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Guilt by Association? Exploring the Effects of Business Association Activity on Economic Growth Gabriel Mattera Faculty Advisor: Professor Sami Alpanda Submitted to the Department of Economics at Amherst College in partial fulfillment of the requirements for the degree of Bachelor of Arts with Distinction April 22, 2005 Acknowledgments First and foremost among those to whom I owe a great debt is my advisor, Professor Sami Alpanda. As fellow neophytes, he to the process of thesis advising, I to the process of thesis writing, I like to think that we both had something to teach the other. Unfortunately, I know that this is simply not true. The theoretical insights, econometric understanding and general guidance he bestowed upon me vastly outweigh anything I could hope to offer in return. I wish to thank him especially for his patience across many weekly meetings, and for his tolerance of my proclivity towards independent action. The greatest teachers, I like to think, are those that lead their students to discover things on their own. I would also like to sincerely thank Ashfaq Qadri for his honest and straightforward comments on early drafts of the manuscript. It is truly a noble friend who willingly offers to take time out of his busy day to read tens of pages of dry undergraduate economics. Zeina Nasr deserves special mention. Without her anxious reminders of the impending April deadline, I would never have become nervous enough to do the intense work necessary to finish this project in a timely manner. Thanks goes also to Ngoc Trang, whose conversation and joking in the Economics Computer Laboratory was a burst of fresh air during the writing process. Finally, I must acknowledge both of my parents. Throughout my life they have constantly stressed the value of a full education and the pleasures of a curious mind. Without their influence and support I would not be at Amherst College. ii INTRODUCTION Business associations are a natural phenomenon in modern, democratic states. In so far as firms and individuals can benefit from sharing professional experience with each other, or from uniting to pursue a common economic aim, it stands to reason that businesses will always have an interest in joining together. The issue, though, is how this activity affects overall social welfare. Many other private interest organizations pose a similar question. What partly distinguishes business associations from these others is that they are a fluid and varied category, representing a range of groups including, but not limited to, local professional clubs, national business federations, and on a grander scale the lobbying wings of multinational corporations. In part because of this, while interest groups as a whole have been examined at length, there have been few attempts to isolate the effects of business associations from the greater aggregation of private organizations. The goal of this paper is precisely to do that. More specifically, it seeks to find whether or not business associations can have a positive influence on social welfare. A key hypothesis tested in the study is what is here termed the “information effect”, the idea that business associations channel information to government about industry and economic trends that it does not otherwise have access to. This information should in turn improve the efficacy of government economic policymaking and so lead to higher growth. Building on the analysis of Stephen Knack (2003), the current study uses an econometric model to test the relationship between associations and economic growth. Membership in professional organizations forms the key explanatory variable. Also 1 incorporated, however, are interaction terms that highlight the relationship between this variable and gross, public and private investment rates. The idea is to see whether business associations affect different types of investment. Of specific interest is public investment. Government capital expenditures are key component of economic policy. If the information effect is true, then business associations should have a positive effect on public investment. Regression results prove somewhat surprising. Membership alone appears to have a negative effect on economic growth. Turning to the interaction terms, membership has a positive and significant influence on the efficacy of total and private investment, and does not seem to be significantly correlated with public investment. These findings suggest a new perspective on the role of business associations in economic affairs. The layout of the paper is as follows. The first section is a brief survey of the ongoing academic debate about interest groups on social welfare. It focuses in particular on the activity of business associations. Section two describes the principle data set used in the empirical analysis. The third section outlines the statistical model used here to examine the relationship between association activity and economic growth. Section four gives the regression results and their interpretation. The fifth section is a case study of Japan. The idea of incorporating such a study is to provide a concrete instance of a country considered to have a high degree of interaction between business associations and government. A major point of this section is to draw connections between the Japanese example and the results of the empirical analysis. 2 2 BACKGROUND Before discussing business associations directly it is critical to consider their position against the greater backdrop of existing private organizations. Political scientists have offered differing judgments on private interest groups. Mancur Olson (1982) argues that interest group activity creates inefficiencies because of collective action problems. Small groups find it relatively easy to organize and achieve their aims—benefits are focused in few hands, and it is easier to impose constraints to keep members in line. Bigger groups, on the other hand, have many members, and as such each individual obtains little reward from any effort he or she alone puts forth in advancing the group’s cause. Observed in a social context, the problem becomes clear. Consider the example of a small manufacturing industry that succeeds in lobbying the government for tariff protection. Managers and laborers in the industry would see a great reduction in wages or even layoffs if they had to face foreign competition. On the other hand, the loss each domestic consumer faces as a result of the tariff is a relatively minor price increase. As such, private individuals do not have a strong impetus to counter the lobbying industry. This holds true even though such a price increase, when multiplied across the entire consumer population, translates into a major loss bigger than that faced by those in industry. Thus, total social welfare is reduced because of the collective action problem inherent in trying to unite all consumers together. Heckleman’s (2000) study is one of few empirical investigations to use data associated with business activity to test Olson’s predictions. He bases his data on information gathered from Murrell (1984) on the concentration of trade associations in a 3 sample of OECD and non-OECD countries. In his study the number of these associations in each country serves as a proxy of overall interest group strength. Regressing a tenyear average of per capita income growth against this variable and a host of control indicators, his results reveal moderate evidence to support Olson’s idea that interest groups are a drag on economic growth. There are opposing views to Olson, however. Robert Putnam (1993) believes that private associations with horizontal, non-hierarchical structures can actually work to increase social productivity by instilling a spirit of trust and cooperation between members within a group. Such groups may also have a hand in overcoming collective action issues by bringing together diverse individuals who might not meet under ordinary circumstances because of differences in language, culture, or socio-economic status. Local neighborhood crime-awareness associations may be seen as an instance of this type of activity. They serve to unite people of all backgrounds in a given community who may not normally have much significant interaction with each other. Through the association, the community achieves a common good, namely crime prevention, that would not have been realized otherwise. Literature looking at the Putnam hypothesis in the context of business associations has been largely theoretical, using mathematical modeling to represent association behavior on a macroeconomic level. Most of this work, though sharing Putnam’s premise that interest groups have a positive influence on welfare, incorporates a different logic from that used by him to explain why this might be the case. For instance, one argument made is that lobbying on the part of associations can have positive “spillover effects”. These effects may arise when gains are incurred not only by the 4 lobbying parties but by outside individuals as well (Mohtadi and Roe, 1998). An instance of this phenomenon is found in the example of construction firms that lobby for increased government expenditure on road works. Though the firms themselves are directly rewarded through contracts for new roads, in fact all automobile users gain because they can use these new roads for their own transportation needs. Other models posit that business associations may have a role to play in augmenting government economic policymaking. This idea might be termed the “information effect”. Associations are a channel of communication between private and public sectors, and can help state officials learn about, among other things, certain market failures that are impeding private investment in productive sectors. Banning business associations or their affiliated lobbies would deprive government of what might be a decision-enhancing dialogue (Ball, 1995). Interest in the role of information in economic development has been strengthened by a spate of recent literature on the topic of industrial policy. A key reference in much of this writing is Peter Evans (1995). His concept of “embedded autonomy” describes a situation in which policymakers “are embedded in a concrete set of social ties that binds the state to society and provides institutionalized channels for the continual negotiation and renegotiation of goals and policies” (Evans, 1995, p.12). In other words, the state is closely connected to, though not co-opted by, the private sphere. A major case study for Evans is Japan, where he argues that it was just this sort of strong relationship between government and industry that led to that country’s spectacular growth following the Second World War. The example of Japan is discussed at length in section five. 5 According to Rodrik (2004) and Rodrik and Hausmann (2003), business associations and other organizations that bridge the gap between government and the private sector can do more than just help existing industries. They may also serve to promote growth in new industries that were previously locked out because of the kind of collective action problems highlighted earlier. This activity might be seen as a different form of the information effect. Without state support of some kind, entrepreneurs active in the process of investing in new business ideas would have to bear the full brunt of the costs of discovery. Discovery is a hit or miss process, and investors must often spend a great deal of capital on unproductive projects before hitting upon a viable business idea. Without external regulation, competitors could simply wait around for entrepreneurs to find a productive opportunity and then co-opt this opportunity for themselves, thereby eliminating the lucrative profits entrepreneurs had hoped to achieve as the result of their investments. Patent and copyright laws are one method of curbing the problems arising from this information externality. Business associations may be another, allowing entrepreneurs to “tip off” public officials to productive opportunities, which government can then support through subsidies, licenses, and other policies that reward capital outlays and research aimed at the discovery process. The information effect lies at the core of the current paper. As noted above, much of the economic literature on the topic of interest groups has displayed mixed results. Quantitative studies have looked very broadly at the subject as a whole, and those authors who have honed in on business have done so largely from a theoretical perspective. 6 This study is an empirical analysis that looks directly at the correlation between business associations, investment and growth. Data and methodology follow Knack (2003). Using cross-country data from the World Values Surveys (WVS), Knack examines a broad range of social organizations, separating these into what he calls “Olson” and “Putnam” groups. “Professional Associations” are placed into the Olson group. Thirty-eight countries are sampled, and levels of participation in each of the two groups form the core explanatory variable. Eighteen-year averages of per-capita income growth and domestic investment serve as the dependent variables. Ultimately, Knack is unable to support either the Olson or Putnam hypothesis conclusively, as he finds neither category of group to be significantly correlated with his measures of economic performance. 7 2 DATA Like Knack (2003), the World Values Surveys (WVS) serve as the source of the most critical data here. Coordinated by Professor Ronald Inglehart of the University of Michigan and a host of other social researchers, the WVS were designed with the intent to be “a worldwide investigation of socio-cultural and political change” (WVS website). The WVS are public opinion polls with queries on a number of topics ranging from religion to politics and economics. Participating populations represent a variety of communities across the globe, including those defined by clear country boundaries (“Japan”), as well as some defined by regional affiliation (“Basque”). Though the surveys are centrally coordinated, in each case the actual polling is managed at a local level, with researchers in each population funding and conducting their own studies. Standardization is maintained as much as possible, though in some countries costs and geographical obstacles prohibit a perfect random-sampling. Questionnaires are extremely similar across each population, differing only on a few topics that speak to social particularities (for example, questions regarding affiliation with ethnic identities found in the “home” society but not anywhere else). Country sample sizes range from 500 to 4000 individuals, though most are approximately 1000. Of the four total surveys that have taken place, three are currently available to the wider public. These are for 1981, 1990, and 1995-1998. All three are used in the present study. Moreover all populations found are included, with the single exception of those that are not defined by country borders. The reason for omitting these is that standard data on economic indicators such as life expectancy and education exist only for internationally recognized states. 8 The portion of the WVS used here is the subsection relating to membership in voluntary organizations. This study is concerned with gauging the effect of business association activity on the economy. As a result, unlike Knack, only the item on “professional associations” within the greater set of voluntary organizations is used. Although Knack incorporates this one in his own study, he does so in aggregation with a host of other organizations that includes labor unions, recreational associations and environmental groups. Rather than testing the effect of each of these group types individually, he clusters them together in a single membership index. As a result of this it is impossible to separate out the unique effect of professional associations. In the WVS participants are asked to give a response about the degree of their membership in professional associations. This membership is defined differently between survey waves. In the 1990 questionnaire participants were asked to list whether or not they belonged to professional associations, and additionally whether or not they did voluntary work for these groups. In contrast, in the 1995-1998 questionnaire participants had to list whether they were active members, inactive members, or not members of professional associations. Active membership refers to individuals who take an active role in the association, and inactive membership to individuals who belong but do not actively participate. Though no questionnaire is available for the 1981 survey, it seems that the format of the subsection of this survey on voluntary organizations was very similar to that of the 1990 survey. Copies of the voluntary organizations subsection of both available questionnaires appear in Appendix 2.A at the end of this paper. Interestingly, there is a disjunction between the way the membership categories are listed in the questionnaires and the way that they appear in the online WVS database 9 found at the University of Michigan’s university library website. In that database, membership data for all three surveys appears under “active”, “inactive” and “not member” categories. In effect, it is as if the 1981 and 1990 surveys had been subsumed under the format of the 1995-1998 survey. Here again, brief communication with Professor Inglehart served to clarify the issue (personal communication, April 2005). It appears that the 1981 and 1990 data was transferred into the WVS database as follows; participants who merely belonged to professional associations were placed in the “inactive” category, and those who belonged and did voluntary work were placed into the “active” category. All others went into the “not member” category. Thus, though the database seems inconsistent at face level its measurements are in fact reliable and can be used in analysis. The membership categories are modified slightly for use in the current study. Two measurements are used here. One is simply “active” membership as it appears in the WVS database. The other measurement used is “total” membership, defined here as the sum of active and inactive individuals. The idea is to see whether these have different effects on economic growth. Each country was assigned two membership scores for each survey, one corresponding to the total percent of respondents in the sample population who said they were “active” members, and the other to the combined total percent of “active” and “inactive” respondents. Admittedly, it would be improper to tacitly equate “membership in ‘professional associations’” with the strength of business association activity in a given country. Because such activity cannot be translated into any sort of direct units, however, a membership measurement has to suffice. 10 Membership in professional associations functions here as the explanatory variable of interest in a pair of cross-country growth regressions. These utilize data from the three individual of the WVS currently available to the public. The dependent variables in the regressions are decade averages of year-over-year growth in GDP per capita, roughly matching the survey years of the WVS. The three decades so observed are 1975-1985 (for the 1981 survey), 1985-1995 (for the 1990 survey) and 1995-2003 (for the 1995-1998 survey). Growth data comes from the World Bank. 2003 is the last date for which growth data are available, and so forms a cut-off date in the final decade. A simple illustration of the data is given in Figure 2.1 on the following page. It displays simple plots of membership against decade growth averages. China is removed from the 1985-1995 plot and Nigeria and Bosnia from the 1995-2003 plot because of extreme growth and membership that distort the clarity of the plots. It is apparent from this figure that that there is no clear-cut relationship between membership and growth. The little correlation that is in fact visible is in the third graph, and seems to be negative, a result that at face value contradicts the Putnam hypothesis that business association activity has a positive effect on growth. If there is conclusive story to be built from the WVS data, it will come only from a more detailed analysis. Indeed, though there is no conclusive absolute correlation between membership and growth, there may be a conditional relationship that will only be visible once other factors that play a role in growth are controlled for. Going further, it is possible that business associations exhibit a more pronounced effect on growth only through their influence on domestic investment. These ideas are expounded upon in the next section, which deals with the specifics of the econometric model. 11 Figure 2.1 - Total and active membership in professional associations against GDP per capita growth in the three sample periods (1975-1985, 1985-1995a, 1995-2003b). 1975-1985 7 6 5 Growth (%) 4 3 2 1 0 -1 0 5 -2 10 15 Membership (% of sample population) Total Membership Active Membership 1985-1995 10 Growth (%) 5 0 0 5 10 15 -5 -10 -15 Membership (% of sample population) Total Membership Active Membership 1995-2003 10 8 Growth (%) 6 4 2 0 -2 0 5 10 15 20 25 -4 -6 Membership (% of sample population) Total Membership a b China has been removed. Bosnia and Nigeria have been removed. 12 Active Membership 30 35 3 MODEL Along with the membership data described above, a host of control variables are also incorporated in the analysis here. The idea of adding controls is to account for factors other than membership in professional organization that may affect growth. Without them, estimates of the effect of membership are likely to be biased. The control variables included follow the guidelines of Robert Barro and Xavier Sala-i-Martin (1995) on growth regressions. Decade averages (following the periods listed above) of life expectancy, annual population growth rates and annual domestic investment rates are used. Also incorporated are single-year measures of initial GDP-per capita and male secondary schooling attainment, captured at the beginning of each respective period in the years 1975, 1985, and 1995. Schooling attainment data for each country come from Barro and Lee (2000). Attainment is defined as the average number of years of secondary education completed by an individual in a sample of the male population age 25 and over. According to theory and empirical research, higher rates of attainment signify a greater presence of human capital in the domestic economy and should be positively correlated with economic growth. The other controls all come from the World Bank’s World Development Indicators (WDI) database. Initial GDP-per capita is given in 1995 international dollars scaled to account for purchasing power parity. The idea of convergence states that poorer countries will grow faster than richer ones, controlling for other variables. Economies demonstrating high per-capita income, the reasoning goes, are already quite saturated 13 with physical capital and so face diminished rates of return on that factor. Initial GDPper capita should be negatively correlated with growth. Life expectancy is given in years, and represents the expected life-span of the average infant born in the year of measurement. As an indicator of mortality, life expectancy is positively correlated with a range of health-related variables, and so a major benchmark for economic development. Countries with a higher life expectancy should experience greater economic growth. Population growth rates are measured annually. Greater population growth is usually indicative of higher domestic birth rates. Since children are net consumers, higher population growth should be negatively correlated with growth. Though Barro and Sala-i-Martin (1995) do not find a significant effect, population growth is a standard feature of many growth models and so is incorporated here as well. Investment is represented in a number of different forms in the regressions that follow. One of these is as total domestic investment, defined as gross fixed capital formation as a percentage of GDP. Alternatively, it is broken down into “public” and “private” investment variables, to test the separate effects that each might have. “Public” investment is simply government capital expenditure (also as a percentage of GDP), and “private” investment is set as gross fixed capital formation less government capital expenditure. In Barro and Sala-i-Martin (1995), international differences in investment rates are not found to be significantly related to growth when other factors are controlled for. Despite this finding, investment is included in this study. It is a crucial vector, one that allows for specific testing of the “information effect” hypothesis. According to this 14 theory, business associations improve government economic policymaking by channeling information about industry that public officials do not have access to. A simple measure of public investment is used here to account for government economic policy. If the information effect is true, then higher levels of business association activity should squeeze more growth out of each average, additional unit expenditure by the government on physical capital. Interaction terms are used here to test this effect. The first of these terms pairs membership with gross investment in an attempt to determine whether or not association activity has a net effect on investment. The second two terms pair membership with private and public investment, respectively. Interaction between membership and public investment directly tests the information effect. The other interaction terms are included partly to balance out the model and partly to determine whether membership might have separate effects on gross and private investment. The complete generalized model is presented below: Growth = β0 + β1 Membership + β2 Initial per-capita GDP + β3 Secondary Education + β4 Life Expectancy + β5 Population Growth + β6 Investment + β7 Membership*Investment + ε Four versions of this model are estimated. For two of these, investment is defined as “gross investment”, and for the other two it is split up into its “private” and “public” components. Within each of these groups of two, “active” membership is used in one regression and “total” membership is used in the other. Data from the sample decades (again, 1975-1985, 1985-1995 and 1995-2003) under observation make up three separate equations for each version, for a total of twelve 15 equations. Each set of three is pooled together to form a single system of equations corresponding to one of the versions. Each version of the model is estimated in two ways. In the first, the system is completely restricted. The constant term and all coefficients are fixed between the equations such that the regression provides one coefficient estimate for each explanatory variable across all periods. In the second estimation, all coefficients are fixed but not the constant terms. The individual estimation of constant terms is to allow for fixed effects between the different time periods. Estimations are made using the Ordinary Least Squares (OLS) technique. Pooling the data has two major advantages. One is that it allows for a greater sample size and thus greater degrees of freedom, enhancing the reliability of the results. The other is that it controls for business cycle effects between decades. Though ten years is a significant interval of time, it may still be subject to many macroeconomic fluctuations. The obvious response is to run estimates over longer periods of time. The nature of the membership data from the WVS, however, makes this difficult. The survey waves are spread out unevenly in time (occurring in 1981, 1990 and 1995-1998). Moreover the number of countries varies from one survey to the next. Averaging the data from the three to construct a single data set may give inaccurate results. As a consequence, using each of the surveys individually in decade data sets and pooling these together seems the most appropriate way to mitigate business cycle distortions. 16 4 RESULTS Table 4.1 presents estimates for the first two versions of the model, which use gross investment. Estimations using “complete restriction” of the constant and all variable coefficients and estimations allowing for “fixed effects” are both shown. Results for the controls roughly correspond to expectation in both total and active membership versions using both estimation methods. Initial GDP-per capita is negative and significant, secondary education positive and significant, population growth negative and insignificant, and gross investment positive but insignificant. Life expectancy is positive but insignificant. Surprisingly, the test variables show a mixture of effects. In the total membership version total membership alone is negative and significant using the “complete Table 4.1 - Membership in professional associations and economic growth, with gross investment. Complete Restriction Fixed Effects Initial GDP per capita -0.000126** (-2.387137) -0.000111** (-2.179256) -0.000156** (-2.618758) -0.000127** (-2.221636) Secondary Education 0.473061** (2.047595) 0.497064** (2.244661) 0.520501** (2.170988) 0.527959** (2.234159) Life Expectancy 0.040728 (0.789169) 0.037769 (0.744689) 0.044352 (0.854522) 0.040976 (0.787960) Population Growth -0.477395 (-1.411758) -0.355925 (-1.089347) -0.481079 (-1.435498) -0.362071 (-1.106738) Gross Investment 0.067071 (0.780475) 0.078448 (1.224211) 0.105482 (1.192222) 0.104138 (1.546363) Total Membership -0.283467* (-1.758448) Active Membership Total Membership * Gross Investment Active Membership * Gross Investment -0.175955 (-1.022700) -0.626865** (-2.615578) 0.014356** (2.018198) -0.487535* (-1.821115) 0.010418 (1.409252) 0.029715*** (2.839901) 0.024340** (2.147692) Notes: N = 40. *, ** and *** indicates significance at .10, .05 and .01 respectively. 17 restriction” method and negative but not significant using the “fixed effects” method. The interaction between total membership and gross membership is positive and significant using the “complete restriction” method and positive but not significant using the “fixed effects” method. In the active membership version active membership alone is negative and significant using both estimation methods. The interaction between active membership and gross membership is positive and significant using both estimation methods. Table 4.2 provides estimates for the second two versions of the model, which split total investment into private and public components. The behavior of the control Table 4.2 - Membership in professional associations and economic growth, with private and public investment. Complete Restriction Fixed Effects Initial GDP per capita -0.000131** (-2.393517) -0.000114** (-2.169944) -0.000163*** (-2.659965) -0.000128** (-2.195264) Secondary Education 0.463860* (1.919043) 0.501179** (2.148688) 0.511630** (2.068897) 0.527912** (2.157013) Life Expectancy 0.045976 (0.865482) 0.041360 (0.790610) 0.050943 (0.952792) 0.042845 (0.801702) Population Growth -0.480204 (-1.397317) -0.341329 (-1.018443) -0.485441 (-1.425431) -0.352486 (-1.047408) Private Investment 0.075886 (0.858072) 0.081638 (1.246675) 0.116374 (1.277598) 0.106044 (1.541650) Public Investment 0.159470 (0.554945) 0.121484 (0.556780) 0.210951 (0.729065) 0.131689 (0.582834) Total Membership -0.244425 (-1.374061) Active Membership Total Membership * Private Investment -0.594452** (-2.314817) 0.013423* (1.817215) Active Membership * Private Investment Total Membership * Public Investment Active Membership * Public Investment -0.126811 (-0.670963) -0.471116* (-1.685575) 0.009209 (1.197739) 0.028799** (2.649387) 0.004607 (0.234978) 0.023903** (2.051126) -0.001158 (-0.058881) 0.019862 (0.700485) 0.018299 (0.641956) Notes: N = 40. *, ** and *** indicates significance at .10, .05 and .01 respectively. 18 variables here is similar to that of the first two versions, and though investment is now defined as two variables both of these again prove positive but insignificant for each membership type. Test variables are again mixed. In the total membership version total membership alone is negative and not significant using both estimation methods. The interaction between total membership and private investment is positive and significant using the “complete restriction” method and positive but not significant using the “fixed effects” method. The interaction between total membership and public investment is positive and not significant using the “complete restriction” method and negative and not significant using the “fixed effects” method. In the active membership version active membership alone is negative and significant using both estimation methods. The interaction between active membership and private investment is positive and significant using both estimation methods. The interaction between active membership and public investment is positive but not significant using both estimation methods. The results reveal a surprising story. Active membership, a more defining measure of business association activity, is negative and significant in all four versions of the model. Thus business association activity in and of itself appears to have a negative influence on growth. This result is somewhat in line with the Olson theory. The investment interaction terms provide somewhat of an opposing effect to the stand-alone membership variables. As mentioned above, the interaction between active membership and gross investment is positive and significant under both estimation methods. Even total membership reacts positively and significantly with gross investment under the “complete restriction” method. So though gross investment by 19 itself is not related to growth, when combined with business associations it is. This result would seem to support Putnam’s theory that interest groups are a positive force. Going further, business associations seem to have different effects on public and private investment. The interaction between membership and public investment is highly insignificant for both membership types. Private investment, however, reacts positively and significantly with active membership, and with total membership in using the “complete restriction” estimation method. In summary, membership appears to increase the efficacy of private investment, and to have no effect on public investment. This result would seem to contradict the “information effect” hypothesis outlined earlier. At the same time, it may be possible the thinking of this hypothesis in a new light. Specifically, it may not be government that benefits from business association information, but the private sector. There are a number of potential ways to explain the disparity between the interaction of membership and the interaction of public investment and membership and private investment. Focusing on the relationship between business associations and government, it might be that the typical criticisms of industry lobbies are correct. Lobbies invariably represent both productive industries and unproductive industries. The latter, in particular, divert government subsidies and funding away from beneficial projects and are thus a drain on government investment. This effect may cancel out any positive influence that business associations bestow by providing economic information to government. That would explain the lack of significant interaction between membership and public investment in the regression. Note that lobbying behavior may also explain the negative and significant effect that membership alone had on growth. 20 A reworking of the information effect provides some interesting reasons to explain the positive correlation between membership and private investment. Business associations are formed not only as a mechanism for transmitting needs to government but as a forum for discussion, both between companies within an industry and between industries in the economy. These entities meet to share information about the business climate, to establish joint business ventures, and to set industry-wide standards on issues such as hiring practices or distribution of resources. These are all forms of informational exchange. By encouraging cooperation between different business and reducing economic uncertainty, then, business associations can enhance the success rate of investments made by firms. Another way in which a business association might have a positive effect on private investment is as a signaling mechanism. Many business associations have particular standards which companies must meet if they wish to gain membership. Conditions may include achieving a certain level of market capitalization, or using certain production techniques (growing crops organically, for instance). Once in, however, these conditions might become a sign of distinction for a given firm, putting it in a recognizable category and indicating its legitimacy to potential investors. Private investors looking to invest in companies that meet specific qualifications are thus provided with a means of comparing and classifying different businesses, information which they can then use to make more informed investment decisions. 21 5 JAPAN Up to now the current paper has concerned itself with a broader empirical analysis. This section is meant to provide a specific instance of business association activity. Japan is a good candidate for study, representing an economy that many political scientists and economists argue is highly influenced by business associations. Here particular emphasis is paid to the “information effect”, the role that these associations play in transmitting information about industry to government. In order to place this discussion firmly in the context of the paper, discussion of Japan will parallel the framework of the empirical analysis. First a traditional argument for Japan’s economic success will presented. The central reasoning behind it is essentially a form of the information effect, positing that business associations and government in Japan engaged in prolonged institutionalized dialogue with one another, and that this dialogue led to the formulation of highly effective economic policy by government. Afterwards this same argument will be criticized. Just as the empirical analysis earlier called into question a typical understanding of the information effect, so too will traditional ideas about Japanese industrial policy be examined anew. Finally, it will be seen whether Japan’s development success can be explained in an alternative light consistent with the findings of the empirical analysis on the relationship between business associations and private investment. In the last paragraph an explicit assumption was made about Japan being a model of economic success. Before heading straight into a discussion about what caused this success, this assumption deserves some comment. This is especially true considering that in the last decade or so Japan has been a byword for economic “bust”. A rigid 22 bureaucracy, corrupt financial sector, and isolation from foreign markets have all been cited as reasons for the country’s decline in recent times. These criticisms are most certainly valid in their present context. Nevertheless they should not discredit the country’s past triumphs. Indeed, from the end of the Second World War to the beginning of the 1990’s, Japan was an exemplar of development. GNP per capita rose at an average rate of 6.9 percent per year between 1946 and 1985. As the first of the East Asian “miracle” economies, Japan would become a model for its neighbors and a global leader in high-end industry. The period of post-war growth in Japan, then, is a highly reasonable instance of economic success. The source of this success has long been debated by economic and political theorists alike. Despite differences in opinion, however, many have attributed some if not most of the credit to industrial policy. Japan has long been touted as an archetype of the “developmental state”. In the initial post-war years the country was an economically ravaged place, with much of its physical capital destroyed and many of its people in poverty. Rather than bolstering agriculture, textiles or small crafts, sectors that could benefit from the low-wage production in which Japan had a comparative advantage, policymakers instead turned to heavy manufacturing. Ultimately, some of the sectors that succeeded most were initially “infant industries” benefiting from the sort of “greenhouse” trade controls and subsidies anathema to classical economists. Japan’s automobile industry, today the world’s largest, was one of those. Yet industrial policy is not a form of economic management limited to Japan. Indeed, many other countries attempted similar projects and failed at the same time that Japan was seeing its greatest growth rates. The import-substituting industrialization (ISI) 23 policies undertaken by the governments of many Latin American countries spring to mind. If industrial policy truly was the foundation of Japan’s triumph, than it was a version of it tempered by a unique organizational style or set of practices. Of those who have studied the Japanese economy, many argue that the secret was in the close relationship and strong communication between state officials and industry leaders. One half of this relationship was government, the body that actually formulated policy. Speaking to this aspect, Chalmers Johnson (1982) posits that it was the existence of a centralized and prestigious bureaucracy, with sweeping control over economic resources, that promoted rapid development. The Ministry of International Trade and Industry (MITI) was the “pilot agency” of this bureaucracy. As one of the two most competitive ministries (the other was the Ministry of Finance) for college graduate recruits, MITI naturally cultivated an abundance of brain-power within its ranks. Evidence of this, Johnson argues, can be seen in its judicious support of particular exportled industries such as shipbuilding and consumer electronics. Johnson is not the only one to give significant credit to MITI. Daniel Okimoto (1989) too affirms the organization’s central place in Japan’s rise. Like Johnson, he also puts an emphasis on MITI’s bureaucratic pedigree. His description of the elements that made the organization successful, however, goes further. In addition to its elite bureaucracy was MITI’s sweeping administrative control over most areas of Japanese industry. This power was especially relevant in the early post-war period, when physical capital was scarce. MITI oversaw allocation of foreign exchange and government development loans, and was responsible for the imposition of trade controls and approval of most subsidies to the private sector. This breadth of responsibility allowed the 24 organization to formulate a cohesive industrial policy. It was able to “[weigh] the interests of one sector against those of others and [aggregate] the welter of diverse, sometimes conflicting, demands into a comparatively coherent whole” (Okimoto, 1989, p. 114). Most interesting for the purposes of this case study, though, is another major element that Okimoto believes was crucial to MITI’s success. This element was the Japan’s network of business associations, the other half of the close relationship between business and government spheres. Though MITI was the primary channel for dialogue, it was Japan’s business community, bound together in its web of associations, which provided the points of access between both parties. Okimoto describes three distinct group types through which MITI, and indeed other government ministries, accessed industry leaders. These are keiretsu (company aggregates), industrial associations and business federations. The term keiretsu translates into something like “system” or “succession”. Keiretsu themselves can be further divided into two major subgroups, kin’yuu keiretsu (financial keiretsu) and kigyou keiretsu (enterprise keiretsu). Financial keiretsu are a “loosely knit, permeable set of industrial networks, connected through cross-cutting cleavages” (Okimoto, 1989, p. 133). There are few such keiretsu, and all involve a grouping of major companies centered around a large city bank and a trading company. Companies in a financial keiretsu network obtain relatively easy long-term credit access from their group bank. The unique practice of cross-shareholding is also important to the structure of financial keiretsu. In 1981, the average amount of stock in a given financial keiretsu company held by the other members of the group in total was 25.5%. To a large extent, the group structure offers a manner of 25 financial risk protection from negative business cycle swings. Other benefits include a high degree of informational exchange between companies. In contrast to the financial keiretsu are the enterprise keiretsu. These groups are based on linkages between a large manufacturing company or group of such companies and the range of subcontractors, distributors, and other firms that operate both “upstream” and “downstream” to close the supply loop. For instance, an automobile manufacturer such as Honda is connected on one end to a chain of smaller businesses that supply parts, and on the other to the distributors pushing its product on the retail market. Another type of private business group is the industrial association, which represents the interests of a particular sector. Examples include the Electronics Industries Association of Japan and the Japan Chemical Industry Association. Industrial associations work to promote intra-industry cooperation and project the needs of their member companies. The third major group is the business federation. These are groups such as Nihon Keidanren (Japan Federation of Economic Organizations) and Nisshou (Japan Chamber of Commerce) that unite a wide swath of firms from various industries under common leadership. The Keidanren is by far the largest of these, representing over one thousand major companies and industrial associations. It is organized into numerous subcommittees that tackle different problems in the economy. The results of the deliberations of these groups, in turn, are taken up by Keidanren leaders and communicated to appropriate ministries within the government. Each of these groups, Okimoto argues, was crucial for the success of MITI’s industrial policy. All were forums through which firms could communicate their needs 26 and relay information about how macroeconomic trends were affecting industry. After government formulated its policy response, these groups also acted as a vehicle of dissemination, communicating public decisions back to the private sector. This idealized picture of government-business dialogue has come under heavy criticism in recent years. On one level, it is now evident that the back and forth between business and government did not go on without its share of clashes of interest. Industry leaders, especially in later years, often went against the wishes of state officials to pursue avenues of business they felt had more potential, even if such moves cost them certain policy benefits. During the 1960’s MITI encouraged a series of mergers between automobile manufactures, supposedly to reduce competition and allow fewer firms to produce more cars, taking advantage of greater economies of scale. Few firms complied with this policy recommendation. On a more general level, many academics have questioned the idea that a centrally directed industrial policy was the source of Japan’s economic success. Most criticism has been leveled at MITI, the very same monolithic institution that had been praised by so many Western writers in the 1980’s. David Flath (2000), for example, gives evidence to support the notion that MITI’s industrial targeting was misguided. Citing a study by the economist Paul Krugman, he posits that the tax breaks and subsidies granted to primary goods industries such as steel actually slowed development by propping up sectors in which domestic producers could no longer profitably compete after the mid-1960’s. Some of MITI’s poorest decisions were invariably political ones. Like political leadership in any other democratic state, the Liberal Democratic Party, governing 27 Japanese politics without interruption from 1955 to 1993, naturally developed entrenched voter bases that it sought to retain through patronage. Ministry bureaucrats, in turn, were often forced to construct policies benefiting industries with concentrations of political constituents irregardless of the potential of these industries for future success. MITI subsidies to the Japanese coal and textile industries are two examples of this phenomenon. Yet political favoritism was not the only instance of support for unproductive industries. Indeed, many of MITI’s policy failures were made with the full intent of bolstering economic productivity. Okimoto (1989) himself points to a variety of industries, including commercial aircraft, aerospace and petrochemicals, that failed despite sustained aid from the public sector. Moreover MITI sometimes proved unable to see potential in firms that would turn out to be the greatest engines of economic growth. Its attempt to cartelize the automobile industry, highlighted earlier, was a specific reflection of this. It is thus evident that MITI and government policy were not infallible and did not always “pick winners”. The results of the empirical study in this paper would also seem to provide some support in favor of rethinking Japanese industrial policy. In the results section it was shown that business associations do not have a significant influence on public investment. This calls into questions typical ideas about the information effect, and suggests that it might not have been the close interaction between government and business that was at the heart of Japan’s economic success. As discussed at the end of the empirical study, one way to redeem the information effect may be to look at the influence that business associations have on private investment. Indeed, perhaps somewhat coincidentally, Japan has seen continuously high 28 domestic savings rates since the end of the Second World War. Over the past four decades these rates have hovered at an approximate average of 33 percent of GDP. Most of this has been spent in private investment in the form of fixed capital expenditures. It does not seem farfetched to hypothesize that business associations might have played a strong role in bolstering the efficacy of private investment during Japan’s development. For example, the financial keiretsu, it will be recalled, provide a network of financial and logistical support through cross-shareholding, informational meetings and other means of inter-firm exchange. They are also unified around a central city bank that acts as the greatest source of lending for member companies. These characteristics may have contributed to the success rate of investment in the long-run, as members facing financial strain were supported through emergency loans, preferential trading and other measures in the event of credit problems. At worst they would be restructured or reorganized in some other format within the keiretsu group. The point is that ailing firms were saved from total failure, a situation that would result in a total waste of invested resources. Even in the case of keiretsu, , however, counter-arguments exist. Indeed, some have argued that keiretsu, rather than simply “tiding over” good companies experiencing short-term financial problems, actually kept afloat companies that could not conceivably be productive. If this is true then it becomes more difficult to identify a “uniqueness” in Japanese business associations that might explain at least part of that country’s miracle growth in the post-war period. More generally, it may be that some of the reasoning given in the last section to explain the interaction between business associations and private investment also applies 29 in the case of Japan. The ability of associations to act as forums of discussion between companies and industries, or as signal mechanisms to private investors is something that has not been significantly explored in economic literature, much less in the economic literature on Japan. When juxtaposed against the findings presented in the empirical study here, these ideas present interesting avenues for future research. 30 CONCLUSION This paper began with the general goal of clarifying the role of business associations in economic activity. As with many studies, it seems that even as certain questions are answered new ones arise. The overall effect of business associations remains unclear. Nonetheless, novel insights have appeared to challenge old assumptions. In particular, though lobbies do not seem to have a significant influence on public investment, they do appear to have a positive and significant effect on private investment. This finding poses a direct challenge to typical conceptions of the “information effect”, which argue that business associations bolster government policymaking through the transfer of crucial economic knowledge to public officials. In place of this interaction between business and government, a new kind of information effect was hypothesized in the results section. This hypothesis is based on the idea that business associations may serve as a forum within which dialogue between companies and industries can occur, and/or as a sort of ranking mechanism providing points of distinction or comparison between different companies. Business associations are found in many forms and take on many roles. They are a complex form of organization. This paper tested some generalized ideas about business association activity and in turn produced generalized but surprising results. The case study of Japan was an attempt to provide a concrete example to complement the more general findings of the empirical analysis. Future studies would do well to narrow the frame of reference and explore certain facets of the debate laid out here. Of particular interest is the influence of business association on private investment, a relationship observed in the empirical results. 31 Though some potential explanations for this influence were provided, it remains to be seen whether these explanations are in fact robust. Moreover, there may be other lines of reasoning to support the interaction between business associations and private investment that have not yet been proposed. Regardless of which hypotheses are ultimately tested, a crucial imperative for research on this topic remains to acquire more detailed information about the extent of business association activity. Obtaining figures for the number of major associations in each industry and/or the average size of associations in a given country would be a good starting point. Other highly useful information for each country would include the average yearly expenditure of business associations in each industry and across the whole economy, and the average number of times per year that associations call meetings of their members. Any data along these lines would be of tremendous aid to future research on business associations. Indeed, without it, it will be extremely difficult to learn more about a phenomenon that seems to have such a real and important effect on economic life. 32 BIBLIOGRAPHY Ball, Richard. 1995. “Interest Groups, Influence and Welfare.” Economics and Politics, 7 (issue 2): 119-146. Barro, Robert J. and Jong-Wha Lee. 2000. “International Data on Educational Attainment: Updates and Implications.” Harvard University Center for International Development Working Paper no. 42. Barro, Robert J. and Javier Sala-i-Martin. 2001. Economic Growth. Cambridge: The MIT Press. Evans, Peter. 1995. Embedded Autonomy: States and Industrial Transformation. 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Princeton: Princeton University Press. Rodrik, Dani. 2004. “Industrial Policy for the Twenty-First Century.” C.E.P.R. Discussion Papers: 4767. World Bank. 2004. Statistics retrieved from the World Development Indicators [Online]. 34 Appendix 2.A – The WVS survey questionnaires for 1990 and 1995-1998 Copy of the 1990 World Values Survey questionnaire, subsection on membership in voluntary organizations. Please look carefully at the following list of voluntary organizations and activities and say… a) which, if any, do you belong to? (CODE ALL ‘YES’ ANSWERS UNDER (a)) b) which, if any, are you currently doing unpaid voluntary work for? (CODE ALL ‘YES’ ANSWERS UNDER (b)) Belong to (a) V19 Social welfare services for elderly, handicapped or deprived people V20 Religious or church organizations V21 Education, arts, music or cultural activities V22 Trade unions V23 Political parties or groups V24 Local community action on issues like poverty, employment, housing, racial inequality V25 Third world development or human rights V26 Conservation, the environment, ecology *V27 Professional associations V28 Youth work (e.g. scouts, guides, youth clubs, etc.) V29 Sports or recreation V30 Women’s groups V31 Peace movement V32 Animal rights V33 Voluntary organizations concerned with health V34 Other groups 35 Do unpaid Work for (b) 0.010418 V35 None V 36 Don’t Know *Variable used in the current paper Copy of the 1995-1998 World Values Survey questionnaire, subsection on membership in voluntary organizations. Now I am going to read off a list of voluntary organizations; for each one, could you tell me whether you are an active member, an inactive member or not a member of that type of organization? Active Member Inactive Member Don’t Belong V28 Church or religious organization 1 2 3 V29 Sport or recreation organization 1 2 3 V30 Art, music or educational organization 1 2 3 V31 Labor union 1 2 3 V32 Political party 1 2 3 V33 Environmental organization 1 2 3 *V34 Professional association 1 2 3 V35 Charitable organization 1 2 3 V36 Any other voluntary organization 1 2 3 *Variable used in the current paper 36