Financial globalization and crony capitalism

Many economic transactions are characterized by asymmetric information; that is, one of the parties is more aware of or has more control over the circumstances and performance of the transaction than the other party has. This is particularly true when money is lent. The borrower typically has a better idea of and more control over what the money will be used for, and the risks involved in that use, than the lender does. Any transaction that involves the extension of credit or the expectation of future performance by one party may have similar characteristics. Asymmetric information can inhibit transactions if lenders believe that borrowers will typically behave in opportunistic fashion and exploit their informational advantage. At worst, the financial system could be dysfunctional and economic development could be retarded.

This problem is handled in different ways in different cultures. A traditional, closed society with a high degree of cultural homogeneity might develop a widely shared sense of solidarity and "fair play" that would inhibit opportunistic behavior. A more pluralistic society might develop a system where networks of people who are related by ethnicity, family, religion, class, school ties, or some other bond would deal preferentially within the network, excluding those outside the network. We might call this "crony capitalism." Large, modern pluralistic societies might develop elaborate means for reducing the incentives for opportunism, requiring borrowers to make large down payments, put up collateral or performance bonds, hold compensating deposits, and so on. Such contracts can become very complicated, and elaborate legal process is usually available to enforce their terms. We could call this the "litigious society."

Which of these approaches a society adopts will depend a great deal on its size and degree of heterogeneity in culture, religion, and race. It will also depend on the widely shared ideological and religious values within that society.

Crony Capitalism

Opportunistically taking advantage of people, especially in a business relationship, is something that usually will work only once. "Fool me once, shame on you; fool me twice, shame on me." Having an ongoing relationship between business partners is a deterrent to the abuse of asymmetric information, because sacrificing the relationship forecloses too many future opportunities for profitable deals. When a relationship is multi-dimensional, there are many avenues open for retaliation against a business partner who behaves badly. This is the most obvious when family relationships are involved. Families have non-economic ways of punishing opportunistic behavior. Favoring family means you tend to be dealing with people whose character you understand, whom you will deal with repeatedly in economic and non-economic contexts, and who have a moral loyalty to you because of the family connection. So in the family context, opportunism is less likely than it would be with strangers. The elaborate means we in the West use to thwart opportunism are less necessary where the loyalty of family can be assumed. However, a family orientation may inhibit the formation and institutionalization of large-scale industrial enterprises, as Fukuyama suggests (1995, ch. 7). But even when large corporations are involved, the Asian practice of preferential dealing within "families" of companies affords this kind of protection. The traditional practice of "relationship banking" in the Western world indicates that the advantages of "crony" relationships are not lost on lenders in the West, either.

The "crony capitalism" approach to asymmetric information is consistent with, and reinforced by, some aspects of Asian and Islamic cultures. Of course, all of these cultures have traditions that call for hospitality toward strangers and guests, but there is a firm line drawn between insiders and outsiders.

In the Islamic world, outsiders were traditionally labeled "infidels"; to the Chinese they were "barbarians." Bernard Lewis's book (2002) about the encounters between the Islamic world and the West make it clear that there was enough hostility and suspicion on both sides to make the relationship difficult from the start, but it is tempting to conclude that "What went wrong" in the Islamic world was the failure to embrace the non-discriminatory principle that Westerners value so highly. Many Western observers tend to think that the economic development of those countries is inhibited by the tendency not to deal with outsiders. Other analysts would point to the history of Western hostility towards Islam as providing plenty of justification for Muslims to be wary in dealing with the West.

Chinese economic culture represents another example. The Chinese are famous for favoring those with family connections in their economic dealings. Many observers have credited this aspect of their culture for the great commercial success of Chinese communities around the world (Lodge 1995, Fukuyama 1995, chs. 8 and 9). This "family values" approach to commerce has also led to tremendous resentment of the expatriate Chinese, because of the way it closes off economic opportunity to non-Chinese, even natives in their own country. This approach may play a role in both the recent success of the economy of China, as well as the difficulty in incorporating China into the WTO. National treatment of exporters of financial services has been particularly difficult to achieve with China (and other Asian economies), perhaps because this is exactly where asymmetric information is most problematical, and therefore favoritism is likely to play the largest role.