, firms sit inside dense business networks from which potential funders can gain a considerable amount of inside information about the track record and projects of a firm.22 The overall structure of the market for corporate governance is equally important. Since firms often fund their activities from retained earnings, they are not always sensitive to the terms on which external finance is supplied. But they can be forced to focus on profitability and shareholder value if faced with the prospect of hostile takeover by others claiming to be able to extract more value from the company. Thus, the corporate strategies found in many CMEs also depend on tax provisions, securities regulations, and networks of cross-shareholding that 22 In previous decades, the German banks were also important contributors to such networks by virtue of their control over large numbers of shares in industrial firms (Hall 1986: ch. 9). In recent years, the role of the large commercial banks has declined, as they divest themselves of many holdings (Griffin 2000). 24 Peter A. Hall and David Soskice discourage hostile mergers and acquisitions, which were very rare until recently, for instance, in Germany. (ii) The internal structure of the firm reinforces these systems of network monitoring in many CMEs. Unlike their counterparts in LMEs, for instance, top managers in Germany rarely have a capacity for unilateral action. Instead, they must secure agreement for major decisions from supervisory boards, which include employee representatives as well as major shareholders, and from other managers with entrenched positions as well as major suppliers and customers. This structural bias toward consensus decision-making encourages the sharing of information and the development of reputations for providing reliable information, thereby facilitating network monitoring. In the perspective we present, the incentives facing individuals, whether managers or workers, are as important as those facing firms. In CMEs, managerial incentives tend to reinforce the operation of business networks. Long-term employment contracts and the premium that firmstructure places on a manager’s ability to secure consensus for his projects lead managers to focus heavily on the maintenance of their reputations, while the smaller weight given to stock-option schemes in managerial compensation in CMEs relative to LMEs inclines them to focus less on profitability than their counterparts in LMEs. The incentives for managers are broadly aligned with those of firms. (iii) Many firms in coordinated market economies employ production strategies that rely on a highly skilled labor force given substantial work autonomy and encouraged to share the information it acquires in order to generate continuous improvements in product lines and production processes (Sorge and Warner 1986; Dore 1986). However, companies that adopt such strategies are vulnerable to ‘hold up’ by their employees and the ‘poaching’ of skilled workers by other firms, while employees who share the information they gain at work with management are open to exploitation.23 Thus, CMEs need industrial relations institutions capable of resolving such problems. The German industrial relations system addresses these problems by setting wages through industry-level bargains between trade unions and employer associations that generally follow a leading settlement, normally reached in engineering where the union is powerful enough to 23 ‘Hold up’ is Williamson’s (1985) term for the withdrawal of active cooperation to back up demands. Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 25 assure the labor movement that it has received a good deal. Although union density is only moderately high, encompassing employers’ associations bind their members to these agreements. By equalizing wages at equivalent skill levels across an industry, this system makes it difficult for firms to poach workers and assures the latter that they are receiving the highest feasible rates of pay in return for the deep commitments they are making to firms. By coordinating bargaining across the economy, these arrangements also limit the inflationary effects of wage settlements (Streeck 1994; Hall and Franzese 1998). The complement to these institutions at the company level is a system of works councils composed of elected employee representatives endowed with considerable authority over layoffs and working conditions. By providing employees with security against arbitrary layoffs or changes to their working conditions, these works councils encourage employees to invest in company-specific skills and extra effort. Their effectiveness is underpinned by the capacity of either side to appeal a disputed decision to the trade unions and employers’ associations, who act as external guarantors that the councils function as intended (Thelen 1991). (iv) Because coordinated market economies typically make extensive use of labor with high industry-specific or firm-specific skills, they depend on education and training systems capable of providing workers with such skills.24 As Culpepper notes in his chapter, the coordination problems here are acute, as workers must be assured that an apprenticeship will result in lucrative employment, while firms investing in training need to know that their workers will acquire usable skills and will not be poached by companies that do not make equivalent investments in training. CMEs resolve these problems in a variety of ways. Germany relies on industry-wide employer associations and trade unions to supervise a publicly subsidized training system. By pressuring major firms to take on apprentices and monitoring their participation in such schemes, these associations limit free-riding on the training efforts of others; and, by negotiating industry-wide skill categories and training protocols with the firms in each sector, they ensure both that the training fits the firms’ needs and that there will be an external demand for any graduates not employed by the firms at which they apprenticed. Because German employer associations are encompassing organizations 24 Compared to general skills that can be used in many settings, industry-specific skills normally have value only when used within a single industry and firm-specific skills only in employment within that firm. 26 Peter A. Hall and David Soskice that provide many benefits to their members and to which most firms in a sector belong, they are well placed to supply the monitoring and suasion that the operation of such a system demands as well as the deliberative forums in which skill categories, training quotas, and protocols can be negotiated. Workers emerge from their training with both company-specific skills and the skills to secure employment elsewhere. (v) Since many firms in coordinated market economies make extensive use of long-term labor contracts, they cannot rely as heavily on the movement of scientific or engineering personnel across companies, to effect technology transfer, as liberal market economies do. Instead, they tend to cultivate inter-company relations of the sort that facilitate the diffusion of technology across the economy. In Germany, these relationships are supported by a number of institutions. Business associations promote the diffusion of new technologies by working with public officials to determine where firm competencies can be improved and orchestrating publicly subsidized programs to do so. The access to private information about the sector that these associations enjoy helps them ensure that the design of the programs is effective for these purposes. A considerable amount of research is also financed jointly by companies, often in collaboration with quasi-public research institutes. The common technical standards fostered by industry associations help to diffuse new technologies, and they contribute to a common knowledge-base that facilitates collaboration among personnel from multiple firms, as do the industry-specific skills fostered by German training schemes (Lütz 1993; Soskice 1997b; Ziegler 1997). Casper’s chapter in this volume shows that Germany has also developed a system of contract law complementary to the presence of strong industry associations that encourages relational contracting among companies and promotes this sort of technology transfer. Because of the many contingencies that can arise in close inter-firm relationships involving joint research or product development, tightly written, formal contracts are often inadequate to sustain such relationships. However, the German courts permit unusually open-ended clauses in inter-firm contracts on the explicit condition that these be grounded in the prevailing standards of the relevant industry association. Thus, the presence of strong industry associations capable of promulgating standards and resolving disputes among firms is the precondition for a system of contract law that encourages relational contracting (cf. Casper 1997; Teubner in this volume). In these respects, German institutions support forms of relational contracting and technology transfer that are more difficult to achieve in Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 27 liberal market economies. One of the effects is to encourage corporate strategies that focus on product differentiation and niche production, rather than direct product competition with other firms in the industry, since close inter-firm collaboration is harder to sustain in the presence of the intense product competition that tends to characterize LMEs. The chapter by Estevez-Abe, Iversen, and Soskice examines the linkages between these product market strategies, skill systems, and social-policy regimes. The complementarities present in the German political economy should be apparent from this account. Many firms pursue production strategies that depend on workers with specific skills and high levels of corporate commitment that are secured by offering them long employment tenures, industry-based wages, and protective works councils. But these practices are feasible only because a corporate governance system replete with mechanisms for network monitoring provides firms with access to capital on terms that are relatively independent of fluctuations in profitability. Effective vocational training schemes, supported by an industrial-relations system that discourages poaching, provide high levels of industry-specific skills. In turn, this encourages collective standard-setting and inter-firm collaboration of the sort that promotes technology transfer. The arrows in Fig. 1.3 summarize some of these complementarities. Since many of these institutional practices enhance the effectiveness with which others operate, the economic returns to the system as a whole are greater than its component parts alone would generate. 1.4 Liberal Market Economies: The American Case Liberal market economies can secure levels of overall economic performance as high as those of coordinated market economies, but they do so quite differently. In LMEs, firms rely more heavily on market relations to resolve the coordination problems that firms in CMEs address more often via forms of non-market coordination that entail collaboration and strategic interaction. In each of the major spheres of firm endeavor, competitive markets are more robust and there is less institutional support for non-market forms of coordination. (i) Several features of the financial systems or markets for corporate governance of liberal market economies encourage firms to be attentive to current earnings and the price of their shares on equity markets. Regulatory regimes are tolerant of mergers and acquisitions, including the hostile 28 Peter A. Hall and David Soskice Corporate governance system, permitting LR finance without publicly assessible information, using reputational monitoring LR finance allows credible commitments to LR security by employers Certification helps assess company Allows viability consensus decisionmaking Education and training system which permits sunk human capital investments in firms and sometimes defined industries Reduces risk of sunk investments Skilled employees in powerful position in companies Cooperation between companies needed to allow reputational monitoring Allows credible commitment Co-determination to long-run provides way to bring relations profitability needs into between consensus decision-making companies Provides common ind. tech skills needed for cooperation based System of interon common company relations Company standard needs Makes consensus vocational standard-setting possible Industrial-relations system which provides employee cooperation in companies and wage moderation allows cooperation, standard-setting and technology transfer Reduces temptation to poach Product market cooperation lowers external labour market competition Fig. 1.3 Complementarities across subsystems in the German coordinated market economy takeovers that become a prospect when the market valuation of a firm declines. The terms on which large firms can secure finance are heavily dependent on their valuation in equity markets, where dispersed investors depend on publicly available information to value the company. This applies to both bonds, share issues, and bank lending.25 Compensation systems that reward top management for increases in net earnings 25 Firms in LMEs tend to rely on bond and equity markets for external finance more heavily than those in CMEs. However, bank lending in such economies also privileges publicly accessible, balance-sheet criteria, since banks find it difficult to monitor the less- Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 29 or share price are common in such economies. Liberal market economies usually lack the close-knit corporate networks capable of providing investors with inside information about the progress of companies that allows them to supply finance less dependent on quarterly balance sheets and publicly available information. The relevant contrast is with CMEs, where firms need not be as attentive to share price or current profitability in order to ensure access to finance or deter hostile takeovers. Of course, there are some qualifications to these generalizations. Companies with readily assessable assets associated with forward income streams, such as pharmaceutical firms with a ‘pipeline’ of drugs, consumer-goods companies with strong reputations for successful product development, and firms well positioned in high-growth markets, need not be as concerned about current profitability. New firms in hightechnology fields can often secure funds from venture-capital companies that develop the resources and technical expertise to monitor their performance directly and trade ownership stakes in these firms for the high risks they take.26 On the whole, however, the markets for corporate governance in LMEs encourage firms to focus on the publicly assessable dimensions of their performance that affect share price, such as current profitability. (ii) In the industrial relations arena, firms in liberal market economies generally rely heavily on the market relationship between individual worker and employer to organize relations with their labor force. Top management normally has unilateral control over the firm, including substantial freedom to hire and fire.27 Firms are under no obligation to establish representative bodies for employees such as works councils; and trade unions are generally less powerful than in CMEs, although they may have significant strength in some sectors. Because trade unions obvious dimensions of corporate progress in an environment that lacks the close-knit corporate networks conveying such information in CMEs. Intense monitoring by a loan officer is feasible only when small sums are involved, since it exposes the bank to problems of moral hazard that are especially acute in countries where officers can take advantage of fluid labor markets to move elsewhere. 26 Note that we avoid a distinction often drawn between countries in which firms can raise ‘long-term’ versus those in which only ‘short-term’ capital is available because this distinction is rarely meaningful. Many companies in LMEs with established market reputations can raise capital for projects promising revenues only in the medium to long term, and firms often finance the bulk of their activities from retained earnings. Of more relevance are the rules governing hostile takeovers, whose prospect can induce firms to pay more attention to corporate earnings and the price of their shares. 27 Partly for this reason, the market valuation of firms in LMEs often depends more heavily on the reputation of its CEO than it does in CMEs. 30 Peter A. Hall and David Soskice and employer associations in LMEs are less cohesive and encompassing, economy-wide wage coordination is generally difficult to secure. Therefore, these economies depend more heavily on macroeconomic policy and market competition to control wages and inflation (see Franzese in this volume; Hall and Franzese 1998). The presence of highly-fluid labor markets influences the strategies pursued by both firms and individuals in liberal market economies. These markets make it relatively easy for firms to release or hire labor in order to take advantage of new opportunities but less attractive for them to pursue production strategies based on promises of long-term employment. They encourage individuals to invest in general skills, transferable across firms, rather than company-specific skills and in career trajectories that include a substantial amount of movement among firms. (iii) The education and training systems of liberal market economies are generally complementary to these highly fluid labor markets. Vocational training is normally provided by institutions offering formal education that focuses on general skills because companies are loath to invest in apprenticeship schemes imparting industry-specific skills where they have no guarantees that other firms will not simply poach their apprentices without investing in training themselves. From the perspective of workers facing short job tenures and fluid labor markets, career success also depends on acquiring the general skills that can be used in many different firms; and most educational programs from secondary through university levels, even in business and engineering, stress ‘certification’ in general skills rather than the acquisition of more specialized competencies. High levels of general education, however, lower the cost of additional training. Therefore, the companies in these economies do a substantial amount of in-house training, although rarely in the form of the intensive apprenticeships used to develop company-specific or industry-specific skills in CMEs. More often, they provide further training in the marketable skills that employees have incentives to learn. The result is a labor force well equipped with general skills, especially suited to job growth in the service sector where such skills assume importance, but one that leaves some firms short of employees with highly specialized or company-specific skills. (iv) Inter-company relations in liberal market economies are based, for the most part, on standard market relationships and enforceable formal contracts. In the United States, these relations are also mediated by Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 31 rigorous antitrust regulations designed to prevent companies from colluding to control prices or markets and doctrines of contract laws that rely heav-ily on the strict interpretation of written contracts, nicely summarized by MacNeil’s dictum: ‘sharp in by clear agreement, sharp out by clear performance’ (Williamson 1985). Therefore, companies wishing to engage in relational contracts with other firms get little assistance from the American legal system, as Casper observes. In some fields of endeavor, such as after-sales service, companies can engage successfully in incomplete contracting by building up reputations on which other parties rely. But extensive reputation-building is more difficult in economies lacking the dense business networks or associations that circulate reputations for reliability or sharp practice quickly and widely. Because the market for corporate governance renders firms sensitive to fluctuations in current profitability, it is also more difficult for them to make credible commitments to relational contracts that extend over substantial periods of time. How then does technology transfer take place in liberal market economies? In large measure, it is secured through the movement of scientists and engineers from one company to another (or from research institutions to the private sector) that fluid labor markets facilitate. These scientific personnel bring their technical knowledge with them. LMEs also rely heavily on the licensing or sale of innovations to effect technology transfer, techniques that are most feasible in sectors of the economy where effective patenting is possible, such as biotechnology, microelectronics, and semiconductors. In the United States, the character of standard-setting reinforces the importance of licensing. Since few sectors have business associations capable of securing consensus on new standards, collective standard-setting is rarely feasible. Instead, standards are often set by market races, whose winners then profit by licensing their technology to many users (see also Tate in this volume). The prominence of this practice helps to explain the presence of venture-capital firms in liberal market economies: one success at standard-setting can pay for many failed investments (Borrus and Zysman 1997). In LMEs, research consortia and inter-firm collaboration, therefore, play less important roles in the process of technology transfer than in CMEs, where the institutional environment is more conducive to them. Until the National Cooperative Research Act of 1984, American firms engaging in close collaboration with other firms actually ran the risk of being sued for triple damages under antitrust law; and it is still estimated that barely 1 to 7 per cent of the funds spent on research and development in the American private sector are devoted to collaborative research. 32 Peter A. Hall and David Soskice It should be apparent that there are many institutional complementarities across the sub-spheres of a liberal market economy (see Fig. 1.4). Labor market arrangements that allow companies to cut costs in a downturn by shedding labor are complementary to financial markets that render a firm’s access to funds dependent on current profitability. Educational arrangements that privilege general, rather than firm-specific, skills are complementary to highly fluid labor markets; and the latter render forms of technology transfer that rely on labor mobility more feasible. In Finance available on publicly assessable information, all risks, repuations if publicly assessable; inside info. only if monitorable, e.g. by venture captalists Credible commitment difficult for LR relational sunk investments in training Credible commitment Unilateral control difficult for LR reinforces market in corporate control; and allows relational sunk investments owners to set high-powered between incentives companies Permits mobility and retraining Lack of sunk training investments reinforces market for corporate control Education and training system permitting investments in general skills Disincentive for sunk cost training Difficult to use other companies to monitor inside information Company competing in rapidly changing markets Short-run finance prevents power bases developing among employees Permits mobility and retraining Deregulated labor markets, low-cost hiring and firing, no co-determination rights, flexible reward-setting Strong competition policy; standardsetting via market competition; technology transfer via market (incl. alliances, rjvs, hires) Permits tech. diffusion via high-skill labour mobility Product market instability reinforces labor market deregulation Fig. 1.4 Complementarities across subsystems in the American liberal market economy Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 33 the context of a legal system that militates against relational contracting, licensing agreements are also more effective than inter-firm collaboration on research and development for effecting technology transfer. Special note should be taken of the complementarities between the internal structure of firms and their external institutional environment in liberal and coordinated market economies. In LMEs, corporate structures that concentrate authority in top management make it easier for firms to release labor when facing pressure from financial markets and to impose a new strategy on the firm to take advantage of the shifting market opportunities that often present themselves in economies characterized by highly mobile assets. By contrast, in CMEs, where access to finance and technology often depends on a firm’s attractiveness as a collaborator and hence on its reputation, corporate structures that impose more consensual forms of decision-making allow firms to develop reputations that are not entirely dependent on those of its top management. By reducing the capacity of top management to act arbitrarily, these structures also enhance the firm’s capacity to enter credibly into relational contracts with employees and others in economies where a firm’s access to many kinds of assets, ranging from technology to skills, may depend on its capacity for relational contracting. Lehrer’s chapter explores some of these linkages between corporate structure and the external environment in more detail. 1.5 Comparing Coordination Although many of the developed nations can be classified as liberal or coordinated market economies, the point of this analysis is not simply to identify these two types but to outline an approach that can be used to compare many kinds of economies. In particular, we are suggesting that it can be fruitful to consider how firms coordinate their endeavors and to analyze the institutions of the political economy from a perspective that asks what kind of support they provide for different kinds of coordination, even when the political economies at hand do not correspond to the ideal types we have just outlined. It is important to note that, even within these two types, significant variations can be found. Broadly speaking, liberal market economies are distinguishable from coordinated market economies by the extent to which firms rely on market mechanisms to coordinate their endeavors as opposed to forms of strategic interaction supported by non-market institutions. Because market institutions are better known, we will not explore the differences among liberal market economies here. But a few 34 Peter A. Hall and David Soskice words about variation in coordinated market economies may be appropriate, if only to show that variation in the institutional structures underpinning strategic coordination can have significant effects on corporate strategy and economic outcomes. One important axis of difference among CMEs runs between those that rely primarily on industry-based coordination, as do many of the northern European nations, and those with institutional structures that foster group-based coordination of the sort found in Japan and South Korea. As we have seen, in Germany, coordination depends on business associations and trade unions that are organized primarily along sectoral lines, giving rise to vocational training schemes that cultivate industry-specific skills, a system of wage coordination that negotiates wages by sector, and corporate collaboration that is often industry-specific. By contrast, the business networks of most importance in Japan are built on keiretsu, families of companies with dense interconnections cutting across sectors, the most important of which is nowadays the vertical keiretsu with one major company at its center. These differences in the character of business networks have major implications. In Germany, companies within the same sector often cooperate in the sensitive areas of training and technology transfer. But the structure of the Japanese economy encourages sharp competition between companies in the same industry. Cooperation on sensitive matters is more likely to take place within the keiretsu, i.e. among firms operating in different sectors but within one ‘family’ of companies. The sectoral cooperation that takes place usually concerns less-sensitive matters, including recession cartels, licensing requirements, and entry barriers as well as the annual wage round (Soskice 1990a). Partly for this reason, the attempts of MITI to develop cooperative research projects within sectors have had very limited success; serious research and development remains the preserve of the laboratories of the major companies. This pattern of keiretsu-led coordination also has significant implications for patterns of skill acquisition and technology transfer. Serious training, technology transfer and a good deal of standard-setting take place primarily within the vertical keiretsu. Workers are encouraged to acquire firm- or group-specific skills, and notably strong relational skills appropriate for use within the family of companies within which they have been trained. In order to persuade workers to invest in skills of this specificity, the large firms have customarily offered many of them lifetime employment. And, in order to sustain such commitments, many Japanese firms have cultivated the capacity to move rapidly into new Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 20111 1 2 3 4 5 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40 1 35 products and product areas in response to changes in world markets and technologies. This kind of corporate strategy takes advantage of the high levels of workforce cooperation that lifetime employment encourages. To reinforce it, Japanese firms have also developed company unions providing the workforce with a voice in the affairs of the firm. Japanese firms tend to lack the capacities for radical innovation that American firms enjoy by virtue of fluid market setting or for sectorcentered technology transfer of the sort found in Germany. Instead, the group-based organization of the Japanese political economy has encouraged firms there to develop distinctive corporate strategies that take advantage of the capacities for cross-sector technology transfer and rapid organizational redeployment provided by the keiretsu system. These translate into comparative institutional advantages in the largescale production of consumer goods, machinery, and electronics that exploit existing technologies and capacities for organizational change. Although Japan is clearly a coordinated market economy, the institutional structures that support group-based coordination there have been conducive to corporate strategies and comparative advantages somewhat different from those in economies with industry-based systems of coordination. The varieties of capitalism approach can also be useful for understanding political economies that do not correspond to the ideal type of a liberal or coordinated market economy. From our perspective, each economy displays specific capacities for coordination that will condition what their firms and governments do. France is a case in point, and the chapters in this volume by Lehrer, Culpepper, and Hancké explore some of the implications of this approach for it. Collaboration across French companies is based on career patterns that led many of the managers of leading firms through a few elite schools and the public service before taking up their positions in the private sector. Lehrer observes that the top managers of many French firms, therefore, have close ties to the state and weak ties to the rest of the enterprise. As a result, he argues, they are less likely to pursue the corporate strategies found in Britain or Germany and more likely to look to the state for assistance than their counterparts in other nations. Using the case of vocational training, however, Culpepper shows that there are clear limits to what states can do in the absence of strong business associations capable of monitoring their members. Hancké examines how large French firms are adapting to these limits, suggesting that many are taking industrial reorganization upon themselves, sometimes devising new networks to coordinate their activities. 36 Peter A. Hall and David Soskice In sum, although the contrast between coordinated and liberal market economies is important, we are not suggesting that all economies conform to these two types. Our object is to advance comparative analysis of the political economy more generally by drawing attention to the way in which firms coordinate their endeavors, elucidating the connections between firm strategies and the institutional support available for them, and linking these factors to patterns of policy and performance. These are matters relevant to any kind of political economy. 1.6 Comparative Institutional Advantage We turn now to some of the issues to which this perspective can be applied, beginning with a question central to international economics, namely, how to construe comparative economic advantage. The theory of comparative economic advantage is important because it implies that freer trade will not impoverish nations by driving their production abroad but enrich them by allowing each to specialize in the goods it produces most efficiently and exchange them for even more goods from other nations. It can be used to explain both the expansion of world trade and the patterns of product specialization found across nations. The most influential version of the theory focuses on the relative endowment of basic factors (such as land, labor, and capital) found in a nation and suggests that trade will lead a nation to specialize in the production of goods that use its most abundant factors most intensively (Stolper and Samuelson 1941). However, recent developments have dealt a serious blow to this account of comparative economic advantage. The most important of these include the expansion of intra-industry trade and increases in the international mobility of capital. If the theory is correct, nations should not import and export high volumes of goods from the same sector; and there is a real possibility that international movements of capital will even out national factor endowments. As a result, many economists have become skeptical about whether comparative advantages really exist, and many have begun to seek other explanations for the expansion of trade and the geographic distribution of production. Some explain the growth of trade, and intra-industry trade in particular, as the result of efforts to concentrate production in order to secure returns to scale (Helpmann 1984). Others explain the concentration of particular kinds of production in some nations as the result of firms’ efforts to secure the positive externalities generated by a group of firms Introduction 1111 2 3 4 5 6 7 8 9 10111 1 2 3 4 5 6 7 8 9 2...
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