Good Governance Gone Bad

How Nordic Adaptability Leads to Excess

Darius Ornston

• Publisher: Cornell University Press
• Year: 2018
• Print ISBN: 9781501730177
• eBook ISBN: 9781501726125
• Topic: Economics
• Subtopic: European History
• Index: Economics

If we believe that the small, open economies of Nordic Europe are paragons of good governance, why are they so prone to economic crisis? In Good Governance Gone Bad, Darius Ornston provides evidence that adapting flexibly to rapid, technological change and shifting patterns of economic competition may be a great virtue, but it does not prevent countries from making strikingly poor policy choices and suffering devastating results. Home to three of the "big five" financial crises in the twentieth century, Nordic Europe in the new millennium has witnessed a housing bubble in Denmark, the collapse of the Finnish ICT industry, and the Icelandic financial crisis.

Ornston argues that the reason for these two seemingly contradictory phenomena is one and the same. The dense, cohesive relationships that enable these countries to respond to crisis with radical reform render them vulnerable to policy overshooting and overinvestment. Good Governance Gone Bad tests this argument by examining the rise and decline of heavy industry in postwar Sweden, the emergence and disruption of the Finnish ICT industry, and Iceland's impressive but short-lived reign as a financial powerhouse as well as ten similar and contrasting cases across Europe and North America. Ornston demonstrates how small and large states alike can learn from the Nordic experience, providing a valuable corrective to uncritical praise for the "Nordic model."

1

GOOD GOVERNANCE GONE BAD

Overshooting in Nordic Europe

Why are the Nordic countries so economically successful? And why do these seemingly well-governed societies suffer such severe economic crises? In this chapter I argue that the cause of these two apparently contradictory phenomena is one and the same: the tight-knit relationships that connect elites (and masses) across different regions, sectors, and socioeconomic classes. I begin by explaining how cohesive, encompassing networks facilitate investment in a wide range of collective goods, from peaceful industrial relations to human capital. If anything, the literature on small states (and cooperation more generally) understates the benefits of these social structures. Dense ties can accelerate policy reform and industrial restructuring by enabling entrepreneurial actors to persuade skeptics, compensate losers, and coordinate activity. These same processes, however, can lead to policy overshooting, overinvestment, and economic volatility. Although international openness guards against economic mismanagement in hard times, it does little to check excess in good times. The result is a distinctive pattern of economic volatility in which the Nordic countries respond effectively to economic crises but are prone to policy errors and bad investments when things are going well.

Small States, Interconnectedness, and Good Governance

As I relate in the introduction and subsequent chapters, Nordic success is intrinsically perplexing, because the Nordic countries have succeeded in contrasting ways using different economic models. Denmark, Finland, Iceland, Norway, and Sweden have prospered under highly interventionist regimes and laissez-faire ones, opening themselves to international trade and developing behind protective tariffs. They have relied on lightly processed natural resources and excelled in cutting-edge high-technology markets. Partly because of this diversity, scholars have cycled among competing explanations, alternately emphasizing the strength of the state (Rothstein and Stolle 2003, 19), labor power resources (Korpi 2006, 202), or employer organization (Hall and Soskice 2001, 15). In fact, these characteristics have varied considerably, both cross-nationally and over time.

The literature on small states suggests that the unifying thread in the Nordic region is not a particular industry, economic model, or even a single actor but rather the relationship among them. More specifically, elites (and masses) are connected within cohesive, encompassing networks (Campbell and Hall 2017, 34). These relationships are cohesive in the sense that actors trust one another and have an easy time cooperating. They are encompassing in the sense that they transcend political, regional, and sectoral divisions. In other words, Nordic societies’ dense, high-trust relationships take the form of “bridging” rather than “bonding” capital, cutting across salient social cleavages rather than reinforcing them (Rothstein and Stolle 2003, 9).

In appendix 1 I discuss the conceptualization and measurement of these cohesive, encompassing relationships, making the case that the Nordic countries are unusually interconnected. It is worth emphasizing, however, several key differences between this book and other research on small states. First, small size may be a necessary condition for the creation of cohesive, encompassing networks (Campbell and Hall 2009, 548), but it is most certainly not a sufficient one. This is most obvious in the highly polarized small states of Southern Europe such as Greece and Portugal, but it also applies to Austria and Switzerland, where industry is generally organized along regional or sectoral lines rather than national ones (see chapter 5). In Nordic Europe, however, constrained geopolitical space has interacted with external security threats and cultural homogeneity to foster the development of unusually broad, dense, and high-quality social ties.

Scholars historically have used the language of “neocorporatism,” a formal system of interest intermediation in which policy makers cooperate with large, encompassing producer associations, specifically trade unions and employers, to characterize these relationships (Fioretos 2013, 312; Katzenstein 1985, 91; Thorhallsson and Kattel 2013, 84). The Nordic countries rank high on measures of neocorporatism and this captures an important form of interconnectedness.¹ This emphasis on industrial relations and cross-class cooperation, however, does not directly address the corporate linkages that might accelerate (or inhibit) the diffusion of new business models within the private sector. As a result, we need to consider interfirm relations and the degree to which these do (or do not) transcend political, regional, or sectoral cleavages.

This interest on interfirm relations is reminiscent of the Varieties of Capitalism literature, which seeks to measure the degree of strategic coordination among firms. In appendix 1, however, I outline several problems with coordination, not least of which is the insensitivity to the dense informal ties that structure life in small states.² Scholarship and interviews alike suggest that individuals are more likely to be connected through professional associations, military service, common courses, soccer clubs, informal roundtables, and even family ties (Gingrich and Hannerz 2017, 13). Even when not directly connected, concentrated media markets bind actors by generating shared experiences and values (Gingrich and Hannerz 2017, 24). Widely acknowledged in the literature on small states (Katzenstein 1985, 89; Rehn 1996, 234), these informal ties lie at the center of my analysis, which uses 335 interviews to characterize social relations instead of relying exclusively on quantitative measures of neocorporatism or coordination (see appendix 1).

Whether employing the language of neocorporatism, coordination, or informal networks, research on small and large states alike has argued that cohesive, encompassing ties can improve the quality of governance by facilitating investment in collective goods. Neocorporatism has been linked to peaceful industrial relations, price stability, lower unemployment, higher growth, and a host of other positive economic outcomes as very large producer associations internalize the cost of their demands (Soskice 1990, 37). When this pattern of organization extends to the corporate sector, the Varieties of Capitalism literature suggests that dense interfirm relationships permit investment in more specialized inputs such as human capital, technological development, and product standards (Ornston and Schulze-Cleven 2015, 562–63).

Research suggests that dense informal relationships deliver similar benefits. Economists point out that tight-knit networks facilitate investment in collective goods by making it easier to detect opportunistic behavior and raising the reputational cost of free riding or shirking. For example, opportunistic firms jeopardize access to training, legal representation, standard setting, as well as other collective benefits (Soskice 1990, 45). Sociologists suggest that membership within a cohesive community encourages actors to sacrifice short-term individual interests in order to achieve long-term collective goals (Campbell and Hall 2009, 559). In the Nordic region, these instrumental and other-regarding motivations reinforce one another. A Finnish research director, describing his decision to participate in a large collaborative research project, began with an appeal to economic patriotism, citing his commitment to his country. He concluded on a more individualistic note, acknowledging not only the ease of cooperation in a small society but also the high reputational cost of free riding in a tight-knit community:

One aspect, which I forgot to mention, is that everybody knows everybody. We are five million people. It’s not Luxembourg, but it’s still easy to establish cooperative networks between suppliers and customers. It’s never possible in bigger countries and it doesn’t have anything to do with bribes. We have been studying in the same university … so natural forms of cooperation are easier to establish in that sense since [we] know each other relatively well. And it is such that people have to perform. Your reputation is on the line. (interview with research director, 19 October 2005, Finland)

In addition to delivering benefits, these informal relationships also mitigate the worst features of neocorporatism, a highly centralized system of interest intermediation which may be unrepresentative and insensitive to local conditions (Pontusson and Swenson 1996, 237). Dense interpersonal connections, of the sort that characterize Nordic Europe, reduce the distance between top-level leaders and rank-and-file members. Widely distributed networks that cut across political, regional, and sectoral cleavages are particularly beneficial. In addition to increasing access to local information (Scott 1999, 38), they expose decision makers to a wider variety of economic (and noneconomic) perspectives (Breznitz 2007, 16). At the same time, ordinary citizens are more likely to trust experts in a high-trust environment, contributing to pragmatic and flexible policy making (Campbell and Hall 2017, 14).

As a result, the literature on small states provides a compelling way to understand good governance in Nordic Europe. Although the specific nature of these ties has varied over time and space, actors are connected through formal institutions and, more importantly, dense interpersonal ties. Transcending political, regional, and sectoral cleavages, these connections exemplify best practice as identified by business scholars (Kristensen and Lilja 2011), economists (Rodrik 2007), sociologists (Safford 2009), and political scientists (Burt 2005; Ostrom 1990), enabling decision makers to access high-quality local information and motivating individuals to contribute to collective goods. These ties not only enable the Nordic countries to invest in goods such as industrial peace and wage moderation but also support the development of more sophisticated and complex inputs such as infrastructure, machinery, education, research, and risk capital.

The literature on small states provides a nice explanation for Nordic prosperity, highlighting the constant cohesive, encompassing networks that connect different countries, time periods, and economic models. But it offers little insight into one of the region’s most distinctive features. In Nordic Europe, prosperity is not merely a story about the gradual accumulation of productive inputs. Rather, the last century has witnessed sudden shifts in both policy making and comparative advantage. Sweden, for example, transformed itself from one of the most laissez-faire societies in Western Europe to one of the most statist during the interwar years. In the late twentieth century, Finland redefined itself from a paper producer and supplier to the Soviet Union into a high-technology leader. These two examples suggest that the Nordic countries exhibit not only a capacity for investing in collective goods but an aptitude for radical reform and restructuring. How do we explain this dynamism?

The Politics of Interconnectedness and Systemic Change

The connection between cohesive, encompassing networks, comprehensive institutional reform, and radical restructuring is not immediately obvious. Tight-knit relationships are more often perceived to delay change. Historically, heightened connectedness in small states was associated with generous social policies that cushioned the pace of economic adjustment to a socially acceptable level (Katzenstein 1985, 47). This is most obvious in the social democracies of Scandinavia, but even welfare laggards such as Switzerland developed alternative private-sector instruments, such as long-term bank loans, to slow the rate of adjustment (Katzenstein 1984, 96). These compensatory social policies are embedded within consensual political systems that discourage comprehensive reform. Reliance on proportional representation, multi-party governments, and the institutionalized participation of large producer associations all represent “veto points” that can be used to block reform (Immergut 1992, 391). As a result, institutional change is generally perceived to occur gradually, unfolding at the margins of society through incremental processes of layering, conversion, drift, or erosion (Streeck and Thelen 2005).

In small states, the impact of generous social policies and consensual political institutions is compounded by informal relationships, which increase the number of veto points. An Icelandic policy maker described how interconnectedness could inhibit reform:

In a sense, you would think that a small state would make it easier. Everyone knows everyone and the lines of communication are very short…. But a problem with smaller states is that everything is personal. In a large state you can decide to make some reforms and it is easier because you don’t have to deal with the individuals. Here even if you are talking about joining programs or merging universities, you have to deal with all of the individuals that are affected. And they can be very well connected, even to political leaders. (interview with policy maker, 5 March 2012, Iceland)

Collectively, these institutions are perceived to delay the redistribution of resources to new firms and activities. Scholars of business, economics, and innovation repeatedly conclude that consensus-based societies, small and large, are struggling to adapt to an increasingly fast-paced and dynamic global economy (Alesina and Giavazzi 2006; Eichengreen 2006). This is not limited to literature on formal institutions. Research on informal relationships consistently draws similar conclusions, arguing that dense high-trust networks restrict individual freedom (Portes 1998), increase resistance to new ideas (Gargiulo and Benassi 1999), stifle innovation (Kern 1998), and contribute to regional “lock-in” (Grab-her 1993, 260–64). With their consensual political systems, cooperative economic institutions, and high levels of social capital, the Nordic countries appear uniquely vulnerable to this kind of political and economic sclerosis.

Proponents of relational capitalism, influenced chiefly by the German case (and other Central European countries), have accepted many of these claims and responded by reconceptualizing incrementalism as an economic asset. More specifically, the cooperative relationships described above, formal and informal, are perceived to protect asset-specific investments. Firms (and workers) are more willing to invest in specialized equipment, skills, and knowledge, knowing that other enterprises, large banks, or the state are willing to protect them against opportunistic behavior, international economic shocks, and other negative events (Zahariadis 2002, 607). These commitments are more credible to the extent that consensual political institutions, large producer associations, and a general spirit of social solidarity discourage policy makers from introducing any sudden large-scale institutional reforms (Cusack, Iversen, and Soskice 2007, 379).

Countries (and regions) with consensual political systems, cooperative economic institutions, and dense informal networks can rely on these asset-specific investments to insulate themselves from economic competition, entering stable low- and medium-technology industries with high barriers to entry such as machine tools or automobiles. They react to economic shocks not by dismantling industries, but rather by upgrading preexisting investments in specialized skills and equipment (Streeck 1991, 26). Scholars have argued that this tendency is particularly pronounced in small states, which have successfully defended century-old niches such as Austrian steel (Katzenstein 1984, 210), Dutch electronics (Dalum 1988, 117), and Swiss watchmaking (Porter 1990, 324).

This incremental view of cooperation does an excellent job of explaining how Central European countries such as Austria and Switzerland compete in the international economy (see chapter 5), but it yields little insight into Nordic Europe, where comprehensive reform and restructuring is commonplace. Late industrializers, the Nordic countries relied on the rapid diffusion of new organizational innovations such as the universal bank to enter capital-intensive low- and medium-technology industries with high barriers to entry in the late nineteenth and early twentieth centuries (Fellman et al. 2008). Then, in the late twentieth century, the Nordic countries systematically dismantled many of these institutions, including their heavily regulated financial systems, in a bid to promote innovation and market competition. These days, they are more commonly associated with fundamentally new and often radically innovative industries, such as biotechnology, software, and telecommunications equipment (Ornston 2012b, 13). How do we make sense of this fundamentally discontinuous pattern of institutional reform and economic adjustment?

I argue that cohesive, encompassing networks, the constant that governs the adoption of new policy instruments and business models, can facilitate reform and restructuring in three ways: through the politics of persuasion, the politics of compensation, and the politics of coordination. First, reform-oriented actors can rely on persuasive appeals to mobilize support. The politics of persuasion is particularly effective in tight-knit societies, because reform-oriented actors can more easily identify the actors who oppose reform and their motives (Culpepper 2002, 778). Having done so, they can then use high levels of trust to convince skeptics, draw on the shared values that may have special resonance in a cohesive community, or appeal to a spirit of social solidarity (Campbell and Hall 2009, 552). This applies not only to policy reform but also to the private sector, where new business models diffuse quickly within dense social circles. To cite one example that is not covered in the book, Finnish banking representatives argue that the country’s pioneering role in electronic banking could only have happened in a small state. High-trust relationships among a very small number of financial institutions made it easier to convince skeptics about the benefits of electronic banking, agree on a single, common standard, and collaborate on technological development (interview with bank representative, 2 November 2005, Finland).³

Second, when the politics of persuasion fails, dense social structures make it easier to generate consensus by delivering side payments to adversely affected actors. Scholars have long recognized that small states can use generous social policies to neutralize opposition to free trade (Katzenstein 1984). But the politics of compensation can facilitate other reforms as well. For example, Swedish industry supported the construction of a massive welfare state in exchange for industry’s r...

Table of contents

• Acknowledgments
• Introduction: The Nordic Paradox
• 1. Good Governance Gone Bad: Overshooting in Nordic Europe
• 2. Manufacturing a Crisis: Planning in Sweden
• 3. Connecting People: Innovation in Finland
• 4. From Banking on Fish to Fishy Banks: Liberalization in Iceland
• 5. Overshooting in Comparative Perspective: Contrasting Cases
• 6. Overshooting beyond Nordic Europe: Ireland and Estonia
• Conclusion: Lessons for Large States
• Appendix 1: Measuring Cohesive, Encompassing Networks
• Appendix 2: Characterizing Economic Adjustment
• Notes
• References
• Index