Extending the varieties of capitalism

The process of economic reform is one of devising new institutions that frame economic activity and drive economic actors toward broadly distributive institutions. Ideally, these institutions allow firms to pursue profits and politicians to be re-elected while promoting economic growth and development. The basic challenge is to develop institutions that will govern markets so as to support the wealth-enhancing and innovative activities of firms. Not all firms are well served by the same institutions, however, and not all market economies follow the same systemic logic. This point has been well established with the development of a broad research agenda on the varieties of capitalism. The central message of the literature that focuses on VoC in the advanced industrial societies is that different countries develop distinctive institutions that generate strong complementary effects to support economic activity.

The VoC literature proposes two main variants: the coordinated market economies (CMEs) of continental western Europe and the liberal market economies (LMEs) of, for example, the United Kingdom, the United States, and Australia. In the former, firms depend “more heavily on non-market modes of coordination” such as relational contracting, the use of inter-firm networks, and collaborative instead of competitive relationships with other firms (Hall and Soskice Reference Hall and Soskice2001: 8–9, 33–6). In liberal market economies, by contrast, firms coordinate on the basis of competition. The CME/LME framework of the varieties of capitalism project has opened up research on the complexity and variation both between and within these clusters.

The extension of this agenda to contexts in which institutions are still in a developmental phase requires some adaptation. In the post-socialist countries, where market institutions developed to replace pre-existing state socialist institutions, similar institutional complementarities have developed. These support forms of market-based activity that are radically different from either the CME or LME types, however. The main distinction is the extent to which economic activity and actors are politicized and rely on networks that differ from those present in CMEs.

Efforts to expand the VoC framework have been undertaken by numerous scholars. While Feldmann (Reference Feldmann2006) argues that the two VoC types can be applied to post-socialist countries, most authors find that these types cannot be directly transported. Nölke and Vliegenthart (Reference Nölke and Vliegenthart2009) argue that the post-socialist countries represent a fundamentally different type of capitalism with a heavy transnational component and suggest a third variant: the dependent market economy (DME), in which transnational corporations are the core coordination mechanism. Bohle and Greskovits (Reference Bohle and Greskovits2007) also highlight the difference between post-socialist capitalism and the two variants present in advanced industrial societies. They argue, however, that not one but several different variants of post-socialist capitalism have emerged out of the common legacy of state socialism, classifying states by how much they have imposed constraints on private economic activity.

These authors underscore the extent to which firms in post-socialist countries are collectively trying to solve a very different set of problems from those present in the advanced industrial economies, such as much higher levels of uncertainty, a lack of indigenous capital, poorly developed institutions, and lower state capacity. It follows that firms in post-socialist countries address these problems using strategies other than those identified in CMEs and LMEs. Bohle and Greskovits in particular draw attention to the role of the state in light of the influence of transnational actors. Yet the fundamental point of the VoC literature is that different variants of capitalism persist because of the strong institutional complementarities they generate. The DME and the variants identified by Bohle and Greskovits label the distinct qualities of post-socialist capitalism but do not identify the nature of the complementarity of arrangements that underpins it. One such arrangement is the configuration of the relationship between the polity and the economy. In my view, this is the foundation of each distinct form of post-socialist capitalism.

How these forms develop is explained in the VoC literature. The process by which countries embark on different paths occurs at two levels according to the framework developed by Hall and Soskice. On the ground, firms seek to create institutions that increase their chances of survival. Once firms choose a particular set of institutions, a macro-social evolutionary logic drives the development of complementary institutions. In the CMEs, for example, Hall and Soskice’s argument is that, if the prevailing labor practice is to sign long-term contracts with skilled laborers to ensure the availability of skills, then it is also highly likely that firms will rely on extensive education and training schemes and develop systems for sharing technology with other firms as a remedy for the lack of labor mobility. The benefits of institutions increase as other complementary institutions develop around them. By this mechanism, the initial preferences of firms start countries on an institutional path.

Hall and Soskice’s evolutionary vision of the development of economic institutions is useful in explaining the different variants of post-socialist capitalism that have emerged. In the post-socialist countries, early moves toward network-based forms of coordination drove countries toward the establishment of matching institutions in other areas that frame economic activity. For example, if business finds new clients primarily via networks, it is likely that it will also borrow by using preferential access to banks. Over time an insider network logic takes hold in the whole economy, because a hybrid mix of institutions would generate costs and confusion rather than the synergies to be found with complementary institutional forms.

Discovering which institutions will generate the best results for a given group of firms and a particular context is not a simple problem, however. Hall and Soskice (Reference Hall and Soskice2001) focus on the preferences of firms and to some extent the formation of coalitions of firms. They pay relatively little attention to the interaction of firms with political actors. Yet it is precisely this interaction – the ability of firms to create coalitions and negotiate acceptable solutions with state leaders – that is crucial in the developing world and emerging markets, where the state is often predatory or suffers from insufficient capacity to achieve its goals alone. Further, state leaders can have the wrong motivations or bad information, be under the influence of powerful but narrow lobbies, or even simply harbor bad ideas – all with disastrous effects. Leaders can also pursue their own short-term interests by choosing to serve the preferences of economic allies. All these dynamics were at work at times in the economic and political transformation from state socialism, which involved the readaptation of old institutions and the construction of new institutions to regulate the emerging economies.

Differences between countries persist because the majority of firms in one country might oppose, for example, the elimination of selective benefits that come with the development of a competition-enforcing authority or the protection of minority shareholders (Black, Kraakman, and Tarassova Reference Black, Kraakman and Tarassova2000: 1753; Hoff and Stiglitz Reference Hoff and Stiglitz2002: 38). These firms might fear the unexpected consequences that accompany a move away from the status quo. Influential firms in some countries might prefer weak shareholder protections and be willing to sacrifice the ability to raise funds in capital markets. Similarly, some firms may prefer a more developed system of banking, credit, and the institutions that accompany developed lending markets, while others will prefer to source credit from within networks.

Later chapters show how firms in the post-socialist countries have settled on different levels of what can be called “selective advantages.” Countries across the post-socialist region vary widely in the development of key areas of market regulation, such as banking, financial, and competition law, and the regulation of political finance by firms. The variance of interest here is the extent to which institutions are designed to distribute benefits broadly or narrowly. Over time, as a result of foreign pressure and changing internal economic conditions, key institutions of market regulation may creep toward and ultimately converge on Western norms, such as those established in the EBRD’s transition indicators of progress on institutional development. There are many long and tortuous roads to that end point, however. Countries take different paths toward that destination, and it is much too soon to argue for a convergence of institutional types.

Thus, when adapted to the market conditions of countries in the developing world, the conceptual tools of the VoC literature allow us to understand how trajectories of institutional development persist over time despite the pressure of international economic integration. Networks provide the social foundation through which an array of complementary alternative market practices form the basis of national economic models that deviate from competitive markets.

Considering multiple forms of embeddedness

Throughout the post-socialist reform period businesspeople sought to influence politicians so that new institutions would benefit their existing or nascent ventures, while politicians sought to secure financial support from businesspeople. In other words, economy and polity were both in the process of developing different forms of embeddedness (Evans Reference Evans1995; Polanyi Reference Polanyi2001). The concept of embeddedness was applied by Evans to explain why some states in the developing world were able to promote growth while others failed. “Embeddedness” signifies the extent to which networks connect the state to the economy. According to Evans, when these two spheres are too closely connected, opportunities for collusion are easily within reach. At the other extreme, when they are too distant, opportunities for entrepreneurs and policy makers to coordinate and communicate are not available, and critical signals and information are lost. Policy makers and businesspeople both fail to understand the goals and priorities of their counterparts. At the ideal balance point for embeddedness, political and economic actors are connected but the state is able to remain autonomous – gathering key information but nevertheless able to make difficult and often unpopular decisions without being too influenced by the demands of narrow business interests. When this balance is struck, business can receive vital support from the state while also facing incentives that make firms innovate, becoming more productive and competitive.

Evans offers an important foundation for thinking about how state–economy ties are both critical for and able to derail developmental policy. Where Evans’s approach and the developmental state literature fall short is in failing to make clear why political elites would want to pursue developmentally oriented policy as opposed to short-run self-dealing. In the developmental state literature, we are told that states able to achieve the miraculous outcomes associated with east Asian development had a special blend of embeddedness and autonomy.

Later studies questioned the benign nature of embeddedness and its sufficiency to explain good economic governance. Kang (Reference Kang2002), for example, instead focused on the importance of a situation he labels “mutual hostages.” In this circumstance, instead of a state mediating to bring about good outcomes, Kang sees two social networks of elites that counter each other’s power. The conflict between them promotes good governance by limiting the power of each to engage in excessive self-dealing. When the economic and political elites are unified, on the other hand, excessive self-dealing undermines governance. Kang’s approach avoids ascribing to the state the almost magical qualities of the developmental state to coordinate economic development, and takes a much more cynical view of the east Asian “miracle.” This approach is not sufficient to explain good governance in democracies, however, where there are always at least two separate groups of political elites but very different outcomes obtain across countries.

For both Evans and Kang, good developmental outcomes result from network ties, albeit through different mechanisms: information sharing versus mutual monitoring. In both, the problem of development is essentially a type of coordination problem facing elites. I build on these ideas toward a hybrid position, viewing the problem of development under incomplete institutions as a coordination problem in which multiple elites must collaborate to realize the greater gains to be had after institutional reform.² To collaborate requires that they overcome pervasive information, monitoring, and commitment problems.

Such coordination under incomplete institutions is facilitated by networks. According to Beckert (Reference Beckert2007a), Polanyi’s original notion of embeddedness was precisely one of the glue that allows market actors to operate in stable worlds that are calculable. Polanyi identified three key coordination problems that are exacerbated by uncertainty (Beckert Reference Beckert2007a; Beckert Reference Beckert2007b). First, the problem of value refers to the difficulty with which individuals are able to form notions of value of items offered on the market. Value is socially and, more importantly in the present context, politically created. The second coordination problem is that of competition. Markets are based on competitive pressures, but profit emerges only when markets are imperfect. Hence, market actors try to create conditions that protect them from pure price competition. Incumbents try to retain their position by using existing regulation, while market actors who are disadvantaged attempt to challenge incumbents (Weber Reference Weber, Roth, Wittich, Fischoff, Gerth, Henderson, Kolegar, Mills, Parsons, Rheinstein, Roth, Shils and Wittich1978 [1922] and Fligstein Reference Fligstein2001, both cited by Beckert Reference Beckert2007a). The state plays a central role here by setting out the rules of the game. Third, cooperation problems arise from the fact that not all actors have the same access to information about factors such as “price, product quality and the possible opportunism of exchange partners” (Beckert Reference Beckert2007a: 14). Embeddedness provides a solution to all three problems. Even for Beckert, however, embeddedness is a “mysterious substance which provides. . .stability in market exchange” (Beckert Reference Beckert2007a: 11).

This book adopts a view of embeddedness as just such a solution to the coordination problems of value, competition, and cooperation that businesspeople and politicians are trying to solve, and unpacks its mysterious mechanisms. As the coming chapters show, it was precisely these problems that plagued economic actors and led them to form different types of bonds with political elites. Each group articulated a series of demands to their counterparts wherein their common aim was to make the future more legible. As I will show later, certain network structures facilitate that task while also leading to the development of broadly distributive institutions, while others result in narrowly distributive institutions. The structure of networks also can allow economic and political elites to act as constraints on one another. For both reasons, the developmental state literature set an agenda for studying ties between political and economic elites. The rest of this book builds on this foundation to understand the relationship between individuals, the social structure within which they act, and the development of institutions.

How uncertainty leads to institutional development

Two groups of elites have been identified as key actors in the process of state building in contemporary new democracies: business leaders and politicians. Together they operate in emerging markets – sites of high economic volatility where opportunities for economic growth are immense but the institutional framework is incomplete. Since the 1960s emerging markets have been a subject of fervent conversation among social scientists, investors, politicians, and development experts, at times because emerging markets were a source of surging growth, at others because they were sites of financial volatility, desperation, and social unrest. But what does it mean to be an emerging market? Economists tend to think of such markets as places where opportunity and uncertainty are high because political and economic institutions are not yet present or well established but economic dynamism and innovation are present. At the same time, we tend to think of emerging markets as places where social networks fill the gap left by missing institutions, generating other types of uncertainty, such as poor information flow.

Both these circumstances are present simultaneously: markets are based on social structures as well as institutions and impersonal signals (Fligstein Reference Fligstein2001). It is the interaction of these in a variety of forms, each with a different political foundation, that determines the extent to which uncertainty and networks are relevant. Hence, family capitalism (Morck and Yeung Reference Morck and Yeung2004; Fogel Reference Fogel2006) is different from business group or alliance capitalism (Gerlach Reference Gerlach1992; Kang Reference Kang2002) and institutional capitalism (Black Reference Black1992; Hawley and Williams Reference Hawley and Williams1997). These capitalisms differ because their institutions vary according to the cultural and political context in which they are embedded (Granovetter Reference Granovetter1985). Each of these forms of capitalism presents a different relational solution to the challenge that businesspeople in emerging markets face: how to minimize uncertainty in order to generate profits.

Two decades have now passed since the largest political and economic transformation in recent history swept across nearly half the globe and affected every country lying between East Germany, North Korea, and Vietnam. What this massive transformation did, at the most basic level, was to introduce uncertainty into economies that were previously planned and governed by one party. This was accomplished by expanding the base of stakeholders in the economy and the polity and making them compete.

The ability to reduce uncertainty underlies the paradox investigated in this book. After all, the presumed purpose of introducing elections and markets into previously one-party systems and planned economies is precisely to introduce uncertainty into contexts in which everything was rather certain. But uncertainty can be paralyzing, as actors unable to form expectations about the future will refrain from taking any action at all. Unable to calculate the likelihood of outcomes, economic actors prefer to keep assets buried in the proverbial backyard.

What is the optimal point between too much uncertainty and too much certainty? Should elites coordinate closely and exchange information in the process of development, as the east Asian developmental model suggested? Or does close elite coordination generate bad growth rates and political corruption, as African, Latin American, and indeed the post-socialist cases suggest? In other words, is it true that social networks generate institutions that are narrowly focused and redistribute to narrow coalitions? Current scholarship presents a confusing picture. On the one hand, networks are seen as inefficient except under special circumstances when their impact is limited by elite competition (Kang Reference Kang2002), acute international competition (Doner, Ritchie, and Slater Reference Doner, Ritchie and Slater2005), or special bureaucratic capacity (Evans Reference Evans1995), which is extremely difficult to reproduce. Under these conditions, it is argued that networks can be harnessed toward productive ends (Evans Reference Evans1995; Chibber Reference Chibber2003). Other research, however, finds that even overt corruption does not correlate with lower levels of investment when the environment is predictable and businesspeople have clear expectations about the outcome of their illicit exchanges (Edgardo Campos, Lien, and Pradhan Reference Edgardo Campos, Lien and Pradhan1999). In other words, we do not yet have a clear understanding of the boundary conditions under which networks and uncertainty can lead elites toward collaborative and broadly productive outcomes.

My position is that broad networks reduce uncertainty and thus render the future more readable for economic and political agents. The former use networks to facilitate business and exchange information about the changing nature of the economy. The latter use networks to obtain information about the preferences of economic actors and to secure political finance. When these networks are broad, the intense uncertainty of a period of simultaneous and rapid institutional and economic development is reduced for a large number of actors with heterogeneous interests. Thus, networks become conduits for implementing broad preferences rather than narrow ones. Moreover, if political competition is high in combination with networks, it acts as an offsetting force by both limiting the amount of time that politicians have at the helm and making them more sensitive to the preferences of societal actors, thereby raising the incentives for cooperation.

Comparison across the post-socialist region shows that various patterns of influence expression and interest aggregation have emerged. These patterns do not correspond to economic factors such as GDP growth, suggesting that there are multiple paths and political models of functioning markets in the region. Close examination of the interactions of business and political actors since 1989 in three case studies reveals that broad networks play a crucial role in the emergence of broadly distributive institutions, however.

How networks affect institutional development

Granovetter’s (Reference Granovetter1973) theory of weak ties provides the basis for my argument about the value of broad networks. Research spearheaded by Granovetter on the spread of new ideas finds that social systems lacking weak ties will be “fragmented and incoherent” (Granovetter Reference Granovetter1983: 202). The effect of this fragmentation is that new ideas spread slowly and individuals are exposed to homogeneous views likely to be held by their friends. Because networks of strong ties are likely to link actors with similar outlooks, such social systems will be deprived of diversity of thought by the failure to “bridge” to other groups with dissonant outlooks.

According to Granovetter, “[A]cquaintances, as compared to close friends, are more prone to move in different circles than oneself. Those to whom one is closest are likely to have the greatest overlap in contact with those one already knows, so that the information to which they are privy is likely to be much the same as that which one already has” (Granovetter Reference Granovetter1983: 205). A dangerous consequence of such tight and closed networks is the unchallenged persistence of poor information, bad ideas, or inappropriate strategies, because the lack of exposure to outside information reinforces the status quo even if external circumstances have changed. Thus, particularly when network members’ weak ties act as bridges to other groups, they are crucial conduits of information. This is especially relevant in situations when actors are engaged in “searches” for information (Stigler Reference Stigler1961).

Search theory, commonly applied to labor and producer markets, can equally well apply to markets for influence and information in politics. In all these contexts, actors are reliant on information in order to obtain better outcomes for themselves. For example, individuals who maintain weak ties tend to have greater success in job searches (Granovetter Reference Granovetter1995) and obtain higher wages (Montgomery Reference Montgomery1992). Similarly, maintaining “acquaintance relationships confers an informational advantage for individual lobbyists” as a result of the same weak tie mechanism (Carpenter, Esterling, and Lazer Reference Carpenter, Esterling and Lazer1998: 439). Granovetter points out that weak ties also generate macro-social benefits, for example by increasing the efficiency of job placements. Stigler argues that lowering the costs of information search lowers price variability and increases efficiency in the target market.

Thus, when networks are broader and link diverse groups, actors (whether people or firms) will be exposed to new ideas, more information, and greater diversity. Such broad networks of weak ties therefore benefit from the challenges that come from encounters between dissimilar actors. If one accepts that heterogeneity and conflict strengthen social systems by subjecting plans and ideas to constant trial as well as causing new ideas to spread widely, then diversity is performance-enhancing. In fact, this is a central premise of explanations for the performance of complex adaptive systems – that is, systems of multiple interconnected agents capable of learning from experience (Axelrod and Cohen Reference Axelrod and Cohen1999; Miller and Page Reference Miller and Page2007). Broad networks of such ties, therefore, are crucial for the successful design of institutions.

I focus on the breadth of network ties as a key feature of networks because it determines the extent to which networks can act as the conduits of diversity. Networks themselves are arrays of relations between a set of actors that form a structure. These structures can vary in how dense they are, because some actors have many more ties than others. They can be more hierarchical if they have a distinct center around which other actors are organized, or they can be disjointed, with many isolated actors. These and many other properties of networks can be observed and measured to obtain an understanding of the possibilities that different actors have. In other words, networks create a structure of possibility for the actors in them. They also relationally structure the identities of actors in them; much as in a high school clique, we are defined by those to whom we are connected. Those who are connected to many can potentially use their network to mobilize others much more effectively than those who are connected to only a few. They can also control and funnel information more effectively. As a result, networks with such actors may be more efficient at passing news, though also more vulnerable to disruption if the single central actor is removed.

The basic idea of network analysis is that systematic patterns of relations among actors reveal the structure of a system. Networks are defined as lasting relations that generate expectations of reciprocity or provision of some sort (Granovetter Reference Granovetter1985). A central consideration of network analysis is how relationships among multiple actors jointly affect individual network members’ behavior. In other words, networks capture the structure of opportunity and reciprocity, and can both empower and constrain members.

Networks do not simply present a map of existing social structures, moreover. When we move to a temporal conception of networks, network approaches are able to capture both structure and agency. Kilduff and Krackhardt (Reference Kilduff and Krackhardt1994), quoting Cialdini (Reference Cialdini, Giacalone and Rosenfeld1989), present a clear illustration of this mechanism with Baron de Rothschild, who signaled his close link to a would-be borrower by walking across the floor of the stock exchange arm in arm with him. Observers of the display of friendship upgraded their evaluation of the creditworthiness of the baron’s apparent friend and would-be borrower. Thus, by observing the same network over time, we can observe the effect that structure has on individual choice within a network.

As in the example of Baron Rothschild, networks can both empower and restrict an individual’s ability to act, as the individual is defined by his or her ties. Networks by definition have non-linear effects, as information spreads relationally. The difficulty and the value of network approaches both lie in the relational and recursive nature of network ties. Much as in an iterated game, players update their strategies on the basis of observed and expected behavior alike. As such, neither is a fixed point; their actions mutually affect the choices that the other will make. Taking again the cases at hand, ties between individuals and between organizations structure political outcomes. In the process of building capitalism, politicians and firms both anticipate and adapt to the actions that their counterparts take. Thus, to say that firms adapt their strategies to the policy choices that politicians make would be to tell less than half the story, as politicians are already incorporating both the anticipated and the observed actions of firms in their behavior.

Similarly, firms have considered the reactions of politicians in the earlier moves that led to politicians’ current choices. The mutually constructed nature of institutional choice results from this process of anticipation and reaction. Of course, information is imperfect and consequences are often unintended, making the process of institutional design a meandering journey of experimentation and selection. As the chapters that follow show, politicians formulated and altered their strategies to develop firms as a source of political resources that they needed in order to win elections. In parallel, firms forged relations with the political sphere in ways that reflected both their strategic opportunities at any given time and the effects of earlier political decisions that had a constitutive impact on them as political actors.

This relational perspective has the advantage of drawing attention to the internal configurations and external connections of interest groups. By including network features as an independent variable, this book takes networks seriously as part of the political process. In particular, it seeks to understand how networks affect institutional function and development.

What, then, is the relationship between networks and institutions? Institutions provide a set of rules that govern political and economic life. Networks provide a social structure to supplement incomplete rules and indeterminate institutional outcomes. Institutions determine who has the authority to make decisions and who can benefit from and dispose of material goods. Networks enable their members to influence decisions, and sometimes the nature of the institutions themselves.

For this reason, the period during which institutions are being chosen has been of particular interest to social scientists; during such times the participants in the process of institutional development cannot know fully the effects of the institutions they are choosing. Nevertheless, they often have strong beliefs about their likely distributional consequences. Hence, they jockey for individual advantage, form coalitions, strike bargains, share information, and engage in open conflict to arrive at their desired outcome.

Ties between businesspeople and politicians are one place where networks and institutional development meet. Newspaper headlines resonate in the popular imagination when they refer to visible or alleged ties between the economy and the polity. The political goals of businesspeople affect elections, shape legislation, and impact the institutional landscape. Businesspeople lobby, make private deals with politicians, create organizations, and sometimes use violence.

Precisely in the middle ground when institutions are not yet fully developed, social groups – networks of individuals – fill in the gaps, influencing the process by which institutions are built through formal and informal means. I therefore focus on the network that we imagine as the most powerful in contemporary democratic polities: the community of businesspeople and their ties to the political sphere. How does the network that we imagine as most powerful affect a nation’s ability to make economic policy and guide economic development? The answer lies, I argue, in understanding the various ties between the economy and the polity.

My argument is not to be mistaken for the “grease the wheels” argument, which states that corruption arises as a solution to the problem of inefficient bureaucracy (Leys Reference Leys1965). Corruption is generally acknowledged to be inefficient (Mèon and Weill Reference Mèon and Weill2010) and harmful to development (Aidt Reference Aidt2009). Nevertheless, some authors argue that corruption can be used to address inefficiencies, such as the extra time needed to deal with a slow or inept bureaucracy (Lui Reference Lui1985). Others have argued that extra payments related to corruption may attract talent to bureaucratic work in contexts where low government pay would otherwise have the opposite effect (Leys Reference Leys1965). These arguments suggest that corruption constitutes a second best solution by allowing business to operate in contexts that would otherwise present major obstacles to private sector activity and in which the development of functional institutions is not a viable alternative. By contrast, the argument being made here is not about corrupt payments or “wheel greasing” to obtain certain outcomes, such as queue jumping. Instead, it focuses on collaborative agreements, which may involve electoral support to parties from business in exchange for influence in shaping institutions and affecting legislation, regulation, or other policy-related decisions.

The business owners discussed in this volume used existing networks, reconfigured old ties, and built new coalitions in order to achieve their goals. One of these goals was to influence the basic content of rules, laws, and regulations that were being designed as part of long-term reform projects with potentially huge rewards for the first set of incumbents. Because one key focus of this study is the large business owner, this is also an account of the impact of “who owns what” on institutional development. Ownership is one of the core forms of economic power defined by institutions such as contracting and the rules of property rights. Ownership is therefore a form of politics. And yet we have only just begun to understand how the structure of ownership influences the conduct of politics. Thus, ownership structure is one of the key starting points of the argument. Whenever one firm buys a stake in another firm or one individual owns two firms, ownership creates networks of firms. These ownership networks interact with and reinforce personal and personnel networks. “Who owns what” links with “who knows whom” to create a structure through which some individuals and organizations wield much more influence than others. Therefore, in addition to ownership networks, I examine elite career networks. Both these networks influence the creation and function of social institutions; they are a core part of the construction of markets and the consolidation of state power over them.

Argument

The post-socialist countries provide an opportunity to explore and trace the process of contemporary institution building because, by the time of transition, these states had lost the capacity to extract resources, control their assets, and effectively issue commands and sanctions. As other scholars have argued, late socialism was a time of state weakness and breakdown (Ganev Reference Ganev2001; Grzymała-Busse and Jones-Luong Reference Grzymała-Busse and Jones-Luong2002; Volkov Reference Volkov2002; Ganev Reference Ganev2007). In the early 1990s new democratic governments had weak state structures, as evidenced by the tunneling of resources out of state-owned firms and frequent business-related violence. Actors in control of the state had to create a new framework and rebuild capacity if they had any hope of carrying out political and economic reforms.

What enabled them to do so? Two elements are central in the answer advanced by this book, as shown in Table 1.1. First, the breadth of networks among members – whether they are broad or narrow – is a key resource that determines how firms behave when calculating and pursuing their interests. The ties of any one individual constrain or enable their opportunities for action. By extension, as discussed in Chapters 3 and 4, the identities of actors are also relevant. Some firms, such as financial institutions, maintain more ties, on average, than industrial firms by virtue of their sector. Thus, the prominence of financial institutions in a given country will shape the network structure. And, as Chapter 4 shows, the structure of firm ownership and control networks affects the incentives of elites to engage in collective action.

Table 1.1 The effect of networks and uncertainty on the state

A second critical feature shaping the macro-trajectories of countries is the level of uncertainty actors face when calculating the future. The nature of political competition generates a key form of uncertainty. It has been argued that political alternation and divided government generate suboptimal behavior because sets of actors with opposing goals make policy decisions that often reverse course on decisions made earlier (Persson and Tabellini Reference Persson and Tabellini2000; Frye Reference Frye2010). For example, US states with divided governments have larger fiscal deficits (Alt and Lowry Reference Alt and Lowry1994; Poterba Reference Poterba1994). Similarly, the alternation of governments is linked to higher deficits (Rumi Reference Rumi2009). Frequent alternation has detrimental effects on the quality of policy because longer time horizons allow office holders to plan and execute better policy decisions (Rumi Reference Rumi2009). This may indeed be the case in well-institutionalized contexts. The same time-horizon-limiting features that lead politicians to make poor spending decisions, however, or react slowly to budget crises can also force them to concentrate on the present and collaborate with other societal actors. Scholars have found, for example, that frequent government alternation in the post-communist area correlates with lower levels of influence peddling (Horowitz, Hoff, and Milanovic Reference Horowitz, Hoff and Milanovic2009), and, when constructive lobbying is possible, alternation is a substitute for rather than a complement to corruption (Campos and Giovannoni Reference Campos and Giovannoni2008). I find that uncertainty, and especially political uncertainty, promotes collective action between party and business elites by disciplining politicians, who must deliver on their promises to business or risk punishment in the next election cycle.

High uncertainty means that societal actors do not know who will be in power next and thus cannot assess the value of their social networks. They also find it difficult to predict policy changes that may come with the next government. These changes could range from policies such as tax and labor policy to the awarding of public contracts. Uncertainty may come from high levels of political competition in an unsettled party system, such as in Bulgaria, which has seen the regular entrance of new parties. It may also come from high levels of competition in a polarized party system. This does not necessarily mean that the same parties will alternate. For example, in Poland failure at the elections has frequently meant organizational death for Polish political parties. While the party labels changed, however, the parliamentarians themselves largely reappeared under a new organizational guise. Shabad and Slomczynski (Reference Shabad and Slomczynski2002) document the emergence of career politicians in Poland, showing that an increasing proportion of the candidates for office have competed in prior elections (Shabad and Slomczynski Reference Shabad and Slomczynski2002: 342). Career politicians thus preserve the value of ties between business leaders and political actors even if old party organizations are replaced by new ones.

This is contrasted with low uncertainty, in which it is much easier to identify the dominant political force because the levels of political competition are lower. For example, in Romania not only was there a dominant party³ but the recruitment of political elites was highly centralized (Gherghina, Chiru, and Casal Bértoa Reference Gherghina, Chiru and Casal Bértoa2011). According to Chiru and Gherghina (Reference Chiru and Gherghina2012: 511), for more than two decades major Romanian parties (they examine five) have displayed an “uninterrupted oligarchic inertia,” in which parties have highly centralized leadership selection and removal procedures with low party membership and little member involvement.

The view that uncertainty drives elites toward better policy making is echoed by other post-communism scholars. For example, Grzymała-Busse (Reference Grzymała-Busse2007) finds that high levels of competition limit corrupt behavior by political parties. When opposition parties offer a viable alternative, parties resist opportunities for private gain and instead move forward with reform agendas such as institution building and privatization. Similarly, O’Dwyer (Reference O’Dwyer2006) finds that high levels of competition reduce opportunistic moves by political parties to expand the size of the state bureaucracy. And Horowitz, Hoff, and Milanovic (Reference Horowitz, Hoff and Milanovic2009: 118) find that more government turnover is associated with higher levels of the development of the rule of law.

In both the case studies and the quantitative analysis that follow, political uncertainty is the key form of uncertainty that affects political and economic actors. Political uncertainty specifically is generated by the difficulty of predicting alternation across the dominant left–right (post-communist/anti-communist) cleavage. This corresponds to what Horowitz, Hoff, and Milanovic (Reference Horowitz, Hoff and Milanovic2009) refer to as “ideological turnover.” This is differentiated from leadership turnovers: a shift in the majority coalition of political parties that does not necessarily imply a shift across the ideological divide. I choose the term “ideological turnover” because it better captures what firms are actually concerned with: that another ideological option to which a firm has no access will come to power. Firm–party networks are often a legacy of the pre-1989 period, and the contacts of business owners often run to a broad group of either post-communist or anti-communist political elites (McMenamin and Schoenman Reference McMenamin and Schoenman2007). As also becomes clear in the case studies, ideological turnover matters because the ideological divide is a key factor shaping the personal networks linking economic and political elites.

Ideological turnover is, thus, closer to the argument being made here than regular government turnover. The purpose here is to capture the extent to which changes in party personnel in positions of power limit a firm’s ability to extract rents and favors. Despite the emergence of a new coalition, when a government turnover is not also an ideological turnover, the same actors have often been reshuffled into a new leadership coalition.

Without an ideological turnover, the networks of firms to power holders might not be disrupted because leadership turnovers can be the equivalent of rearranging “the thrones of heaven, or the deck chairs on the Titanic, as the case may be” (Horowitz, Hoff, and Milanovic Reference Horowitz, Hoff and Milanovic2009: 110). In fact, they find that ideological turnovers have a slightly stronger effect on the development of the rule of law than leadership turnovers, reasoning that the latter may allow for more continuity of corrupt contacts (Horowitz, Hoff, and Milanovic Reference Horowitz, Hoff and Milanovic2009: 121). Thus, for my argument, ideological turnovers are clearly more relevant.

One question to be answered is how ties between parties and business can be maintained in competitive democracies. Why do citizens not mobilize to disrupt the alliance between business and political parties, withdrawing their votes from parties that are seen as self-serving and serving the interests of business allies rather than those of voters? Kopecky (Reference Kopecky2006) notes that political parties have traditionally been studied and classified by their connection with societal actors and the representative function they performed. Thus, an earlier literature on parties compared them on the basis of patterns of representation (worker’s party, peasant party, religious party) and organizational form (cadre party, mass party, catch-all party). This approach to political parties reflected an era when the key function of parties was to represent societal actors.

In the post-communist context, however, political parties have ceased to function primarily as representative actors. In fact, the decline of the party–society linkage across Europe is well documented in the literature (Katz et al. Reference Katz, Mair, Bardi, Bille, Deschouwer, Farrell, Koole, Morlino, Müller, Pierre, Poguntke, Sundberg, Svasand, van de Velde, Webb and Widfeldt1992; Mair and van Biezen Reference Mair and van Biezen2001; Kopecky Reference Kopecky2006; van Biezen and Kopecky Reference Van Biezen and Kopecky2007; Dalton Reference Dalton2008; Whiteley Reference Whiteley2011; van Biezen, Mair, and Poguntke Reference Van Biezen, Mair and Poguntke2012). Evidence of this in the post-communist world is seen in the comparatively low levels of popular party identification, strikingly high levels of electoral volatility – the net change in the popular vote across consecutive elections (Lewis Reference Lewis2002; Birch Reference Birch2003; Bielasiak Reference Bielasiak2005; Sikk Reference Sikk2005), low levels of party membership, declining voter turnout, and weak links between parties and collateral organizations (Dalton and Wattenberg Reference Dalton and Wattenberg2000; Bielasiak Reference Bielasiak2002; van Biezen Reference Van Biezen2003; van Biezen and Kopecky Reference Van Biezen and Kopecky2007).

Numerous reasons are cited in the literature to explain this lack of embeddedness in post-communist civil society. Some have argued that the legacy of repression and forced political mobilization under communism has left post-communist citizens reluctant to become involved with political organizations and skeptical of the political realm (Kitschelt Reference Kitschelt1992; van Biezen and Kopecky Reference Van Biezen and Kopecky2007). Alternatively, in what is known as the “tabula rasa” approach, citizens are a seen as blank slates shifting from party to party as they try to make sense of a confusing landscape of new political organizations, learn about political participation, and understand their own interests in an unfamiliar and complex economic system (Kitschelt Reference Kitschelt1992; Sztompka Reference Sztompka1992; Sztompka Reference Sztompka1993). In addition, economic interest did little to create stable alliances to parties during the transition, as voters were faced with an array of mainstream parties proposing pro-market economic programs imposed by international economic pressure (Brada Reference Brada1996; Kochanowicz Reference Kochanowicz1997; Ost Reference Ost2006). Parties in some countries, such as Poland, also leaned toward making broad appeals to voters instead of narrowly targeting socio-economic groupings, thus undermining the sense that a particular party speaks to a specific group (Szczerbiak Reference Szczerbiak1999).

What is clear from this debate is that the attachment of voters to parties in the post-communist world is remarkably unstable. On the supply side, voters are faced with the frequent entrance of new parties and movements wooing voters (Tavits Reference Tavits2008). On the demand side, voters are shifting alliances from party to party, although not necessarily to new entrants (Sikk Reference Sikk2005). Nevertheless, voter volatility has continued to rise well into the second decade of transformation after multiple elections, by which time we would expect voter preferences to have settled (Innes Reference Innes2002 ). While Tavits (Reference Tavits2005) argues that party systems are slowly moving toward stability, on the basis of a decreasing trend in volatility after an average eleven years of democratic transition, Epperly (Reference Epperly2011: 2) finds that “the passage of time is not consistently associated with decreasing levels of volatility,” based on a data set covering a longer period. Regardless of who is correct, both support the view that the voter–party linkage is too weak to interrupt exchanges between interest groups and politicians.

This is not to say that some parties have not made progress in developing connections to constituents. In fact, some differences can be observed in the extent to which programmatic parties have emerged and created ties to societal groups across the post-communist world. The difference, however, is between modest progress in countries such as Poland and Hungary and the poor record of parties in most other countries in post-communist Europe. Moreover, as Innes argues, the impression of stabilization in countries such as Poland and Hungary given by “rational choice” approaches to the study of parties in post-communism is misconstrued. Even in these countries, where there has been a noticeable shift toward programmatic competition among parties, party systems remain “peculiarly vulnerable” (Innes Reference Innes2002: 101). In this context of region-wide weak ties to societal constituencies, it does not make sense to view post-communist parties as an outgrowth of societal interest groups (van Biezen and Kopecky Reference Van Biezen and Kopecky2007). Because this linkage is absent, we also should not expect party–society ties to perform the usual function of disciplining parties in their behavior. In other words, the role traditionally assigned to civil society in a democracy is undermined (Katz and Mair Reference Katz and Mair1995; Scarrow Reference Scarrow1996; Dalton and Wattenberg Reference Dalton and Wattenberg2000; Bartolini and Mair Reference Bartolini, Mair, Diamond and Gunther2001; Detterbeck Reference Detterbeck2005). As a result of the absent society–party linkage, parties are driven to form other bonds in the direction of the state (Kopecky Reference Kopecky2006; Meyer-Sahling Reference Meyer-Sahling2006; van Biezen and Kopecky Reference Van Biezen and Kopecky2007). As Kopecky (Reference Kopecky2006) explains, in post-communist eastern Europe “political parties are weakly anchored in society while at the same time they have strongly penetrated the state.” Consequently, in analyzing parties, these authors argue for a shift of attention from the party–society linkage to the party–state one. They point out that political parties and the state are linked through a series of channels: the flow of campaign finance funds from the state to parties is the most visible. Patronage resources such as appointments in the state bureaucracy and state-owned or partially privatized firms also flow from the state to political parties, however. Control of these resources through the appointment of party personnel to the boards of firms is another key manner in which the state–party linkage is reinforced. Building on a paper by Kopecky (Reference Kopecky2006), van Biezen and Kopecky (Reference Van Biezen and Kopecky2007) propose that the nature of the party–state linkage can be assessed on three key dimensions: the public funding of parties, the public regulation of parties, and party rent seeking. These three dimensions reveal some of the substance of the linkage between party and state. The public funding of parties is an indicator of the dependence of parties on the state for financial resources. Public funding is widespread in the region. Szczerbiak finds that it clearly favors “insiders” and has been increasing in amount in Poland since the establishment of state financing in 1993 (Szczerbiak Reference Szczerbiak2006).

The public regulation of parties is seen as a reflection of the increasing perception that parties are a necessity and that their role must be defined and specified in the law and, increasingly, directly in the constitution. Van Biezen (Reference Van Biezen2004) argues that this has transformed parties from voluntary associations emanating from society to a kind of “public utility” to be regulated and managed by the state. The constitutionalization of parties is an extreme form of the institutionalization of parties (van Biezen and Kopecky Reference Van Biezen and Kopecky2007).

Finally, party rent seeking is an indicator of the extent to which parties dominate and have penetrated the state. Of the three dimensions, this is perhaps the most commonly associated with post-communism and the widespread political corruption that has been a central part of post-communist political development.

Kopecky finds that public financing is widespread, public regulation of parties is extensive throughout the region, and party rent seeking is also common. Meyer-Sahling (Reference Meyer-Sahling2006), in fact, shows that attempts by governing parties in Hungary to penetrate the state and politically staff the bureaucracy, commonly referred to as politicization of the state, have increased over time and are not just a feature of early post-communism.

The above dynamics support a focus on the interaction of economic actors and politicians. I thus propose that uncertainty and network structure together define potential future costs for individuals or firms calculating the payoffs of strategic behavior. In other words, the availability of networks and the level of political competition determine the ability of businesspeople and politicians to calculate the probable shape of the future and make decisions about collaboration. As uncertainty rises, businesspeople have a harder time predicting who will lead the next government. Thus, uncertainty shortens time horizons. It does not mean, however, that parties know they won’t be in power again (it is only post hoc that we know this). In an attempt to increase their chances at the polls, parties turn to business for support. Under broad networks, politicians and businesspeople are able to forge deals because monitoring, information flows, and credible commitments are facilitated and parties have the credibility needed to raise broad support. Defecting on deals under broad networks will undermine the future ability of parties to turn to business. Networks offer informational, binding, or commitment opportunities. They determine the balance of relations between polity and economy, and influence the ability of individuals to calculate likely future scenarios. The breadth of networks among economic actors (firms and their proxies) and between business and political elites thus affects the predictability of the future. Broad networks allow information to flow and provide a structure of mutual credible commitments, but they also include more and heterogeneous actors. The resulting deals are likely to represent broader demands. Narrow networks have the opposite effect.

The combinations of network structure and uncertainty and the resulting state type are summarized in Table 1.1. I present below the characteristics of the resulting trajectories of institutional development.

1. (1) When networks are broad and uncertainty is high. In this context, political and economic elites are engaged in a process of concertation, and the state broadly functions as a coordinating body by channeling information, mediating among interests, and potentiating network ties. In these contexts, concertation states develop mutually beneficial institutional solutions for competing factions over the long term.

2. (2) When networks are narrow and uncertainty is low. In this context, political elites dominate economic elites. The resulting patronage states award selective benefits to allies on a case-by-case basis.

3. (3) When networks are narrow and uncertainty is high. In this context, economic elites dominate political elites. This combination of features gives rise to captured states, which are colonized by and helpless in the face of strong societal actors.

4. (4) When networks are broad and uncertainty is low. This combination describes an embedded corporatist state in which groups of well-established political elites do not face the disciplining effects of uncertainty and they co-opt business through broad networks. Although this type is logically possible, the combination of low uncertainty and broad networks does not appear among the cases covered here and is unlikely in contexts with competitive elections.⁴

The different dynamics that took hold between business, parties, and the state are brought to life in the statements of business leaders and officials. A Polish businessperson described the relationship as one driven by “wspolny interes,” mutual interests: “Mutual interests are the basis of interaction with parties and the state. It is not about the general interest but self-interest so it would be difficult to say that politicians are on the side of business or anyone else. They each solve their own problems.” Business leaders also spoke of this relationship as a collaborative one, however, looking to the state as a partner “with which you can do something together.” This combination of self-interest and partnership defined the Polish dynamic, and contrasts sharply with the other two cases.

Noting the influence of narrow interests, a Romanian business leader said, “The biggest challenge for Romanian big business today is the bureaucracy, but not just the bureaucracy but the input of special interests into this bureaucracy. And the relations and sweet deals that come out of it.” These relations developed in the context of top-down party–business relationships in which parties held the upper hand; as another business leader pointed out, “The idea of party leaders running around to gather money is wrong. There is more money available in the grey and black economy than can be spent.” And, as will be discussed later in this book, numerous interviewees noted the absence of any coherent business community.

In Bulgaria, the opposite dynamic took hold. Remarking on the inability of the state to govern business and the consequent explosion of corruption, an official said, “There were too many sharks in too small a lake, which the state cannot cope with.” Describing the power and reach of business over the state as an unofficial lobby, another offical observed, “The lobby that these business groups own involves not only senior people but also lower levels of the state.”

Conclusion

This chapter has advanced an argument that is distinct from much of the literature on the political economy of institutional development. Existing scholarship focuses on the extent of democratization and popular opposition, the speed of reform, and the role of legacies. I take a different view: that institutional development is essentially a collective dilemma facing political and economic elites. To this end, the developmental state and varieties of capitalism literatures both offer insights into the way that these two sets of elites view economic institutions and the process by which these two groups can work toward socially beneficial outcomes. I draw on both lines of scholarship to construct a theory that also incorporates the untreated variables of networks and political uncertainty. Bringing political competition over economic resources to the fore, I extend and develop both literatures to contexts that are democratic but not in the advanced industrialized world. The result is a theory that conceptualizes the moves of political and economic elites and their success in realizing mutually beneficial outcomes.