Published on 12 January 2023
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Asia and the power of connections

The extraordinary economic growth of a number of Asian economies in the second half of the 20th century came about thanks not only to activist governments but also to the organisation of major business groups. But this driver of past success will be a drag on future growth unless governments introduce new policies to change the way the business groups operate, say Simon Commander and Saul Estrin.

Close ties between the major business groups – such as South Korea’s chaebols or qiye jituan in China – and political elites are ubiquitous in Asia. The business groups tend to be family-owned, diversified and non-transparent in their operations. The business group format has some important advantages, such as helping with raising money for investment or developing a skilled managerial cadre. But it also facilitates opaque corporate governance, weak minority shareholder rights and a raft of undesirably close relationships with politicians.

Moreover, these business groups have leveraged their connections to build substantial market power and, through their diversification, a tight grip across the economy as a whole. One measure of the latter is the extent of concentration defined by the revenues of the largest companies – most of whom are either business groups or state-owned companies – relative to GDP: overall concentration. For the largest five firms, that ratio (CR5) in South Korea and Vietnam exceeds 30% and even in very large economies – India and China – exceeds 10%. For the ten largest firms (CR10), in South Korea it exceeds 40% and in India and China tops 15%. In fact, overall concentration ratios are high throughout Asia and are in sharp contrast, for instance, to the US where the shares are 3% and 4% respectively.  Moreover, such market concentration and the role played by powerful business groups stands in the way of creative destruction by tying up resources that allow inefficient firms to survive, while restricting new entrants.

Asia’s high levels of market and overall concentration have clearly not been a barrier to growth in the past half-century. But the constraints on competition and, particularly, the brake on innovation that has resulted does now threaten Asia’s prospects. Yet, neither businesses nor politicians have sufficient incentives to deviate from the mutually rewarding relationships that have spawned these characteristics.

Unravelling the Connections World

In our recent book, The Connections World: The Future of Asia, Cambridge University Press, 2022, we therefore argue that Asian governments need a new policy approach to drive future economic progress. What can be done to loosen the chokehold of the Connections World and bring about greater competition along with more entry and exit of companies? A starting point must be to lower the attraction of the business group format.  Business groups are typically not a significant phenomenon in developed market economies and the main reason has been policies to prevent their operation.

Probably the most radical approach was taken in the US in the 1930s where Roosevelt pushed through policies that effectively eliminated the business group format. Limits were placed on the number of levels or tiers in ownership pyramids, higher taxes were imposed on inter-group dividends, consolidated group tax filing was eliminated, and constraints imposed on financial institutions acting as controlling shareholders and on business groups controlling public utilities. But this was done at a time of economic depression and with a public backlash against big business. It is not likely that anything so sweeping would be feasible in contemporary Asia. Rather, a combination of incremental policies addressed to corporate governance, taxation and market structure have far more chance of success.

Corporate governance

Asian business groups, with few exceptions, have highly non-transparent corporate governance. And for a reason. It facilitates the dominant (mostly oligarchic) owners exerting control, mostly at the expense of minority shareholders. Improving protection of minority shareholders by giving them legal rights to call shareholder meetings and to limit the dilution of their shareholdings can begin to address this imbalance. An important mechanism for accumulating market power and distorting resource allocation is the use of inter-group loans and financial transfers, typically in a non-transparent way. This could be reduced by requiring the publication of plans for related party transactions and ensuring that minority shareholders have a say in such transactions. For instance, this could be done by voting at shareholder meetings and veto rights over sales of additional shares could be made mandatory.

Then there are possible changes to how businesses are permitted to configure themselves, to reduce the number of levels permitted in business group pyramidical structures, as also their number of subsidiaries. In addition, policies to restrict cross-shareholdings and constrain the use of holding companies, have been adopted in some countries, such as South Korea, though as yet these measures have been relatively unsuccessful. An alternative approach, effectively introduced in Israel, has been simply to give business groups a limited time in which to reduce their pyramids to no more than two layers, while also banning large companies from controlling both financial and non-financial entities.

Tax policy

Using tax policy to influence how a business is organised is another option, although this has also proven difficult to implement effectively. Although in principle higher taxation of dividends could restrict inter-group transfers, most Asian business groups do not rely on dividends for these purposes, using loans and transfer pricing instead. However, imposing additional tax liabilities over and above normal corporate tax rates on closely-held family businesses (excluding, however, young entrepreneurial family firms) is a more promising avenue. By targeting the business entity, the value of any control premium is effectively attributed and taxed to all the relevant members of the family.

A further tax intervention likely to be effective is the adoption of inheritance taxes. The South Koreans have recently introduced a 50% inheritance tax rate. The effective tax rate in 2020 on the value of the deceased Chairman of the Samsung Group shares amounted to over 58%; some $10 billion. This has led the current Chairman to announce that he does not intend to hand over management to his children. Over time, inheritance taxation is likely to prove a more effective way of curtailing family business groups than the raft of measures on cross holdings and other institutional formats that have been tried.  It will also help address the high levels of wealth inequality throughout Asia

Competition policy

A formal competition policy and associated regulations concerning mergers and bankruptcy are in place in most Asian countries.  But even when the relevant structures are in place, the implementation of competition law has been erratic and sometimes captured by the very actors it is meant to control. Further, Asian authorities need to move beyond evaluating small changes to market structure. Following Israel’s experience in the 2010s, policy should explicitly consider overall levels of market concentration. One way to do this is to set limits on the maximum market share that a firm or business group can hold – say to 30% – and then require existing firms to be broken up to ensure the thresholds are not exceeded, sector by sector. Although this sort of approach would be more stringent than in most advanced economies, the starting point in Asia is one where there is far more market power vested in a limited number of business groups.

Raising transparency

Of parallel importance is how to apply pressure on politicians and political parties to limit their scope for leveraging connections with business. This involves increasing transparency while also creating a workable system of enforcement. As experience shows, these are hard to achieve even in democracies.  For example, greater media transparency, whilst inherently desirable, has proven woefully insufficient for reining in politicians’ self-seeking behaviour.

Still, there are steps that can be taken. For instance, rules regarding political contributions can be tightened. Except for South Korea, no other Asian country has a ban on contributions by companies to political parties. Likewise, there are few, if any, restrictions on the amount that can be donated to politicians whether by individuals or corporates.

Compulsory asset and interest declarations also have a role to play. Although many Asian countries do notionally mandate such declarations, much depends on how such reporting is designed let alone implemented. Registers of interests – individual and familial – with differing degrees of intrusiveness can be used for parliamentarians and Ministers. Pushing for greater automatic disclosure along with easy and wide access to that information is crucial. That needs to be accompanied by parallel measures aimed at limiting corruption in public spending decisions, including contract assignment. At the same time, some countries have achieved traction by setting up dedicated anti-corruption agencies – for instance, Indonesia’s KPK – that are tasked with pursuing corrupt practices and have sufficient autonomy and political support to take on sensitive cases. 

Asia’s enormous and sustained growth has come about thanks to concentration in resources, assets and market power. The paradox is that those same features have created an organisational and political structure that will be deleterious to the region’s prospects in the next phase of its development – unless the policy framework adapts.

Image: A network map of politics and business links or connections in China. The large red node at the centre of the map is the Chinese Communist Party, black represents the individual, maroon represents a party, blue represents a state-owned enterprise (SOE), and the green represents a firm.

Book: The Connections World: The Future of Asia by Simon Commander and Saul Estrin, Cambridge University Press, 2022


Simon Commander

Simon Commander is Managing Partner of Altura Partners and Visiting Professor of Economics at IE Business School in Madrid.

Saul Estrin

Saul Estrin is Professor of Managerial Economics at LSE and previously Professor of Economics and Associate Dean at London Business School. 

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