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Which model of capitalism?

Capitalism takes different forms, each with deep roots. What
can we learn from the very different examples of Germany and the United
States?

RICHARD BRONK, LONDON SCHOOL OF
ECONOMICS

Capitalism has won. The key question now is what type of capitalism will
prevail? And what are the prospects for a new global model of capitalism, given
the rapid globalisation of product and financial markets, and the emergence of
new, more homogenous technologies?

Other processes are also forcing the pace of change. Increasing integration
of world markets and the interdependence of national economies are leaving less
and less room for idiosyncratic national institutions or economic policies,
while liberalisation of trade and capital markets is widely seen as making
further liberalisation of labour and social markets indispensable for countries
who wish to remain competitive. On this view, OECD countries should be assessed
on their readiness to accept necessary convergence on a dominant model of
capitalism based on liberal economic principles. This article probes whether
such wholesale convergence of capitalist models is really inevitable, or indeed
desirable, by examining the reasons for past divergence and the continuing
implications.

One key divergence relates to the level of social protection and the
structure of labour markets. While most continental European countries have
sought to retain generous welfare states and other key elements of their
distinctive social models, Anglo-Saxon economies have favoured a more ‘residual’
welfare state, with reduced tax rates and flexible labour markets which
incorporate high incentives to finding work. Such divergence is often
characterised as depending primarily on different political conceptions of the
appropriate trade-off between economic efficiency on the one hand, and social
justice on the other – with liberal market, social market, or “third-way”
conceptions offering different trade-offs. But, as this article will argue, the
variation between national models also reflects wider differences of view as to
how economic efficiency itself can be best achieved, depending in part on the
different comparative advantages of the economy concerned.

Aristotle argued that virtue lay in a “mean between two vices”, and since the
Enlightenment, most democratic nations have sought, consciously or otherwise, to
maintain a balance between collective action and individual liberty; between
co-operation in the pursuit of public goods and the creative power of
competition; and between respect for social values and the pursuit of individual
self-interest. In the field of economics and business, the search for such an
elusive balance has been not merely for an optimal trade-off between social
fairness and economic efficiency but also for the most efficient model of
capitalism itself. It has long been understood that efficient market-based
capitalism requires more than a system of market exchange, property rights and
the rule of law. Social norms engendering trust and removing the threat of
opportunism are essential if economic agents are to engage in any relationships
more durable than “spot transactions” without being burdened by the costly (and
ultimately futile) search for the “complete” legal contract.

Organisational structures, too, have a profound impact on economic
efficiency, depending on the extent to which they enable, for example,
co-operative innovation and teamwork. Without these, markets all too easily fail
to maximise economic and social value – producing too much pollution because its
value is not reflected in market prices, or producing too little employee
training or customer-specific investment by suppliers because – in the absence
of commitment mechanisms – they are unduly risky. But as Aristotle might have
pointed out, too much commitment between economic agents can be as damaging as
too little – leading to social and economic rigidity and a lack of incentives.
There must be a balance between commitment and flexibility and between public
and private goods.

Over the last fifty years, many different models of capitalism have emerged
which seek in different ways to achieve such a balance. Their evolution has, of
course, been to some extent path-dependent – reflecting pre-existing differences
in institutional structures, economic specialisations, and political coalitions.
While most OECD countries (and some regions) have distinguishable versions of
capitalism, two models (often in somewhat idealised form) have come to typify
two essentially divergent approaches. One is the US model, which typifies the
liberal market approach seen in Anglo-Saxon countries; the other is the German
model, which shares many features with other so-called “co-ordinated” market
economies, such as those of Sweden and Japan. There are, of course, some hybrid
systems such as the French, but for reasons of brevity, this article will
concentrate on a schematic comparison between the archetypal German and US
models.

Both models share a broad acceptance of free trade, market determined product
pricing and autonomous monetary policy. But, whereas the US model largely relies
on market co-ordination of economic agents and seeks to address market failures
by providing additional market elements where they are missing (e.g., tradable
pollution permits, patents, etc.), the German model relies in many areas on
non-market coordination, supplemented by a generous system of welfare
protection. So, for example, Germany has a widespread and successful vocational
training system that is underpinned by cooperation: between firms in the setting
of standards and the avoidance of free-riding; between firms and employees,
through collective wage bargaining and co-determination (via a largely mandatory
system of works councils and worker participation on supervisory boards); and
between these social partners and the education system.

There is also substantial inter-firm collaboration in research and
development (in conjunction with state-sponsored research institutions).
Employees and companies alike are willing to make substantial
relationship-specific investments and technology transfers on the basis of the
trust engendered by co-determination, formal business organisations and the
long-term provision of capital from “hausbanks” and committed
cross-shareholdings. All this contrasts markedly with the US model with its
“residual” welfare state, and its emphasis on competitive relations between
companies, flexible labour markets, management autonomy, general education,
market-determined technological standards and capital market financing. US
companies have, of course, often succeeded in inspiring commitment from staff by
creating a cohesive internal corporate “culture”, and their focus on shareholder
value can demand an impressive attunement with the desires of the marketplace.
Extensive legal liability, shareholder activism and, in some cases, “social
audits”, can also align the interests of the US corporate sector with broader
social goals.

Over the last decades, there has been considerable focus on the degree of
flexibility shown by the different models in response to economic shocks,
technological changes and the internationalisation of capital markets. In
Germany, as in many other European countries, a high degree of employment
protection appears to have interacted with other labour rigidities and with
demand shocks to create an “insider-outsider” problem in the labour market –
preventing the wages of those still in work being bid down low enough to price
the unemployed back to work. Moreover, extensive cross-shareholdings, long-term
bank finance, and co-determination (the very features that have helped underpin
a long-term approach to investment and innovation ) may have also prevented
reallocation of capital and resources to radically new technologies with the
scale and rapidity that we have seen in the US.

By contrast, flexibility is built into the heart of the Anglo-Saxon model, in
particular by the rigours of the capital markets on which it relies for finance.
Given the emphasis on tangible short-term returns (outside the area of hi-tech
start-ups), companies need a high degree of flexibility to react quickly to
product-market and technological developments. They therefore place a high
premium on management autonomy and the ability to hire and fire. The market for
corporate control in particular increases the need for flexibility.

What then is likely to be the impact of the spread of international capital
market financing and a market for corporate control to Germany? Will it imply a
further need for flexibility? And if German companies are forced by capital
markets and hostile takeovers to adopt a more short-term focus, will this imply
that many of the “commitment” features of the German model become seen as
harmful “rigidities”? To many commentators it seems clear that the German and
other similar models no longer represent the optimal trade-off between
commitment and flexibility. Faced with the internationalisation of finance, a
revolution in technology and persistently high unemployment, they seem to need a
new mix of institutions – retaining, for example, a vocational training system,
but combined with greater labour-market flexibility. Such thinking suggests that
it may be time for a new institutional compromise incorporating the best of the
various national models, perhaps now at a European or international level since
many of the key institutions or actors are no longer nationally bounded.

For various reasons, however, the smooth evolution of a new hybrid model –
representing a finely calibrated compromise – may not be likely. To expect such
is to ignore the extent to which the various features of any one model are
interdependent, limiting the possibility of cherry-picking features from other
models without introducing institutional inconsistency. It may be no accident,
for example, that countries with liberal capital markets and flexible labour
laws have generally been relatively unsuccessful in vocational training,
incremental innovation, and long-term investment. Employees who are unsure of
their prospects may not choose to invest in very specific (as opposed to
general) training, while companies operating in a market for corporate control
may be more wary of inter-firm co-operation in technology transfer and more
driven to maximise shareholder value over the short term.

To the extent that the German system is, then, a complex system of
mutually-reinforcing and interdependent features, the change of some key
features, such as the introduction of hostile takeovers and less employment
protection, might imply a radical shift to a new institutional equilibrium. It
is a general feature of complex systems involving increasing returns from a
complementary mix of factors that the change of certain key elements can lead to
a non-linear development and to a sudden “flip” to a new self-reinforcing
equilibrium. The timing and extent of such a change is usually difficult to
predict.

At the same time, however, the fact that a major reform might lead to a
radical unraveling of the whole model concerned should ensure that those key
actors who benefit from its existence strive hard to preserve it. This should be
especially true to the extent that each model meets the functional requirements
of that country’s particular specialisation. Countries have generally developed
specialisations that suit their respective institutional structures and vice
versa. This in turn gives key national actors a strong vested interest in
retaining those institutions they deem essential to the competitiveness of their
respective specialisations. The institutional framework of the US, with its
strong venture capital, general education and flexible labour laws – suits
admirably an economy focused on high-technology industries characterised by
radical innovation.

But, likewise, the German system, with its vocational training and long-term
cooperation, may be ideally suited to engineering industries reliant on
incremental innovation, long-term investment and the production of
customer-specific products. Wholesale change in either system might entail a
weakening of that country’s area of comparative advantage. This does not,
however, prevent pressure for change if a country’s preferred area of
specialisation is contested and if key actors (such as international investors)
are not nationally bounded and therefore do not share the system’s
interests.

It is the interdependence of the features of each model of capitalism and the
different functional requirements of each country’s particular area of
specialisation which make prescription in this area so difficult. Not only do
national models of capitalism reflect historical political compromises and core
social values, they can also represent part of the very basis of each country’s
comparative advantage. Effacing national differences may deprive the world
economy of some of its economic vibrancy and diversity.

There may be good economic as well as democratic reasons for hoping that
international actors in the world economy seek to exploit the comparative
advantages of different models of capitalism rather than remove them. Some
change – perhaps significant change – is necessary or inevitable in most models
if they are to achieve a balance between flexibility and commitment that is
suited to the demands of the modern global economy. But, as the eighteenth
century German philosopher Herder argued, it is important for each nation to
sing its own song and develop according to its own distinctive historical
rhythm. Transposing his scepticism of the logic of universalism to today’s
context might suggest that international capital markets, no less than the
European Union, should respect a degree of subsidiarity. Each country needs to
find its own path to economic efficiency, regardless of how full a participant
it is in the global economy of tomorrow.

* * * * * * * * * * * * * * * * * * * * * *

Selected Bibliography

* Bronk, Richard, Progress and the Invisible Hand, 1998 (Little, Brown)

* Crouch, Colin & Streek, Wolfgang (eds), Political Economy of Modern
Capitalism, 1997 (Sage)

* Kitschelt, Herbert et al (eds), Continuity and Change in Contemporary
Capitalism, 1999 (Cambridge)

* Soskice, David & Hall, Peter, Varieties of Capitalism – forthcoming,
2000

* Whitley, Richard, Divergent Capitalisms, 1999 (Oxford)

* CPB Netherlands Bureau for Economic Policy Analysis, Challenging
Neighbours, 1997 (Springer)

©OECD Observer No 221/222, Summer 2000

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