12 March 2008

Enterprise Groups: Notes

This post is dedicated to notes from Aoki & Patrick (1994; see "Sources" below). Note the book is now 14 years old and it's mainly of historical interest, since the Japanese financial system has experienced such drastic transformation since. For future reference, I have used the terms "business group" and "enterprise group" interchangeably.

The enterprise group (held together largely by the financial system) is not merely a Japanese phenomenon:
In Korea, for instance, the top thirty business groups, known as chaebols, accounted for 40 percent of Korea's output in the mining and manufacturing sectors and 14 percent of GNP in 1996. In Thailand, Malysia, Singapore, and Taiwan, business group affiliates [...] that were listed on these countries' stock exchanges accounted for 24.3, 24.9, 39.6, and 56. percent, respectively, of those exhanges' total market capitalization in 2002. Further, many East Asian business groups have a significant international presence.
(Chang, 2006-p.1)
My interest in business groups (or enterprise groups) arises from their great importance in economies outside of the USA. Except for the USA and a few other countries, enterprise groups have been the predominant means of business organization.

Since the 1997 Asian Financial Crisis, the Japanese galaxy of enterprise groups has been severely disrupted.1 Likewise, several of Korea's major chaebols have been sharply reduced in size and cohesion.2

However, outside of Japan and Korea, enterprise groups have been paramount to national development strategies.3 In most cases, this seems to reflect later "globalization" of the economy: while Japan went through a century-long period in which its economy was dominated by enterprise groups, it has now been a global trading nation for even longer and enterprise groups are in decline. Korea, likewise, experienced five decades of enterprise group-dominated development, which is gradually winding down. China's enterprise group experience dates back to 1987. India has long experience with enterprise groups, but South Asia is generally a special case; Russia's "oligarchs" are defined by their mastery of large industrial agglomerations similar to business groups.4

Japan and Korea (and Taiwan?) as B-Group Killers
While the most famous and powerful business groups in the world are from Korea, Japan, and Taiwan, several defining features of their host countries made them particularly vulnerable to reform. One was technical sophistication of the economies: Japan and Korea, dominated by high-tech industries, require transparent administration. The USSR could function with both a space program and opaque business governance because it didn't export consumer goods into competitive markets, and because it had vast natural resources. In some cases, a highly disciplined management and labor force can do without transparency, but eventually the bad decisions become insuperable.

In the 1980s, serious literature on the Japanese "miracle" acknowledged a distinction between effectiveness and efficiency: Japanese enterprise seemed capable of absolutely anything, provided cost was no object--and it never was. It was effective, but burned through resources. The export sector, in particular, was reliant on an indirect subsidy from the rest of the economy (in the form of a severely undervalued yen). In 1986-87, this subsidy was abruptly withdrawn, but instead of "market pressure" maneuvering Japan's economy away from exports, enterprise management "tried harder" against unfavorable winds. It broke into more technically demanding sectors by substituting capital for labor. Eventually the strain was more than Japan's industrial system could manage.5

The effect of endaka on Japan's kigyō shūdan was complex. First, Japanese firms were compelled to adapt to remain competitive, and most did--heroically.6 In other words, the firms became even better at their old jobs than they had ever been. It was the financial engineering required to make this possible that instigated the bubble.

Second, the firms faced with the bubble and the challenges it posed performed quite differently from each other. The onset of endemic financial distress (and great financial successes) placed fresh strains on the informal mutual assistance arrangements of the kigyō shūdan, while punishing keiretsu whose leading firms were loyal to 2nd and 3rd tier members. In effect, companies like Sharp, Sony, and Matsushita (which tended to keep production in Japan) lost out to companies like Mitsubishi Electric and Hitachi.7 And the informal mutual assistance arrangements of the Japanese economy tended to become more obvious as they were strained. They were more vulnerable to WTO complaints lodged by major trade partners.

Third, the financial system bore an unusually large share of the damage from the economic crisis.

  1. Lincoln & Gerlach (2004), Chapter 6; Lincoln & Shimotani (2009) is available online. The literature (including my article on enterprise groups) sometimes distinguishes between kigyō shūdan (horizontal enterprise groups) and keiretsu (vertical enterprise groups). Lincoln & Gerlach analyze the evolution and structure of the entire enterprise groups as interlocked. The decline of the vertical component was correlated with the decline of the horizontal one.
  2. Kim, Hoskisson, Tihanyi, & Hong (2004); Lee (2008). Chaebols in the Republic of Korea have never been comparable in size to the kigyō shūdan of Japan; they are closer in size (measured by assets, turnover, or employees) to keiretsu. Informal estimates suggest that the "enterprise group sector" in both Japan and Korea was about 40% of GDP, and this represented a more passive component of enterprise. For example, group affiliates were more risk averse (Lincoln & Gerlach, 2004, "The Structural Analysis of the Network Economy").
  3. For example, in Taiwan, see Chung (2003); Chung, incidentally, cites a far higher estimate of GDP-share for chaebols in the Republic of Korea (p.6) than the one I gave in the previous footnote. Here I will only say that I strongly suspect the lower figure is more accurate. For China, see Ma & Lu (2005) & Huang (2008), who also mention that qiye jituan in the PRC are almost entirely agglomerations of state-owned enterprises (SOEs).
  4. For enterprise groups in India, see Chakrabarti, William L Megginson, & Pradeep K Yadav (2007); for the Russian oligarchs, see Guriev & Rachinsky (2005). The first paper is critical of India's overall business climate, but concludes that business groups facilitate access to credit. The second makes surprisingly favorable judgments of the performance of oligarch-controlled enterprise.
  5. R. Taggart Murphy, The weight of the Yen: how Denial imperils America's Future and ruins an Alliance, W. W. Norton & Company (1997), "Coping with Endaka," esp. after p.198. "Endaka" is Japanese for "expensive yen," which it had become after 1986-87.
  6. Chikara Higashi, Geza Peter Lauter, The internationalization of the Japanese economy, Springer, (1990), "Endaka or the High Yen," p.184. Note the date of publication. Higashi & Lauter were impressed by managers' use of zaitech (financial engineering) to finance the massive technical investments required to do this.
  7. Megumi Oyanagi, "Japanese Global Electronic Companies – Why Winners and Losers?" Those in Media blog (2012). Readers will notice an anachronism here--Ms. Oyanagi was writing about winners and losers in 2011, whereas I am alluding to 1988-1995. But the general idea applies.

Sources & Additional Reading
" , Business History, Vol.51 (1): 77-99 (2008). Tests three alternative (and non-exclusive) motivations for the transformation of Chinese state-owned enterprises into business groups.

  • Sook Jong Lee, "The Politics of Chaebol Reform in Korea: Social Cleavage and New Financial Rules" , Routledge (2008)

  • James R. Lincoln & Michael L. Gerlach, Japan's Network Economy: Structure, Persistence, and Change, Cambridge University Press (2004). This is an exhaustive statistical analysis of Japanese enterprise structure during the high-water mark of the kigyō shūdan (1964-1997). One interesting feature (not discussed here) is the use of blockmodel (network clustering) analysis to determine the connectedness and benefits of various enterprise groups.

  • James R. Lincoln & Masahiro Shimotani, "Whither the Keiretsu, Japan's Business Networks? How Were They Structured? What Did They Do? Why Are They Gone?" Clans for Markets: the Social Organization of Inter-Firm Trading Relations in China's Automobile Industry
  • " ,Korea Institute for International Economic Policy, Seoul National University (August 2006)

  • Xufei Ma & Jane W. Lu, "The critical role of business groups in China" , Ivey Business Journal (May/June 2005)

  • Sea-Jin Chang, Business Groups in East Asia: Financial Crisis, Restructuring, and New Growth, Oxford University Press (2006)
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