Capitalism, Institutions, and Economic Development

Michael G. Heller

• Publisher: Routledge
• Year: 2009
• Print ISBN: 9780415482592
• eBook ISBN: 9781135214982
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Based on a timely reassessment of the classic arguments of Weber, Schumpeter, Hayek, Popper, and Parsons, this book reconceptualizes actually-existing capitalism. It proposes capitalism as an impersonal procedural solution to the problems of spontaneously coordinating public institutions that enable durable market-based wealth generation and social order. Few countries have achieved this. A novel contribution of the book is that it identifies a practical sequence of economic and institutional shortcuts to real capitalism.

The book challenges current orthodoxies about varieties of capitalism and relativist recipes for economic growth, and it criticizes culturalist and incrementalist viewpoints in institutional economics. It calls on the social sciences to help in constructing dynamic and prosperous open societies of the twenty-first century by reclaiming older ideas of 'social economics'. Better and faster solutions will emphasize crisis-induced change, rational leadership, ideological persuasion, institutional engineering, rules-based market freedom, and the universalistic formal-procedural impersonality of optimal regulatory systems.

1 Institutional capitalism

A common fallacy of our time is that because the institutions of the more advanced countries evolved over many generations so too must the developing countries follow their own evolutionary path and slowly create institutions that match their special needs and values. Any effort to shortcut the evolutionary process, goes the argument, will be a recipe for disaster. The error of this view lies in the conviction that there are no universal truths about institutions, that a society only sets itself such institutional tasks as it can solve through original experimentation and learning, and that the task only presents itself when the social conditions for its solution already exist. The argument advanced in this book is that if an institutional solution has been tried and tested, knowledge of it can be used to advantage by other societies. With appropriate knowledge, motives, resources, opportunities and leadership, it is possible to compress the evolutionary process by imitating the successful institutional systems. Contemporary societies in transition to capitalism have no need to rediscover by a long and costly route of trial and error the institutions that enable durable prosperity and dynamic social order.

The term ‘capitalism’ is used unusually in this book to describe a particular kind of institutional system found in the more advanced societies, one which has arisen as a solution to the problem of coordinating the institutional subsystems of market regulation, law, public administration, and political representation. This is a general solution manifested in rules about institutional procedures, rules about the functions of key institutional subsystems, and rules about the formulation and enforcement of rules. It is quite different from the everyday temporal and conjunctural solutions that must continually be found to resolve problems of context, such as new regulations for new markets or new methods for managing a public service. Rather it encompasses overarching principles that enable modern society to coordinate its institutional forces in such a way that the everyday tasks can be accomplished most effectively without threatening the survival and further evolution of the system.

I will examine the institutional nature of capitalism, and priorities of institutional change in a capitalist direction, themes which have a long history in the social sciences. I draw on the scholarship of Weber, Schumpeter, Hayek, Popper, and Parsons, among others. In contrast to many present-day social scientists, these writers expressed considerable intellectual confidence in capitalism and had a keen sense of the policy dimensions of capitalist transitions. In exploring and adapting their work I have aimed for a composite and favourable analysis of capitalism’s institutional architecture and the methods of its construction. Two insights emerge, which can be the building blocks of ideas that communicate the nature of capitalist transition to the agents of change.

1. There is only one form of capitalism. Organizations of the state are the institutional centre of capitalism. Capitalism is characterized, above all, by the enforceable impersonality of state procedures. This means, for the most part, that state organizations operate predictably ‘without regard to persons’. Within reason, the capitalist state does not systematically discriminate among individuals and groups to achieve economic or political outcomes. In these terms, few countries can today be called ‘capitalist’. Even those that can be so classified still break many of capitalism’s institutional rules.
2. Effective shortcuts to capitalism follow a disequilibrium sequence. In most cases, the sequence will be markets to law, law to bureaucracy, and bureaucracy to democracy. Crises pattern the sequence and provide opportunities and incentives for change. It is usually unavoidable that transitional countries will need to embrace volatility and pursue discontinuous paths of economic and institutional change when constructing impersonal institutions.

Technological frontiers have advanced to the point where it is now easier than ever before to foment economic revolutions. Arguably, the technical, scientific, financial, and managerial resources needed for capitalist transition are available in the world on a demand-and-supply basis. As long as there is relatively free trade of goods and services, and relatively free competition in ideas, the vectors of capitalist transition should be mobile. But if the obstacles to development are in principle surmountable and capitalist transition is feasible, what currently prevents it from occurring in more countries?

One central argument in the following pages is that the demand for institutional change is determined in large part by the supply of knowledge in the form of ideas or ideologies. Societies are normally able to choose their own destiny. Yet since they can only choose from among known alternatives, the prospects of emulating capitalism depend on available knowledge of capitalism. Capitalism was not designed, so there is no blueprint to follow. Nevertheless, now that capitalism does exist its unique characteristics and outcomes can be defined. It should be possible to identify not only the institutions of capitalism but also the means of obtaining them. There is no logical reason why social scientists–and development practitioners and political leaders–should not explain capitalism persuasively in public-policy terms. This chapter makes a start towards that objective by defining capitalism institutionally and explaining the procedurally impersonal nature of the essential formal institutional subsystems of the state.

One capitalism, not many

This section sets the scene for a new conceptualization of capitalism by briefly describing more conventional viewpoints. First, considerable attention has been given in recent years to the supposed functional equivalencies of so-called ‘varieties of capitalism’. Commonalities among ‘types’ of capitalism are easy enough to discern if one adopts the dictionary definition of capitalism. The Oxford English Reference Dictionary describes capitalism as ‘an economic system in which the production and distribution of goods depend on invested private capital and profit-making’, or ‘the dominance of private owners of capital and production for profit’. Using that explanation, it is possible to fit non-socialist state-coordinated economies, many mixed economies, and liberal market economies, all of very different size and sophistication, into one general category. The view that capitalism has evolved in such diverse forms can be found in writings that categorize types of capitalism according to whether they are state-guided, dominated by particular groups and organizations, or competitive and entrepreneurial. The valid general point is that there are different forms of economic organization or economic governance among many nations that allow private ownership of property. Depending on the context and circumstance of its application, each of these models might prove to be more or less encouraging of economic growth (Baumol et al. 2007).

In practical terms the ‘capitalist diversity’ approach has much in common with a second line of enquiry that eschews all mention of capitalism and seek instead to identify the relative merits of different ‘recipes’ for economic growth (Rodrik 2007). Recipe studies examine workable combinations of sectoral and multilevel policy ‘ingredients’ in a national or global economy, and their applicability or sequencing according to the condition and history of the economy in question. It is typically argued that all the policies for economic growth and institutional change must always be context-specific. Recipe studies deal with much the same basic and indispensable debates about economic governance found in the ‘varieties of capitalism’ literature.

Each approach has its merits, but neither will easily accommodate a single vision of an ideal institutional system that is universally functional for enabling economic growth and improvements in social policy and governance. To give an idea of how large is the gap between these two approaches and the one adopted in the present book, it may help to borrow the culinary metaphor used recently by the World Bank-sponsored Commission on Growth and Development (2008) to qualify its support for the policy ‘recipe’ approach–‘There are many different recipes for pasta. The precise ingredients and timing are different for each. But if you leave out the salt or boil it too long, the results are distinctly inferior’ (ibid.: 5). The Commission may be saying that although it is helpful to experiment with workable permutations of economic and social policy in different national contexts and at different times in history, it is also important to remember that a few general rules apply in all recipes. My aim is to move the analysis a few steps back, and to examine more fundamental relations of cause and effect. If pasta making is the metaphor, you cannot grade the quality of varieties of genuine and counterfeit pasta until you know how the cereal is grown and how the grain is turned to flour dough. The essence of capitalism resides not in the potential policy models or their many applications and effects, but rather in some more basic qualities of the institutional actions that give rise to them.

Capitalism is often equated simply with market growth. Dynamic market enclaves in an economic territory are sometimes labelled ‘capitalist’ even when the legal, administrative, or political institutions are underdeveloped. States that have engineered rapid national economic growth for two or three decades are routinely called ‘capitalist’ before they have built modern institutions. Even in sociology the economic view of capitalism seems to be dominant. Many sociologists conceive of social institutions, such as the legal system and parliament, as merely contingent supports for the capitalist economic system. Peter Berger’s (1987: 206) opinion that ‘capitalism is an economic system and nothing else’ could not be more blunt. Randall Collins (1999: 204) similarly describes capitalism as the ‘quantitative dominance of market dynamics such that all other structures are reduced to minor roles’. On these grounds, Collins claims to have detected ‘Asian routes to capitalism’ and even a ‘Buddhist capitalism’ in early modern China and Japan.

I identify ‘market freedom’ as the primary economic characteristic of capitalism. Capitalist economies cultivate market freedoms above all else. The key to understanding capitalism, however, lies on the institutional side. Market freedom, which is the necessary condition of long-run economic growth, operates only in a territorial structure of legal, administrative, and political subsystems of the state. Market freedoms cannot be effective or durable without certain institutional supports. Capitalism only exists in societies where state institutions perform jointly to maintain market freedom, rule of law, definite limitations on the functions and powers of the state bureaucracy, and free political representation. On this definition, ‘capitalist’ is not yet the right descriptor for societies like Brazil, India, or China. As a rule of thumb, in today’s advanced capitalist economies the allocation of resources is mostly by the price mechanism, and individuals have equal rights and opportunities to buy and sell, to profit from private enterprise, and to enter new markets. Yet the reasons for the long-run success of this economy are institutional. It is not the size of an economy or even the extensiveness of market transactions that denotes capitalism, but rather an impartially regulated open-market economy, judicial independence and the enforcement of general laws, impersonal public administration, and a system of free political representation. These are demanding criteria. A country can qualify for membership of the Organization for Economic Cooperation and Development (OECD)–the ‘club of capitalist nations’–with somewhat less.

‘Capitalism’ has become a fungible and misused concept. If defined too narrowly as an economic system of capital ownership and profit making, capitalism is bound to be misunderstood in the societies where people’s lives could be improved by a transition to capitalism. It might seem strange to make these claims in a book that draws on the ideas of Max Weber. He employed many descriptors–among them, ‘booty’, ‘pariah’, ‘political’, ‘robber’, ‘mercantile’, ‘fiscal’, ‘adventurer’, ‘imperialist’, and ‘non-ethical’–to capture the uneven historical permutations of emerging capitalism, the inconsistencies of evolving norms in transitional societies, and disproportionalities between capitalism’s nascent institutional and economic systems. Weber denoted these types as obstacles to overcome in the staggered unfolding of secular, bourgeois, rational, or modern capitalism. A valid reason for the distinctions was that capitalism has never conformed perfectly to the ideal type. ‘Robber capitalism’ and ‘modern routinised capitalism … are ultimately different but everywhere intertwined’ (Weber 1978: 1118). With hindsight, however, it is clear that Weber’s descriptors were weaknesses in the analytical architecture. One dramatic example in The Protestant Ethic reads as follows: ‘capitalism existed in China, India, Babylon, in the classic world, and in the Middle Ages’ (Weber 1992: 52). That conceptual slippage has blurred Weber’s theory of capitalism. Arguably, his varieties of capitalism left a legacy of confusion that has bedevilled the analysis of capitalism ever since. ‘The essential point’, as Talcott Parsons (1949: 631) said, ‘is that modern capitalism is one socioeconomic system, not two.’

It should be pointed out, furthermore, that capitalism is a territorial institutional system, not a world system. Despite the pressures of globalization that have waxed and waned for over five centuries, capitalism remains the national exception rather than the global rule. There is no circumstance in the world today where the institutionally bounded market society would not coincide territorially with the political community, a politically guaranteed legal order, and the nationalization of all legal norms regulating the relations between the people of that territory. The determinants of capitalism’s evolution lie in the institutions that structure and regulate market society within a political territory. Weber’s concept of ‘separate political community’ is congruent with the ‘nation state’. It denotes the existence of: (1) a territory; (2) the capacity to use force to maintain domination over the territory; and (3) an institutional system that regulates social and economic action within the territory (Weber 1978: 54–6, 901–4). A political community is a neutral organizational category that says nothing about the normative content of state action. It may be a robber state, or a constitutional state.

Contemporary capitalism does, of course, have global dimensions. The citizens of most precapitalist countries are linked into the centres of advanced capitalism as producers, wholesalers, retailers, and consumers of tradable goods and services, including media communications. Multinational enterprises and international organizations already influence the allocation of resources in precapitalist countries, and may be vectors for the spread of markets and commercial ethics. Politicians, bureaucrats, judges, entrepreneurs, scholars, and intellectuals in the developing societies assimilate sophisticated and globally mobile ideas about capitalism. They are also enmeshed in cross-national political and economic networks, or in associations that articulate global interests. All of these forces transcend political communities.

But a capitalist world system could exist only if formal authorities of law, administration, and political representation were centralized globally and took precedence over national state institutions. Enforceable international regulations governing political or economic action have not yet developed to the point where they can significantly influence the global experience of capitalism. Until they do, capitalism will remain a market order whose integrated institutional structures evolve within territorially bounded political units. The present study uses the social system as the unit of analysis and focuses on changes in independently subsisting political communities where vectors of capitalism are tolerated or rejected. On the other hand, it is nowadays unimaginable that one nation state could thrive as a viable economic community without being integrated in the world economy. The market system has been globally extensive for centuries.

It is also worth considering whether capitalism has a purpose. In a well-known polemic, Friedrich Hayek argued that capitalism has no ‘end’ or purpose. A society with a ‘prescribed common end’ will stifle dissent, suppress liberty, and thereby eliminate the possibility of spontaneous change, which Hayek believed was the only true condition of progress. The argument is an important one and will be explored in this book. At this point, that debate can be circumvented in favour of a ‘policy ends’ hypothesis about capitalist transition. Various instrumental objectives commonly associated with national development can equally be treated as policy justifications for deliberate capitalist transition. Universal end goals of socioeconomic development, especially continuous increases in a society’s standard of living, have historically been most closely associated with capitalism rather than with precapitalism or any alternative form of social order. An argument that I will put forward later is that although the practical essence of capitalism really lies in the institutional or procedural ‘means’ for obtaining these ends, a clear ideological vision of the ends can provide a motive for creating the means.

In this book I discuss not only ‘economic ends’, but also behavioural, procedural, and social-order effects of capitalism, such as a sense of security and predictability about the processes of legal, administrative, and political life, which are ‘institutional ends’. The effects of the procedural and social-order gains relate broadly to institutional performance. We see this equally in the efficient provision of services such as infrastructure, health, and education, and in the relative safety afforded by effective rule of law, all of which impact on the prospects for economic growth.

It may be reasonable to say that capitalism’s material end is economic growth. The policies that generate sustained growth will foster patterns of ownership and organization, and methods of exchange, profit making, and capital accumulation that characterize capitalist economies. In fact, growth is both a means and end of capitalist development, since wealth creation is the precondition for the pursuit of social objectives in mass society. In the words of Nobel Laureate, Amartya Sen (1999: 14): ‘The usefulness of wealth lies in the things that it allows us to do–the substantive freedoms it helps us to achieve.’ The Indonesian economist, R. M. Sundrum, similarly said:

The advantage of economic growth is not that wealth increases happiness, but that it increases the range of human choice…. The case for economic growth is that it gives man greater control over his environment, and thereby increases his freedom.

(in Arndt 1987: 177)

Hayek wrote: ‘Strictly speaking, no final ends are economic, and the so-called economic goals which we pursue are at most intermediate goals which tell us how to serve others for ends which are ultimately non-economic’ (Hayek 1982: vol. 3, 168). In addition, since opportunity for socioeconomic mobility is one of the surest ways of legitimizing a social order, economic growth has a doubly important function. ‘Without growth’, points out Gellner (1994: 203), ‘mobility is a risky zero-sum game, in which anyone’s gain is balanced by someone’s loss. Nothing much is gained in the aggregate, and instability is the price.’

Finally, it must be emphasized that the achievement of economic growth is not just a matter of suppressing the symptoms of bad institutions. For growth to be durable through time, it is necessary to make changes to the system of institutions in a country. It is often remarked that the primary constraint on economic growth in developing societies is ‘rent seeking’. Rent-seeking analysis, which criticizes the welfare losses from non-market politicization of economic life, is a powerful explanation of blocked development. If governments selectively control entry into markets, they create the political incentives for populations of rent seekers to obtain government-granted rights or permissions to enter into production and trade. The pursuit of political influence by economic actors ‘in contexts where institutional structures create opportunities for private gain that do not involve increased production’ is a major source of inefficiency, which generates ‘social waste rather than social surplus’ (Brennan and Buchanan 2000: 134; Buchanan 1980: 4). Rent seeking is a competitive but usually unproductive struggle for scarce resources, since government restrictions on economic activity mean that competition for rents must be added to the costs of competition in product markets (Krueger 1980). Rent seeking generates vested interests in its own perpetuation. By de-legitimizing markets in the eyes of the public, rent seeking probably also has negative ideological consequences.

The existence of rent-seeking surely affects people’s perceptions of the economic system. If income distribution is viewed as the outcome of a lottery where wealthy individuals are successful (or lucky) rent-seekers, whereas the poor are those precluded from or unsuccessful in rent-seeking, the market mechanism is bound to be suspect…. People perceive that because of competitive rent-seeking the market mechanism does not function in a way compatible with socially approved goals. A political consensus therefore emerges to intervene further in the market, rent-seeking increases, and further intervention results. While it is beyond the competence of an economist to evaluate the political impact of rent-seeking, the suspicion of the market mechanism so frequently voiced in some developing countries may result from it.

(Krueger 1980: 69–70)

Having specifie...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Preface
• 1 Institutional capitalism
• 2 The modern state
• 3 Law and economy
• 4 Development in disequilibrium
• 5 Carriers of change
• 6 Models of crisis
• 7 The transition sequence
• 8 Making the change
• Bibliography