Small States in World Markets

Industrial Policy in Europe

Peter J. Katzenstein

• Publisher: Cornell University Press
• Year: 2015
• eBook ISBN: 9781501700354
• Topic: Economics
• Subtopic: European History
• Index: Economics

By the early 1980s the average American had a lower standard of living than the average Norwegian or Dane. Standards of living in the Netherlands, Belgium, Sweden, Switzerland, and Austria also rivaled those in the United States. How have seven small democracies achieved economic success and what can they teach America?In Small States in World Markets, Peter Katzenstein examines the successes of these economically vulnerable nations of Western Europe, showing that they have managed to stay economically competitive while at the same time preserving their political institutions. Too dependent on world trade to impose protection, and lacking the resources to transform their domestic industries, they have found a third solution. Their rapid and flexible response to market opportunity stems from what Katzenstein calls "democratic corporatism," a mixture of ideological consensus, centralized politics, and complex bargains among politicians, merest groups, and bureaucrats.Democratic corporatism is the solution these nations have developed in response to the economic crises of the 1930s and 1940s, the liberal international economy established after World War II, and the volatile markets of more recent years. Katzenstein maintains that democratic corporatism is an effective way of coping with a rapidly changing world, a more effective way than the United States and several other large industrial countries have yet managed to discover.

Chapter One

Introduction

Like many other industrial countries, the United States is experiencing far-reaching structural changes of its economy. Like many others, it is responding with the cure that has worked best in the past: liberal policies and unfettered market competition. By the middle of the 1980s, however, Americans remained divided in their assessments of both the character of the crisis and the adequacy of the cure.

The signs of crisis have become unmistakable. In the early 1980s an ever-growing list of books employed the language of statistics to demonstrate that rampant inflation and high unemployment—either separately or in combination—had shifted the American economy from growth to stagnation. An impressive array of statistical measures, moreover, productivity, capital formation, and the international balance of trade among them, indicated that the U.S. economy was lagging behind those of a growing number of other industrial states. Even as the share of American products in world markets continued its gradual decline, it dropped sharply in certain key domestic markets. At the same time the strength of the economic recovery in 1983–84, the dramatic lowering of the inflation rate, and decreases in unemployment which, compared to those in several European countries, could only be called impressive, all pointed to America’s inherent economic strength. Its markets continue to be large and dynamic. In the 1970s America accepted while Europe rejected large numbers of migrant workers. The American economy nevertheless generated 20 million new jobs across the decade; Europe produced none. In several high-technology industries, moreover, the American lead over Europe was increasing.

Because the evidence supports both pessimistic and optimistic assessments of the American economy, analysts differ in their policy prescriptions. They agree, however, that America’s economic performance lacks international competitiveness. In June 1980 Business Week titled one of its special issues “The Reindustrialization of America.” Barry Bluestone and Bennett Harrison’s widely noted study of plant closings bears the same title with one slight but all-important change—The Deindustrialization of America.¹ Whatever the diagnosis and whatever the cure, no one knew whether the world economy, and with it the American economy, had in the mid-1970s started a prolonged period of economic stagnation or a transition prior to renewed economic vitality.

By 1982 five European states had surpassed the United States in per capita gross domestic product (GDP), among them Switzerland, Sweden, Norway, and Denmark.² The average Norwegian or Danish family today enjoys a standard of living higher than its American counterpart. If they are aware of it, this fact disturbs Americans accustomed by a generation of prosperity and international leadership to thinking of themselves as number one. Their concern suggests that the small European states’ experience with industrial policy deserves more attention than it has received in American public discourse.

The New Global Context

During the last 25 years the American economy has opened itself up to global competition to a degree that is unique in this century.³ More than one-fifth of America’s industrial output is now exported. Forty percent of American farmland produces for foreign markets, as does one of every six jobs in manufacturing industries. Exports and foreign investments account for almost one-third of the profits of U.S. corporations, and for many of America’s largest and most successful firms that proportion exceeds 50 percent. Imports meet more than half of U.S. demand for 24 of the 42 raw materials most important to industry, and the cost of oil imports alone increased from $3 billion to $80 billion in the course of the 1970s. The weakening of the dollar in 1977–78 helped push America into double-digit inflation. Between 1978 and 1980, 60 percent of the modest increase in gross national product (GNP) could be credited to a sharp improvement in the U.S. trade balance: America’s exports grew twice as fast as world trade in each of these years. Similarly, the deep recession of 1981–83 was accentuated by the appreciation of the dollar in international markets. In short, international factors now influence America’s domestic economy in an unprecedented fashion.

The increasing dependence of the American economy on global markets has been coupled since the mid-1970s with the success of Japan’s export offensive on the American market. Japan’s achievements have convinced a growing number of Americans that a nation’s competitiveness depends on more than its endowment with natural resources and the workings of the market. But America’s national debate on industrial policy betrays the strength of a liberal ideology. We conceive of the political alternatives that confront us as polar opposites: market or plan. The biases of our ideology are reinforced by a veritable national obsession with Japan, a country that American businessmen in particular view as a statist antidote to America’s ideological celebration of market competition.

Our political debate typically pits the proponents of government action against the advocates of market competition. Fundamentally, the debate concerns the character of state involvement in the economy. Is the state smart or stupid? Should it be generous or frugal? The successes and failures of Japan often become important reference points in the discussion of American priorities and choices. One influential group, whose members became known as “Atari Democrats,” relies on a sophisticated interpretation of what Chalmers Johnson has called Japan’s “developmental state.”⁴ This view suggests competition rather than collusion as the organizing concept for industrial policy. Government action is informed by long-term market developments. It assists individual firms, segments of industry, or whole industrial sectors to prepare for international competition. (This interpretation of Japan draws on both the notion of Japan Incorporated that informs the views of many businessmen and on those liberal economists who stress the intense competition in Japan’s domestic market.)

This “smart-state” view of industrial policy is, however, open to criticism.⁵ Japan’s developmental state has failed in areas as different as textiles and commercial aircraft. America’s system of government, moreover, has institutional limitations that inhibit the implementation of a smart-state strategy. Such criticism serves as a useful corrective to the mixture of artistic and athletic imagery used by those who emphasize the suppleness and swiftness of Japan’s industrial policy. At the same time, however, these criticisms risk conceding the debate by default to those who base their case against industrial policy on the mythical notion of unfettered market competition.

A second set of arguments addresses the question whether the state should be generous or frugal. AFL-CIO officials drawing on the experience of several European states and Robert Kuttner among other writers give pride of place to human capital and the impact of industrial policy on labor markets and social welfare.⁶ A “generous-state” strategy views welfare and efficiency as complementary rather than conflicting goals. A well-trained labor force whose representatives are involved in shaping fundamental economic choices is, it holds, an essential ingredient in maintaining a competitive position in global markets. Critics of this argument point to a lack of competitiveness that, they argue, stems directly from the excesses of the welfare state both in Europe and in the United States.⁷ Social fat must be cut to stop the atrophy of economic muscle. In emphasizing the long-term benefits of efficiency and competition, these critics accept that the transition from an uncompetitive welfare state that impoverishes to a competitive market economy that enriches will carry unavoidable costs. It is primarily the politically weak and the economically poor who must foot the bill. Perhaps the hardest of all the lessons in the education of David Stockman was the fact that the Reagan administration was more successful in cutting the strong claims of weak clients than it was in curtailing the weak claims of strong clients.⁸

One important voice in the debate, Robert Reich, has argued that today we face a choice “between evading the new global context or engaging it—between protecting the American economy from the international market while generating paper profits, or adapting it to meet international competition.”⁹ But what are the ingredients of successful adaptation? The debate about industrial policy is of little help in analyzing those ingredients because it is organized around misplaced polarities of state action: smart vs. stupid, generous vs. frugal. Americans are beginning to perceive foreign threat in terms not only of revolutionary Communism but also of competitive capitalism. It is therefore unwise to lump together, as Reich does, Europe and Japan or all of Europe. In celebrating or criticizing foreign capitalism, generalization stresses how much of an exception America is. Comparative analysis is a useful antidote to this subtle form of ethnocentrism.

Today we can discern three dominant political forms of contemporary capitalism: liberalism in the United States and Britain; statism in Japan and France; and corporatism in the small European states and, to a lesser extent, in West Germany. The high-tech shoot-out between liberal America and statist Japan, cowboy and samurai, has so captured the imagination of the American public as to exclude serious consideration of other political possibilities within contemporary capitalism.

This book analyzes the industrial adjustment strategy of small, corporatist European states: Sweden, Norway, Denmark, the Netherlands, Belgium, Austria, and Switzerland. It compares them with one another as well as with the large industrial countries: the United States, Britain, Germany, France and Japan.¹⁰ I focus on this particular group of small states, excluding Ireland, Finland, and some of the Mediterranean countries, for reasons both practical and historical. This group of seven states is close to the apex of the international pyramid of success, yet we lack good comparative studies of how they manage their relations with the global economy. The group is large enough to allow some plausible inferences about the effects of structural constraints and opportunities, yet not so large as to defy intellectual mastery. Moreover, since these seven small states industrialized earlier than did other small states on the European periphery, they have related to the international economy in a distinctive manner. Finally, in these seven states a decisive realignment of their domestic economies with world markets occurred no later than around the turn of the century, a generation or two earlier than in the European periphery.

Although I use numbers in this book where relevant, I deliberately differ from statistically inclined investigations that seek to enhance our understanding by correlating small size with a broad range of economic, social, and political outcomes. In method of analysis I accord pride of place to historically informed comparisons rather than to statistical investigations. Granting the specifics of national settings, the historical evolution of these seven small European states justifies our particular attention.

The experience of the small European states in the international economy illustrates a traditional paradox in international relations concerning the strength of the weak. That experience is instructive in studying the problems of large, advanced industrial states, including America, for three different reasons. First, the large states are shrinking. This proposition is patently true in terms of territory: in the course of the last generation the large industrial states completed their withdrawal from their traditional empires, and no new formal empires are likely to emerge in the foreseeable future. Second, the diminution of the large states is reflected in the growing openness of their economies and their weakening control over the international system. Throughout the 1970s, for example, the economies of large industrial states opened up faster than those of small European states.¹¹ The large states are gradually relinquishing their traditional prerogative of imposing political solutions on others and are adjusting like small states to changes imposed from abroad. For America and the large states, “rule taking” rather than “rule making” is becoming increasingly important.¹² Finally, the production of goods for profitable niches in international markets has long been an economic reality for the small European states—a reality that the large industrial states, not accustomed to being squeezed, have acknowledged only rhetorically. But for the large industrial states, rhetoric is quickly becoming reality. They too must learn how to tap-dance rather than trample.

Three Political Responses to Economic Change

The 1970s and 1980s have been years of rapid change in the global economy. One way to suggest the rapidity with which change has occurred is to list the major issues that have affected the international economy since the early 1970s: global inflation, explosion in energy prices, prolonged recession, increases in trade rivalries and protectionism, volatile foreign-exchange markets, skyrocketing interest rates and debts, and structural readjustment. Alternatively, one could simply observe the behavior of economists who are in the business of making predictions. In the 1950s and 1960s their models generated impressively accurate results. Today an economic prediction often involves little more than averaging everyone else’s guesses about future trends—and even that method often does not work. Among energy specialists, for example, few economists predicted with any degree of accuracy the glut in international oil markets in 1981–82, much less the glut that accompanied a major war in the Gulf in 1984, and still fewer were willing to hazard a guess about its probable duration.

The sources of these changes in the global economy are diverse. They include political realignments in the international state system as well as major changes in the supply conditions and production structures of many countries. At no time since the end of World War II have questions of economic competitiveness and economic security so riveted attention throughout the industrialized world.

None of the major competing schools of thought in economics have offered a plausible diagnosis of accelerating change, let alone a workable means of dealing with it. Yet the deepening problems of the advanced industrial world have prompted substantial changes in the policies of several industrial states. Examples illustrating the point are easy to come by. In the hope of overcoming stagflation through invigorating market institutions, Britain under Prime Minister Thatcher and the United States under President Reagan made sharp breaks with the past, pursuing deflationary policies and deregulation. In sharp contrast, in the first year of President Mitterrand’s administration France was looking to more government intervention and an inflationary growth policy as the most promising cure for economic problems—an approach that Mitterrand was later compelled to abandon. In ways unanticipated a decade ago, moreover, and without any policy worth the name, northern Italy is witnessing the emergence of an embryonic but highly competitive, decentralized economy, one that challenges the long-presumed superiority of industrial mass production. As these policies suggest national elites are attempting to meet structural change in the world economy in different ways.

In the interest of systematic analysis we need categories to group diverging policies. This book relies on a threefold scheme that corresponds to the dominant political forms of contemporary capitalism.¹³ Liberal countries such as the United States rely on macroeconomic policies and market solutions. Lacking the means to intervene selectively in the economy, the United States, in those extraordinary situations where the traditional market approach appears to fail, tends to export the costs of change to other countries through the adoption of a variety of limited, ad hoc protectionist policies. Such policies often create a temporary “breathing space” for producers hard pressed by international competition, but they rarely address long-term structural shifts in international competitiveness. Conversely, statist countries such as Japan are endowed with the means and the institutions to preempt the costs of change through policies that pursue the structural transformation of their economies. Because they seek to meet structural changes in the world economy head on, their strategy often requires systematically protectionist policies, at least in the short and medium term. Exporting or preempting the costs of economic change in times of adversity are political options for those large industrial states whose power is sufficient to exercise effective control either over parts of their international environment or over parts of their own societies.

This book is about a different kind of response. It is a response that does not fit easily into the categories of analysis (competition or intervention, market or state) suggested by the experience of the large industrial states. The small European states lack the power demanded by the strategies with which the United States and Japan typically deal with adverse economic change. For the small European states, economic change is a fact of life. They have not chosen it; it is thrust upon them. These states, because of their small size, are very dependent on world markets, and protectionism is therefore not a viable option for them. Similarly, their economic openness and domestic politics do not permit them the luxury of long-term plans for sectoral transformation. Instead, elites in the small European states, while letting international markets force economic adjustments, choose a variety of economic and social policies that prevent the costs of change from causing...

Table of contents

• Preface
• 1. Introduction
• 2. Flexible Adjustment in the Small European States
• 3. Democratic Corporatism and Its Variants
• 4. The Historical Origins of Democratic Corporatism
• 5. Conclusion
• Notes