While there is no single template for successful collaboration between the state and the business sector, the literature identifies the following elements of effective state-business relations, based on country experiences of successful collaboration.
Credible commitments on the part of the government
Credible commitment of the state to policies, deals or arrangements is an essential attribute of effective state-business relations. Investment decisions may have large sunk costs – that is, the costs of certain investments cannot be recovered in full if the investment decision turns out to be less profitable than anticipated (Pindyck 1991). The state needs to make a commitment that it will not change its policies, or renege on deals and arrangements; in order to incentivise entrepreneurs to make investment and production decisions (Rodrik 1991). If the state were not to uphold its announcements and promises, it is very likely that investors would not believe the state in the future, and investment would suffer (Bardhan 2005).
Credible commitment can be obtained through both formal and informal institutions. Formal institutions include properly enforced laws which prohibit the expropriation of private property without just cause, and well-functioning courts which protect firms if the state engages in predatory behaviour. Informal institutions are personalised relationships (“deals”) between the agents of the state and the business sector that are repeated over time (Hallward-Driemeier and Pritchett 2015). If these deals are “ordered” – that is, if deals negotiated between the state and business are reliably honoured – then informal institutions can provide the credible commitment necessary for investment to take place, even when formal institutions are missing or poorly functioning (Pritchett and Werker 2013, Sen 2013a).
The literature suggests that trust between the government and the private sector is an important contributing factor for the credibility of government actions and policies. While policies can be credible whether or not trust exists, policies and statements are more likely to be credible when there is prior trust (Rodrik 1997). Trust between business and government elites can reduce transaction costs and monitoring costs, diminish uncertainty, lengthen time horizons and increase investment (and policy fulfilment more generally) (Maxfield and Schneider 1997). Trust in state-business relations is an outcome of repeated interactions between bureaucrats and politicians on the one hand and private sector actors on the other, and can occur both through formal mechanisms (such as periodic meetings of a Joint Economic Council) and informal mechanisms (such as through networks of friendship and contacts that state and private actors may have).
Credible commitment in India’s economic success
In the 1960s and 1970s, the Indian government followed a command-and-control regime with the private sector that led to collusion and rent-seeking behaviour, and had significant negative impacts on India’s economic performance (Bhagwati 1993). There was an atmosphere of mutual distrust between the political and economic elites, along with a strong anti-business attitude of the government (Kohli 2007). With a change of government in 1980 and the return of Indira Gandhi as Prime Minister, the promotion of economic growth became the focus of the government’s economic policy, leading to a growing alliance between the political and economic elites. As Kohli (2012: 30-31) notes: ‘just after coming to power in January 1980, […] Indira Gandhi let it be known that improving production was now her top priority. In meeting after meeting with private industrialists, she clarified that what the government was most interested in was production.’ Therefore, beginning in the 1980s, the Indian state clearly signalled to domestic capitalists its intention to commit credibly to an environment where private enterprise would be supported and growth-enhancing policies followed (De Long 2003, Rodrik and Subramanian 2004). This was reflected in changes in economic policies, such as the slow but steady liberalisation of import controls, especially on capital and intermediate goods. The shift in the relationship between political and economic elites from one of mutual distrust to a more collaborative and synergistic relationship was further accentuated with the coming to power of Rajiv Gandhi in 1985. He took particular interest in modern sectors, such as information technology and engineering, and tried to bring in new economic elites, from these emerging sectors, into the relationship that the political elite had with the business sector. In addition, with the rise of non-traditional business groups in southern and western India, there was a growing diversification of business ownership, leading to a broadening of the political connectivity of the business elite (Mehta and Walton 2014). Private investment increased significantly since the mid 1980s, especially in new sectors such as information technology and pharmaceuticals and, within a decade, India was one of the fastest growing countries in the world (Sen 2013b).
The Joint Economic Council in Mauritius
The collaborative relationship between the state and the private sector has been seen as one of the key factors behind Mauritius’ development success (Bräutigam and Diolle 2009). An important element of this relationship was the institutionalisation of the Joint Economic Council in 1970, which provided a forum for repeated – often public and high level – opportunities for meaningful consultation between the state and private sector. The meetings in the Joint Economic Council allowed the private sector to express concerns about the government’s overall economic policies. The Joint Economic Council was important in normalising expectations that the government-business relationship should be institutionalised, rather than a personal relationship between political leaders and heads of business, thereby minimising the risk of collusive and predatory engagement (Handley 2008).
Consultation, coordination and reciprocity
Successful collaboration between the state and the private sector needs close consultation, coordination and reciprocity. The private sector depends on bureaucrats and politicians for the successful design and implementation of policies, and the government depends on the private sector to ensure that private firms make the profitable investments that are necessary for growth and for policies to be sustained (Sen 2013b). Close consultation and coordination can help increase levels of trust, lower the costs for the state of monitoring private sector performance, and reassure the private sector that their interests and concerns are being addressed (Doner and Schneider 2000).
Reciprocity is an important element of effective state-business relations – if the state offers subsidies to the private sector, government officials need to know that the private sector will ensure that these subsidies are used productively (Harriss 2006). If subsidies are contingent on performance, the state should have the capability and commitment to discipline the private sector if it does not meet its targets, and the private sector should be aware that the government will behave in this way.
Sharing information
Accurate, reliable information is a crucial element of successful collaboration between the state and business. Regular sharing of information between the state and businesses helps ensure that private sector objectives are met with public action and that local level issues are fed into higher level policy processes (Sen 2014). The greater the flow of information, the more accurately the government can predict the behaviour of the private sector in the case of a policy change, and the more likely that the policy will have the desired effect (Evans 1997, 2013). The private sector can identify constraints, opportunities, and policy options for creating incentives, lowering investment risks, and reducing the cost of doing business. The flow of information is also important in overcoming co-ordination failures in investment decisions. Co-ordination failures can result from the high costs of collecting and processing information for new products, technologies and industries (Sen 2013a).
The exchange of information between the state and the private sector depends on the technical capacity of the state to compile and analyse the data, and the willingness of the private sector to share it (te Velde 2013). By investing in information-collection and processing, and by making information about new industries freely available to firms, the state can facilitate the introduction of new products and the move to new industries, and help bring about structural change and technological upgrading in the economy (Lin and Monga 2010).
Government Failure, Market Failure and Co-ordination Failure
Government failure occurs when excess government intervention in the economy leads to inefficiencies, which in turn lead to poor economic performance, or when there is an under-supply of critical public goods such as schooling, infrastructure and finance, and also under-provision of appropriate regulatory frameworks needed for private sector development, growth and structural transformation.
Market failure occurs when the markets inefficiently allocate goods and services.
Coordination failure occurs when certain desirable economic activities fail to take place due to lack of coordination among private sector associations, firms and the agencies of the state.
Effective state-business relations can help prevent government failure by providing checks and balances on government policies, tax and expenditure plans. Regular sharing of information between states and businesses ensures that private sector objectives are met with public action and that the concerns of the private sector on distortionary effects of poor quality government intervention are taking into account when setting government policies (te Velde 2009). Good state-business relations also help ensure that the provision of public goods is appropriate and high quality.
Effective state-business relations can help prevent market failure by the joint action of the state and the private sector to raise collective efficiency in areas such as skill development of workers, technology policy, and upgrading quality of exports.
Effective state-business relations can help prevent coordination failure by providing an institutionalised mechanism to coordinate dispersed information between business associations and government departments, and by reducing policy uncertainty for the private sector.
Information sharing between the state and the private sector in the Korean ‘growth miracle’
South Korea has been one of the fastest growing economies of the world since the 1960s. Central to Korea’s economic success has been the close and collaborative relationship between economic elites and political and bureaucratic elites, especially in the early decades of Korea’s industrial transformation (Evans 1997). Private industrial elites were seen by the political elite as key collaborators in enabling industrial transformation, and as key sources of information regarding the feasibility of industrial goals. At the same time, the state provided information to the private sector about export opportunities, sectoral markets, labour market conditions and other issues that affected investment planning (Maxfield and Schneider 1997). The close relationship between the state and the private sector allowed government officials to ensure that the right information was received by the right managers. These information flows shaped expectations about government intentions and enhanced credibility by giving investors signals about political commitments to certain courses of action (Doner and Schneider 2000).
A stable policy environment
Firms in low-income countries operate in an uncertain environment and frequently face risk and resource shortages (Kang et al. 2014). Uncertainty can have significant negative effects on investment, particularly when investment involves large irreversible costs and investors can delay the decision to invest until they have further information (Dixit and Pindyck 1994). A stable policy environment provides an enabling environment for the private sector to invest, by ensuring that there are no policy reversals that cannot be justified on economic grounds, and no flip-flops due to political pressures (Rodrik 1991, Harriss 2006). For example, if the government levies a high (but not unreasonable) rate of corporate tax on the private sector, keeps its stable, and uses the proceeds to finance high quality public goods (such as efficient administration and infrastructure), the predictability of this tax policy would be more effective in encouraging investment than tax reductions that are variable and unpredictable (Cali and Sen 2012).
Checks and balances on government
Strong checks and balances on government policies and on tax and expenditure help ensure that taxation policies and the provision of public goods are appropriate and of good quality (te Velde 2013). Strong checks on tax and expenditure policies do not imply the absence of corruption. Rent-extraction and rent-sharing are often a feature of effective state-business relations (Khan 2006). The design of effective government policies and regulations depends, among other things, on input from, and consultation with, the private sector. More efficient institutions and rules and regulations might be achieved through policy advocacy which could reduce the costs and risks faced by the private sector and enhance productivity (te Velde 2009). It should be noted that formal checks and balances can be of value only when state actors are incentivised to follow formal rules.
Checks and Balances on Fiscal Policy in Zambia
The engagement of interest groups in the budget-making process can generate relevant information that enables policy makers to make better choices on tax and expenditure. In Zambia, the government has put in place a mechanism through which individuals and interest groups can submit tax and expenditure proposals for inclusion in the national budget. This has become an important feature of the national budget-making process (Bwalya et al. 2011). This mechanism has enabled different interest groups (including the private sector) to seek dialogue with the government on budget decisions by formally submitting and presenting their preferred fiscal policy positions to government at various stages of the budget process. The lobbying by interest groups can be formal, through budget submissions, or informal through avenues such as articles in the media. By entering into a dialogue with the government on fiscal policy, the private sector has strengthened fiscal transparency and accountability in the government’s taxation and expenditure policies (Bwalya et al. 2011). For its part, the government was responsive to formal consultations on the budget through the emergence of a stable “reform coalition” with the Zambia Business Forum as the key non-state actor in the coalition since the 1990s (Bwalya et al. 2011).
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