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Transaction costs and crony capitalism in East Asia (Forthcoming in Comparative Politics) David C. Kang Tuck School of Business Government Department Dartmouth College Hanover, NH 03755 (603) 646-2548 (o) (603) 646-2152 (fax) email: [email protected] May 21, 2002 Many thanks to Danny Blanchflower, Kathleen Collins, Michael Ross, and three anonymous reviewers for their comments. An earlier version of this article was presented at Stanford University; the University of Notre Dame; and the conference “Asian political-economy in an era of globalization,” Tuck School of Business, Dartmouth College, May 10-11, 2002. 1 Abstract: Transaction costs and Crony Capitalism in East Asia Wordcount: 7,808 Why did corruption and cronyism impede growth in some developing countries but not in others? Building upon theoretical advances in the fields of rent-seeking, transaction costs, and the new institutional economics, in this article I suggest a first-cut explanation that will help us understand when cronyism is deleterious and when it is not. This study finds that if there is a situation of “mutual hostages” among a small and stable number of government and business actors, cronyism can actually reduce transaction costs and minimize deadweight losses, while either too few or too many actors increases deadweight losses from corruption. This study uses cases from East Asia and shows how a small set of actors led to mutual hostages in government-business relations in Korea, while in the Philippines and Indonesia too many or too few actors raised transaction costs. 2 "[crony capitalism is a system] where stocks are purchased and loans are made on the basis of association, not economic value." -Alan Greenspan, testimony before the U.S. House of Representatives, January 30, 1998 The previous generation of scholarship on Asian development agreed on one seemingly plausible analytic point: uncorrupt governments were better at fostering growth than those riven by crony capitalism and corruption.1 Yet the events of 1997, combined with the waves of corruption scandals during the 1990s in success cases such as Korea and Taiwan, have made the widespread existence of crony capitalism too obvious to ignore.2 As Richard Doner and Ansil Ramsey argue, "if corruption and rentseeking can be damaging to growth in some countries, but not others, we need a clearer understanding of what kinds of corruption and rent-seeking affect economic performance in what kind of circumstances."3 Why did corruption and cronyism impede growth in some developing countries but not in others? 4 Building upon theoretical advances in the fields of rent-seeking, transaction costs, and the new institutional economics, in this article I suggest a first-cut explanation that will help us understand when cronyism is deleterious and when it is not. 5 This study finds that if there is a situation of mutual hostages among a small and stable number of government and business actors, cronyism can actually reduce transaction costs and 3 minimize deadweight losses through a mutual hostage situation; while either too few or too many actors increase deadweight losses from corruption. This article examines corruption and cronyism through the lens of transaction costs, and shows why a particular set of government-business relations– although corrupt – also lowered transaction costs and made investment more credible while another set of relations did not. This study thus provides the outlines of a story that can explain one aspect of corruption and also yields a theoretically-grounded causal mechanism that lets us distinguish between types of corruption. It is widely accepted that low transaction costs -- the costs of making, monitoring, and enforcing agreements between actors – affect economic and political outcomes. 6 Cronyism -- family-based clans, personal relationships, and informal networks -- is often seen to raise transaction costs in a country.7 But there are also conditions under which cronyism can lower transaction costs.8 Personal relationships can lead to better information, provide more opportunities and longer time-horizons for side-payments and reciprocity, reduce monitoring costs, and make enforcement of agreements easier. Such ties may be even more important in developing countries, which typically have weak institutional and legal structures. As Richard Doner and Ben Ross-Schneider write, “distributional objectives may coexist or even alternate with more productive goals…[and] result in the ‘joint production’ of both private and public goods.”9 4 Using South Korea, the Philippines, and Indonesia as cases, this study examines cronyism and shows how explaining when personal relations are useful and when they are deleterious can help us understand contrasting economic and political outcomes. The comparison of these three countries is useful because is widely accepted in the literature that Korea was a more successful developer due in part to a much lesser role for corruption than existed in the Philippines and Indonesia. Yet policymaking in all three countries has been dominated by political considerations and informal connections, and bribery and rent-seeking has been the norm in Northeast Asia as well as in Southeast Asia.10 As Mushtaq Khan writes, "the problem is that transfer-based rents were ubiquitous in all developing countries, not just in the stagnating ones. Thus it is misleading to argue that economic success required the absence of rents based on transfers."11 Much of the argument presented here is compatible with a number of other approaches. Alice Amsden’s notion of subsidies in exchange for performance, Peter Evan's argument about embedded autonomy, and Michael Ross' emphasis on political uncertainty in Indonesia all touch on aspects of transaction costs.12 A transaction costs perspective systematizes these diverse approaches and allows them to be seen as aspects of a larger analytic issue. This article does not attempt to provide a general explanation for growth in these three countries. A full explanation for different economic trajectories would entail 5 understanding differences in state capacities between Northeast and Southeast Asia, different colonial legacies, different geopolitical situations, and a host of other factors.13 Rather, my purpose is more limited: to explore whether we can make discriminating hypotheses about one factor that is widely considered to be important for economic outcomes. Thus, this article does not explain the origins of the unique domestic structures, institutions, and external situations of each country. Rather, I take these structures as given and ask whether it is possible to make generalizable statements. The article is organized in four major sections. In the first section I provide a brief analytic framework that contrasts a transaction cost approach with neoclassical models of the economy, and show that a transaction cost approach leads us to different expectations and different conclusions regarding cronyism and policymaking. The second section shows how a small set of actors led to a mutual hostages in Korean government-business relations, while the third section shows that in the Philippines and Indonesia too few or too many actors raised transaction costs. A final section concludes by drawing lessons for the literature and focusing on future research. I. Cronyism and transaction costs Part of a larger field of the “new institutional economics” (hereafter NIE), the study of transaction costs focuses on exchange between actors.14 Neoclassical economic 6 theory assumes that the institutional framework -- the legal, political, and informational aspects of an economy -- is given. In a neoclassical world contracts are costlessly and immediately enforced, property rights are secure, and any initial distribution of resources can be voluntarily bargained over and exchanged in order to maximize efficiency. Thus built into the model is the idea that any government intervention must be deleterious, since it involves a move away from a perfect market. However, once we begin to question the idea of an undistorted initial period, much of the distinction between profit and rent-seeking breaks down. If the initial distribution of resources is distorted, then rent-seeking may involve fights over the distribution of rents, and may not necessarily involve inefficient dissipation.15 In contrast, transaction cost economics emphasizes that creating, monitoring, and enforcing long-term agreements is inherently impossible, and therefore long-term or iterated exchange is risky.16 Transaction cost analysis thus examines the search for institutions that reduce the costs of exchange, and the basic insight is that institutions evolve in order to minimize transaction costs. Closely related to this theme is a focus on property rights, informational asymmetries, and principal-agent models. In this world, a high-performance economy is one in which institutions minimize transaction costs, property rights are secure, information is common or at least relatively public, and judicial and political rights are immutable. These conditions are not met in most 7 developing countries. 17 Coercion and uncertainty are both central to politics and also intensify a political actor’s fears regarding potential expropriation, opportunism, and shirking. The search for institutions and methods by which actors can credibly engage in cooperative behavior is thus one central aim of the NIE. 1. Cronyism An NIE perspective is particularly useful in understanding cronyism – a blanket term to refer to a number of related concepts: family and personal relations, bribery and corruption, patron-client relations, and collusion. In some cases cronyism involves political factions, groups, or informal networks, while in other cases it involves actual clans, families, or social groups. Cronyism is often seen as deleterious to economic growth because it implies decisions based on non-market principles, increases transaction costs, impedes efficiency and involves rent-seeking, distortion of economic incentives, and makes exchange between actors more difficult.18 And, in most instances, reliance on personal relations is detrimental to economic efficiency. In addition, bribes are merely transfers, and the relevant question is whether the resources will be put to more productive use in the possession of the seeker or the seekee.19 However, sometimes personal relations can enhance efficiency. In countries with weak legal, political, and economic institutions – the case in most developing countries -- 8 information about market conditions and possibilities is both scarce and difficult to obtain, and investments and property rights may be insecure. In general this leads to an increased difficulty in making long-term commitments of any sort, because the political and economic conditions and actors can change rapidly. Capital markets do not function as effectively in developing countries, and in general political or economic decisionmaking is subject to greater uncertainty than in developed and democratic systems. For businessmen and politicians in this environment, the transaction costs of making and keeping agreements and securing property rights can be prohibitively high. Absent some enforcement mechanism, parties may be reluctant to enter into long-term relationships. Under these conditions, cronyism can actually reduce transaction costs. This is because actors have deep and enduring contact with and knowledge of each other, and are able to make nuanced judgements about actors’ credibility and integrity. Monitoring is also easier, because all parties know each other, and actors with long-term, close, and overlapping personal ties can sanction each other and spread information more easily. It is not the case that if long-run gains are hazardous that actors look myopically short-run: rather they attempt to craft alternatives that will add some predictability and stability to the future, and this often means relying on personal relations.20 9 Thus, cronyism can lead to better information, monitoring and sanctioning, strengthen property rights, and provide alternative means for reciprocity and sidepayments. In this context, cronyism within a well-defined set of actors may reduce transaction costs across the board. Since institutions are weak and property rights fluid, confidence in exchange and agreements can be imbued only through other relationships. Thus the question becomes: under what conditions does cronyism lower rather than raise transaction costs? 2. A situation of mutual hostages among elites reduces transaction costs The most important factor that reduces transaction costs is a situation of mutual hostages among a small number of elite actors. "Mutual hostages” exist whenever two actors have significant vulnerability relative to each other. This can arise from either an explicit or an implicit exchange of hostages. In so doing, each side thus has an incentive both to continue the relationship, and can also limit opportunism by the other party. Thus, rents can be had and corruption can occur, but neither group dominates the other. Both political and economic elites are powerful enough to harm the other, but deterred from such actions by the damage the other side can inflict.21 In this sense, a mutual hostage situation between government and business elites corresponds to a Prisoner’s Dilemma, and cooperation is not automatic. While in the short run either actor may be better off 10 defecting and gaining all the rents for himself, the other actor retains the ability to punish defection over time, and thus grudging cooperation may ensue.22 Furthermore, small numbers lower costs in other ways, as well. The less competitive the rent-seeking process, the less the total costs arising from the process. Gordon Tullock argues that “getting a monopoly is essentially a competitive industry.”23 Tullock’s argument is that rent-seeking has double costs: the distortionary effects of the rent itself, and then the diversion of productive resources towards competition for the prize of the rent. In situations in which an unlimited number of supplicants may bid for a rent, the expected price for the rent will be higher as actors compete with each other to bid up the price for the rent. Fewer actors lessens competition for rents, and thus less resources are diverted in obtaining rents. Much rent-seeking also entails competing with other actors to win rents and then building entry barriers and other mechanisms to protect those rents. Thus, when compared to an open-market auction, a smaller number of actors will decrease the deadweight loss if they can form a cartel.24 A group that has exclusive access to the rent markets has lower information costs, and can collude over time with other rent-seekers to lower costs.25 The less these “protection costs,” the less deleterious will be rent-seeking. The implication from this is straightforward: smaller numbers of rent-seekers reduce the total social cost because bidding is limited, property rights over the rent are more secure, and deadweight losses are lowered.26 11 Small numbers also affect informational needs. In this case, government and business elites have greater information about each other and are able to make relatively more sophisticated judgements about trustworthiness and ability. Small numbers also lead to iteration; actors know each other and are able to develop reputations. Iteration reduces opportunism because the same actors will be active in the future, as well. While such iterated interaction among a constant set of actors may lead to an Olsonian form of distributional coalition that impedes efficiency compared to that of a pure market, the more important point is that such a coalition will entail lower rent-seeking costs than an unorganized and unlimited number of bidders, and that agreements are both stable and durable.27 In countries with weak legal and political institutions, a situation of mutual hostages among a small set of government and business actors lowers transaction costs can provide a number of benefits that reduce transaction costs: better information about the actors, greater ease of monitoring and enforcing agreements, greater confidence in exchange, and more ease in making side-payments and engaging in reciprocity. Table 1 summarizes the two approaches – a neoclassical and an NIE perspective on cronyism. //Table 1 here// 3. The Goldilocks principle: too few or too many 12 The two polar conditions are either many actors, or centralization around one important actor. In the case of large numbers of actors, there is no stable balance, and "cascades" of cronies will flock to the side currently in power, hoping to curry favor. Large-N also makes generating consensus and stability more difficult over the long run. This leads to widely fluctuating economic policies, frequent re-negotiation of agreements, an over-reliance on personal connections, and an unpredictable investment climate, which increase transaction costs (Figure 1).28 //Figure 1 here// The opposite pole – the case of a dictator – entails transaction costs that are either much lower or much higher. On the one hand, decisionmaking is potentially very efficient. Investors would often prefer to deal with a dictator, because making agreements is easier than working through large numbers of veto players, and even if the bribe is very large, it is only negotiated with one person. Economic decisionmaking can be quick and efficient, and enforcing it may be easier because there is only one dictator with whom to deal. However, a dictator can change his mind at any time, especially if he is a tinpot dictator. Without a group that can counterbalance the dictator, arrangements are highly contingent: property rights may be temporarily more stable under a dicator, but they are less durable through crisis or transition. If time-horizons are short, or there is some uncertainty regarding the stability of the dictator, then transaction costs can be very high 13 and property rights virtually meaningless.29 In times of transition, centralization of authority leads to higher transaction costs, greater uncertainty, and potentially skyrocketing costs during the dictator's collapse. Evaluating the role of transaction costs and cronyism is important, even though scholars widely acknowledge the difficulty in measuring them.30 Recognizing this difficulty, this study uses detailed case studies of polar cases of Korea, the Philippines, and Indonesia in order to lay out the ranges of the variables and test the model’s plausibility. II. Mutual hostages in Korea All Asian countries have been characterized by cronyism. Close personal or family connections have been central to political and economic life in Korea, the Philippines, Indonesia. This process involved intermarriage among elites and the assiduous cultivation of personal relationships. In these countries an introduction from a mutual acquaintance has been critical in opening doors. And the broad pattern of politics appears superficially similar: leaders have extensive power and weak parties devolve into personal vote machines that trade pork for payoffs. In these countries, political payoffs allow business influence over policy decisions, and access to the state was the avenue to economic success. Because of the need to finance political parties, and thus the pivotal 14 role of big business, in these countries the state had trouble disciplining business and enforcing limits. The erratic nature of economic policy and the extensive corruption can be seen as an outcome of this effort to build these bases of business and political support.31 Yet the case of Korea has one major exception: despite extensive cronyism, corruption was constrained by a mutual hostages between the business class and a coherent state. Both of these groups actors were able to benefit from their close relationship with the other, but neither was ever able to gain the upper hand. Business and government elites needed each other and relied upon each other, and stability allowed for long-term investment and iterated relationships. This is all the more remarkable because the same small set of actors has remained essentially the same through a tumultuous halfcentury of Korean history including numerous coups d’etat, an assassination, a democratic transition, and frequent political and economic crises. In Korea, government intervention was subject to political influence in a number of ways that reduced both rent-seeking on the part of the entrepreneurs, and transaction costs for the politicians and bureaucrats involved in monitoring the policy process. This mutual hostages between government and business limited the opportunities for excessive advantage. While the “strong developmental state” has been the focus of much of the literature on Asian growth, the surprising strength of the business sector has received less 15 attention. This section will examine three areas that highlight the mutual hostages in Korea and show how cronyism can lower transaction costs. The first area is the pattern of financial relations in Korea. Second, the strength and organization of the chaebol as exemplified by the Federation of Korean Industries (FKI). Third, the 1961 Illict Wealth Accumulation Act and what it implies for our understanding of the strength of the Korean state. First, the state’s control over finance and the coherent and small set of Korean business (chaebol) created a situation of mutual hostages. State control over the financial sector had enormous consequences for the organization and conduct of business in Korea.32 Since Korean companies were highly leveraged, these were vulnerable to state control. Paradoxically, this weakness became a source of strength relative to the state. By encouraging the formation of large conglomerates that accounted for large percentages of the Korean economy, the state in effect became mutual hostages with the chaebol. The Korean government’s control over capital made any threat to cut off credit to the chaebol lack credibility, because all actors knew that it would hurt the regime as much as the chaebol. A flow of political payoffs to politicians cemented this pipeline of easy money.33 For politicians, the need for political funds to run elections and other political activities, as well as a natural proclivity toward greed, gave them no incentive to 16 sanction companies unless the business managers were utterly incompetent. While both business and the state benefited from close ties, neither side was able to dominate the other.34 This is analogous to a prisoner’s dilemma: in PD both sides would prefer to defect, but they are restrained from doing so by the ability of the other side to respond in kind, and hence a form of stability ensues. The exchange of hostages led to an uneasy balance of constrained collusion that existed throughout the period of high growth. Mutual hostages lowers transaction costs in a number of ways. Business and the state both knew that each needed the other, both also knew that few alternatives existed. The set of favored cronies was relatively small, and thus the costs of competing with each other were lower, because the prospects for opportunism and the need to protect investments was lower.35 In addition, elites knew they were playing an iterated game, where actors would be around for a while, with both the opportunity for reciprocity and the fear of payback. The second aspect of cronyism that lowered transaction costs in Korea was the relative organization of business. Business in Korea was more coherent and organized, allowing it to restrain and influence a strong state. The political circumstances in which Park Chung Hee came to power initially dictated an effort to control business activities. Over the longer run, however, the government was less preoccupied in limiting business power, more dependent on business for both economic performance and political support, 17 and thus more willing to actively organize business in an effort to achieve its economic objectives. As a result, business associations played a more significant role in the formulation and implementation of policy than they did in the Philippines, particularly during the early phase of the export-led growth strategy.36 This best example of this is the Federation of Korean Industries (FKI). Formed of those leading businessmen who were arrested in 1961 for illicit accumulation of wealth, the FKI operates as sort of a club for the richest and most influential of the big capitalists, and limits its membership to an elite stratum of entrepreneurs. After their release from jail, the members of the FKI submitted a plan to the Supreme Council on National Unification identifying fourteen key industrial plants -- cement, steel, fertilizer, etc. -- in which they were interested in investing. One of the FKI’s initial actions was to travel overseas and invite foreign capital to invest in Korea, and each member was designated a particular field for investment.37 The FKI also lobbied successfully for the construction of an integrated industrial complex at Ulsan in 1962 and the export industrial complex at Kuro that was an early predecessor of the later export-processing zones.38 Thus the original investment decisions in the early 1960s were a result of business-government relations, bypassing lengthy and costly bureaucratic procedures.39 In an interview, Hahn-been Lee, former Prime Minister, said that “of course the political leadership made all the major decisions about projects. 18 We were there to provide a rationale for the decisions the regime had already made, and then to implement them. The approval guidelines were there to help, but were not strictly enforced.”40 The influence of the FKI makes clear that the bureaucracy’s role was to justify and implement economic choices made for political reasons. The FKI has also been influential regarding finance, particularly gaining access to foreign exchange.41 Because Korean businessmen in the early 1960s did not have experience in obtaining foreign capital, the FKI – in conjunction with the government -took on the role of selecting and overseeing firms that wished to borrow abroad. With FKI approval, firms were more likely to obtain approval from the state, which results in coordination and streamlining procedures. The FKI also was instrumental in expressing its interests to the state and – at times – presenting a unified voice. One example is the August 3rd, 1972, “Presidential Emergency Decree on Economic Stabilization and Development” (informally known as the “8-3” or pal-sam decree), when Park Chung-hee decided to freeze high-interest informal (“curb”) market loans and replace them with long-term bank loans. The chairman of the FKI finally decided to ask the president directly for help. After two personal meetings in June between the FKI chairman and the president, Park Chung-hee told his chief of staff, Kim Chung-nyum, along with presidential secretary Kim Yonghwan, to prepare an emergency decree.42 The FKI was in fact able to appeal directly to 19 the president and have an influence.43 The FKI was not the only institutional voice to press the state, and indeed individual business and cronies were more influential. The full story of government-business relationsis complex. However, the FKI is significant for a number of reasons. The FKI was able to aggregate voices and shows the ability of the Korean business sector to compete and bargain with the state. The third example of how strong business and strong state lowered transaction costs is the 1961 bargain between state and business in Korea. As with the mutual hostages of debt, the 1961 compromise is an example of the mutual hostages that existed between elites in Korea. Perhaps the most-cited example of the South Korean state’s power over chaebol arises from Park’s expropriation of major business leaders’ wealth soon after his coup in 1961.44 In 1961 Park promulgated the bujong chukje-an, or “Illicit Wealth Accumulation Act,” which allowed him to arrest hundreds of businessmen and to seize their assets for illicit wealth accumulation under the Rhee administration.45 This incident has generally been used to buttress the “strong state” thesis, showing that Park had tremendous leverage over capital. However, expropriation was only the initial stage of this incident. By examining the whole incident and by looking at the end results of the actual expropriation, a different story emerges -- one that shows the power of business relative to the state. 20 The evidence indicates that instead of “dominating” capital, Park worked closely with capitalists and promoted rather than censured them. Park rapidly realized that eliminating these businessmen would mean widespread economic problems. Kyong-dong Kim neatly summarized the reason: "the only viable economic force happened to be the target group of leading entrepreneurial talents with their singular advantage of organization, personnel, facilities and capital resources."46 The result was a compromise with the military government: the charges concerning illicit wealth accumulation would be dropped in return for cooperation with the government in its efforts at industrial planning. The thirteen businessmen with the largest assessed fines were the only Koreans allowed to go abroad and solicit foreign loans, and upon their return they made a number of policy recommendations to the Park government, including the establishment of an industrial port at Ulsan. Many of those businessmen who had been assessed fines instead negotiated to invest in the Five-Year Plan under Park, and received government loans for that purpose. When the manufacturing plants were completed, these entrepreneurs decided to pay their fines in cash rather than in stock, thus retaining control of the very firms that Park had hoped to nationalize. In this way, even at the beginning of the Park regime, capitalists realized that they were not entirely vulnerable to the state, but rather that both had a certain ability to sanction the other. Opportunism was constrained, information about a small set of cronies 21 was plentiful, and property rights were more secure. After 1961, the Korean state, which, despite its bluster, rarely moved against the economic elite. When the state did attempt rationalization in Korea, as with the automotive industry, it generally failed.47 Korean mutual hostages lowered transaction costs because the number of players was smaller, which allowed for more and better information, easier monitoring, consistent policies, and better enforcement. Thus, the pattern of business-government relations in Korea was a clear mutual hostages that allowed for a measure of stability and limited the potential for one group to dominate the other. III. The Philippines and Indonesia as polar cases The Philippines and Indonesia represent the polar examples of cronyism in government-business relations. In the Philippines and Indonesia transaction costs have been highe, and while property rights and economic decisions were often redistributed through the power of the state, often there was no constraint or incentive that pushed Philippine or Indonesian actors to use those rights more productively than before. The Philippines and Indonesia are also interesting because they represent polar cases themselves: in the Philippines the presence of too many actors led to cascades of supplicants, while in Indonesia extreme centralization of authority was initially efficient but ultimately led to chaos. 22 1. Cascades in the Philippines In the Philippines, too many actors raises the costs of making and enforcing agreements, and both the state and the oligarchs have been unable to cohere. During the democratic era the powerful oligarchs were able to overrun the state, while under Marcos, the pendulum swung too far in the opposite direction and the state was able to prey upon society.48 In the Philippines there was never a balance as existed in Korea. Thus Philippine politics has been dominated by a pendulum of corruption that swung to and fro, but never reached an equilibrium where corruption was constrained or property rights were stable. Transaction costs were higher in the Philippines, stability lower, and the economy less efficient. Cascades of supplicants were drawn to whomever was temporarily in power, and although the leader may have attempted to limit these demands, eventually the crush of supplicants would become too great, overwhelming the system. During the democratic era, the Legislature was an important focus of both rentseeking competition and political competition. Oligarchs obtained access to the state through electoral competition, and the victors then divided the spoils among themselves.49 This process is best described as a pendulum of political power where two weak parties (the Liberals and Nacionalistas) regularly traded power. Through the cascade effect, 23 opportunists and supplicants scrambled to make hay while the sun shone. Over time the demands would become too crushing, and aspiring opposition politicians would begin to have the opportunity to lure oligarchs to their side in return for promises of greater spoils. Eventually the defection of supporters from the incumbent politician would lead to a tipping of the balance, and a headlong rush would begin as toadies and flatterers flocked to the new, rising politicians.50 An example of this was the “50-50” agreement of 1959. The president and congress had competed with each other to provide patronage appointments within the bureaucracy, with the result that the government had grown out of control. Negotiations resulted in an agreement that fifty percent of the bureaucracy would be filled by the president, fifty percent by congress. Notable not only was the pressure to provide patronage, but also that both sides immediately ignored the agreement and continued business as usual. 51 This process of cascades led to swings in who nominally held office.52 At the initial stages everyone jumped on, in order to receive the benefits that the new politician could provide. 53 Over time, as the presence of more hangers-on began to dilute the benefits and make ruling unwieldy, aspiring opposition politicians began to gain defectors, who hoped to gain more by defecting. And then the pendulum would swing back, and a new politician would take office. 24 These machines offer their votes to aspiring politicians in return for favors, both legal and illegal. Power careened wildly between parties. Gabriella Montinola argues that the overall result was an excess of demands on the state and the inability of top politicians to formulate or implement coherent policies. 54 During election years, those in power would run budget deficits as they handed out pork and granted other favors. Table 2 shows the excessive government spending during election years. //Table 2 here// Like South Korea, Philippine business is dominated by large, diversified, familybased conglomerates that have endured and survived over generations. Indeed, Filipinos talk of the 100 or so Philippine families that control most of the country’s business.55 In 1980, 98 percent of all sectors had “four or fewer companies controlling 35 percent of sales.”56 However, In contrast to Korea, the Philippines has been described as an "anarchy of families."57 The actual number of relevant business families in the Philippines is far larger in number, more diffuse geographically, and more widely distributed across various industries. Among commercial banks, for example, the five largest banks comprise only 20 percent of the entire market.58 This is much lower than in Korea, where the state maintained dominant control well into the 1990s. Business in the Philippines has been intricately enmeshed in cascades. This raises transaction costs and lowers economic efficiency in a number of ways. First, greater 25 economic and social mobility means that the competition for rents is more costly and more diffuse. Second, the distribution of property rights is more tenuous, because families have less influence on government and less power to resist.59 Finally, the mobility of families means less coherence in pressing demands on the state, and a more easy division by state actors. As Paul Hutchcroft writes, "As long as such rents can be obtained....rent seekers find it more important to maintain their government connections than to concern themselves with the internal efficiencies and investments of their firms."60 Investment in the Philippines, lacking safeguards, was difficult to undertake. Similarly, much energy was diverted from developing efficient businesses and channeled instead into political protection of economic interests. The pattern of Philippine government-business interaction raises transaction costs in other ways, as well. Philippine business has been unable to coordinate or organize, and the Philippines the Philippine Chamber of Commerce, Makati Business Council, and other associations were notoriously unable to speak with a unified voice. Philippine business tends to be geographically more dispersed, limiting both the coordination and the collusion possible between the families themselves. In addition, because interests are familial and cross-sectoral, the business sector has been unable to coherently form demands and press the state for consistent policies. "Philippine business associations are notoriously weak and poorly institutionalized, and its members know that the way to 26 make money is to gain privileged access to the government and then to 'exclude information from each other.' "61 The nature of political competition under both democracy and authoritarianism meant that the families were concerned about providing particularistic goods to themselves only, and that cooperation for jointly beneficial policies and lobbying was difficult to achieve. Although Philippine family conglomerates have been well organized in some respects (diversification, many with their own banks, able to extract rents from the state), as a sector the families found it difficult to work together to further their interests with respect to the state. Again, this raises transaction costs by forcing companies not only to curry favor with politicians, but also to expend resources competing with each other. If the democratic era saw a weak government overrun by interest groups, martial law saw the pendulum swing too far in the opposite direction, with Marcos concentrating power in the presidential palace to a degree that gave him the opportunity to do virtually whatever he wished. From a weak state and a strong society during the democratic era, the pendulum had swung too far in the other direction: a coherent state was able to divide a weak society and predate upon it. Centralization under Marcos, although initially viewed was providing the Philippines stability and direction, rapidly devolved into an erratic decisions that choked off economic growth. 27 To maintain his rule, Marcos played a game of divide and conquer. He attacked those oligarchs strong enough to be potential competitors, developed new oligarchs who were solely dependent upon him for their success, and left the majority of the oligarchs alone as long as they left him alone. As an anonymous politician noted, “Marcos’ tactics were purposeful. First, grab the cash flow of heavy industries such as Mercalco (power generation). If you have cash, you can pay anybody off. Second, divide and conquer. Third, obfuscate by creating a squid’s screen of ad hominen attacks and distortions. Finally, deliberately create trouble so you can be the savior.”62 Marcos created new oligarchs who were dependent solely on him for their success, and he also rewarded traditional elites who actively cooperated with him.63 Thus the direction of corruption shifted once again, this time from bottom-up plundering of the state to the top-down plundering of society.64 As Richard Doner writes, These were businessmen, who, by virtue of close links to the Marcos family, grew so large as to control strategic portions of the economy...the Filipino private sector of the 1970s came to be dominated by a set of entrepreneurs who, while financially quite well off as a result of state subsidies, were poorly managed and largely oriented towards short-term profits.65 Although Marcos was able to take advantage of a disorganized business class, he did not fundamentally transform Philippine society. Rather, Marcos took the pattern of Philippine corruption to its logical extreme. The oligarchs were not destroyed but instead 28 new oligarchs were brought in, who rapidly tried to become like the old oligarchs. The cascades of the democratic era continued, and everybody still needed -- and desperately wanted -- access to the presidential palace. Although this system initially worked smoothly, soon the regime began to crumble under its own weight, and the process began again. The pattern of crony relations in the Philippines has contributed to high transaction costs and resultant lower economic performance. Business groups competed with each other over the spoils of the state, with power shifting rapidly between groups. Both property rights and elites were not stable. Business itself was unable to organize and as a result had no coherent voice with which to press the government for consistent policies, and more importantly business devoted many resources to competing among themselves for government favor. Although the Marcos era saw increased state strength, new cronies brought in created by expropriating traditional oligarch’s wealth further exacerbated the high transaction costs in the economy. 2. Efficiency and chaos in Indonesia Indonesia illustrates the polar case -- and both potential outcomes -- of centralization around one figure. Initially, when Suharto's (president from 1966-1999) rule was stable, Indonesia experienced sustained and impressive growth, and most 29 domestic and international actors saw corruption as a merely a cost of doing business with him. Power concentrated in Suharto led to a state-dominated economy permeated by patronage and corruption but one that was also decisive and flexible. 66 Observers noted that “the absence of institutional constraints on executive power meant that policy could be adjusted quickly.”67 Spurred by oil revenues, the interventionist state oversaw significant economic growth during the 1970s and 1980s, and foreign direct investment surged into Indonesia. However, while flexibility contributed to Indonesia's growth during the boom years, decisionmaking was never institutionalized and remained ad-hoc. As Michael Ross argues, as Suharto's rule became increasingly tenuous, centralization led to a political and economic crisis from which Indonesia is still trying to recover.68 Centralization restricted political participation and kept power in the hands of Suharto and later, his family. The business sector, small and weak to begin with, never developed to the point that it could coordinate and become an independent base. Policy was determined by those with crony ties to Suharto or the ruling family receiving favorable treatment at the hands of the government. John Sidel writes that “Suharto presided over the continuous flow of capital, labor, and commodities, and the regular rotation of military and civilian personnel…it was precisely this steady circulation…that kept Indonesia in motion as Suharto stood still, for more than thirty years.”69 30 As in the Philippines, favored supporters gained access to government largess. However, centralized authority in Indonesia meant that politics took the form of competition within the elite who were concerned mainly with creating good ties to Suharto and in gaining access to the distribution of spoils. Cronyism extended to Suharto’s family and close friends, as well. Suharto’s six children have become major players in business over the past three decades, with the family as a whole having been involved in an estimated $73 billion in business between 1966 and 1998, and are estimated to have financial or business interests in over 550 companies in Indonesia alone.70 The bureaucracy and the state banks were also under the control of Suharto. Technocrats were dependent upon Suharto’s personal support to implement policy initiatives, and these initiatives were often overridden or ignored for political reasons.71 Although a balanced budget law was implemented in the 1960s, by the 1980s Suharto himself was ignoring the rule, using the state coffers to finance electoral campaigns or support various cronies, such as B.J. Habibie’s use of the “reforestation fund" to finance his pet project, construction of an Indonesian aircraft.72 The financial sector remained dominated by the state banks, state-owned enterprises – many headed by members of Suharto’s family – came to dominate large sectors of the economy, and the native Indonesian entrepreneurs remained sidelined in the political process. As Adam Schwarz 31 writes, “State bank involvement is crucial for the cronies [of Suharto] since some of their projects are of such dubious quality that private lenders would shun them.”73 Military officers were constantly circulated and reassigned to limit their power.74 In addition, the business sector was either weak or dependent on Suharto, not a situation of mutual hostages as in Korea. 75 Richard Robison and Andrew Rosser note that “in each instance, the rise of the new business interests was contingent upon the opening of former public monopolies,” and that by 1980 the state controlled almost 60% of equity in all domestic investment.76 “Political patronage and state protection afforded privileged access to bank credit, forestry concessions, trade and manufactured monopolies…and state contracts for supply and construction.”77 A major cause of business weakness was its ethnic makeup. Between forty and seventy percent of the modern private sector is owned by the ethnic Chinese minority, even though they comprise just three percent of the population.78 Chinese Indonesians who became leading business figures included Liem Sioe Liong of the Salim Group, Bob Hasan of the Hasan Group, and Goh Swie Kie of the Gunung Sewu Group.79 Not only was there widespread resentment against the ethnic Chinese entrepreneurs, “New Order policies discriminating against the ethnic-Chinese impeded their circulation and ascendancy.”80 Exclusive Chinese organizations have been discouraged or banned, and only one Chinese held a ministerial position under Suharto.81 Because they faced hostility 32 and periodic anti-Chinese riots, Chinese businessmen were unable to cohere as a powerful group and politically vulnerable, and so they became dependent on Suharto. Without Suharto’s protection they would be widely despised. Thus -- in contrast to the Korean chaebol who were genuinely independent and powerful outside of the military regime -- the Indonesian business sector was unable to balance the Suharto family’s interests. As Suharto's rule became increasingly unstable, the pattern of flocking towards Suharto resulted in excessive uncertainty. Michael Ross writes that “the highest level of uncertainty should be found in the waning days of personalistic regimes…and investors who have holdings in economies governed by personalistic regimes should be anxious to determine when the regime is likely to end, and how disruptive that end is likely to be.”82 Ross McLeod argues that deep problems of credibility and unreliability reveals the deeply flawed nature of the system.83 An imbalance between political and economic power led to corruption and weak property rights, and when the Asian financial crisis struck the region in 1997, the weaknesses of the system became exposed, and Suharto and the regime were toppled by widespread political turmoil.84 Most tellingly, the crisis hit Indonesia harder than other Asian countries, foreign direct investment in Indonesia has plummeted, and Indonesia has taken longer to recover both political and economic stability (figure 2).85 With decentralized power, Indonesia has been swamped with too 33 many players, and "the fluidity of uncertainty of political power reportedly makes bribe takers more demanding than before, because they face a real risk of quickly losing whatever power they have when the political winds shift."86 //Figure 2 here// The Philippines and Indonesia represent the polar cases where too many or too few actors raises transaction costs, and leads to unstable policies, greater uncertainty, and more corruption. In the Philippines too many actors led to a cascade of supplicants who followed whoever happened to gain power for the moment. In Indonesia, centralized authority during Suharto’s reign -- although efficient while his rule was stable -- led to higher transaction costs once uncertainty about his rule began to surface. In both cases there is a marked contrast with the durability and stability of mutual hostages in Korea. IV. Conclusion This study has provided an explanation that links differences in the nature and type of cronyism to different patterns of government-business relations in Korea, the Philippines, and Indonesia. A mutual hostages situation lowered transaction costs in Korea, while cascades raised them in the Philippines and centralization had mixed effects in Indonesia. In countries with weak legal and political institutions, long-term relationships may be difficult to create. In Korea the balance kept corruption from 34 swamping growth, while Philippine and Indonesian cases show the lack of stability that harms long-term growth. We should emphasize, however, that cronyism is only one variable involved in explaining developmental outcomes.87 Fostering economic growth requires much more than limiting cronyism and eliminating corruption.88 A mutual hostage situation is uncommon – most developing countries are closer to one of the poles of either too few or too many actors. Indonesia and the Philippines are still relatively successful cases of development "at the poles" when compared to many developing countries such as Nigeria, Venezuela, and pre-NAFTA Mexico. However, while many of the reasons for lesser growth in these countries have to do with other factors, high transaction costs are a major problem for growth in all countries. New developments in microeconomics, sociology, and anthropology have underlined the role of institutions in East Asia's economic performance. Rather than seeing markets as the frictionless intersection of supply and demand curves, markets are being reinterpreted as complexes of principal-agent relationships in which problems of imperfect and asymmetric information, contracting and credibility are ubiquitous. The smooth functioning of markets is not simply a matter of getting policies, incentives, or prices right, but of public and private institutions that facilitate market exchange: from the legal system and a clear delineation of property rights; to the public provision of 35 information; to informal institutions that build trust. Central to understanding these components is understanding the conditions under which the pattern of cronyism lowers transaction costs and supports economic growth, and when it raises transaction costs and harms economic growth. 36 Table 1. Two approaches to rent-seeking and cronyism Neoclassical rent-seeking 1. The initial distribution of Perfect property rights (t=0) NIE Imperfect, even chaotic 2. who can play the game Anyone Small-N lowers transaction costs. The cost of rentseeking is lower because there is no need to build entry barriers, pricecollusion, etc. 3. resources used to get rents Deadweight loss (DWL) Initially all resources are allocated to their highest marginal return in point 1. Bribes=transfers. Not necessarily any DWL 4. use of rents and property rights in (t=1) DWL Transaction costs lowered because information is easier to obtain and from iteration among elite groups; resources are underutilized anyway in t=0, and rent-seekee potentially uses resources more efficiently than in t=0 37 Figure 1. Actors and transaction costs high Chaos Cascades Transaction costs Mutual hostages low Efficiency Dictator Small-N Number of actors 38 Many Table 2. Excessive government spending in election years, 1957-1968 Year President Election year? Central government net receipts (million PP) 1957 Garcia Yes -123.4 1958 Garcia No 17.8 1959 Garcia Yes -60.7 1960 Garcia No 46.9 1961 Garcia Yes -159.2 1962 Macapagal No 88.8 1963 Macapagal Yes -110.0 1964 Macapagal No 75.3 1965 Macapagal Yes -208.2 1966 Marcos No -86.7 1967 Marcos Yes -120.8 1968 Marcos No -85.3 Source: Harvey Averch, John E. Koehler, and Frank H. Denton, The Matrix of Policy in the Philippines (Princeton: Princeton University Press, 1971), p. 101. 39 Figure 2. FDI in Indonesia, 1981-1999 ($US billion) 7 6 5 4 3 2 1 0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 -1 -2 -3 -4 Source: IMF, International Financial Statistics Yearbook, various years 40 1997 1998 1999 ENDNOTES 1 Dani Rodrik wrote that “What was required was a competent, honest, and efficient bureaucracy to administer the interventions, and a clear-sighted political leadership that consistently placed high priority on economic performance.” Rodrik, "Getting Interventions right: How South Korea and Taiwan Grew Rich," EconomicPolicy 20 (1995): p. 91. Peter Evans has argued that “highly selective meritocratic recruitment and long-term career rewards create commitment and a sense of corporate coherence.” Evans, Embedded Autonomy (Princeton: Princeton University Press, 1995) p. 12. Alice Amsden also wrote that “economic success in Korea challenges the assumption...that government intervention degenerates into “rent-seeking.” Alice Amsden, Asia’s Next Giant (Cambridge: Cambridge University Press, 1989), p. 327. For other specific instances, see Karl Fields, “Strong States and Business Organization in Korea and Taiwan,” in Business and the State in Developing Countries, edited by Sylvia Maxfield and Ben Ross Schneider (Ithaca: Cornell University Press,1997), p. 126; Chalmers Johnson, “Institutions and Economic Performance in South Korea and Taiwan,” in The Politics of the New Asian Industrialism, edited by Frederic Deyo, (Ithaca: Cornell University Press, 1987), p. 152; and Ziya Önis, “The Logic of the Developmental State,” Comparative Politics 24 (1991), p. 114. 2 For more detailed discussion of corruption in Asia, see Cheng-Tian Kuo, “Taiwan’s Distorted Democracy in Comparative Perspective,” Journal of Asian and African Studies 35, no. 1 (2000): 85-111; Tun-jen Cheng and Brantly Womack, “General Reflections on Informal Politics in East Asia,” Asian Survey 36, no. 3 (March 1996): 320-338; Mushtaq Khan and Jomo K.S., eds., Rents, Rent-Seeking and Economic Development: Theory and Evidence in Asia (Cambridge: Cambridge University Press, 2000); and Author. 3 Richard Doner and Ansil Ramsey, "Rent-Seeking and Economic Development in Thailand," in Mushtaq Khan and Jomo K.S., eds., Rents, Rent-Seeking, and Economic Development: Theory and Evidence in Asia (Cambridge: Cambridge University Press, 2000), p. 147. 4 I use cronyism here as a generic term to refer to corruption, rent-seeking, and personal relationships. For economists, such actions have the same effect – as the Greenspan quote suggests, it implies decisionmaking made on grounds other than pure economic efficiency. 5 There has been a recent wave of interest in understanding cronyism (broadly defined). See, for example, Kathleen Collins, “The Political Role of Clans,” Comparative Politics (forthcoming); Janet Landa, Trust, Ethnicity, and Identity: beyond the new institutional economics of ethnic trading networks, contract law, and gift-exchange (Ann Arbor, MI: University of Michigan Press, 1994); Richard Doner and Ben RoseSchneider, “Business Associations and Economic Development: Why Some Associations contribute More than Others,” Business and Politics 2, no. 3 (November 2000):261-288; Paul Hutchcroft, Booty Capitalism (Ithaca, NY: Cornell University Press, 1998); Masahiko Aoki et al., eds., The role of government in East Asian economic development : comparative institutional analysis (New York: Oxford University Press, 1997); Murray L. Weidenbaum and Samuel Hughes, The bamboo network : how expatriate Chinese entrepreneurs are creating a new economic superpower in Asia (New York: Martin Kessler Books, 1996); Lucian Pye, “Money politics and transitions to democracy in East Asia,” Asian Survey 37 (March 1997): 213-28; Gary Hamilton and Nicole Biggart, “Market, culture, and authority: a comparative analysis of management and organization in the Far East: Japan, South Korea, Taiwan,” American Journal of Sociology 94 supplement (1988): S52-S94; Mushtaq Khan, “The Efficiency Implications of Corruption,” 41 Journal of International Development 8, no. 5 (1996): 683-696; Pranab Bardhan, “Corruption and Development: A Review of Issues,” Journal of Economic Literature 35 (1997):1320-1346; Andrei Shleifer and Robert Vishney, “Corruption,” Quarterly Journal of Economics 108 (1993):599-617; Khan and Jomo, eds., Rents, Rent-Seeking, and Economic Development; and Mushtaq Khan, “The Input-output Function for rent-seeking: A comparative analysis of differential effects,” (Unpublished manuscript, University of London, 1997). 6 See Oliver E. Williamson, The Economic Institutions of Capitalism (New York: The Free Press, 1985); and Barry Weingast, “Constitutions as Governance Structures: The Political Foundations of Secure Markets,” Journal of Institutional and Theoretical Economics 149 (March 1993):286-311. 7 See Paul Krugman, “What Happened to Asia?” (MIT, manuscript, 1998). Krugman argues that moral hazard was the main reason for financial failures in Asia. Moral hazard is a specific issue that is subsumed under a larger discussion of the NIE, and hence Krugman’s argument is compatible with but more limited than the analysis presented here. See also Paolo Mauro, “Corruption and growth,” The Quarterly Journal of Economics 110 (August 1995): 681-712; Daniel Treisman, “The Causes of Corruption: a cross-national study,” (UCLA: ms, 1997); and Cheryl W. Gray, “Corruption and development,” Finance and Development 35 no. 1 (March 1998): 7-10. 8 See Douglass North, “Government and the Cost of Exchange in History,” Journal of Economic History 44, no. 2 (1984):255-264. 9 Doner and Schneider, “Business Associations and Economic Development,” p. 261. 10 On corruption in Korea during the Park era, see Park Kyung-suk, “Taet’ongnyÒng kukhoe wiwÒn sÒngo chagÚm (Campaign Funds for Presidential and Assembly Elections),” Sindonga (May 1967), especially pages 204-7; Kim Jin-bae and Park Chang-rae, “Ch’agwan (Foreign Loans),” Sindonga (December 1968), p. 88; and Joungwon Alexander Kim, Divided Korea: The Politics of Development, 1945-1972 (Cambridge, MA: Harvard University Press, 1975), esp. pp 230-244. For corruption in Taiwan, see ChengTian Kuo, “Taiwan’s Distorted Democracy in Comparative Perspective"; Shelley Rigger, “Electoral Strategies and Political Institutions in the Republic of China on Taiwan,” in Harvard Studies on Taiwan: ss of the Taiwan Studies workshop, volume 1 (Cambridge, MA: Fairbank Center for East Asian Research, 1995); and Michael Ying-Mao Kau, “The Power Structure in Taiwan’s Political Economy,” Asian Survey 36, no. 3 (March 1996), p. 290. For corruption in Japan, see Chalmers Johnson, “Tanaka Kakuei, Structural Corruption, and the Advent of Machine Politics in Japan,” Journal of Japanese Studies 12, no. 1 (Winter 1986); Yayama Taro, “The Recruit Scandal: learning from the causes of corruption,” Journal of Japanese Studies 16, no. 1 (Winter 1990); and Jacob Shlesinger, Shadow Shoguns: the rise and fall of Japan’s postwar political machine (Simon and Schuster, 1997). 11 Mushtaq Khan, "Rents, Efficiency, and Growth," in Khan and Jomo, eds., Rents, Rent-Seeking, and Economic Development, p. 39. 12 Amsden, Asia’s Next Giant; Evans, Embedded Autonomy; and Michael Ross, “Indonesia’s Puzzling crisis,” (Paper prepared for the conference “Asian political-economy in an age of globalization,” Tuck School of Business, Dartmouth College, May 10-11, 2002). 13 For comparisons of Northeast Asia to Southeast Asia and Latin America, see Andrew MacIntyre, ed., Business and Government in Industrializing East and Southeast Asia (Sydney: Allen and Unwin, and Ithaca, NY: Cornell University Press, 1994); and Gary Gereffi and Donald Wyman, eds., Manufacturing Miracles: Paths of Industrialization in Latin America and East Asia (Princeton: Princeton University Press, 1990). 42 14 See Oliver E. Williamson, The Economic Institutions of Capitalism (New York: The Free Press, 1985); Douglass North, “A Transaction Cost Theory of Politics,” Journal of Theoretical Politics 2, no. 4 (1990):355-367. For introductions to the NIE, see David Kang, "South Korean and Taiwanese Develoment and the New Institutional Economics," International Organization 49, no. 3 (Summer 1995): 555-87; Terry Moe, “The New Economics of Organization,” American Journal of Political Science 28 (1984): 739-777; James E. Alt and Kenneth A. Shepsle, eds., Perspectives on Positive Political Economy (Cambridge: Cambridge University Press, 1990); and Erik Furubotn and Rudolf Richter, “The New Institutional Economics: An Assessment,” in Furubotn and Richter, eds., The New Institutional Economics (College Station, TX: Texas A&M Press, 1991). For critiques, see Mark Granovetter, “Economic Action and Social Structure: The Problem of Embeddedness,” American Journal of Sociology 91 (November 1985):481501; Richard Posner, “The New Institutional Economics Meets Law and Economics,” Journal of Institutional and Theoretical Economics 149 (March 1993):73-121 (with replies from Ronald Coase and Oliver Williamson); and Ronald Dore, “Goodwill and the Spirit of Market Capitalism,” British Journal of Sociology 34 (1983):459-482. 15 See, for example, David C. Colander, ed., Neoclassical political economy : the analysis of rent-seeking and DUP activities (Cambridge, Mass. : Ballinger Pub. Co., 1984); A. Breton, “Toward a presumption of efficiency in politics,” Public Choice 77, no. 1 (September 1993):53-65; Robert Ekelund and Robert Tollison, Mercantilism as a Rent-Seeking Society: economic regulation in historical perspective (College Station: Texas A&M, 1981):18-19; and K.S. Jomo and Edmund Terence Gomez, “Rent Generation and Distribution, and their Consequences in Malaysia,” (unpublished ms.) 16 Pranab Bardhan, “The New Institutional Economics and Development Theory: A Brief Critical Assessment,” World Development 17, no. 9 (1989):1389. 17 See Douglass North, Structure and Change in Economic History. 18 Paul Milgrom and John Roberts, “Bargaining costs, influence costs, and the organization of economic activity,” in James E. Alt and Kenneth A. Shepsle, eds., Perspectives on Positive Political Economy (Cambridge: Cambridge University Press, 1990), Ha-joon Chang, The Political Economy of Industrial Policy (London: St. Martin’s Press, 1994); and Yoram Barzel, “Measurement Cost and the Organization of Markets,” Journal of Law and Economics 25 (April 1982):27-48. 19 Theoretically only the lowest-cost firm could afford the highest bribe. Pranab Bardhan, “Corruption and Development: A Review of Issues,” Journal of Economic Literature 35 (1997), p. 1322. 20 For similar arguments about patron-client relations and cronyism, see Mushtaq Khan, "Rent-Seeking as Process," in Khan and Jomo eds., Rents, Rent-Seeking, and Economic Development, pp. 114-7. 21 This argument is similar to the idea of bilateral monopoly in economics. Bilateral monopoly exists when there is only one consumer and producer. In this situation, rents will be lower than the potential maximum and there is no clear equilibrium. William Baumol’s work on “contestable” markets is also similar. The presence of contestable markets limits, but do not eliminate, the rents a monopolist can earn. See David Kreps, Microeconomic Theory (1992), p. 551-573; William Baumol, “Contestable markets: an uprising in the theory of industry structure,” The American Economic Review 72 (March 1982): 1-15; and Roger Blair, David Kaserman, and Richard Romano, “A Pedagogical Treatment of Bilateral Monopoly,” Southern Economic Journal 55, no. 4 (April 1989):831-841. 22 Robert Axlerod, The Evolution of Cooperation (New York: Basic Books, 1984). 23 Gordon Tullock, “Rents and Rent-seeking,” in C. Rowley, R. Tollison, and G. Tullock, eds., The Political Economy of Rent-Seeking (Boston: Kluwer, 1988), p. 228. 43 24 See Khan, "Rent-Seeking as Process," pp. 91-114. 25 Chang, “Organising Development,” 120. 26 There is, however, variation across sectors (textiles versus steel). In relatively atomistic sectors that approximate pure market competition, rents will be lower and the need for coordination among actors will also lower. 27 See Mancur Olson, The Rise and Decline of Nations: economic growth, stagflation, and social rigidities (New Haven: Yale University Press, 1982). 28 The argument presented here is similar to that advanced by Andrew MacIntyre regarding policy fluctuation, and differs in its focus on cronyism. See Andrew MacIntyre, “Institutions and Investors: the Politics of the Economic Crisis in Southeast Asia,” International Organization 55, no. 1 (Winter 2001): 81122. 29 Including an explicit discussion of the conditions under which dicators may be either efficient or uncertain is beyond this paper. See Ronald Wintrobe, "The Tinpot and the Totalitarian: an economic theory of dictatorship," American Political Science Review 84 (September 1990): 849-72. 30 On measuring transaction costs, see Oliver Williamson, The Economic Institutions of Capitalism (New York: The Free Press, 1985), pp. 80-84 and 211. For measuring corruption, Daniel Treisman uses an index of perceived corruption as his measure of actual corruption in “The Causes of Corruption: a cross-national study,” (UCLA: ms, 1997); Robert Wade traces the sale of office in India in “The Market for Public Office: Why the Indian state is Not Better at Development,” World Development 13, no. 4 (April 1985): 467-497; and Chalmers Johnson follows a series of corruption scandals in Japan in “Tanaka Kakuei, Structural Corruption, and the Advent of Machine Politics in Japan,” Journal of Japanese Studies 12, no. 1 (Winter 1986). 31 Tun-jen Cheng, Stephan Haggard, and David Kang, “Institutions and Economic Growth in Korea and Taiwan: the bureaucracy,” Journal of Development Studies 34, no. 6 (August 1998): 87-111; and Doronila, The State, Economic Transformation, and Political Change in the Philippines, p. 5. 32 Jones and Sakong 1980. 33 See, for example, Park Kyung-suk, “Taet’ongnyÒng kukhoe wiwÒn sÒngo chagÚm (Campaign Funds for Presidential and Assembly Elections),” Sindonga May 1967, especially pages 204-7; and Lee Youngsuk, “sÒngÒ chagÚm kwa chaebÒl (Election Funds and Chaebols),” Wolgan Chosun (November 1987), 222-239. 34 On the failed attempt to rationalize the auto industry in the 1970s, see Seok-jin Lew, “Bringing Capital Back In: A case study of South Korean automobile industrialization.” (Ph.D. diss., Yale University, 1992). 35 On bribes, see Yoon Young-ho, “ChÒng Tae-su wa kÒmÚn ton (Chung Tae-soo and black money),” Shindonga (March 1997), p. 201. 36 See Cheng, Haggard, and Kang, "Institutions and Economic Growth in Korea and Taiwan." 37 Federation of Korean Industry, ChÒnkyÒngnyÒn SamsipnyÒnsa (A Thirty Year History of the FKI) (Seoul, FKI, 1992). 38 Federation of Korean Industry, ChÒnkyÒngnyÒn SamsipnyÒnsa, p. 35-49; and Lee Young-hwan, “Hankuk Úi kyÒngje tanch’e wa chÒngch’aek kyÒlchÒng kujo (Corporatist Development and the Structure of Policymaking in Korea).” in Lee Young-hwan ed., Hankuk kiÒpÚl segyehwa chÒllyak (Strategies to globalize Korean industry) (Seoul: Chulpansa 1995), p. 304. 39 For more on this, see Author. 40 Author’s interview, October 22, 1996. 44 41 For an eyewitness account of lobbying with the Park regime, see Lee Byung-chull, Ho-am chachon (HoAm’s autobiography) (Seoul: Jungang Ilbo, 1986), p. 134. 42 Lee Young-hwan, "Hankuk Úi kyongje tanch’e wa chÒngch’aek kyÒlchÒng kujo (Corporatist Development and the Structure of Policymaking in Korea)," in Lee Young-hwan, ed., Hankuk kiÒpÚl segyehwa chÒllyak (Strategies to globalize Korean industry) (Seoul: Chulpansa, 1995). See also Kyunghyang Ilbo, August 31, 1991. 43 For a discussion of this time, see Lee Sung-hyong, “Kukka kyekÚp mit chabon ch’ukchÒk: 8, 3 chochi’rÚl chungsimÚro (State, class, and capital accumulation: The president’s decree of 8-3-72),” in Choi, ed., Hankuk Chabon juÚi wa kukka (Korean Capitalism and the State): 273-74; and Carter Eckert, “The South Korean Bourgeoisie: A Class in Search of Hegemony,” in Hagen Koo, ed., State and Society in Contemporary Korea (Ithaca: Cornell University Press, 1993), p. 108. 44 Karl Fields, “Strong States and Business Organization in Korea and Taiwan,” in Maxfield and Schneider, eds., Business and the State in Developing Countries (Ithaca: Cornell University Press, 1997), p. 136. 45 Pak Pyongyun, Chaebol kwa chÒnch’i (Chaebol and Politics) (Seoul: Hanguk Yongusa, 1982); and Stephan Haggard, Byung-kook Kim, and Chung-in Moon, “The Transition to Export-led Growth in South Korea: 1954-1966,” The Journal of Asian Studies 50, no. 4 (November 1991): 850-73. 46 Kyong-dong Kim, "Political Factors in the Formation of the Entrepreneurial Elite in South Korea," Asian Survey 16, no. 5 (May 1976), p. 470. 47 See Park Byung-yoon, ChaebÒl kwa chÒngch’i (Seoul: Hanguk Yongusa, 1982), p. 210 48 For details of intrigue in the Marcos palace, see William Rempel, Delusions of a Dictator: The Mind of Marcos as Revealed in His Secret Diaries (Boston: Little, Brown, 1993). 49 De Dios, "A Political Economy of Philippine Policy-Making," in John W. Langord and K. Lorne Brownsey, eds., Economic Policy-Making in the Asia-Pacific Region (Halifax, Nova Scotia: Institute for Research on Public Policy, 1990), p. 111. See also Carl Lande, Leaders, Factions and Parties, esp. pp. 12. 50 See Carl Lande, Leaders, Factions, and Parties: The Structure of Philippine Politics (Yale University Southeast Asia Series, no. 6, 1964); Kit Machado, “Changing Aspects of Factionalism in Philippine Local Politics,” Asian Survey 11, no. 12 (December 1971):1182-99, and Amando Doronila, “The Transformation of Patron-Client Relations and its Political Consequences in Postwar Philippines,” Journal of Southeast Asian Studies 16, no. 1 (March 1985): 99-116. 51 Gregorio A. Francisco, Jr., and Raul P. de Guzman, “The 50-50 Agreement,” in de Guzman, ed., Patterns in Decision Making: Case Studies in Philippine Public Administration (Manila: Graduate School of Public Administration, University of the Philippines, 1963), pp. 93-102 52 Mark R. Thompson, The Anti-Marcos Struggle: Personalistic rule and Democratic Transition in the Philippines (Quezon City: New Day Publishers, 1996). 53 Wurfel, Filipino Politics, Development and Decay, p. 80. 54 See Gabriella Montinola, “Politicians, Parties, and the Persistence of Weak States: Lessons from the Philippines” (paper delivered at the American Political Science Association annual meetings, Washington, DC, August 27-31, 1997). 55 Edita Tan, “Interlocking Directorates, Commercial Banks, and Other Financial Institutions and Nonfinancial Corporations,” Discussion paper 9110 (September 1991), School of Economics, University of the Philippines, p. 12. 45 56 John Doherty, “Who Controls the Philippine Economy: Some Need Not Try as Hard as Others,” in Belinda A. Aquino, ed., Cronies and Enemies: The Current Philippine Scene Philippine Studies Series, no. 5 (Honolulu: University of Hawaii, Philippine Studies Program, 1982), pp. 12-33. Cited in McCoy, “RentSeeking Families and the State,” in McCoy, ed., An Anarchy of Families, p. 437. 57 Alfred McCoy and Michael Cullinane, eds., An Anarchy of Families: Political Elites and the Philippine State (Madison: University of Wisconsin Center for Southeast Asian Studies, 1993). 58 Paul Hutchcroft, “Predatory Oligarchy, Patrimonial State," p. 321. 59 PAL, San Miguel, ABS-CBN, and Meralco are all examples of family-owned companies that have changed hands through government intervention. 60 Hutchcroft, "Oligarchs and Cronies," p. 423. The study cited comes from Laurence Davis Stifel, The Textile Industry: A Case Study of Industrial Development in the Philippines, Data Paper Number 49 (Ithaca, NY: Southeast Asia Program, Cornell University, 1963), p. 50. Thomas R. McHale wrote that "business is born, flourishes or fails, not so much in the market place as in the halls of the legislature or in the administrative offices of the government." Thomas R. McHale, "An Ecological Approach to Economic Development" (Ph.D. diss., Harvard University, 1959), quoted in Stifel. 61 Hutchcroft, "Oligarchs and Cronies," p. 426. Hutchcroft cites an interview with Wilhelm G. Ortaliz, former director of the Bureau of Industrial Coordination, Ministry of Industry. Ortaliz described the preeminent business association, the Philippine Chamber of Commerce and Industries as a "mere post office of diverse concerns, very personality oriented, and unable to formulate common positions on major issues.” 62 Author’s anonymous interview, September 10, 1999. 63 Gary Hawes, The Philippine State, p. 82. 64 Robin Broad, Unequal Alliance: The World Bank, the International Monetary Fund, and the Philippines (Berkeley: University of California Press, 1988), p. 45. 65 Doner, “Domestic Coalitions and Japanese Auto Firms,” p. 131. See also Overholt, “The Rise and Fall,” p. 1143. 66 For historical discussion, see Benedict Anderson, “The Idea of Power in Javanese Culture,” in Claire Holt, ed., Culture and Politics in Indonesia (Ithaca: Cornell University Press, 1972); and Harold Crouch, The Army and Politics in Indonesia (Ithaca: Cornell University Press, 1986). 67 MacIntyre, "The Politics of Crisis in Southeast Asia," p. 115. See also Pranab Bardhan, "Corruption and Development," p. 1325. 68 Michael Ross, “Indonesia’s Puzzling Crisis.” 69 John T. Sidel, “Macet Total: Logics of Circulation and Accumulation in the Demise of Indonesia’s New Order,” Indonesia 6 (October 1998), p. 160. See also Jeffrey Winters, Power in Motion: Capital mobility and the Indonesia State (Ithaca, NY: Cornell University Press, 1996). 70 Dwight King,” Corruption in Indonesia: a curable cancer?” Journal of International Affairs 53, no. 2 (2000), p. 604, 612. 71 For more detail on bureaucrats in Indonesia, see Jeffrey Winters, Power in Motion: Capital Mobility and the Indonesian State (Ithaca, NY: Cornell University Press, 1996); and Andrew MacIntyre, “Investment, Property Rights, and Corruption in Indonesia,” in J.E. Campos, ed., Corruption: The Boom and Bust of East Asia (Manila: Ateneo University Press, forthcoming). 72 Jonathan Pincus and Rizal Ramli, “Indonesia: from showcase to basketcase,” Cambridge Journal of Economics 22, no. 6 (November 1998), p. 729. 73 Adam Schwartz, A Nation in Waiting (Boulder, CO: Westview Press, 2000), p. 151. 46 74 Sidel notes that “This pattern of fluid sirkulasi…witnessed a steady erosion of the personal loyalty owed by the military to the President himself.” Sidel, “Macet Total,” p. 163. 75 Alex Irwan, “Business Patronage, Class Struggle, and the Manufacturing Sector in South Korea, Indonesia, and Thailand,” Journal of Contemporary Asia 19, no. 4 (1989): 398-434. See also Andrew MacIntyre, “Power, Prosperity, and Patrimonialism: Business and Government in Indonesia,” in Andrew MacIntyre, ed., Business and Government in Industrialising Asia(Ithaca, NY: Cornell University Press, 1994), p. 245. 76 Richard Robison and Andrew Rosser, “Contesting Reform: Indonesia’s New Order and the IMF,” World Development 26, no. 8 (August 1998): 1593-1609. 77 Richard Robison, “Authoritarian States, Capital-owning Classes, and the Politics of Newly Industrializing Countries: the case of Indonesia,” World Politics 41 (October 1988), p. 62. 78 Michael Ross, “Indonesia’s Puzzling Crisis,” p. 19. 79 Sofyan Wanandi estimates that Chinese-Indonesian business constitute 25 percent of economic activity. “The Post-Soehart Business Environment,” in Geoff Forrester, ed., Post-Soehart Indonesia: Renewal or Chaos (Netharlands: KITLV Press, 1999), p. 128-134. See also Kunio Yoshihara, The Rise of Ersatz Capitalism in Southeast Asia (Oxford: Oxford University Press, 1988); and Jamie Mackie and Andrew MacIntyre, “Politics,” in Hall Hill, ed., Indonesia’s New Order (Sydney: Allen and Unwin, 1994). 80 Sidel, “Macet Total,” p. 166. See also Jamie Mackie, “Towkays and Tycoons: The Chinese in Indonesian Economic Life in the 1920s and 1980s,” Indonesia (1991): 83-96. 81 Bob Hasan, in 1998. David Cole and Betty Slade, Building a modern financial system: the Indonesian experience (Cambridge: Cambridge University Press, 1996), p. 326. 82 Ross, “Indonesia’s Puzzling crisis,” p. 14. 83 Ross McLeod, "Soeharto Indonesia: A Better Class of Corruption," The Indonesian Quarterly 228, no. 1 (2000): 16-27. 84 J. Soedradjad Djiwandono, "Bank Indonesia and the Recent Crisis," Bulleting of Indonesian Economic Studies 36, no. 1 (April 2000): 47-72. 85 See Linda Lim and Aaron Stern, "State Power and Private Profit: A review essay on the political economy of corruption in Southeast Asia," Asia Pacific Economic Literature (November 2002). 86 Lim and Stern, "State power and private profit," p. 10. 87 Jonathan Temple notes that “so many variables could be used to explain growth that it is difficult to find variables that are not only highly correlated with the endogenous variables but can also plausibly be excluded from the regression.” Temple, “The New Growth Evidence,” Journal of Economic Literature 37 (March 1999), p. 129. 88 K.S. Jomo and Edmund Terence Gomez, “Rent Generation and Distribution, and their Consequences in Malaysia,” (Unpublished manuscript, 1998); Barry Weingast, “Constitutions as Governance Structures,” Journal of Institutional and Theoretical Economics 149, no. 1 (1993): 286-311; and Hilton Root, The Fountain of Privilege: Political Foundations of Markets in Old Regime France and England (Berkeley: University of California Press, 19994). 47