Varieties of Capitalisms

Lecture 1 Semester 2
Agenda
Economic systems and varieties of capitalisms
How different capitalisms influence the business in different way
Introduction
Interests in economic and political institutions across the world
Political systems  How a society allocate power and select leaders
Economic systems  How a society allocate production and
consumption
Understanding economic and political institutions help us answer
range of questions:
(i) Policy related  ex: what kind of policy to improve aggregate
economic performance?
(ii) Business related  ex: how firms can succeed in a certain country
with distinct political economic systems?
A simple typology (hypothetical) of
economic systems

Command (Free) Market

Economy Economy

Government makes a centralized Individuals have full freedom to

decision on consumption and make decision on consumption
production and production

These two extremes of economic systems do not exist in reality!

Command economy leads to sub-optimal outcome (Government are unable to estimate
everything correctly)
Free market economy leads to inequality (it only works when resources are distributed evenly,
and all actors have equal access to resources)
What happens in reality?
Political economists try to understand how the economic decisions
are organized in the real world  Try to categorize different
economic systems that actually exist in the world!
More importantly, political economists try to understand how
different economic systems affect the economic outcome differently!
To answer the above questions:
Whitley came up with national business systems typology (but we
have discussed Whitley’s national business systems last semester!)
Hall and Soskice (2001) came up with their typologies of economic
systems called “Varieties of Capitalism”
Hall and Soskice’s varieties of capitalism
Hall and Soskice’s approach in creating varieties of capitalism:
1. Firm-centric  Firms are primary actors in economic transaction as
they coordinate the allocation of resources in the production and to
some extent consumption
2. Therefore, firms and their relations become essential in
understanding the economic systems of the nation
3. Five spheres of firms’ relationship: (i) governance, with financial
institutions, (ii) industrial relations, with labor unions (external) and
potentially government, (iii) vocational trainings and education (iv)
inter-firms, with suppliers (v) their own employees
Five spheres/dimensions of varieties of
capitalism
Governance (with financial Industrial relations (with Skill formation sphere
institutions/shareholders). labor union or (with vocational trainings
This sphere influences government). This sphere and education). This
firm’s access to capital and influences wage bargaining sphere influences firms’
the ownership power of the firm access to human capital

Inter-firms relations Firms’ own employees.

(mainly with suppliers). This sphere influences
This sphere influences the firm’s capabilities and
firm’s capabilities and information storage.
technology transfer
Five spheres/dimensions of varieties of
capitalism
It is important to note that these dimensions interact with each
other
Ex: Employees’ capabilities is influenced by the skills formation in
vocational training and education sphere (in the long run also vice
versa).
There is a “institutional complementarity”  one characteristic in a
sphere reinforces other characteristic exists in the system.
Ex: Firms have strong bargaining power over labor (“favorable”
industrial relations) when vocational training and education sphere
provides only generic skills to prospective labors.
Two systems in the Varieties of Capitalism
Liberal Market Economies (LME)
Firms coordinate their activities primarily via
hierarchies and competitive market
arrangements.
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 on the
basis of the marginal calculations
In short, relationships between firms and other
actors in LME are characterized as
“transactional relationship”
Coordinated Market Economies (CME)
Firms depend more heavily on non‐market
relationships to coordinate their endeavors
with other actors and to construct their core
competencies.
Non‐market modes: (i) extensive relational or
incomplete contracting, (ii) network monitoring
based on the exchange of private information
inside networks,
More reliance on collaborative, as opposed to
competitive, relationships to build the
competencies of the firm.
relationships between firms and other actors in
LME are characterized as “relational
relationship”
Let’s compare and contrast LME vs CME in
each sphere/dimension
Governance relations sphere (relationships
with financial institutions or shareholders)
Liberal Market Economies (LME)
Firms raised capital primarily through stock
markets
Financial institutions provide firms with
access to capitals based on short-term return
(e.g., capital gains through an increase in
stock price)
In making their decisions, financial
institutions rely on publicly available
information  monitoring through public
information + supporting institutions
(accounting firms, credit ratings).
Coordinated Market Economies (CME)
Firms raised capital primarily through
retained earnings and bank loans
Financial institutions provide firms with
access to capital that is not entirely
dependent on firms’ short-term return
(patient capital).
Instead, capital is provided based on
private/inside information about the
operation of the firm
A few ways financial institutions can monitor
firms: (i) cross-directorship (ii) joint
membership in industry association
Industrial relations sphere (relationships with
labor union or labor markets)
Liberal Market Economies (LME)
Firms are in competition to recruit workers
(especially highly skilled or educated workers)
Because of such competition, wage bargaining
is set through a market (a transactional process
between individual worker and the firm)
Wage setting becomes “flexible” (high variation
across and within industry, depending on
supply and demand)
Highly skilled/educated workers can have high
salary (because of high demand), while low-
skilled workers have low wage  contribute to
income inequality
Adversarial relationship between firms and low-
skilled workers
Coordinated Market Economies (CME)
Firms in CME typically employ highly skilled
labor with high degree of autonomy  workers
have high bargaining power + risk of hijacking
CME countries solved the above problems by
setting wages in industry level bargain between
labor union and employers association equal
wages prevent the risk of hijacking and equalize
the bargaining power of workers, as well as
firms.
For this reason, there is high coordination
between labor union and employers’
association (e.g., chamber of commerce).
Wage setting, however, becomes rigid and firing
becomes difficult.
Skill formation sphere (relationships with
education systems)
Liberal Market Economies (LME)
Intense competition in the industry prevent
firms to invest optimally in specific skills for
their workers (fear of hijacking by competitors)
For workers, success in careers depend on
acquiring generic skills that can be used in
different firms  increase the chance of inter-
firm mobility (for the purpose of wage bargains
or vertical mobility)
As a result, there is high incentive for
educational institutions to provide generic
education that provide transferable skills
Firms, however, in some cases, need to provide
limited additional trainings for workers
Low coordination between university and firms
Coordinated Market Economies (CME)
Firms make extensive use of labor with high
industry/firm‐specific skills
As a result, firms depend on education systems
that provide training in technical/specific skills
Education systems also provide apprenticeships
program to students  requires high
coordination firms or industry
Skills acquired through this systems is highly
specific, and may not be transferred to different
industry/jobs  limit the mobility of workers
Inter-firm relations sphere
Liberal Market Economies (LME)
Inter-firm relations are based on enforceable
formal contract (not based on informal
relationships)
Laws tend to prevent firms in the same
industry to collaborate (in the fear of
monopolization)
Technological diffusion within industry
occurred through horizontal mobility of
scientists/engineers
In recent years, due to increased
technological specializations and the need to
establish standards, technological alliances
become more common
Coordinated Market Economies (CME)
Collaborations/coordination with other firms
are necessary for the survival of the (focal)
firm.
Coordination with other firms is needed for:
(i) industry-wide wage bargaining with labor
(ii) technological diffusion/creation (iii)
resources sharing
Coordination can be achieved formally
(through business associations like in
Germany) or informally (based on trusts and
long-term relationships like in Japan)
As a result, firms are less competitive (but
more collaborative) in nature
Employee relations sphere
Liberal Market Economies (LME)
Firms make limited investment in
workers’ training (fear of
competitors’ hijacking prevent firms
to over invest in workers’ skills)
Workers are not represented in the
management/board of the company
For low-skilled workers, work
benefits and protection are often not
proper
As a result, employees-employers
relations often become adversarial
Coordinated Market Economies (CME)
Firms rely on labors with specific
skills
For this reason, firms often invest in
workers’ training
Firms often give autonomy to highly
skilled workers
Workers are represented in the
board of the company
As a result, employees-employers
relationship become less adversarial
and more collaborative in nature
Inter-connections among
sphere/characteristics
It is important to note that characteristics in one sphere is often
associated with characteristics in other spheres
For example, characteristics in industrial relations sphere influences
or are influenced by characteristics in skill formation, inter-firm
relations, and employee relations spheres.
Such associations/connections across spheres are what we call as
“institutional complementarity”
How varieties of capitalisms (LME vs. CME)
affects firms’ operations and strategies
In terms of capability development, firms in LME and CME employ
different strategies:
Due to development in stock markets, firms in LME rely more on
mergers and acquisition (M&A) than alliance or internal investment
to develop new capabilities
Due to high collaboration with external stakeholders (suppliers,
universities, and even competitors), firms in CME rely more on
alliance than M&A. Firms in CME are also more likely than firms in
LME to engage in internal investment to develop new capabilities
How varieties of capitalisms (LME vs. CME)
affects firms’ operations and strategies
In terms of entering and exiting an industry:
Due to market flexibility (easy access to finance + low costs of firing
and hiring), firms in LME can enter and exit an industry with little
difficulty
In contrary, firms in CME face high sunk costs (investment in
suppliers, workers, and other partners), and therefore face difficulty
in entering and exiting their existing industry.
How varieties of capitalisms (LME vs. CME)
affects firms’ operations and strategies
In terms of innovation
Firms in CME rely more on knowledge accumulated by employees
(remember inter-firm mobility is low in CME countries!). Such
internal knowledge accumulation encourage firms in CME to engage
more in incremental innovation (modifying existing
products/services)
Firms in LME rely more on quick access to technology (supported by
financial access), and therefore are more likely to engage in radical
innovation (introduction of completely new products/services)
How varieties of capitalisms (LME vs. CME)
affects firms’ operations and strategies
In terms of responsible practices
Because their survival depend on the well being of stakeholders,
firms in CME are more likely to engage in responsible business
practices (e.g., paying living wages to workers and suppliers)
Counter-argument: The need to take care of internal stakeholders
(workers) may encourage firms to engage in bribery (e.g., Siemens)
Because of shareholders’ pressure to make short-term return, firms
in LME are more likely to engage in irresponsible business practices,
such as fraud (Enron), or pollution.
Note: Recently, there is more pressures from consumers demanding
firms to be more responsible