The Connections World of Asian Business Threatens Future Progress

In our recent book – The Connections World: The Future of Asian Capitalism – we argue that mutually beneficial links between dynastic business houses and political elites have been important drivers behind Asia’s extraordinary renaissance. But these close ties now threaten future economic growth. That is because the ubiquitous Asian corporate structures of business groups systematically work with politicians in Asia to create excessive market power and overall concentration. They have proven remarkably adept at entrenching themselves. Although concentrating resources in relatively few hands was an effective engine of growth in the past half century, the limitations on competition and brake on innovation threatens future progress.

Pervasive and highly resilient networks of connections running between businesses and politicians have provided a common backbone to Asian development and have cut across political systems. We characterize these networks as the connections world, which comprises a web of interactions between businesses and politicians/political parties that are highly transactional and commonly contain significant degrees of reciprocity. Thus, politicians look to firms to make campaign or personal contributions, pay bribes, provide jobs for family or associates, while also providing reciprocal favors such as creating jobs in regions or at moments that are politically advantageous. At the same time, businesses look to politicians for protection from foreign or domestic competition and to supply subsidies, loans and/or public sector contracts. All parties benefit from these interactions, creating a stable political economy equilibrium.

These arrangements have served Asia well over the past half century, with Asia’s share of the world economy rising from 9 percent in the 1970s to nearly 40 percent today. The connections world, however, will provide a less supportive foundation for growth in the future for a variety of reasons. For a start, neither politicians nor business groups have sufficient interest in stimulating competition, whether through the entry of domestic or foreign multinational as competitors. At the same time, most Asian business groups are configured in ways that make them surprisingly hard to dislodge. Not only are they often highly diversified but arrangements within the group ensure that the ownership stakes of the oligarch or dynasty are parlayed into high degrees of control through cross-holdings and ownership pyramids. This commonly comes at the expense of minority shareholders. Most significantly, such business groups have managed to accrete significant amount of market power.

The pervasive ties between politicians and companies result in business groups getting privileged treatment and entrenching themselves. The consequences of the connections world will be far less propitious for Asia’s prospects not least because growth will have to rely more and more on innovation. The existing networks are, for the most part, ill-suited to promote innovation which thrives on an open ecosystem of science, universities and business parks, funders, lawyers and entrepreneurs, as well as a healthy willingness to risk and lose.

The connections world crowds out new entrants, soaks up capital, skilled workers and managers and suppresses the competitive environment so essential for the trial-and-error process at the heart of much successful innovation. Even when the business groups themselves are innovative – and a significant number are indeed so – there is relatively little innovation going on in the wider economy. This is because other businesses lack the access to funding, skills and other critical resources with which to innovate.

What should be the policies and other measures that could address the shortcomings of the connections world? Central to the policy menu for loosening the grip of entrenched business will have to be measures designed to induce the transformation of business groups into more transparent and better governed businesses, while also radically weakening the links between politicians and business. This will not happen naturally because the mutual benefits from market entrenchment and political connections outweigh any gains to the current players from reform.

The required policies will need to include changes to corporate governance that undercut pyramidal ownership structures, mergers and cross-holdings that impose inheritance taxes and shift to new types of and targets for competition policy. Some of those policies were successfully introduced in the US during the presidency of Franklin D Roosevelt in the 1930s. More recently, Israel has adopted criteria in competition policy for overall as well as specific market concentration levels, while South Korea has placed high inheritance taxes at the heart of their raft of policies to weaken the vice-like grip of gigantic business groups.