Week Three Class Notes

Political and economic systems, Part II

The objective of this week's work is to think about the likelihood of transition difficulties, reversion, or vacillation as a state attempts to transition from one form of political/economic system to another. We can recap the end of last week's work in this 2x2 grid.

Market EconomicsCommand Economics
Individualist(I) Capitalist democracies (US, UK)(II) Social democracies (Sweden)
Communal/
totalitarian
(III) China-  current Russia?(IV) Classic socialist
Soviets, Central Europe



Market Economies subscribe to the idea that the market is the most efficient allocator of inputs and outputs through the price mechanism. Prices send information to buyers and sellers and they, acting in their own self interest, decide what to do.  Prices usually reach a (moving) equilibrium and resources are thereby allocated efficiently.

Command economies dictate what goods and services are to be produced and at what price - based on the premise that resources should be allocated to the greater good of society. Historically, these have not fared well in efficiency or in correctly creating productive incentives and have created internal market failures such as black markets and opportunism.

In an individualist society, the objectives of the one are more important than the group or the state. In the individualist state, property rights (i.e., the right to choose how to deploy resources and to what end) are key. Governments exist (or should exist) at whatever minimal level is required to assure the protection of those rights, much as in Smith's framework. Alternatively expressed, these states focus on equal opportunity rather than equal outcome.

Collective systems argue that a greater social good requires the constraint individual rights/freedom to the extent that the exercise of those rights runs counter to the larger scale good. Individual property rights tend to be weaker in collective regimes (if they exist much at all). Many communal theorists argue that the inequality of property as outcome is unfair, unjust, or unethical. Thus, a society is better off if all are equal in outcome. The role of the state is to create this end - which requires some control over the resources to achieve it.

Last week, most of you argued that the combinations usually end up in I or IV and I agree with this. There are, however, interesting variants in II and III. Some, like the Scandinavian social democracies, look to be intentionally permanent points but China may be a carefully changing from IV to I via III. Russia may be an example of a vacillating state, having leapt from IV to I (at least nominally) and then sliding into III. These latter two are examples of transitional political economies - or are they? In fact, as Gat puts it, these states as "authoritarian capitalists" may illustrate a potential de-linking in political and economic systems. Presciently, Gat observed that young or developing liberal democracies (with their links to market based systems) could be deeply damaged by a "crushing economic crisis" - which has, in fact, happened (both the crisis and the drop in support).  

What are the issues transitional political-economies face in making the change? Why should managers considering expansion opportunities care? What should we be looking for as indicators of which way transition goes or at what pace? This continues and extends the discussion of last week about what comes first - markets or democracies.

Transition can be very disruptive to a society. It causes uncertainty and it can impose real and large costs on people. Because of this, leaders who endorse transition can experience significant backlash and threats to their political - and actual - lives.  In the first lines of their paper, Inglehart and Welzel claim that the "boom" or surge in nations transitioning to democracy has given way to rescission because democracy requires certain social, cultural, and institutional conditions and many states made the attempt without the fundamentals in place. Gat argues that capitalist authoritarian structures might prove to be long-lived indeed and models for others.

Why is change so disruptive? First, because relevant institutions do not often exist (which is why these are transitional economies  -  they are moving from one institutional mode to another). Your discussion last week should have given you some ideas about the sorts of institutions that will matter here. Jeffrey Sachs, a Harvard economist who became deeply involved with helping governments attempt transition in the 1980's and '90s,  wrote about his experiences with Poland. The Solidarity union there had led the battle for change as the old Soviet Union collapsed and Sachs was called in by a new government to craft a change plan. As Sachs puts it, the experiment/challenge was to create the legal/economic/financial/administrative conditions for a market economy. Among other observations, Sachs discusses:

  • the central planning model (weakly) filled a role for financial institutions (like banking/equity/debt) but it was vastly unsuited for more market based processes. Where does a banking and insurance industry come from quickly?
  • consider the problem of ensuring an independent judiciary (especially if it was not so before). What will this take? Identifying/replacing the corrupt, identifying/recruiting new talent. On a larger scale, though, this requires that the government relinquish control (which was one of the reasons for discussing the idea of a free press as a metric or signal of such surrender)
  • consider the problem of implementing property rights in a society that has not really had them. The case of Poland and the privatization of SOEs- as Sachs puts it, who really owns them? Is it the government? Is it the workers? How is this problem resolved to minimize anger? In  larger sense, think of transitioning from a collectively owned to privately owned society - this will cause anxiety, anger - and potentially socially disruptive inequalities as first movers claim best assets (think Russia and the oligarchs)
  • most industry was state owned and over-emphasized heavy manufacturing (ironically, such as shipyards in Gdansk, the home of Solidarity) versus light or consumer oriented production and services. This severely distorted a competitive use of capital. What would happen when this changed?  
  • Consider Poland's problem of privatizing industry firms - who is to manage the new firms and how are they to be trained? Remember, there was  little/no attention paid to business techniques under collective government. How is the new cadre of mangers developed?

   

What kinds of real problems have transitioning societies thus encountered? As Sachs puts it:

  • new, quick change or "shock treatment" policies usually create immediate corrective inflation - but worker wages were NOT allowed to ratchet up similarly. Effect?
  • other policies eliminate subsidies for firms, and place tighter controls on credit/money supply
  • relatedly, the government often needs to close down loss-making heavy industry (i.e., the firms that were never competitive and never will be). In Poland, for example, these included ship building - which was the heart of the Solidarity movement that put the new government in power!
  • often, recession follows and unemployment increases. This happens in the context of a society that previously had effectively guaranteed full employment - what effect?


Still and all, Inglehart & Welzel draw a clear link between development and democracy (and, add to the content of last week's readings) though they modify the argument slightly. In their view, economic growth or development tends to foster certain changes in values which, in turn, lead to social pressures for and endorsement of democratization. The values they examine include the change from traditional to secular-rational (driven by the implementation of industrialization) and from survival to self-expression (from industrial to post-industrial environments). Particularly in societies where self-expression has become important do we see the changes that emphasize freedom, participation in governance, and many other characteristics of open, democratic societies.

A second reason what change is so difficult is one of culture - which we'll begin discussing in the next class session.

Overall, why should managers care about the problems of transitioning states? Clearly, as nation states adopt economic/governance  policies that might conflict with existing cultural or institutional practices, real problems of integration can emerge. This may work, or it may not - can you predict which way? Why is it important to predict well?  What could happen?


Additional reading, if you want to dig further into Sach's experience:

Poland's economic reform.

By: Sachs, J. and  Lipton, D. (1990) Foreign Affairs. Vol. 69 Issue 3, p47-66

(AN 9007160946)

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