Political economy barriers to the emergence of effective state-business relations
The literature on state-business relations in low income countries identifies six political economy barriers to the emergence of effective relations.
Political settlements and elite commitment to growth
A political settlement can be understood as “the forging of a common understanding, usually among elites, that their interests or beliefs are a particular way of organising political power” (Whaites 2008, p.4). Khan (2010) argues that political settlements in low income countries are characterised by informal personalised relationships between political and economic actors that are often collusive and captured by powerful elites. Sen (2013a) argues that the acceleration of growth, after a prolonged period of stagnation or collapse, needs a stable political settlement comprising repeated informal relationships between political and economic elites based on trust and reciprocity. If close relations between the ruling elite and productive entrepreneurs are based on mutual interests, the literature suggests that relations are likely to enhance growth. (Abdel-Latif and Schmitz 2010, Whitfield and Therkildsen 2011). However, the literature does not explain the conditions under which effective informal relations, based on mutual interests, are likely to emerge and be sustained.
There is limited evidence on whether political settlements also need to be inclusive for collaborative state-business relations to emerge. Growth accelerations, where they have occurred, have been underpinned by stable political settlements that were not necessarily inclusive (Hickey et al. 2014). For example, Korea in 1962, Indonesia in 1967 and Thailand in 1958 witnessed large accelerations in economic growth, where growth was sustained for several decades. Sen (2013a) argues that these growth accelerations occurred under authoritarian political regimes that were not inclusive for much of the period of rapid growth.
The literature emphasises that the long-term commitment of ruling elites to stable informal relations with economic actors is a precondition for collaborative state-business relations (Khan 2010, Buur and Whitfield 2013). This is less likely to emerge in FCAS contexts or in low income countries with weak governments. In these contexts, it is harder for ruling elites to look beyond their immediate political survival and strategies. Short-term political survival imperatives constrain the ability of ruling elites to commit credibly to deals with economic actors that are likely to be durable and conducive to long-term investments (Buur and Whitfield 2013).
The nature of the private sector
The divergent interests of the private sector with respect to its demands of the state, depending on the nature of the economy, suggest that the private sector should not be viewed through a single “lens” when assessing the effectiveness of state-business relations.
Pritchett and Werker (2013) argue that different economic sectors offer different incentives to the development of effective state-business relations. Non-competitive sectors include natural resource based industries, where firms may have paid a low price to acquire rights to resources (such as diamonds), and sectors such as utilities and telecommunications where there may be regulated, or natural, monopolies. Competitive sectors are those where there are no excess profits, such as:
- export-oriented manufacturing;
- domestically oriented manufacturing where the industries are competitive;
- subsistence and smallholder commercial agriculture;
- service sectors such as retail trade.
Pritchett and Werker (2013) and Werker (2014) suggest that firms in non-competitive sectors would attempt to have close and collusive relations with the state to ensure that their sectors are closed to the entry of possible competitors. In contrast, firms in competitive sectors would push for an open and transparent relationship with the state. Fragile states are typically characterised by small non-competitive economic sectors, so collusive relations between firms and the state are likely to emerge more in fragile states than in non-fragile states (Peschka 2011).
Collusive state-business relations are also likely to be present more in resource-rich low and middle income economies (Robinson et al. 2006) as well as in countries where there are a few large politically connected firms (whether domestically owned or multinational corporations) in protected industries and where the rest of the private sector is fragmented and populated by small firms with limited political voice (Haggard et al. 1997).
The nature, extent and predictability of corruption
Corruption is a serious impediment to private sector development (DFID 2015). It is the second most significant barrier to doing business (after access to financing) in two-thirds of DFID partner countries (World Economic Forum 2012). Corruption can create additional costs for firms that already face high costs of production in low income country contexts where input and product markets may not be well functioning (Fisman and Svensson 2001). Evidence suggests that corruption can have a negative impact on private sector growth (DFID 2015). However, there may also be positive impacts by reducing inefficiencies in contexts where bureaucrats are able to engage in corruption (Méon and Sekkat 2005).
Whether the prevalence of corruption contributes to ineffective state-business relations depends on the nature, extent and predictability of corruption (DFID 2015). For example, corruption among customs officials may lead to less rent-seeking behaviour among firms than corruption among regulators (DFID 2015).
Predictable corruption, where state officials can offer “ordered deals” to private investors in return for bribes, can be less damaging to the private sector than corruption that is unpredictable and where deals are “disordered” – that is, where state officials renege on or cannot deliver the deals they offer to private investors (Pritchett and Werker 2013).
Predictable corruption is more likely in country contexts where rent-seeking is centralised, usually under a dominant party that is in power and has the authority to maintain the deals (Booth 2015). For example, Larsson (2006) argues that the disorganisation of corruption in Russia versus the organisation of corruption in China can help explain their divergent growth paths. In a survey of investors from emerging economies, Gómez-Mera et al. (2014) find that investors from these economies value political stability and transparency more than control of corruption and risk of expropriation in the host country. Corruption is more likely to be unpredictable in FCAS country contexts, where the state has limited reach or authority to maintain deals (Peschka 2011).
Corruption and economic growth: the cases of Korea and Thailand
Corrupt deals between politicians and the business sector were evident in Korea for much of its early growth period until the 1980s with political elites taking “massive donations from the chaebol in return for loans and sweetheart deals” (Kang 2002). Personal ties between business and political elites and the system of exchanging bribes for political favours underpinned informal institutions of credible commitment in Korea all through the 1960s and 1970s. This was crucial for Korea’s success in the early stage of growth, in a context where the rule of law in Korea was vague and seldom enforced (Kang 2002).
Another example of the role of corruption in providing the basis for a collaborative relationship between political and economic elites in early stage growth acceleration is provided by Thailand. Thailand’s growth acceleration in 1958 coincides with the seizure of power by Field Marshall Sarit Thanarat in 1957. Doner and Ramsay (1997) argue that under the Sarit regime, there were strong clientelist relations between Chinese entrepreneurs and local Thai officials based in sectoral Ministries such as Agriculture, Industry and Commerce as well as the agency established by Sarit to attract foreign capital – the Board of Investment. These patron-client networks were growth-enhancing as they discouraged capital flight by encouraging Thai entrepreneurs to invest in patronage, and were also competition-inducing. “With fragmented political patrons eager to obtain extra-bureaucratic funds, clientelism facilitated a constant flow of new private sector claimants on state largesse and thereby weakened tendencies towards the more common result of clientelism – monopoly cronyism” (Doner and Ramsay 1997, p. 250).
Fragility and conflict
In FCAS country contexts, the impact of conflict, violence and prolonged fragility is particularly damaging to the private sector (Peschka 2011). The literature suggests that foreign and local investors are more likely to leave the country in situations of conflict and state fragility, undermining the strength of local business associations that could help prevent the slide into further conflict (Peschka 2011). Putzel and Di John (2011) argue that in the FCAS context, political settlements do not provide an incentive structure that promotes productivity growth in the main economic sectors, though they can be instrumental in maintaining political stability and state resilience (e.g. as in Zambia). Durable political settlements that can lead to deals between political actors and economic actors that are “ordered” are less likely to occur in FCAS contexts (De Waal 2014).
However, in the East Asian context and in Mauritius, systemic vulnerability – defined as a situation of extreme geopolitical insecurity and severe resource constraints – created strong incentives for economic performance and for the kind of close ties between governments and business that underpin more effective policies (Doner, Ritchie and Slater 2005, Bräutigam and Diolle 2009). Three conditions were seen as necessary for systemic vulnerability to operate in these country contexts: “i) the credible threat that any deterioration in the living standards of popular sectors could trigger unmanageable mass unrest; ii) the heightened need for foreign exchange and war material induced by national insecurity; and iii) the hard budget constraint imposed by a scarcity of easy revenue sources” (Bräutigam and Diolle 2009). In the case of FCAS countries, this implies that it is possible that the presence of systemic vulnerability can lead to the emergence of effective state-business relations, though this would also depend on the stability of the political settlement and the political leadership’s commitment to long-run economic development (Leftwich 2009).
Regulation
A transparent regulatory environment where with low business costs is often seen as being conducive to effective state-business relations (Sen 2013c). Improvements in the regulatory environment can reduce the uncertainty that investors face and increase the credibility of the government’s policy intentions and actions for the private sector (Moore and Schmitz 2008).
Yet evidence about whether regulatory reform is an important enabling factor for effective state-business relations is mixed (Altenburg and von Drachenfels 2008). Moore and Schmitz (2008) argue that that regulatory reform that stresses the creation of formal “arms-length” relationships between the state and investors in weak governance environments is not likely to be as effective as more informal “hand-in-hand” personalised relationships based on trust and reciprocity. However, the literature does not provide clear guidance on whether “hand-in-hand” informal relationships can become a core component of effective state-business relations, as in many low-income countries such relationships tend to become collusive and subject to rent-seeking behaviour (Chingaipe 2013).
Privatisation and the role of state-owned enterprises
The role of state-owned enterprises in contributing to effective state-business relations is unclear. A large presence of state-owned enterprises can inhibit private sector development, and may cause the state to favour its own enterprises for preferential treatment, to the detriment of private sector firms (World Bank 2005a). On the other hand, a programme of privatisation can lead to the capture of large parastatals by a few powerful economic actors who may form an oligarchy, leading to the creation of more collusive state-business relations (Fortescue 2006, Bardhan, in press).
Privatisation may also lead to adverse effects on women and minority communities if the process leads to a weakening of their rights to land and other assets, as resources are transferred from public to private ownership (Lastarria-Cornhiel 2001). Privatisation can also contribute to instability if public sector employment has been used as a mechanism for dispensing patronage to supporters of the ruling elite as a way of obtaining political support. If privatisation leads to large job losses in parastatals, opposition to the ruling elite may emerge, leading to conflict (Acemoglu and Robinson 2008).
What do business and the state see as common bottlenecks?
There are few systematic surveys of what either the private or public sectors see as bottlenecks to effective state-business relations. Most of the evidence on the perceptions held by the private sector comes from the Enterprise Surveys of the World Bank. Lack of electricity and lack of finance are seen as the most important constraints to doing business in 10 out of the 22 FCAS countries covered by the surveys (World Bank 2015). Other major issues are political instability, competition from the informal sector and corruption (Peschka 2011).
Lack of finance is a major constraint for small firms in other low income countries, along with taxes and corruption (Bloom et al. 2014). Limited access to government decision-makers, and to information about regulations, and about markets, are constraints highlighted by surveys of small firms in low-income countries on the value of services provided by business associations (Qureshi and te Velde 2013). There are no equivalent surveys of public sector actors on what they see as the constraints on effective state-business relations.
- As the World Bank (1992) notes, most privatisation success stories come from high-income and middle-income countries. Privatisation is easier to launch and more likely to produce positive results when the company operates in a competitive market, and when the country has a market-friendly policy environment and a good capacity to regulate. The poorer the country, the longer the odds against privatisation producing its anticipated benefits, and the more difficult the process of preparing the terrain for sale.
- An example of this is from the enactment of structural adjustment polices in Africa in the 1980s. Here, attempts by the International Financial Institutions to induce downsizing of the public sector, for example by closing down loss-making parastatals may have played an important role in creating civil war in Sierra Leone and Liberia as political elites used public sector employment as a means to redistribute rents to opponents or potential opponents as a way of obtaining political support (Acemoglu and Robinson 2008).
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