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A Comparative Study of East Asian Capitalism
 155729108X, 9781557291080

Table of contents :
Notes to this edition
Title Page
Copyright Page
1. Précis - Hong Yung Lee
2. Convergence and Divergence: Three Paths toward Modernization in East Asia - Hong Yung Lee
3. Government Intervention for Resolving Non-Performing Loans in Japan and South Korea, 1998–2006 - Myung-koo Kang
4. Financial Reform in China: The Chinese Style of Marketization - Hong Yung Lee
5. The Double Movement and New Labor Market Regulations in Korea, Japan, and Taiwan - Ji-Whan Yun
6. Moving toward a Hybrid System in Japan: The Case of Corporate Governance Reform - Hideaki Miyajima and Yul Sohn
7. Corporate Governance Reform in Korea in the Post–Asian Financial Crisis Era - Joongi Kim
8. The Evolutionary Path of Corporate Governance in China: The Interdependent Model of State-Owned Enterprises and Private Enterprises - Pingqing Liu, Junxi Shi, and Fengxia Jiang
9. Multiple Institutional Templates for Corporate China: The Evolution of Industrial Networks during Marketization - Lowell Dittmer and Kun-Chin Lin
10. The Changing Face of Network Capitalism in Korea: A Study of the Corporate Board of Directors’ Network - Yong-Hak Kim and Yong-Min Kim
11. The Political Economy of Informal Networks in Japan and South Korea: Amakudari vs. Parachute Appointment - Seungjoo Lee and Sang-Young Rhyu
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Notes to this edition This is an electronic edition of the printed book. Minor corrections may have been made within the text; new information and any errata appear on the current page only. Research Papers and Policy Studies 46 A Comparative Study of East Asian Capitalism Hong Yung Lee, editor ISBN-13: 978-1-55729-167-7 (electronic) ISBN-13: 978-1-55729-108-0 (print) ISBN-10: 1-55729-108-X (print)

Please visit the IEAS Publications website at http://ieas.berkeley.edu/publications/ for more information and to see our catalogue. Send correspondence and manuscripts to Katherine Lawn Chouta, Managing Editor Institute of East Asian Studies 1995 University Avenue, Suite 510H Berkeley, CA 94720-2318 USA [email protected]

May 2015

A Comparative Study of East Asian Capitalism


A Comparative Study of East Asian Capitalism

Edited by Hong Yung Lee

A publication of the Institute of East Asian Studies, University of California, Berkeley. Although the institute is responsible for the selection and acceptance of manuscripts in this series, responsibility for the opinions expressed and for the accuracy of statements rests with their authors. The Research Papers and Policy Studies series is one of several publication series sponsored by the Institute of East Asian Studies in conjunction with its constituent units. The others include the China Research Monograph series, the Japan Research Monograph series, and the Korea Research Monograph series. Send correspondence and manuscripts to Katherine Lawn Chouta, Managing Editor Institute of East Asian Studies 2223 Fulton Street, 6th Floor Berkeley, CA 94720-2318 [email protected] Library of Congress Cataloging-in-Publication Data A comparative study of East Asian capitalism / edited by Hong Yung Lee. pages cm. -- (Research papers and policy studies ; 46) Includes bibliographical references. ISBN-13: 978-1-55729-108-0 (alk. paper) ISBN-10: 1-55729-108-X (alk. paper) 1. Capitalism--China. 2. Capitalism--Japan. 3. Capitalism--Korea (South) 4. China--Economic policy--2000- 5. Japan--Economic policy--1989- 6. Korea (South)--Economic policy--1988- I. Lee, Hong Yung, 1939HB501.C713 2013 330.12’2095--dc23 2013039896

Copyright © 2014 by the Regents of the University of California. Printed in the United States of America. All rights reserved. This book is the result of a project of intellectual cooperation and collaboration between Yonsei University and the University of California, Berkeley. The editor gratefully acknowledges financial support received from Yonsei, Berkeley, and the Korea Foundation for Advanced Studies. Cover design by Spoon+Fork.





Précis Hong Yung Lee Convergence and Divergence: Three Paths toward Modernization in East Asia Hong Yung Lee




4 5

Government Intervention for Resolving Non-Performing Loans in Japan and South Korea, 1998–2006 Myung-koo Kang Financial Reform in China: The Chinese Style of Marketization Hong Yung Lee The Double Movement and New Labor Market Regulations in Korea, Japan, and Taiwan Ji-Whan Yun

45 78




Moving toward a Hybrid System in Japan: The Case of Corporate Governance Reform Hideaki Miyajima and Yul Sohn Corporate Governance Reform in Korea in the Post–Asian Financial Crisis Era Joongi Kim





The Evolutionary Path of Corporate Governance in China: The Interdependent Model of State-Owned Enterprises and Private Enterprises Pingqing Liu, Junxi Shi, and Fengxia Jiang Multiple Institutional Templates for Corporate China: The Evolution of Industrial Networks during Marketization Lowell Dittmer and Kun-Chin Lin



PART Iv. NETwORKS 10 The Changing Face of Network Capitalism in Korea: A Study of the Corporate Board of Directors’ Network Yong-Hak Kim and Yong-Min Kim 11 The Political Economy of Informal Networks in Japan and South Korea: Amakudari vs. Parachute Appointment Seungjoo Lee and Sang-Young Rhyu




Lowell Dittmer, Professor, University of California, Berkeley Fengxia Jiang, Assistant Professor, Beijing Foreign Studies University Myung-koo Kang, Assistant Professor, Baruch College, The City University of New York Joongi Kim, Professor, Law School of Yonsei University Yong-Hak Kim, Professor, Yonsei University Yong-min Kim, Professor, College of Business Administration, Kookmin University Hong Yung Lee, Professor, University of California, Berkeley Seungjoo Lee, Professor, Chungang University Kun-Chin Lin, Lecturer, Department of Politics and International Studies, University of Cambridge Pingqing Liu, Professor, School of Management and Economics, Beijing Institute of Technology Hideaki Miyajima, Professor, Graduate School of Commerce, waseda University Sang-Young Rhyu, Professor of Yonsei University Junxi Shi, Ph.D. Candidate, Beijing Institute of Technology Yul Sohn, Professor, Yonsei University Ji-whan Yun, Assistant Professor, Ewha womans University 

Part I. Introduction



HONG YUNG LEE This book represents an initial attempt to compare China, Japan, and South Korea (hereafter “Korea”), three close geographical and cultural neighbors whose developmental trajectories, though divergent in the past, have been moving more recently toward convergence. Over the years, enquiries into the economic development of these three countries have mostly adhered to old patterns of scholarship whereby Japan is studied along with other western liberal economies, China is considered in the context of communism, and Korea is seen as a developing state. Most existing literature on comparative East Asian economic development has been based on the case of Japan, which has then been applied to Korea, but is not yet considered applicable to China. As such, any truly comparative study of this region will require both a new conceptual framework of East Asia that is fully applicable to all three countries, and new insights about the driving forces behind economic development in each country. we would even go so far as to argue that no economic theory can claim to be valid without explaining or at least being able to accommodate some account of the extraordinary economic success of China, Korea, and Japan over the past fifty years. To compare the development experiences of these countries, this edited volume examines similar institutions in similar functional areas within the three countries. while the elements being compared in each chapter may vary, we hope that this book as a whole will demonstrate the intellectual utility of a broad comparative study of East Asian economic development. Towards this end, several of the chapters included here are explicitly comparative. Since Japan and Korea share many similar traditions and systems, three of the chapters—chapters 2, 3, and 5—look at these two cases side by side. Other chapters are country-specific but still provide a comparative perspective when read in conjunction with the cases of other countries. If this volume succeeds in alerting scholars to the urgent need for a comprehensive theory that can cover the remarkable economic performances of these countries, it will have served its purpose.


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Organization of the Book The papers in this volume are arranged into sections according to three major areas of inquiry. Part I includes two chapters, this précis and a paper titled “Convergence and Divergence: Three Different Paths toward Modernization in East Asia” that serves as an introduction to this volume. In this section, we make an argument for the necessity and urgency of this book by briefly comparing the record of economic growth for each of these three countries, then explaining the evolution of scholarship about East Asia’s economic development up to now. “Convergences and Divergences” offers a bird’s-eye view of the turbulent paths to economic development followed by China, Korea, and Japan from the middle of the nineteenth century, as well as their conflict-ridden interactions with one another over the past hundred years. After reviewing the different approaches that have thus far been utilized to explain East Asian economic development, the chapter concludes by arguing for the need for a comparative study of institutions. with China’s recent economic reforms, all three countries in the region can be said to be following the path pioneered by Japan, which combines the conscious decision-making processes of the state with the spontaneous decision-making processes of the market. Yet functional and operational differences (divergences) continue to exist between similar economic institutions even though they are modeled after the same sources (convergences). The authors argue that the concept of “institutional templates”—institution-building tendencies shaped by each country’s cultural traditions and modern experiences—is key to understanding these differences. Following this introduction, part II examines the specific question of how two of the most important elements in economic growth—capital and labor—have been managed by these three countries, and, in particular, by their states. Part II begins by addressing the issue of capital—specifically, non-performing loans (NPLs). The third chapter, “Government Intervention for Resolving Non-Performing Loans in Japan and South Korea, 1998–2006,” presents Myung-koo Kang’s comparative study of how Japan and Korea dealt with the problem of NPLs after the 1997–1998 Asian financial crisis. Although Japan and Korea faced similar challenges subsequent to the financial crisis—namely, the globalization of their financial markets, and the active intervention by the state into the operation of financial institutions such as banks—the process, sequence, and speed of reforms carried out by both countries differed significantly. whereas the Japanese government injected public funds into the economy in intermittent and indecisive ways, the Korean government took early and decisive action to recapitalize failing banks by utilizing asset management corporations



to take over NPLs at reasonable prices. In other words, the Japanese government allowed the Resolution and Collection Corporation (RCC) to operate according to market principles, while the Korean government adopted a centralized, shock-therapy approach. Kang calls the Japanese style of state intervention a “cooperation model” and the Korean style a “command model.” These distinct approaches reflect different decisionmaking styles as well: in Korea, authority is centralized and personalized, while, in contrast, Japan emphasizes consensus building, group decision-making, and networks. In chapter 4, Hong Yung Lee studies financial reforms in China from 1998 to 2005, the period of the Asian financial crisis. The Chinese state, adopting a strategy of incremental reform, combined the task of reducing NPLs with the restructuring of state-owned enterprises and the creation of a market-oriented financial system. Although this strategy has been criticized as a trick, akin to “sweeping dirt under the rug,” this chapter argues that it enabled China’s economy to “grow out of” the planned economy by allowing Chinese banks to reduce their NPLs and to increase their sound loans. China’s financial restructuring can thus be seen as an attempt by the Chinese state to create a rational, market-oriented system in coordination with changing institutional environments. The success of this incremental, step-by-step reform, which violates all the teachings of neoclassical economic theory, can be attributed to China’s ability to be pragmatic given its constraints (i.e., the absence of external conditions conducive to the efficient operation of financial markets). The Chinese experience thus demonstrates that markets do not necessarily emerge automatically through the clarification of property rights, but rather need to be constructed piece by piece by the state. In this case, the Chinese state successfully created actors, rules for competition, and an incentive structure for all the actors involved, including owners, agents, workers, and consumers. In chapter 5, Ji-whan Yun examines how labor is being handled in Japan, Korea, and Taiwan. In particular, Yun compares these countries’ approaches to dealing with the issue of dual-labor markets—markets consisting of both regular and irregular workers—in response to increasing pressures for labor market liberalization and the extension of social welfare benefits. Despite being faced with similar problems, each of these three countries has chosen to address these challenges with different proportions of employment liberalization and income maintenance. Japan opted for what Yun calls the “path of consolidation,” i.e., a segmented employment policy that distinguishes between regular and irregular workers and strengthens the protection of regular workers while rationing welfare benefits. Korea has chosen to implement systemic changes that removed all special protections for regular workers and replacing those protections


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with universal welfare for all workers, regardless of their status. Taiwan has followed a third pattern by compromising with a unified labor market of regular and irregular workers, while extending welfare benefits to previously excluded citizens and labor market groups. According to Yun, differences in labor reform outcomes have been determined by the different degrees of legitimacy to be found within the dual-labor markets, and whether the state shares decision-making authority with societal actors. In Japan, the dual-labor system was widely accepted as legitimate, and the state shared its decision-making authority with societal groups. In Korea, on the contrary, the existing labor regime’s lack of legitimacy, combined with the existence of a strong state, led to systemic changes. Finally, in Taiwan, the state has been relatively autonomous from pressure by social groups, but has had to share its decision-making authority with labor unions. Yun’s analysis thus counters the conventional view that similar institutions can be expected to develop similar patterns when facing similar environmental changes. His work also counters the idea that many of Korea’s and Taiwan’s market institutions can be seen as “isomorphic subtypes” of parallel institutions in Japan. Instead, Yun stresses the need to pay closer attention to the development of institutional differentiation within regional economies. Part III focuses on corporate governance. Since business firms and groups play a more important role in modern economies than individual persons, the question of how those groups are organized, structured, and governed has become one of the most critical considerations affecting economic institutions. The strong influence of each country’s cultural traditions has led to variations in the business group structures and methods of corporate governance. Even when overall globalization trends have applied strong pressure on institutions to change according to international standards, the response of each country has varied. In chapter 6, Hideaki Miyajima and Yul Sohn examine how Japanesestyle corporate governance has handled the global pressure to liberalize. Has the Japanese system started to transition to the more “Anglo-American” shareholder model of corporate governance, under increased pressure from foreign investors since the financial crisis, and as required by deregulation? To answer this question, the authors examine the changing processes of external governance in Japan. According to their findings, only a few large firms with growth potential and a low risk of default have embraced market finance reforms; many more have made only weak efforts in that direction. Moreover, even the few firms that have shifted towards market standards for financing have continued to maintain more traditional structures for their internal governance. The emergence of a hybrid corporate governance model in Japan casts doubt on



our conventional understanding of institutional complementarities, and has profound implications for prevailing views about path dependency. Chapter 7, written by Joongi Kim, offers an extensive and detailed narrative of the corporate governance reforms initiated by Korea subsequent to the 1997–1998 financial crisis. Reform measures taken by the Korean state have not only changed legal and regulatory infrastructures, making them more transparent, but also clarified accountability and responsibility. For example, it is now mandated that a certain percentage of outside directors be appointed to a company’s board of directors, thus strengthening the protection of minority shareholders’ rights and upgrading the role of auditors. Yet despite the Korean state’s forceful imposition of market-oriented discipline—a step that has helped Korea achieve some of the highest standards of corporate governance that exist worldwide—a series of scandals among Korea’s largest conglomerates erupted in 2003. One of the major problems Korea has encountered is how to effectively enforce various statutory regulations and rules in order to help corporate governance operate more efficiently. Controlling shareholders still find ways to use their companies to enrich themselves at the expense of other shareholders, largely as a result of a weakly developed corporate market. Although Korea has attempted to eliminate many of its old practices, which relied almost exclusively on personal control and family ties, such patterns of behavior by relevant actors nonetheless continue. Kim concludes that despite all the elaborate legal regulations regarding corporate governance currently in place in Korea, the actual practice of Korean corporate governance lags far behind an ideally efficient liberal market model. Chapter 8, focusing on another adaptation of corporate governance standards, was written originally in Chinese by Pingqing Liu and Fengxia Jiang, and jointly rewritten in English with Hong Yung Lee. In this chapter, the authors characterize China’s current corporate governance as a “dependent model,” a name that underscores the dependency of Chinese enterprises on the Chinese state for management. They attribute this continuing dependence of Chinese corporations on the state to the lingering after-effects of China’s planned economy, which in turn had roots in patterns established by Chinese traditional culture. Chinese business firms and corporatized companies are still not free from the state’s influence, and are therefore far from being autonomous legal entities that can operate in the market to maximize profits according to formal, regulationdictated rules. This wide gap between the formal requirements required by law and actual practice is due in part to the transitional stage in which the Chinese economy finds itself, a stage that has not yet resolved fundamental issues such as privatization. Consequently, many different types of


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corporations exist in China, ranging from solely state-owned enterprises to private corporations and everything in between. The Chinese Communist Party’s presence in corporations tends to be strong, with either a separate party secretary or a general manager concurrently holding two different titles. Official efforts have been made to separate the state’s administrative function from its ownership rights, but an effective way of handling this issue has yet to be found. The state has likewise endeavored to create an asset management commission that can control state-owned shares according to an administrative hierarchy, but the scope of its authority and its capacity to remain independent from other government hierarchies remains unresolved. To make the situation more complex, multiple layers of “parent” and “child” companies exist. Because many of these are arbitrary (that is, created by the state and subject to multiple layers of decision makers), the interests and jurisdiction of shareholders, boards of directors, the chairmen of boards of directors, and the general managers—zhongjingli—often overlap in confusing ways. The result has been many variations in the actual operation of corporate governance. Chapter 9, coauthored by Lowell Dittmer and Kun-chin Lin, explores the changing mix of authority, exchange, and network relations that have existed during three different stages of China’s reform of its stateowned enterprises. Authority relations prevailed during the first plannedeconomy stage, even with regard to economic management. During this period, normal market exchanges were officially banned, though some prerequisites of market exchange, such as the need to maintain equilibrium between supply and demand, were implemented through planning. In the second stage of reform, exchange principles were gradually introduced as a way of managing the economy. China allowed the emergence of a nonstate sector wherein exchange relations operated relatively free from intervention, the jurisdiction of authority relations was reduced, and an attempt was made to minimize the functioning of network principles in both authority and exchange relations. However, the state continued to use authority relations to manage the planned sector, with the result that exchange activities between the state and nonstate sectors could not be fair and were thus frequently subjected to the undue influence of network relations. The focus of reforms in the third stage shifted to the “clarification of property rights” as a precondition for any fair exchange. The state intended to separate its use of property rights as a majority shareholder from its task of regulating market operations as a neutral and objective referee. China needs state authority to create economic actors who can operate under market conditions; it also requires rules of exchange that are supported by a legal system, which has not yet happened. During this



third stage, forms of networking also changed. Initially, networks operated largely among state bureaucrats, but as exchange relationships expanded, networking principles began to penetrate exchange relations as well. The state controls the majority share of many corporations; in such cases, a single individual often assumes the dual position of party secretary and corporation manager. Under these conditions, it is not surprising to see that both authority and network relations have continued to permeate exchange relations. Despite this murky mingling of the three elements of authority, exchange, and networks in China, the exchange principle has been the dominant mechanism used for managing the economy. Closing with the case of the Chinese oil industry’s evolution, the chapter illuminates the way in which the relative weights of authority, exchange, and networks have changed through time. The final portion of this book, part Iv, focuses on the issue of networks, which many scholars consider to be the primary distinguishing characteristic of East Asian economies. As a result of the orientation towards collectivity that can be found throughout East Asia, networks often permeate not only authority relations but also market exchanges. Existing literature about networks has thus tended to discuss how these networks are established as well as how they actually operate between the state, businesses, and individual economic actors. However, the level of importance of these networks in the actual operations of each country’s economy varies. Networks in China appear to be largely person-to-person, formed on the basis of past work experiences and often intentionally cultivated for utilitarian purposes. Such networks connect state bureaucrats, who still exert enormous formal authority over economic allocations, with economic actors. In contrast, Korean networks are more closed; they are typically based on connections through family, school, and local ties, all of which also come into play in China and Japan, though to a much lesser extent than in Korea. These networks play very important roles in both authority and exchange relations, frequently thwarting formal rules designed to eliminate their influence. The networks in Japan tend to operate in the form of relationships between business firms that are on equal footing rather than in a hierarchical arrangement, and tend to stress exchange rather than authority relations. In chapter 10, Yong-Hak Kim and Yong-Min Kim further flesh out the issue of externally recruited board directors, the most important component of corporate governance reforms, described by Joongi Kim in chapter 7. Using biographical data on all the directors of Korea’s 600 to 700 largest firms between 1995 and 2002, this chapter examines the changing face of network capitalism in Korea. The authors investigate whether the new requirement that a certain percentage of directors be appointed from society at


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large—rather than on the basis of personal connections—has had any actual implications for the composition of boards of directors in Korea. Korean family-owned corporations tend to rely on cross-shareholding and mutual guarantees for bank loans, and owners typically appoint relatives and personal friends to key management positions and even to the boards of affiliated companies. The introduction of outside directors was thus supposed to reduce the homogeneity of boards of directors for all big corporations. Not surprisingly, the authors find that boardrooms continue to be dominated by directors from top-tier high schools and universities, and, more specifically, from the schools and regions with which the family-owners are associated. This concentration of school and regional ties in the boardroom, clearly measurable by Gini indices and their dominance ratios, shows that strong “homophily” effects are still in operation in Korean firms despite attempted reforms. Moreover, larger firms tend to have higher levels of heterogeneity on their boards of directors than smaller firms; surprisingly, older firms also tend to have lower levels of homophily on their boards. In addition, a firm’s debt ratio has a significant and positive relationship with levels of board homophily. Nevertheless, the homogeneity of Korean boards, which had begun to decrease before the economic crisis, has increased since the introduction of reform measures. Despite the forceful imposition of new institutional requirements by the state, old habits of relying on personal networks have remained resilient; the authors are not optimistic about whether even stronger pressures for global liberalization will ever drastically change network capitalism in Korea. Chapter 11 examines one of the most important networks defined by the literature on network capitalism—the connections between government and business. The authors, Seungjoo Lee and Sang-Young Rhyu, compare how retiring Japanese and Korean bureaucrats are appointed to semiprivate and special corporations. Because this study is so narrowly defined, it illustrates how Japan and Korea engage in similar practices but in different manners. In Japan, this practice (called amakudari) involves appointing retired bureaucrats to semiprivate corporations, and is highly institutionalized and follows a well-established pattern. Amakudari thus works to keep political interference at a minimum. In the Korean practice of “parachute appointments,” former bureaucrats who have retired from their regular careers in government ministries are appointed to positions in a variety of related special corporations. In contrast with Japan, the Korean process is much more politicized, with extensive involvement from the presidential office and from political parties. Japanese amakudari largely works as compensation for bureaucrats who have retired early with low salaries, whereas Korea’s parachute appointments are used by political leadership as compensation to loyalists, and



show a low degree of institutionalization. Japan and Korea exhibit clear differences in terms of managing informal networks. Such findings are in line with general differences to be found in Japanese and Korean politics: in Japan, even informal practices are very well institutionalized, allowing for more bureaucratic autonomy. In Korea, political authority tends to be more personal and less institutionalized, though it is also more centralized and exercised in a top-down manner. Analytical Frameworks As an initial step toward a more systematic comparison in the future, this volume intends to provide a comparative perspective on the actual operations of important economic institutions in three East Asian countries. we have thus attempted to utilize the expert knowledge of each contributor on country-specific issues, instead of having each piece perform a strict comparison of all three countries. In this way we hope to provide something more substantive than a general summary of already well-known information. From this perhaps idiosyncratic but, at present, necessary approach to comparative studies in East Asia, several analytical points emerge clearly. First, the tendency towards path dependency is found in all three countries. Despite facing similar challenges and functional needs, each has handled these issues differently, choosing strategies shaped by their attitudes towards the appropriate role of the state in managing the economy. As such, any effort to change, reform, or recreate economic institutions has to start with an understanding and acknowledgment of existing institutions, which, in turn, tends to limit choices. Second, although the state’s role has varied from country to country, it nevertheless has remained central to the economic development of each. Understandably, the Chinese state has been and continues to be the most interventionist of the three. The critical issue of separating political authority from economic exchange—exemplified in China’s efforts to handle NPLs while transforming its financial institutions into more marketoriented ones—has yet to be resolved in China. Despite the introduction of new corporate governance structures, attempts at implementation have been limited by the prevailing interests of authority in the form of various levels of party organizations. In another example, the Korean state’s handling of financial reforms and NPLs has been quite different from Japan’s. The Korean state—with its presidential as opposed to prime ministerial system—tends to exercise its authority more directly and decisively, whereas the Japanese state continues to make decisions on the basis of consensus between politicians, bureaucrats, and various economic actors.


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Consequently, economic policy change in Japan tends to be incremental and gradual, with strong inertia being exerted by existing institutions. Such has been the case with financial, labor, and corporate governance reforms. On the contrary, the problem with the Korean style of state-initiated reform has been the widening gap between formal and informal institutions. Despite the state’s imposition of new formal institutions, informal institutions and practices tend to undermine the actual operation of newly introduced formal rules, as exemplified by the case of outside directors that have been brought into Korean corporations. Third, one can readily notice the continuing influence of cultural traditions on the operation of economic institutions within each country. Although these three countries share a broadly defined Confucian cultural tradition, the ways in which Confucianism is understood and which aspects of it are emphasized tends to vary. Still, the resilience of certain cultural traditions over others in each of these countries makes it impossible to overlook the basic cultural grammar and logic that inevitably govern each country’s practices. To begin the process of making sense of these findings, we suggest a working concept of “institutional templates,” a framework that attempts to consider the ways in which each country is oriented towards authority, exchange, and networks. Although still in the process of being elaborated, the notion of institutional templates can help to explain how and why these three states operate differently with regard to making decisions about and imposing decisions upon their respective economies. For example, authority relations and networks are prominent in Korea; in Japan, as demonstrated by the workings of amakudari, exchange relations tend to predominate. In Korea, authority tends to reside in specific persons rather than in offices, as is shown through its strong presidents and the strong chairmen to be found in Korean chaebols (family-based conglomerates). Furthermore, personal networks in Korea tend to penetrate both authority and exchange relations, whereas in Japan, authority, exchange, and networks tend to be very well separated. Even when authority is being exercised, reciprocity is often stressed in Japan, as was the case with the Japanese developmental state’s leading of Japan’s economy. These are just some of the examples of institutional templates that are gestured towards by the chapters of this book. A more comprehensive study of institutional templates will require further elaboration and refinement through additional comparative studies in the coming years.


Convergence and Divergence Three Paths toward Modernization in East Asia

HONG YUNG LEE Given the remarkable economic achievements of China, South Korea (hereafter “Korea”), and Japan over the past fifty years, it is difficult to imagine how any account of economic development could be considered complete without a comparative understanding of the rapid, and in some respects unprecedented, rise of these three countries. Close neighbors both geographically and in terms of historical interactions, China, Korea, and Japan all began the process of modernization at about the same starting point—i.e., with roughly similar cultural roots and at similar levels of development. However, their economic performances have diverged over the last century, with each country following a slightly different trajectory to reach where it is today.1 The extent to which the economic fortunes of these three countries have fluctuated over the past century and a half becomes apparent when one compares the changing size of their collective share of the world economy in the years since the west came into contact with the East. According to figure 2.1, which is based on secondary literature and historical data, the combined share of the world economy held by China, Japan, and Korea in 1820 totaled about 36.72%, roughly commensurate to their combined share of the world’s population. By the middle of the 1950s, East Asia’s share of the world economy had drastically declined, falling to a mere 7.85%. This drastic decrease was due largely to China’s rapidly shrinking economy. Offsetting that decline, an incremental rise in Japan’s individual share of the world’s wealth in the 1950s was followed by more rapid growth in that country, and then by the economic rise of South Korea. 1

For the traditional regional system of international politics, see Cohen (2000).


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100% 90%


6oo/o so% 40% 30%

20% 10%


• China

• Japan

• South Korea

Rest of the World

Figure 2.1: Chinese, Japanese, and South Korean Shares of the World's Wealth Source: Maddisson 2009. Note: GDP levels are rescaled by the purchasing power parity (PPP) converter of the International Comparisons Program (ICCP) with base unit of 1990 GearyKhamis international dollars. Missing values are interpolated.

By 1978, the year China embarked on massive reforms as a result in a shift in its national goals from social revolution to economic development, growth in the three East Asian countries had succeeded in lifting the region's contribution to the world economy to 13.39%. China's rapid growth since that time has been largely responsible for lifting East Asia's contribution to the world economy to its current level of about 24%. This trend is expected to continue, and the level should eventually reach 30.81%, roughly equivalent to the portion of the world's gross domestic product (GDP) held by East Asia at the outset of its contact with the West. This rapid growth has led some to speculate that the twenty-first century will be the "Asian century." Indeed, it is difficult these days to find anyone who would argue that East Asia will not be at the center of the global economy in the current century. Figure 2.2 shows that each of these three countries enjoyed about thirty years of rapid economic growth, although those periods of growth took place at different times. Japan's period of rapid growth started in the 1950s and lasted until the end of 1980s, whereas Korea's growth period started in 1968 and continued until 1998. High rates of growth in China began

Convergence and Divergence

- - - Japan


- - China

------- Korea

Figure 2.2: GDP Growth Rate in Japan, China, and Korea Source: Heston, Summers, and Aten 2006.

with its 1978 reforms, and have continued: its growth rate for 2009 was 11.54% (Heston, Summers, and Aten 2006). Although each of these three countries achieved similar levels of growth during their respective periods of economic expansion, the total amount of growth that took place also varies slightly from country to country. Japan's total rate of growth over its thirty-year period of rapid growth was 2637%, or an average of about 8.7% per year; Korea's was 2059%, an average of 6.68% per year; and China's has been the highest of the three, totaling 2918%, or about 10% per year. Although these figures are the result of broad calculations based on a number of different assumptions, they are useful indications of East Asia's changing economic position relative to the rest of the world. They are also useful as a way of assessing each country's share of the world's GDP relative to that of its neighbors. Since the beginning of the twenty-first century, not only has the relative strength of these three countries' economies changed, but their degree of economic interdependence has also undergone a radical transformation. The most dramatic indication of this has been the changes in patterns of intraregional trade following the rise of the Chinese economy. In the 1980s, when Japan was pursuing its so-called flying geese model of economic development, trade patterns were characterized by a vertical division of labor: Japanese firms transferred their assembly facilities to other Asian countries; capital goods and components were shipped from Japan


Hong Yung Lee

for processing; and the final products were then exported to industrial countries. As a result, Japan enjoyed trade surpluses not only with the United States but also with most Asian countries, and those Asian countries became increasingly dependent upon Japan (Bernard and Ravenhill 1995; Ernst 2004). The rapid rise of China’s trade volume—from $21 billion in 1978 to about $2 trillion in 2007, an amount that has surpassed the US trade volume and is behind only Germany’s in scale—changed all of this. China imports semifinished goods from other Asian countries to produce final products destined for the United States and other developed countries. This means that China has trade deficits with Asian countries while enjoying trade surpluses with advanced countries. Capital goods are shipped to Taiwan and South Korea, which then send capital-intensive components to China for labor-intensive processing and assembly, before reexporting them to developed markets; about 50% of the imports to China from these countries are then reexported. In other words, at the same time that China is becoming a hub for low-end, labor-intensive goods, it has also become a manufacturing hub for high-end, capital-intensive goods. As a result, other Asian nations have benefited from the expansion of Chinese trade, whereas the United States, whose imports from China exceed those from Japan, suffered a $273 billion trade deficit with China in 2010 (US Census Bureau 2010). Given this fundamental change in trade patterns, it is not surprising that trade volume within the region has been rising more rapidly than trade with other regions (figure 2.3). For example, China has emerged as Japan’s largest trading partner, replacing the position previously held by the United States. By absorbing Japan’s excessive capacity in steel, paper, and machinery, China has been instrumental in helping Japan achieve the degree of economic growth it has enjoyed in recent times. Chinese service industries, especially shipping, are also helpful to Japan. The increase in trade between China and other Asian nations has further facilitated intraregional trade within Asia. According to Chinese data, China’s rate of trade with Korea and Taiwan has likewise been rising rapidly, with more goods being imported from rather than exported to those countries. This has led to an accumulation of trade deficits. The volume of trade between Korea and China is likely to continue at an annual average growth rate of about 20%, with South Korea continuing to maintain a trade surplus. This volume surpassed $100 billion in 2005, and is expected to surpass $200 billion in 2010. On the contrary, Japan’s and Korea’s share of world and US trade has been declining. For instance, China’s share of the US market, calculated on the import of goods, balance of payment basis, increased from 5.4% in 1980

Convergence and Divergence


,, , , 200


, ,/



so 0 ['-. 00 ll"' 10 rt\ 0'\ '"'0'\ "'0'\ 0'\ 0'\ 0'\ 0'\ 0'\ 0'\ 0'\ "'" 0'\ 0'\ 0'\ 0'\ 0'\ 0'\ 0'\ 0'\ 0'\ '"' '"' '"' '"' '"' '"' '"' '"' '"' '"' '"' '"'

00 00






0'\ 0'\


- - Japan-Korea

0 0 0


0 0

3 Sum

How many board members are family members (parents, spouse, brothers, and sisters)?

0 1 2 3 >3 Sum

9 (29%) 15 (48.4%) 3 (9.7%) 1 (3.2%) 3 (9.7%) 31 (100%)


1 2 3 >3 Sum

How many stockholders are family members (parents, spouse, brothers, and sisters)?

Publicly listed companies

Table 8.5. The Human Capital of Private Enterprise

11 (78.6%) 3 (21.4%) 0 (%) 0 (%) 0 (%) 14 (100%)

10 (66.7%) 4 (26.7%) 1 (6.7%) 0 0 15 (100%)

6 (35.3%) 1 (5.9%) 0 0 17 (100%)

10 (58.8%)

Companies that have been public

118 (45%) 88 (33.6%) 35 (13.4%) 9 (3.4%) 12 (4.6%) 262 (100%)

116 (46.4%) 87 (34.8%) 30 (12%) 8 (3.2%) 9 (3.6%) 250 (100%)

98 (37.3%) 32 (12.2%) 14 (4%) 9 (3.4%) 263 (100%)

110 (41.8%)

1,146 (53.5%) 678 (31.7%) 229 (10.7%) 52 (2.4%) 37 (1.7%) 2,142 (100%)

1,292 (62.3%) 560 (27%) 154 (7.4%) 37 (1.8%) 30 (1.4%) 2,073 (100%)

797 (35.4%) 216 (9.6%) 54 (2.4%) 40 (1.8%) 2,252 (100%)

1,145 (50.8%)

Companies that Companies that temporarily do not want to go public want to go public

1,286 (52.6%) 779 (31.9%) 265 (10.9%) 63 (2.6%) 49 (2%) 2,442 (100%)

1,428 (60.4%) 664 (28.1%) 186 (7.9%) 47 (2%) 39 (1.6%) 2,364 (100%)

916 (35.7%) 252 (9.8%) 69 (2.7%) 52 (2%) 2,563 (100%)

1,274 (49.7%)



Pingqing Liu, Junxi Shi, and Fengxia Jiang

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The Evolutionary Path of Corporate Governance in China


Li, Hongbin, and Li-An Zhou. 2005. “Political Turnover and Economic Performance: The Incentive Role of Personnel Control in China.” Journal of Public Economics 89: 1743–1762. Li, Kui wai. 1994. Financial Repression and Economic Reform in China. westport, CT: Praeger. Li, weian. 2002. A Study of Modern Corporate Governance: Capital Structure, Corporate Governance, and Shareholding Reform of State-Owned Enterprises. Beijing: Renmin University Press. Lin, Cyril. 2001. “Corporatisation and Corporate Governance in China’s Economic Transition.” Economic Change and Restructuring 34 (1–2): 5–35. Liu, Pingqing. 2009. Mastering Entrepreneurial Enterprises: Deciphering the Development of Organizations and the Growth of Enterprises in the Transitional Period of China. Beijing: Tsinghua University Press. Lu, Ding. 2000. “Industrial Policy and Resource Allocation: Implications on China’s Participation in Globalization.” China Economic Review 11: 342–360. Mallin, Chris, and Xie Rong. 1998. “The Development of Corporate Governance in China.” Journal of Contemporary China 7 (1): 33–42. McMillan, John, and Barry Naughton. 1992. “How To Reform a Planned Economy: Lessons from China.” Oxford Review of Economic Policy 8 (1): 130–143. Michael, Firth A., M. Y. Peter, B. Fung, and M. Rui Oliver. 2007. “How Ownership and Corporate Governance Influence Chief Executive Pay in China’s Listed Firms.” Journal of Business Research 60 (7): 776–785. Moerland, Pieter w. 1995. “Corporate Ownership and Control Structures: An International Comparison.” Review of Industrial Organization 10: 443–464. Nee, victor. 2005. “Organizational Dynamics of Institutional Change: Politicized Capitalism in China.” In The Economic Sociology of Capitalism, edited by victor Nee and Richard Swedberg, pp. 53–74. Princeton, NJ: Princeton University Press. Oi, Jean C. 2004. “Realms of Freedom in Post-Mao China.” In Realms of Freedom in Modern China, edited by william C. Kirby, pp. 264–284. Stanford, CA: Stanford University Press. Qian, Yingyi. 1995. “Reforming Corporate Governance and Finance in China.” Economic Research Journal 1: 20–29. Schipani, Cindy A., and Junhai Liu. 2002. “Corporate Governance in China: Then and Now.” Columbia Business Law Review 1: 1–69. Shan, Dong. 2008. “Private Economy in Zhejiang Province Since 30 Years Ago: Development History and valuable Experience.” Zhejiang Economy 12: 28–31.


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Shi, Steven, and Drake weisert. 2002. “Corporate Governance with Chinese Characteristics.” China Business Review 29 (5): 40–44. Shirk, Susan L. 1992. “The Chinese Political System and the Political Strategy of Economic Reform.” In Bureaucracy, Politics, and Decision Making in Post-Mao China, edited by David M. Lampton and Kenneth G. Lieberthal, pp. 102–135. Berkeley: University of California Press. Shleifer, Andrei, and Robert w. vishny. 1994. “Politicians and Firms.” Quarterly Journal of Economics 59: 995–1025. Slough, Neil, and Paul Miesing. 2003. ‘‘Chinese Minds in U.S. Bodies: Ten Factors Driving Chinese Business Practices.” Proceedings of the Academy of International Business (November): 185–195. Tai, Katrina. 2004. “Country Review: China.” In Governance and Risk: An Analytical Handbook for Investors, Managers, Directors and Stakeholders, edited by George S. Dallas, pp. 89–110. New York: McGraw-Hill. wang, Changyun. 2005. “Ownership and Operating Performance of Chinese IPOs.” Journal of Banking Finance 29 (7): 1835–1856. wong, Sonia, Sonja Opper, and Ruyin Hu. 2004. “Shareholding Structure, De-politicization and Enterprise Performance: Lessons from China’s Listed Companies.” Economics of Transition 12: 29–66. wu, Jinglian. 1994. Modern Company and Enterprise Reform. Tianjin: Tianjin People’s Publishing. Xu, Yong. 2002. “County Government, Township Faction, village Governance: Structural Conversion of Rural Governance.” Jiangsu Social Sciences 2: 27–30. Yang, Ruilong. 1997. “The Research on Multilevel Principal-Agent Relationship of State-Owned Economy.” Management World 1: 106–115. Yu, Keping. 2002. The Emerging of Civil Society and Its Significance to Governance in Reform China. Beijing: Academy of Social Sciences Press. Zhang, weiying. 1997. “Thinking Effectiveness, Problems and Outlets of the Reform of State-Owned Enterprises in China from the Perspective of Structure of Corporate Governance.” Social Science Front 2: 42–51.


Multiple Institutional Templates for Corporate China The Evolution of Industrial Networks during Marketization


Though of course each modernizing nation-state is distinctive, the East Asian developmental experience, as Hong Yung Lee (2005) has pointed out, inherits a similar traditional cultural legacy and shares a number of broadly analogous socioeconomic patterns. These include a focus on the collective (variously defined) rather than the individual as the primary unit of accounting and identity, a high degree of pragmatic flexibility as to specific means combined with a disciplined and concerted focus on longterm developmental objectives, and high respect for authority and orthodox learning combined with considerable informality in its interpretation of particular problems (i.e., a situation ethics). within this broad pattern there are distinctive national experiences, such as the Chinese moralistic suppression of informal groups as “factions” vs. the much greater Japanese (and Taiwanese) tolerance for factional politicking, the mainly kinship-based Chinese definition of the primary unit vs. the South Korean (hereafter “Korean”) territory-based definition or the Japanese functionbased definition; the greater Chinese tolerance for collegial authority and familial fissiparousness vs. the Japanese emphasis on primogeniture and patrilineality vs. the Korean intermediate position. This chapter attempts to analyze the People’s Republic of China (PRC) pattern or “institutional template” of political-economic-cultural development during the period of “reform and opening to the outside world” since the Third Plenum of the Eleventh Party Congress in December 1978, during which China quadrupled its Gross Domestic Product and in three decades became one of the world’s leading economic powers. Although


Lowell Dittmer and Kun-Chin Lin

there is a growing literature on Chinese industrial reform (written largely by academic economists), the theoretical analysis of the causal dynamics of political-economic-cultural change has been slower to progress. This contribution is but modest preliminary spadework in a field deserving more intensive cultivation. Our purpose here is to explore, from a macroperspective, watershed changes in the evolution of the “institutional template” for state-owned enterprises (SOEs) in post-Mao China. This has been a period of great dynamism, not only in terms of secular GDP growth rates but also in the transformations of the political-economic structure in which this change has been embedded. we identify three distinct periods in the reform of the state-owned sector since 1978: a revived command economy (1978–1983), a dual-track reform economy (1984–1997), and a recentralized corporate economy since 1998. Each period displays a distinctive mix of authority, exchange, and network relational principles within the overall context of a political structure that has shifted gradually (and incompletely) from state ownership to corporate, from plan to regulation. In the first period, the state attempted to revive the planned economy in relatively pristine form, purging the radical followers of the Gang of Four and rationalizing the plan in various ways (more play for material incentives, greater autonomy in enterprise accounting, etc.) to achieve greater efficiency. The traditional distributive emphasis on heavy industry was also adjusted to give greater emphasis to agriculture and light industry in order to absorb unemployed workers, satisfy consumer demand, and boost the export sector. During the second period, the state attempted to lift the burden of a deteriorating central planning system by giving greater fiscal autonomy to enterprise management and introducing a dual-track system to move to a market economy while concomitantly reducing the scope of the central plan. Though highly successful in terms of economic productivity, increasing economic autonomy created confusion over ownership roles and hence led to attenuated authority relations and a proliferation of informal forms of exchange, eventually making the phasing out of the planned economy mandatory for the state’s fiscal survival. In the third period of corporate recentralization, the central government sought to create a bifurcated corporate landscape in which Beijing asserted effective regulatory control over the macroeconomy and reassumed de facto control of the key industrial enterprises (Lenin’s “commanding heights”), while leaving the majority of industries to market forces. we suggest that the consistent objective behind the central state’s manipulation of the institutional template during all three periods is its prioritization of the authority principle—within an administrative or corporate hierarchy—over the exchange principle throughout the process of marketization, in order

Multiple Institutional Templates for Corporate China


to assure macroeconomic stability and regime survival amid transitional uncertainty. The Evolving “Institutional Template” of Chinese Industrialization we define an “institutional template” as consisting of three conceptually distinct principles: authority, exchange, and network relations. These principles have varied in their priority over time as the state has shifted from a regulatory to an ownership role. These two dimensions establish a 3×2 matrix that captures the organizational logic of the industrial economy in the course of reform (see table 9.1). The following sections will further refine the components of this schema and apply it to China’s economic transition. Principles of Economic Transactions and Roles of the State

The Chinese state has played two roles in relation to the economy: first, it arbitrates economic relations from the “outside” as a regulator; and second, it engages directly in these relations as an enterprise owner. As a regulator, it sets the ground rules for price signals and competition. An “outsider” or third-party status does not necessarily mean that the state is disinterested, but simply that it exercises the prerogative to set the ground rules for and adjudication of conflicts between those involved in transactions. while relinquishing control over intraenterprise governance it asserts sovereign control over interenterprise transactions. As an owner, the state also makes strategic decisions regarding the structure of ownership and long-term goals of SOEs. The nature of ownership may vary even within given types of corporate governance and property rights regime, and ownership is not clearly correlated with performance—thus sole ownership does not necessarily imply better control or worse performance than majority shareholding of a corporation. Authority relations follow the contour of the formal power structure and are implemented through administrative commands that are generally not subject to negotiation except through various channels for appeal internal to the administrative corporate hierarchy. Authority relations aim to mobilize local resources and control their use according to the needs of the superiors or principals, typically at the expense of the independent initiatives of local agents, in contrast to the structure of incentives under the exchange and network principles. In the context of Chinese economic reform, authority relations permeate the command economy as the administrative hierarchy under party supervision put into effect the five-year plans. Direct ownership of a large proportion of productive forces not only reinforces the convergence of


Lowell Dittmer and Kun-Chin Lin

Table 9.1. The Organizational Logic of the PRC’s “Institutional Template” Principle of Economic Relations

Role of the State Regulation



Tiaokuai federalism

Corporate governance


Rules of market exchange

Property rights


Association or collusion

Interlocking directorates

political and economic hierarchies but also reduces resources for resistance to fiats from above. while the regulatory role of the state remains undeveloped and largely irrelevant to the daily functioning of firms, it is not entirely absent under the planned economy. Due to bureaucratic fragmentation and overlapping jurisdictions of “line” ministries and local governments, firms as “agents” of multiple political “principals” typically find room for the manipulation of superior orders or get caught up in turf wars. In these circumstances, State Council agencies such as the State Planning Commission, or its current reincarnation as the National Development and Reform Commission (hereafter NDRC), step in to settle the conflicts. The central agencies also act in a regulatory capacity in allocating resources among the provinces and regulating interprovincial competition, with major consequences for economic growth during times of relatively decentralized governance between Beijing and the provinces. In its regulatory capacity, the state does not mainly rely on imposing its will on the contending parties, but rather attempts to persuade them to sacrifice self-interest on behalf of the national plan’s developmental goals. Nevertheless, the likely outcome and process of adjudication follow the power structure rather than some abstract rule of exchange. Exchange refers to the transaction of goods and services through competition between relatively autonomous economic agents. Sometimes described as “horizontal” in contrast with the command-based transactions within an administrative hierarchy, exchange is predicated on price signals that capture the opportunity cost of using the same resources in alternative ways. Exchange relations excel in offering incentives to autonomous agents who make the best use of private information. In an idealtypical market context, efficient legal and market institutions create the “right price.” In less ideal situations, commoditization imperfectly reflects the actual supply and demand of the market, or fails to internalize major welfare functions such as environmental externalities and social goods. It

Multiple Institutional Templates for Corporate China


is arguably more accurate to interpret cases of exchange based on “wrong prices” as decisions based on a mix of authority and free market principles. However, to insist on the ideal type would render us incapable of analyzing China’s (or possibly any other) economic transition; therefore, we will take a broad view of the exchange principle to encompass economic transactions based on price signals formed through profit-motivated competition, even if actually conducted in the context of imperfect market institutions such as quasi-private ownership.1 The state’s regulatory role in competitive exchange is relatively straightforward, as it involves establishing the rules of the game for market exchange. Its ownership function is more complicated. In a hybrid economy, SOEs engage in exchange with other economic entities via the intermediation of the competitive rules and pricing institutions established by the regulatory state. The tremendous potential for conflicts of interests and systematic favoritism can only be contained if the state makes a credible commitment to impartial management of its firms and reduction over time of its ownership shares. while moving toward this commitment, central reforms face the risks of fiscal disruption and attenuation of principalagent relations with managers. The network principle of exchange adheres neither to administrative nor competitive prices, but to interpersonal relations in which a nexus of trust is a necessary prerequisite, either for relatively short-term transactions (e.g., bribery, political quid pro quo) or longer-term kinship or quasi-familial relationships (connections, or guanxi in the Chinese context). These relationships are necessarily informal and quasi-private, occasionally even conspiratorial. Network relations thrive in a pool of inside information contributed by and disseminated among members. The preconditions for the emergence of a network principle are (a) an entrenched “organizational field” with a relatively stable set of actors; (b) repetitive games to establish information and communications patterns; and (c) persistent environmental conditions of threat or uncertainty to prevent the institutionalization of network relations into either authority or exchange principles.2 The works of Douglass North (1981, 1990) and the rich literature on East Asian developmental states (e.g., Moon and Prasadi 1994) suggest that informal networks develop as expedient intermediating responses to the coexistence of formal political hierarchy and arms-length market principles of economic exchange. Network structures entrenched within 1 On the relative importance of competition in market formation, see Killick and Commander (1988). 2 See Granovetter (1985), Powell and DiMaggio (1991), and Uzzi (1996).


Lowell Dittmer and Kun-Chin Lin

the socialist production hierarchy become rearranged in response to the state’s use of its assets and the introduction of new working arrangements in the nonstate sector, as well as to new rules of exchange established by the regulatory state. whether these adaptations lead to increasing support for market principles or the informal undermining of formal institutions in the course of transition is an important area of inquiry. In the next section, we elaborate on variations in the principles of economic transaction, hierarchical authority, and interpersonal relations in the course of the shift from planning to regulation in order to delineate three periods of “institutional templates” in the Chinese SOE sector. First, let us situate SOEs in their broader economic and institutional context. Multiplicity of Institutional Templates

As market reform gathered momentum through the 1990s, China’s national economy became increasingly complex and differentiated, tending to confound rather than clarify our analysis of authority, exchange, and network relations. Firms have become embedded in a variety of organizational contexts, with various ownership, sectorial, and geopolitical characteristics. By the turn of the millennium, China’s exit from socialism had eventuated in four patterns of industrial organization:3 1.


A cutthroat jungle of locally and informally financed, mostly smallscale and labor-intensive, collective and private enterprises formerly known as “township and village enterprises” (TvEs), which approximate the pattern identified with overseas Chinese entrepreneurship in Southeast Asia, Hong Kong, and Taiwan. These firms confront a vigorously competitive market with low barriers to entry, exogenously determined prices, mobile labor market regimes, and relatively hard budget constraints stemming from limited credit availability. Due to an ambiguous ownership structure, hierarchical links to the local state are often retained, though it is hard to tell whether these are more than nominal. As competition heated up in the late 1990s, privatization (“ownership reform” in Chinese) became the way for local states to exit as stakeholders. Informal networks now tend to aggregate around family or work units, indicating a revival of traditional business cultures relying on family or common origin allegiances and trust mechanisms.4

For representative research on the characterizations, see Keister (1998); Tsai (2002); Guthrie (2002); wedeman (2003); Huang (2003); and Lin (2006). 4 For general theories on firm networks in Asia, see Hamilton and Biggart (1988); Luo (1997); Peng (1997); Peng (2000); and Tsui-Auch (1999).

Multiple Institutional Templates for Corporate China




A rapidly expanding foreign-invested (often wholly foreignowned) enterprise sector (FIE). The FIE sector is a vigorous hybrid, which mixes the labor-intensive sweatshops of the local TvEs and collective enterprises with the high-scale, capital- and technologyintensive characteristics of the domestic SOE sector. In both cases we find heavy reliance on market exchange, merciless personnel policies, and organizational flexibility.5 Studies of foreign invested firms in China—typically small and ethnically Chinese—show broadly similar network structuration. However, we should refrain from generalizations, as larger and nonethnic Chinese FIEs show somewhat different dynamics, and the supposed cordial and mutually beneficial reciprocity among firms in the rapidly growing foreign-invested sector may quickly morph into a mechanism for concealing information and avoiding regulation when the economy takes a downturn.


A “virtual economy” (Gaddy and Ickes 1999) among the uncompetitive industries preoccupied with the fallout from phasing out the planned economy without a ready place in the emerging free market. In those sunsetting industries with no compelling fiscal or developmental value to the central state, one finds a wide range of adaptive behaviors producing innovative firms that take advantage of new market information (Bacchetta and Dellas 1997), as well as desperate firms that deploy networks to shield them from competition with more successful firms. The virtual economy emerged among weak firms in the sunset sector of the Chinese industrial economy during market transition, as enterprise directors fought to keep open factories that produce goods with little market prospects, typically by sacrificing the transparency of formal and legal-rational transactions in favor of informal strategies that draw upon personal networks to create the appearance of profitability and capacity expansion. The virtual economy preserves structures and relationships while consuming social resources; markets become fragmented, public finance demonetarized, and localized firms chronically reliant on central handouts.6 Thus, since the early

Gallagher (2002) shows how foreign-invested firms in coastal areas do not produce better labor regimes. For a contrarian view, drawing mostly from case studies of state-controlled joint ventures and foreign invested firms, see Huang (2003), who argues that foreign investments follow political incentives, thus reproducing the state’s favoritism of regions, sectors, and producers. 6 In Russia, the much-anticipated “market” essentially went “underground,” taking on various forms of nonmonetarized, informal, untaxed, mafia-regulated exchanges (woodruff 1999).


Lowell Dittmer and Kun-Chin Lin 1990s central reformers such as Zhu Rongji have attempted repeatedly to rein in local managers’ inclinations to engage in wasteful investment in capacity expansion, i.e., “duplicate construction” (chongfu jianshe), interenterprise arrears, i.e., “triangular debt” (sanjiao zhai), and asset-stripping through “diversification.” These practices were hard to uproot in a downturn as firms could survive by drawing on resources from other players in the residual planned economy, including banks and backward- and forwardlinked enterprises.


The rise of a group of about a hundred “commanding height” firms, mostly in capital- and technology-intensive production, i.e., the “strategic” or “pillar” industries, carefully nurtured by the state to compete with Korean, Japanese, and western multinational corporations (MNCs) in the international market. The perennial trick for the central reformers is to segregate the commanding heights from the dolorous fate of the sunset industries. For the foreseeable future the commanding heights are likely to continue to be essentially state-managed—in the guise of the state as majority shareholder rather than exclusive owner as in the previous planned economy— and the prices and supply-demand ratios comprising their markets seem to some extent state-managed as well, including the supporting networks of industrial cartels or trade associations. Outward foreign direct investment by these firms—most clearly evinced in the shopping sprees of national oil corporations since 2003—also relies heavily on high-level diplomatic initiatives and the ready availability of credit in state-controlled financial institutions.

we focus exclusively on the governance of this last category of firms in the remainder of this chapter. Comparative historical experience suggests that the success or failure of the state to act as regulator of nascent market forces in direct competition with private and foreign economic actors will strongly influence the pattern of industrial and urban sociopolitical organization that ultimately emerges, helping to shape the institutional template that forms in a modernized China. The Evolving Institutional Template for Chinese Industries Period I: Reviving the Command Economy

Mao’s designated successor Hua Guofeng and the heavy industry and energy ministerial advocates who supported him never intended to stray far from the Stalinist economic paradigm and the affirmative “lessons” of reform in Eastern Europe and China in the sixties. Thus they tried to

Multiple Institutional Templates for Corporate China


engineer an erasure of late Maoist imprints on the Chinese economy and a reconvergence toward the Soviet model (Naughton 1995, 64–65). Enterprises were drawn more tightly into the planning system through more precise material balance planning, strengthened central financial controls, and strictly enforced administrative prices. Hua’s Ten-Year Plan attempted to achieve rapid growth by relying primarily on the expansion of the heavy industrial base, often by importing complete industrial plants, funded by an anticipated rise in foreign exchange earnings from petroleum exports. Alas, the oil revenues were not forthcoming and structural and macroeconomic imbalances quickly set in, forcing Chinese planners to scale back their targets (Naughton 1995, 67–74). Naughton (1995, 59– 64) argues that the expiration of Hua’s reform prompted the sudden decision—made at the Third Plenum of the Twelfth Central Committee by the consolidated leadership of survivors of the Cultural Revolution—to initiate a recasting of developmental strategy, even though the same leaders had long been grappling with chronic problems of such an approach during the Maoist era.7 Under the revived command economy approach, authority relations coordinated the units producing for the plan. At the central governmental level, the plan conflated formal ownership with regulation of state-owned assets. State-owned production did not depend on the observance of external price signals simply because the logic of planning was anathema to market forces. Instead, SOEs produced according to their position in a chain of administrative allocation deriving from industry-specific macroeconomic targets established by the Five-Year Plan. The chain of production contained several nodal points of relatively independent subcentral state agencies with divergent interests but overlapping jurisdictions. These nodes included the ministries (Bachman 1991), the provinces (Shirk 1993), the local cellular economy (Shue 1988; Donnithorne 1972), and the parallel hierarchies of the party-state (Lee 1991; Manion 1993); each nodal point was “embedded” in a unique array of socioeconomic and power relations. Price, where it existed, was negotiated to accommodate the various interests; in this sense, it was no different than other politically stipulated goals such as production targets for and welfare obligations of the enterprise. This institutional arrangement served the interests of the central planners in providing predictability and stability, yet allowed room for “particularistic contracting” to foster support and compliance from a wide range of interests (Shirk 1993). 7 For a detailed analysis of incremental learning on the basis of fundamental continuity in the worldview of elite reformers from the first Five-Year Plan to the reform era, see Reardon (2002).


Lowell Dittmer and Kun-Chin Lin

Enterprise managers had no incentive to observe price signals as the determinant of marginal production. Exchanges took place via administrative allocation, and, where nominal prices were visible, they were not specific to the transaction but typically constructed for accounting purposes, which in turn reflected the politics of the plan. Furthermore, the prices of inputs—investment capital, labor, and even raw or intermediate materials—were not internalized within the firm because “soft-budget constraints” (Kornai 1980, 1992) gave ample leeway for discrepancies between cost and return. Simply put, there was no consistent logic linking external prices to intrafirm pricing and production decisions. Even when an SOE geared up to produce for extraquota profitability, the microeconomics often failed to align properly—supply and demand for the product were rarely considered quantitatively with a clear notion of market boundaries and consumer base, and managers did not adjust wage and input costs to maximize profits.8 Circulation of goods and services within the national economy was highly circumscribed. The market remained tightly constrained and localized, though throughout the Cultural Revolution decade there was a fairly rampant gray market (zou houmen) for retail distribution of services, medicine, and other scarce consumer commodities. Except at the retail level, informal network connections were mobilized chiefly for ideological rather than economic objectives, such as the organization of criticism of the Gang of Four, or the mobilization of the summer 1978 shi shi qiu shi campaign in support of Deng Xiaoping’s policy of reform and opening to the outside world. Bureaucracies at all levels teemed with personal networks designed to defend and if possible enhance the policy and power interests of their leading cadres. At the shop floor and commune levels, connections (guanxi) were officially structured in “neotraditional” (walder 1986) patterns, as managers and activists traded ideal and material payoffs for enthusiastic compliance and economic performance. Period II: Dual-Track Hybrid System (1984–1997)

while SOEs started enjoying increased autonomy and profit-sharing schemes as early as the late 1970s, institutional reform did not take off until 1984 with the formalization of the financial obligations of SOEs in taxes, the rapid expansion of the nonstate sector, the commercialization of domestic banks, and the introduction of the “dual-track pricing” system 8 One only needs to note the steady climb of wage levels and fixed-capital investment through the 1980s and early 1990s, unperturbed by several business cycles, to comprehend the disarticulation of various functions for capital, labor, and material inputs.

Multiple Institutional Templates for Corporate China


based on the coexistence of the plan and the market channels for allocating and pricing goods.9 while the dual track perpetuated “soft-budget constraints” and associated problems of incomplete property rights, it provided output stability and ensured the attainment of the conservatives’ key concern of controlling investment resources, while allowing state firms to begin transacting with and even operating as above-plan, market-opportunist firms (Rawski 1993, 33; Naughton 1995, 8). Naughton (1995, 243, 293) has christened this strategy “growing out of the plan,” as the planner gradually reduces the scope of planning and allows the nonstate sector to grow beyond it through liberalization and price reform, eventually leveling the playing field between state and nonstate sectors.10 Authority relations were exercised through hierarchies undergoing ongoing decentralization. Firms selected for reform enjoyed expanded autonomy, and were permitted to retain a share of profits, practice accelerated depreciation, and exploit the right to sell above-plan output according to market prices determined by supply and demand; the managerial “contract responsibility system,” since its widespread implementation in 1987, incrementally delegated to managers the authority to make purchasing decisions on nonstrategic goods, draw up production plans, set recruiting criteria, and restructure the firm.11 From 1985 to 1988, profit retention emerged as the main vehicle for negotiating the financial obligations of enterprises, increasingly taking the form of long-term contracting, which resembled the leasing of state assets to managers (Shirk 1993, 280–330; Naughton 1995, 228, 285). Profit retention proved to be so popular that enterprises aggressively bargained with their often sympathetic bureaucratic superiors, resulting in the program’s overimplementation; however, the fundamental dependency of the enterprises on the plan was not reduced (Naughton 1995; Shirk 1993; Fewsmith 1999). Putterman (1995, 1051) construed the devolution of these disaggregated rights “as the adjustment of an agency relationship, rather than a shifting of the locus of ownership,” which preoccupied the advocates of privatization. In the era of decentralization, local cadres—playing the dual roles of central agents and brokers of market transactions—systemically exploited the porous organizational boundaries of the dual-track system by transferring costs incurred in both their within-plan and above-plan 9 See Lin, Cai, and Li (1996) for a succinct recapitulation of the early-1980s enterprise reform. For insights into the continual policy debate between the conservative and reformist positions within the CCP leadership, see Fewsmith (1994). 10 However, even as of the late 1990s, strategic goods and key corporate decisions remained under political control. See Lu (1996). 11 Naughton (1995, 205–207) and Lu (1996, 154–156). The system “while providing incentives for good performance failed to penalize bad performance” (Pannier 1996, 15).


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exchanges to local state coffers.12 Cadres, their kin, and friends also established their own “companies” to conduct for-profit business on the side, taking advantage of the permissive environment designed to promote the “corporatization” of SOEs and “tertiary businesses” starting in 1993.13 Consequently, the central and local states’ continuing presence as dominant producers created conditions that increasingly undermined the central ministries’ attempts to strengthen fiscal and macroeconomic management.14 The coexistence of the plan and the market generated coordination failures as state and nonstate actors engaged in informal exchange and networking activities that simultaneously circumvented the disciplines of both plan and market and the balance of horizontal and vertical authority relations—or tiaokuai (Schurmann 1968)—within the administrative hierarchy.15 State managers and local officials and their families acquired a habit of arbitraging in the multitrack pricing system, resulting in the wild speculation and investment overheating waves of the late 1980s and the early 1990s.16 As a result, the national economy in the 1980s and early 1990s became increasingly fragmented and populated by variations of quasi-legal and outright illegal property rights arrangements held together by informal networks. Informal networking shifted from its venue in the political struggles for power or survival to a contest for economic gain, and from the central to the regional or local levels. Below the provincial level, Boisot and Child (1996) and wedeman (2003) documented the rise of administrative “fiefdoms” or protectionist localities. wank (2002), Duckett (1998), Pearson (1997), Tsai (2002), and Zweig (1995) have provided independent studies on informal business networks tying local state entrepreneurs, business group leaders, managerial personnel, and domestic private and 12 For a systemic overview of the local state’s relations to nascent markets, see Lin (2006) and Duckett (1998). 13 A live debate in the China field revolves around the relationship between local state agents and economic growth: some have attributed the momentum for investment and production for export to “local state corporatism,” in which cadres put to use their unique position to mobilize the resources of the community and seek opportunities in the national and international markets, while others perceive them as rent-seekers who jealously guard their prerogatives and convert their political capital into private gains. These polar stereotypes show two sides of the same coin of the moral hazard problem inherent in decentralization, from the perspective of the central state as the principal of reform policies. See Nee (2001, 1991); Oi (1995); Zweig (1993); and walder (1995, 975). 14 See Dittmer and wu (1995); Huang (1996); Brandt and Zhu (2000); and Shih (2002) on the redistributive politics of the inflation-retrenchment cycles from the late 1980s to 1995. 15 wu (1997) debunks the myth of “growing out of the plan,” administrative decentralization, and managerial autonomy as effective exit mechanisms out of socialism. 16 For institutional analyses of the dual-track pricing system, see Gore (1998) and Qian (2000).

Multiple Institutional Templates for Corporate China


foreign investors into complex overlapping networks of exchange arranged to compensate for the deficiencies of formal institutions. Keister (1998) and Ding (2000) identified the emergence of formally and informally networked business groups since the late 1980s, and the proliferation of “amphibious” firm organizations, respectively, recalling Stark’s observation of “recombinant property forms” in postsocialist Eastern Europe. All of these findings suggest the emergence of a realm of economic activities beyond the control of the central bureaucracy, which must be balanced against post-Tiananmen indications of an authoritarian state effectively reasserting control over local economic agents and securing their ultimate loyalties (Huang 1996; Yang 2002).17 Period III: State-Building Marketization in the Commanding Heights (1998–Present)

Since the Fifteenth Party Congress in 1997, Chinese reform has taken a decidedly neoauthoritarian orientation, a trend likely to be reinforced in the short run by China’s success in complying with the terms of accession to the world Trade Organization, immunizing it from trade sanctions. In the chronology of market reform, the year 1997 must rank as high as 1978 or 1992 in terms of dramatic turning points in transcending the residual socialist plan, changing the basic organization of the market, and redefining government-business relations.18 Due to a macroeconomic shift from an economy of chronic shortage to one of widespread surplus, and increased central discipline in the financial market and banking sector (after the 1994 reforms), the reformers were able to overcome the entrenched industrial and local state “redistributive coalitions” (Olson 1982) in support of continued decentralization.19 Generally speaking, reform since 1997 has halted the proliferation of “recombinant property forms,” including informal relationships between firms and banks, firms and local governments, and among firms, by reasserting central authority in certain sectors and firms and unleashing the market in others. These changes reflected 17

In a similar spirit, the sociological market transition debate (Cao and Nee 2000) has dwelled on empirical questions of (1) a decline of the advantages of redistributing power and other forms of political capital relative to nonstate economic actors who possess market power; (2) higher returns to human capital than under a centrally planned economy; and (3) new opportunities centered on market activities. 18 Similarly important was the administrative streamlining of 1998 that eliminated several “line ministries” and further empowered generalist and macroeconomic-oriented ministries. Systematic research has yet to be conducted on the impact of bureaucratic reform on economic governance of the commanding heights, although several sectoral snapshots have suggested the improvement of the state’s regulatory functions. See Pearson (2005) for an overall interpretation. 19 For details on the political economy of 1997, see Lin (2003), especially chaps. 2 and 4.


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a crucial convergence of the central state’s capacity-building and market expansion.20 Recentralization does not necessarily imply reversing the declining share of the state sector in the national economy, a trend established in earlier periods that would continue (see table 9.2). Rather, the state shifts from planning to regulation, relying more on competition to regulate the market economy, in the process gaining regime stability, revenue, and even legitimacy.21 The central state, reacting to persistent erosions of its ownership functions during earlier periods, withdrew its blanket support from the state sector, implementing a mixed strategy of de facto privatization in most sectors that was of little consequence to state developmental objectives and creation of centralized corporate hierarchies in the strategic sectors.22 This strategy reached its zenith under the implementation of Zhu Rongji’s “grasping the big, dropping the small” campaign bifurcating the stateowned sector.23 Concurrently, the central state has strengthened regulation over pricing and competition in industries, and has reformed governance of commercial banks and rules of financial markets toward convergence with global best practices. The rapid expansion of domestic stock markets and the eagerness of foreign capital for Chinese assets have created a new channel for the state to gradually reduce its ownership, while earning returns in dividends and buying time for its experiments in corporate governance. Broadly speaking, the direction of post-1997 reforms has been toward a recentralization of economic power in the hands of Beijing as it strengthens its regulatory role over the market, even as it prepares to withdraw direct ownership and support from the vast majority of industries.24 20 For seminal views on state-building and marketization, see Polanyi (1944); Huntington (1968); Gold (1985); Evans, Skocpol, and Rueschemeyer (1985); Doner (1992); Chaudhry (1992); Haggard and Kaufman (1995); and Fligstein (1996a. 21 For two recent treatises on the notion of a regulatory state in China, see Yang (2005) and Pearson (2005). 22 For analyses of preferential treatment of the “strategic sectors,” see Jin (2002); Liu (2001); Yin and Zang (2001, 1999); State Economic and Trade Commission (SETC) Qiye gaige si (2001); and Liang (2000). Also see SETC (2001) for a selective collection of relevant speeches of and discussions among elite policymakers. 23 For a detailed analysis of Zhu’s policies between 1998 and 2000, see Zweig (2001). 24 The number of state-owned or state-controlled enterprises as percent of the total number of enterprises dropped from 26 to 21 during the 1998–2002 period, while the total registered capital of these enterprises declined from 56% to 54% of the total during the same period. State-owned industrial gross output as percent of the total from 1999 to 2002 plunged from 31 to 16, while shareholding and limited liability companies rose from 18% to 32%. SOE numbers declined (to around 114,000 in 2010, some 100 of them centrally controlled national champions), and their share of employment dropped. But since the 2008 global financial crisis, the SOE share of investment has risen, particularly in property, communications, and finance. In 2004 the average industrial output of SOEs was six times that of the average

Multiple Institutional Templates for Corporate China


Table 9.2. Period One: Revived Command Economy, 1978–1983

Role of the state and Principle of economic relations

Regulation (of side markets in agriculture and light industry goods, and import-export)

Authority: Command but Formal: functional and not “commandist” line ministries Informal: factionalism permeates industrial organization

Ownership Formal: plan Informal: factionalism

Exchange (shortage and demand) may be competitive, but not market priced, aiming not to maximize profit but fulfill the plan

Formal: state procurement prices Informal: zou houmen

Formal: state or private ownership Informal: “unit ownership” (danwei suoyouzhi)

Network: Institutional trellis determines both information asymmetry and frequency of communications/ interactions

Communications/interactions: central-local, ministerial-local, partystate, danwei’s position in the socialist hierarchy (Daqing, TvEs in rich countries)

Info asymmetry: Multiple principals over a danwei, manipulation and hoarding to create flexibility and private returns, also moral hazard in overreporting and capacity duplications

However, this recentralization does not herald the return of broad administrative control over the economy as was the case during the planned economy, but introduces a two-pronged approach of sharpening the macroeconomic leverage that the state needs in its regulatory role on the one hand, while consolidating its effective property rights over a select portion of the state sector on the other. In industrial governance, the Chinese state has chosen to move to the creation of chaebol-style (viz., South Korean family-controlled multinational conglomerates) centralized corporate hierarchies in several strategic sectors as the basic institutional template. By importing western multidivisional corporate templates and regulated competition, Chinese reformers aim to strengthen centrally administered industrial regulation private firm; by 2010 it had shot up to 11 times as much. The Economist, 6 October 2012, found at http://www.economist.com/node/21564274.


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and concentrate revenue collection in the hands of the central government. These top-down institutions reflect the reformers’ cumulative judgment of local state agents as inherently opportunistic, prone to shirking and subverting corporate interests, and protectionist against competition from outside the locality. The state has also attempted to establish market prices to govern the new exchange relations through oligopolistic competition and hard budget constraints at the firm level. However, the central government, given the enormity of its fiscal and developmental goals, has hesitated to separate the regulatory from the ownership functions—as in laying out legal-rational competitive guidelines and offering a credible timetable for the selling off of state shares. Part of this difficulty lies in the nature of the bureaucracy, as the State Council needs to decide which agencies or offices will exercise which authorities, and how conflicts of interest and priorities should be adjudicated. Thus the process of selling off of state shares has stalled due to conflicts in the interests of the NDRC, the State-Owned Assets Supervision and Administration Commission, the China Securities Regulatory Commission, the Ministry of Finance, the People’s Bank of China, and affected industrial interests. The Emerging Post-1997 “Institutional Template”: A Case Study of Restructuring the Oil and Petrochemical Industries From 1998 to 2000, the Chinese oil and petrochemical industries underwent a radical transformation in governance structure.25 In the fall of 1998, Premier Zhu Rongji directed the Chinese oil and petrochemical sectors to reconsolidate all assets and operations into three integrated and territorially protected national oil corporations (NOCs) in which the state owned the controlling share.26 Listed in domestic and international stock markets, these NOCs became the darlings of domestic and foreign investors, generating a windfall for the central treasury from their initial public offerings.27 This section examines the institutional changes that established new authority, exchange, and network relations, and offers illustrative examples 25

Much of the following text in this section is excerpted and edited from Lin (2006). The restructuring of oilfields and petrochemical industries from 1998 to 2000 was not only the largest asset reallocation event in the reform era, involving assets valued at 850 billion RMB, but also the most successful, as measured by the scope and speed of reform implementation and short-term financial returns. See various reports in the South China Morning Post, chinaonline.com, and www.chinaopg-online.com around the time of PetroChina’s and Sinopec’s initial public offerings in May and October 2000, respectively. Also see the statement by President of Sinopec Li Yizhong, in Qiushi (1 April 2001), pp. 32–34, for an official account of restructuring; Fesheraki Associates (2000); and Fesheraki and wu (1998, 33–44). 27 See analysis in China International Capital Corporation Limited (2001). 26

Multiple Institutional Templates for Corporate China


of remaining ambiguities in the state’s dual roles and the limits of these changes in ushering in market forces. An Overview of the Restructuring of the Chinese Oil and Petrochemical Sectors

Unlike prior efforts at enterprise restructuring, this new corporate hierarchy dealt with enduring problems of industrial and regional governance, intraenterprise resource dependency, and firm-level soft-budget constraints with a single blow.28 At the industrial level, the Chinese reformers established oligopolistic competition between two onshore, integrated oil giants—CNPC/PetroChina and Sinopec, roughly demarcated along the territorial boundary of the Yellow River—plus one offshore company (CNOOC).29 Nearly all state-owned oilfields, refineries, and petrochemical plants have been incorporated into these national oil corporations; hence, the NOCs corporate headquarters in Beijing manage their exchange relations as intrafirm issues, while responding directly to price signals in the domestic and global markets. The State Council also eliminated the multiple-tier pricing system, replacing it with a peg of centrally administered crude oil prices to various global markets, and liberalizing nearly all prices for finished oil products.30 The parent holding company also assumed the lion’s share of the subsidiaries’ cumulative debt, thus providing instant relief from interest payments and ending the vicious cycle of intraenterprise arrears. At the microeconomic level, the central state has chosen to rely on the organizational effects of a highly centralized “financial principle of control” (Fligstein 1996b, 656–673) based on a few prices and price-derived signals that would bring profit-maximizing discipline into the SOEs.31 Ac28

For details on the organizational forms and principles of the new national oil corporations, see Lin (2003, chap. 5). 29 Other preexisting companies, including Sinochem and other smaller trading SOEs, continued to exist, but without their prior policy-defended niche markets or prospect for competition against the major three NOCs. In fact, China National Star Corporation merged with Sinopec in 2000. 30 Oil and Gas Journal (10 August 1998). The pegged pricing mechanism was revised in October 2001 to reduce transparency and thus predictability for arbitrage players. The new mechanism lets the State Council adjust the crude price based on the price variations in New York, London, and Singapore; the exact formula for adjustment is not publicized. Interview with Bloomberg, Beijing (November 2001). Also see the 20 November 2001 edition of the South China Morning Post for negative domestic responses to this new mechanism. 31 In the formal analysis of sociological and economic institutionalism, the NOCs adopted a centralized “multidivisional form” of industrial governance, under which subsidiaries have been effectively turned into “cost-centers.” This represents a dramatic departure from their status as “profit-centers” under the contract responsibility system of 1987–1997. See Freeland (1996, 483–526) and Bolton and Farrell (1990, 803–826), for theoretical overviews of these organizational concepts.


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cepting the impossibility of salvaging the whole industry, the reformers have implicitly chosen to maximize the survival chances of a minority of its assets. Thus they created core-listed (hence called “core”) subsidiaries that have concentrated the most valuable assets and a relatively lean workforce drawn from the former SOEs. Most of the unprofitable assets and the surplus workforce, including those work units involved in production and technical services and the provision of social services and local public goods, have been lumped under the noncore-unlisted (hence called “noncore”) company. Holding equal authority as independent legal entities, core and noncore companies engage in contract-based exchanges mediated in Beijing by their parent companies, which fall directly under State Council supervision. The state, given its new demand for improved control and fiscal extraction as the dominant shareholder, expects the core to generate maximum profit through the exploitation of its asymmetric contractual relationship vis-à-vis the noncore. The noncore bears a large portion of the restructuring costs by offering services to the core at rates that can generate profits for the latter, while reducing its chronic losses through tough measures such as massive layoffs and property rights reform (Lin 2003, chap. 5). The reorganization of the NOCs figured prominently in the central government’s major initiatives since 1997 toward radical industrial restructuring (McNally 2001; Freund 2001). In pushing for shareholding structures, the Chinese central state has initiated two crucial shifts in industrial management: from a decentralized to a centralized approach to marketization, and from administrative to corporate hierarchy in production relations (Ma 1998, 381–97; Lin 2001; Lin and Zhu 2001; Holz 2001). Compared to the bargaining politics in the late 1980s to early 1990s, the 1998 reforms strengthened the hands of central bureaucrats against collective claims of local officials, managers, and workers. within the corporate hierarchy, the headquarters of NOCs tightened its ownership control through new managerial contracts with specified profit- and cost-reduction targets, financial penalties for breach of contracts, and increased frequency in issuance of fiats that micromanaged various aspects of firm activities that were governed locally during the earlier periods of greater enterprise autonomy.32 whether new authority, exchange, and network relations will adjust in tandem to the centralized orientation of formal institutions, or if these components of an institutional template will develop in tension or fail to develop, remains the yardstick for successful institutional transition. we offer some evidence of disparate development in our case study of the pricing reform of oil products next. 32

For details of implementation, see Lin (2005) and Lin (2006).

Multiple Institutional Templates for Corporate China


Limits on State-Led Marketization: Crude Pricing by an Oligopoly of National Oil Corporations

Bringing to a long-anticipated end two decades of the multitrack pricing system, the Chinese state looked forward to the simplicity and depoliticization of price convergence with the global market. However, the NOCs competed in ways that have sent the State Council back to the drawing board. In the first few months of industrial restructuring in 1998, the two biggest NOCs engaged in vicious arbitrage and repricing of oil products in each other’s territories. Any semblance of a national market soon disintegrated as chaos over prices swept across China (Qiu 2000). In the end, the State Council was forced to impose an administrative pricing mechanism and guidelines for price fluctuations not unlike those of the socialist era. Throughout the summer of 1998, global oil prices sank to the nadir of the decade. For the first time in reform history, the domestic administered price of crude oil in China exceeded that of the global price, leading to a sudden and massive spike in the volume of imported crude (Qiu 2000, 7, 31, 54–56). The average cost of domestic crude was around US $11.6 per barrel, while every major global producer was selling oil under $10 per barrel (Qiu 2000, 72). Chinese retailers did everything possible to survive the glut, including outbidding each other in price wars and securing local government protection. As the retail sector, including gasoline stations, was dominated by non-NOC actors such as local states, various non-NOC government agencies, and private entrepreneurs, there existed no practical way to rein in the cutthroat competition. Provincial governments often faced pressure from the State Council and from their constituents to intervene and establish price stability. The Gansu government and oil companies tried to form a market-sharing agreement among all relevant actors to control retail oil prices within the province—only to watch helplessly as the price cartel collapsed in twenty days!33 On 5 September 1998, the newly established NOCs, CNPC and Sinopec, held a conference to reach “Six Principles” to deal with market instabilities, including provisions for regulating the flows of crude oil between the Northern and Southern territorial niches of the respective national oil corporations. A key point of contention was whether or not and to what extent the oil-consuming Southern region could simply import, more cheaply, rather than rely on buying crude oil from the North. However, each NOC was left to fend for itself within its own region. A central policymaker proclaimed three sure means to stem unruly competition, “Control the supply [of oil], control the supply, and control the supply” (Qiu 2000, 35). Two weeks later, the State Council issued directives to stop imports of 33

Major players in Shanxi were able to reach a precarious agreement (Qiu 2000, 38).


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finished oil products in surplus—especially diesel and gasoline—in order to temporarily enforce the NOCs market-sharing agreement against the pressures of imports. The corporate headquarters of the NOCs also directed their subsidiaries to scale back production, cap wells, and idle refining capacities. As the NOCs were the biggest victims of the smuggling of refined oil products, they became the biggest beneficiaries of the antismuggling campaign. Profitability shot up immediately, but at the expense of raised input costs for refineries and increasing dissension within the hierarchy of the oil corporations and between central and local states. Many smugglers were powerful local politicians and bureaucrats or even managers within the NOCs (Qiu 2000, 84). For instance, the CEO of the Fuzhou Subsidiary of the Fujian Oil Company personally orchestrated the smuggling of 5,000 tons of diesel in February 1998. Recipients of import licenses often abused their power to import in excess of their allotted quota: customs officers found an oil tanker in Hangzhou that was carrying 39,000 tons of diesel, of which only 9,000 was permitted by the license. Finally, David wank (2002) has investigated the notorious Xiamen case that implicated the highest-level provincial and Beijing officials. These publicized cases amounted to no more than the tip of the iceberg.34 By January 1999, the agreement between CNPC and Sinopec had all but disintegrated. Oilfields and retailers in the Northern oil-producing regions had private incentives to sell their oil to Southern regions, often at heavily discounted prices, to steal market share away from their competitors and importers. In a perverse turn of events, Southern retailers would ship the cheap oil back to the North and sell it at a higher price. For example, the local wholesale price of crude in Liaoning Province was 170 RMB lower than the state-stipulated, cartelized price, but 150 RMB above the price of “countercurrent” oil from the South (Qi 2000, 58). The shock to economic planners and NOCs’ corporate headquarters in Beijing could not be understated. The NOCs entered another market-sharing agreement on March 1999. Forced to rethink its role in setting prices of crude and other oil products, the state had taken several regressive steps in revamping the price mechanism since 1997. The initial formula contained a state-determined “market price” for various grades of crude and processed oil, which would be pegged to a monthly average of the Singapore indices for the same products, and a flexible “premium” that accounted for transportation and other local cost differentials.35 However, the predictability of this peg 34 For aggregate smuggling figures for 1997, as estimated by customs officials, see Qiu (2000, 89–90). 35 For details of this formula, see Oil and Gas Journal, 10 August 1998.

Multiple Institutional Templates for Corporate China


mechanism prompted speculative behavior from nonstate actors prior to the declaration of official prices, thus undermining price stability and the monopolistic rent of the national oil corporations. In late 2001, the State Council switched to a different price-setting mechanism of considerably less clarity, which has been widely interpreted by foreign and domestic analysts and nonstate players as grossly biased in favor of the NOCs and hence antimarket in essence.36 Problems in establishing new price-setting authorities and competitive rules of exchange through oligopolistic market structures have been documented in other industrial sectors by Chung (2003) and Kennedy (2003). The past four years of unusually high global crude oil prices have exposed problems in the current system of stateadministered prices, generating upstream-downstream tensions between domestic oil producers and refineries and consumers, supply disruptions in Guangdong, and intense lobbying by NOCs for price hikes. In light of the previously described formative experience in price liberalization, the NDRC has stuck to its guns in defending its authority in controlling prices, only promising greater responsiveness to global price fluctuations within the existing framework.37 Conclusion we have attempted in this chapter to chart the evolution of China’s “socialist market” as it has emerged in the course of the transformation of the Chinese industrial sector since the Third Plenum of the Eleventh Party Congress in December 1978. we argue that this transformation can be usefully analyzed as a change in “institutional templates” organized around authority, exchange, and informal networking, depending on the stage of reforms. These three “principles” have varied in form and relative priority as the state has shifted its role in the course of reform from ownership and command planning to market regulation. The early reform period (after a brief initial period of plan revival, discarded in the early 1980s) emphasized decentralization and marketization to grow beyond a centrally planned institutional context. The post-Tiananmen period has shifted to recentralized administrative and fiscal regulation of a marketed economy. The ultimate goal is “big society, small state,” at once strengthening 36

Passed in October 2001, the new mechanism lets the State Council (SC) adjust the price of finished oil products if the prices in New York (10% of weighting of SC formula), London (30%), and Singapore (60%) vary above a certain undisclosed margin (Interview with Bloomberg, Beijing [November 2001]). Also see South China Morning Post, 20 November 2001 for a sample of critical domestic responses to the new mechanism. 37 “China Signals It will Not Abandon Low Oil Prices,” Agence France Presse (AFP), 26 September 2005; “China To Take Small Steps Towards Oil Price Liberalization–Analysts,” AFP, 1 March 2006.


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the prestige and power of that state while limiting its functional span of control. In most macroeconomic and political respects this transformation seems to have been remarkably successful. The polity has become more quiescent, internecine elite disputes less tense and explosive, and the economic business cycle less choppy, while GDP growth remains high. Yet we emerge from our case study of the oil and petrochemical sectors with a caveat. Chinese reformers counted on limited competition— through oligopoly at the industrial level or between subsidiaries within the firm—to create market prices while ensuring the survival of national firms. However, serious disruptions in preexisting network relations hampered the transition to the intended equilibrium based on exchange principles. Losers among the new institutions used informal networks to appeal to authority and to their exchange partners, prompting at least provisory return to the authority principle of central price setting. Clearly demonstrating its limited tolerance for unbridled price competition, the central state chose to intervene at the first sign of disruptive aspects of the exchange principle and the resurgence of informal network relations potentially upsetting social stability priorities. This is not to say that the network principle is a consistent or reliable partner of the authority principle. The network is also exploited in quasi-market transactions between bureaucrats and entrepreneurs or other clients in various forms of local corruption or investment. The network principle is essentially opportunistic, submitting to the force majeure in any given context. After the brutal crackdown on the protest movement at Tiananmen, the political authorities clearly had the upper hand, which they have endeavored to retain. while initiative has shifted between authority and exchange principles, the network has consistently functioned in an intermediary capacity, providing informal space to adjust between political command and market rationality. The Chinese planners have not abandoned their institutional template of exercising ownership control by fiat in a corporate hierarchy that is nested in exchange relations among its subsidiaries and other statecontrolled corporations. It has however reinforced, at least in certain strategic sectors, an oligopolistic sectoral milieu designed to constrain cutthroat competition.38 while no longer an owner or a command planner, this authoritarian state clearly takes an expansive view of its market regulatory responsibility. 38

See government work report by Premier wen Jiabao at the Fourth Session of the Tenth National People’s Congress on 5 March 2006, in which wen emphasized the urgency of corporate restructuring. Full text available in English translation at http://big5.xinhuanet.com/ gate/big5/news.xinhuanet.com/english/2006-03/14/content_4307484.htm.

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Part Iv. Networks


The Changing Face of Network Capitalism in Korea A Study of the Corporate Board of Directors’ Network


The concept of network capitalism was created to capture the unique characteristics of East Asian markets, which are quite different from those found in advanced capitalism. Scholars, however, have used the term in various ways to focus on different aspects of the East Asian market (Biggart and Hamilton 1992; Greenhalgh 1988; Hamilton 1998). Some used the term to describe the state-business relationship in which the state functions like the headquarters of an M-form, an organizational structure by which a firm is separated into several semiautonomous units controlled by financial targets from the headquarters (Evans 1995). They focused on how the state manages and regulates private firms embedded in a “political-bureaucratic-business” nexus, which are routinely mobilized for more effective state-policy implementation (Moon and Prasad 1994). Others focused on the institutional linkages among firms as found in the network of Japanese keiretsu, a type of business group with interlocking business relationships and shareholdings among member firms (Gerlach, Lincoln, and Takahashi 1992), or Korean chaebols, business groups controlled by an owner family who has almost complete control over all firms within the group (Bae, Kang, and Kim 2002). Unlike the market in the west, long-term, durable, contract relationships based on high trust exists among firms (Dore 1992; Gerlach 1992; Gerlach, Lincoln, and Takahashi 1992; Granovetter 1994, Macaulay 1963). Relations among business and

This chapter is reprinted from the authors’ paper published in the Korean Journal of Sociology 42, no. 8 (2008): 1–26.


Yong-Hak Kim and Yong-Min Kim

financial institutions constitute the quasi-internal capital market1 (Islam 1994, Lee 1992), whose equivalent is not observed in the west. Still others noted personal networks in market transactions as a key aspect of network capitalism, such as the Chinese business network (Bian and Ang 1997). More recently, especially after the International Monetary Fund (IMF) bailout of South Korea (hereafter, “Korea”) in 1997, scholars studying network capitalism focused on corporate governance structure. Analyzing the cause of the Korean economic crisis, they looked at CEOs and managers of big businesses, who are interlinked by regional, kin, and school ties. Big business groups, once praised as the locomotive of Korean economic development (Biggart 1991; Biggart and Hamilton 1992; Gerlarch 1992; Gerlarch and Lincoln 1992; Granovetter 1994; Lincoln and McBride 1987; Orrù 1991), were regarded as the prime cause of low economic efficiency, and represented as crony capitalism. For instance, Korean corporate governance was regarded as lacking a public “checks and balances system” because of tight family control (Beck 1998, 1020). Board members are recruited via personal connections to a company’s owner, not by functional expertise (Chang 2001; Biggart 1990). Although this management practice is also found in western countries (Hillman, Zardkoohi, and Bierman 1999), it has been criticized as crony capitalism, and is perceived as widespread in East Asian countries (Krugman 1998; wei 2000; wei and wu 2001). This chapter examines the changing face of network capitalism in Korea, focusing on the structure of corporate governance, and, more specifically, the composition of corporate boards of directors. The economic crisis of 1997 forced Korean corporations to reshape their institutional arrangement for boards of directors, either by market forces or by the reform measures implemented by the government. Before the 1997 economic crisis it was common for Korean firms to rely heavily on personal connections when recruiting their board members (Shin and Chin 1989). It was an efficient way of reducing behavioral uncertainty such as shirking, thus promoting personal trust via third-party monitoring within the network (Burt 1992). Has the composition of board members changed since the economic crisis of 1997? In this chapter, we investigate this question, and determine whether school or regional ties among board members are more prevalent in certain industries, reflecting industry characteristics.


when capital is mobilized and allocated internally within a business group, e.g., keiretsu, rather than from the external capital market, a business group is said to function efficiently because timely and accurate information regarding the allocation of resources can be obtained from the member firms, as an “information club” (Goto 1982).

The Changing Face of Network Capitalism in Korea


Impact of Economic Crisis on Corporate Boardroom Composition in Korea Connections are important in every society, including advanced industrial nations. whether through the “old boys’ network,” guanxi, an alumni network, or an F-connection,2 personal connections loom large in business and politics (Ben-Porath 1980; Yang 1994). Korean firms in particular had relied heavily on personalistic ties to reduce risk because of high in-group trust but extremely low trust outside the group boundary (Fukuyama 1996; Hamilton and Biggart 1999; Kim 1991). Three yonjuls—regional, school, and kin ties—are the most salient networks. Family members of a chaebol owner headed its subsidiary companies as CEOs and managers. For instance, after analyzing one hundred of the largest Korean firms in 1978, a study reports that about 21% of the total number of executive positions in these corporations was occupied by individuals who had some type of “family tie” to the owners (Shin and Chin 1989). They interpreted that a “trust” factor was a main cause of these kin ties between the owners and executives. An analysis of 1997 data also shows that the number of kin connections within companies has increased over the past nineteen years; 63% of chaebol founders’ sons, 37% of founders’ siblings, and 20% of siblings’ sons occupy the chaebols’ top managerial positions (Chang 2001). Apparently, personalistic ties have continued to shape the Korean economy despite the rapid advance of industrialization and democratization. Against the contentions of modernization theories, which argue that industrialization and capitalism breed universalism and that meritocracy eventually erodes traditional social arrangements (Durkheim 1933, 203– 204; Lerner 1958, 183–189; Tönnies 1971, 76–98), particularistic ties have not attenuated in modern Korea. when corporate finance is not transparent, top managers are prone to rely on personal networks to circumvent fraud, shirking, and rent-seeking by employees. Yet, the economic crisis of 1997 led the traditional mode of business practice to introduce a rationalized mode of corporate governance, as strongly recommended by the IMF. In February of 1998, two months after the IMF bailout, the government introduced a new law to increase the outside supervision and, accordingly, the transparency of corporate governance. The law mandated that all listed companies on the Korea Stock Exchange appoint at least one outside director, and at least one-quarter of all directors must be outside directors. Two years later, in 2000, an additional measure was introduced for large corporations whose assets exceed 2

“F-connection” refers to a social relationship built on family or friends (Ben-Porath 1980).


Yong-Hak Kim and Yong-Min Kim

two trillion won: the number of outside directors must be at least three and together make up at least half of the board. How did the firms respond to the sudden introduction of this new law? would they still recruit outside directors based on personal connections? Research carried out right after the introduction of this law has shown that the reliance on personal networks declined due to the firms’ efforts to cope with the bad economic situation (Lim and Lee 1998). Unfortunately, however, that study only captured the situation at a particular moment and awaits a follow-up study. In this chapter, we trace over time (the 1995– 2002 period) to examine how Korean firms reshaped their board, both to respond to the new law and to overcome the shock of the 1997 economic crisis. Unlike most previous research that restricted its focus to the family members of chaebol founders, this study starts with directors to examine whether they have yonjul relations with the top management, i.e., CEOs. To do so, we extend our analysis to cover not only chaebols but all companies listed on the Korea Stock Exchange. was there a significant change in the composition of the board after the economic crisis of 1997, away from “homophily” toward the “functional” rule of group composition? The mechanism of homophily explains group composition in terms of the similarity of members’ characteristics such as regional origins, schools, and kinship. The mechanism of functional rule, on the contrary, asks groups to be composed of members with diverse achieved characteristics, e.g., leadership and occupational competency (Ruef, Aldrich, and Carter 2003). Did the government regulation actually reduce the level of homophily in the composition of boards? More specifically, our research questions are as follows: First, how strong was the homophily effect before the 1997 economic crisis, and did it change after the crisis? In other words, has the rational restructuring of corporate governance to overcome the economic crisis reduced the relative importance of personalistic ties among board members? Second, what types of firms, if any, rely on homophily more heavily than others? Data and Basic Statistics To examine the immediate impact of the economic crisis on board composition, we had to collect data covering the years before and after the crisis, from 1995 to 2002. The primary data source was Who’s Who in Top Management (1995–2002) published by the Korea Listed Companies Association. From this source, we compiled information about the personal background of board members of each enlisted company, such as their regional origin, schools (high schools and universities they attended)

The Changing Face of Network Capitalism in Korea


and socio-demographic variables. Online biographic databases operated by Joong-Ang Ilbo, Dong-A Ilbo, Chosun Ilbo, and Yonhap News were searched additionally to fill in the missing data.3 Firm characteristics in the period from 1991 to 1999 were then collected by using the Korea Information Service, SMAT (Stock Market Analysis Tool) and FAS (Financial Analysis System). Table 10.1 shows the number of firms, the total number of directors listed in Who’s Who in Top Management, and the average number of board members of a firm for each year during the period. The unit of observation is the firm-year-person, i.e., an executive of a firm in a given year during the period is the unit of our analyses. The number of firms reached a peak in 1997 and steadily declined after the crisis. The total number of board members and the mean board members started to decline in 1998 while the number of outside board members increased. This can be interpreted in two ways. First, firms economized the board size by eliminating unnecessary board members after the economic crisis. Second, they merely responded to the law that outside directors must exceed one-fourth of all directors; in order to appoint a smaller number of outside directors, the firm had to reduce the size of the board. Table 10.2 lists the high schools and universities that produced the largest number of board directors. It is interesting to note that the rank order corresponds almost perfectly to the common-sense ranking of school reputation. The concentration in the top nine high schools and universities is remarkable: they produced 32% and 72% of total directors respectively; the top tier high schools including Kyunggi High School and Kyungbok High School have a lion’s share; and the number of directors who graduated from Seoul National University (27.13%), Korea University (10.8%), and Yonsei University (9.75%), the big three, constituted almost half of the total number of directors in Korea. Such a high concentration in the top educational institutions is even more impressive considering that there are more than two thousand high schools and two hundred universities in Korea. Such an unequal distribution of resources and privileges results partly from school connections among managers and directors in recruitment processes, a common practice in Korean society. Previous studies have shown that regional connections are also an important variable in explaining elite recruitment in Korea. Table 10.3 presents descriptive statistics of the regional origin of directors. Directors from the Youngnam region had the highest proportion (33%), followed by Seoul


These databases were retrieved at http://people.joins.com, http://www.donga.com/ inmul/, http://db.chosun.com/people, and http://www.yonhapnews.co.kr, respectively. [0]

Table 10.1. Number of Firms and Directors by Year


Number of firms

Total number of Average number of directors directors per firm

Outside board members (%)









































Table 10.2. Number of Directors from Top High Schools and Top Universities

High School

Number of Directors



Number of Directors





Seoul National





































































The Changing Face of Network Capitalism in Korea


Table 10.3. Directors’ Regional Origins Number of directors




































(31%); over 60% of the directors are from these two regions, 1.7 times more than the proportion of population size fifty-five years ago.4 These tables show the overrepresentation of directors from specific schools and regions. To see if these school and regional inequalities increased or decreased after the economic crisis, we calculated using the Gini index,5 a standard measure of inequality. Figure 10.1 summarizes the changing degree of inequality. Inequality for “university” and “high school” is huge but shows signs of slight decline. The magnitude of Gini indices (around 0.75) reveals that only a few educational institutions enjoy a lion’s share, as already noted in table 10.2. Regional inequality has also declined somewhat dramatically due to the fact that the proportion of the Youngnam region decreased while that of Honam increased, reducing the 4 The population size of 1949 was used because the mean age of board members was 53.8. The population of each province in 1949 was the earliest government data that allowed us to control for population size. The statistics are obtained from the Korean Statistical Information System (KSIS) of the Korea National Statistical Office (KNSO). 5 Gini index is measured as G=1-∑i{Xi(Yi-1+Yi)}, where xi is the relative size of group i, Y is the fraction of directors produced by group i, sorted by the magnitude of the fraction. It varies from 0 (perfect equality) to 1 (perfect inequality).

Yong-Hak Kim and Yong-Min Kim


-+- Region




-+- High School


Cl Cl