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Using our theoretical model of Chapter 3, we demonstrated in Chapter 4 that a drop in demand can move the economy from one equilibria (that is, structure of the business groups) to another, leading to a string of bankruptcies in the process. We argued that such a string of bankruptcies precipitated the financial crisis in Korea in 1997. In this appendix, we supplement that theoretical demonstration with two empirical arguments related to the financing of the business groups in Korea. While these arguments fall outside the narrow confines of our Walrasian model, they nevertheless offer insight into the sources of the crisis there. First, we argue that the bankruptcies before November 17, 1997, are predicted well by the excessively high debt/equity ratios of the groups. In contrast, the bankruptcies after November 17 cannot be explained by the overall debt/equity ratios, but rather, by the excessively high levels of short-term debt of these groups. In other words, the bankruptcies before November 17 show every indication that the capital market was working as it should, whereas the bankruptcies after November 17 show the characteristics of a financial panic, in which banks are not willing to roll over short-term loans regardless of the performance of their debtors. Second, we explain how the interaction between the bankruptcies of chaebol and the precarious structure of the financial system combined to create the financial crisis during the last quarter of 1997. [ABSTRACT FROM AUTHOR]

Local Economies in an Age of Global Capitalism In his new and very thoughtful book, Principles of Economic Sociology, Richard Swedberg (2003, p. 54, his emphasis) makes the following point: “It seems clear that economic sociology should set capitalism at the very center of its analysis since this is the dominant way of organizing the economy – legally, politically, and socially – in today's world.” Although the point may be obvious, Swedberg (2003, pp. 63–5) notes that very few sociologists actually build an economic sociology on this fact: Today's economic sociologists have often taken capitalism for granted and have failed to develop a sociology of capitalism. On the whole, they have preferred to deal with middle-range phenomena, such as firms and networks of various kinds. … When it comes to the discussion of capitalism among contemporary sociologists … the desire to show that social relations and institutions matter is often so strong that the key mechanism in capitalism – the generation of profit and its reinvestment in production – is hardly ever mentioned, and rarely theorized. This leads to a flawed view of capitalism, and a failure to understand its dynamics as well as its capacity to mobilize people and resources for its purposes. Although Swedberg singles out economic sociologists, we would add that many economists are guilty of the same oversight: The narrowed concentration on the firm and equating the firm with economic organization in general obscures the very workings of capitalism. [ABSTRACT FROM AUTHOR]

In his review of the book Trust: The Social Virtues and the Creation of Prosperity, by Francis Fukuyama, Robert Solow makes the following remarkably candid comment: … I, for various reasons, would like him to be right. Academic economics likes to pretend that economic behavior is pretty much the same, always and everywhere, almost uninfluenced by socially conditioned perceptions and norms. If Fukuyama's thesis could be proved to be right, it might help to loosen up the profession's view in other contexts as well. Unfortunately, the book does not meet Solow's criterion of proof, and he concludes: I believe that the sorts of things that Fukuyama wants to talk about are more important than my colleagues in economics are willing to admit. I would rather they are talked about imprecisely than not discussed at all. But imprecision is not a virtue, and “for example” is not an argument. To convince economists that organizational structure matters, it is necessary to point to objective measures of economic performance that are affected. We have argued at length that the business groups in South Korea and Taiwan are different, and that these differences are rooted in the exercise of authority and market power in the two countries. We have also shown that the predictions of the authority/market power model – in terms of the size, vertical integration, and horizontal diversification of business groups – match up remarkably well with contrasting structure of the groups in South Korea and Taiwan: this was our first test of the model, in Chapter 4. [ABSTRACT FROM AUTHOR]

In the last chapter, we offer what we believe is a new hypothesis for the industrialization of South Korea and Taiwan: A primary force driving not only the emergence, but also the divergence of these two economies is the development of intermediary demand growing out of the U.S. retail revolution, to which Korean and Taiwanese firms were able to respond successfully, but in different ways. This claim will certainly be controversial because the existing explanations for East Asian industrialization consistently ignore factors relating to demand. To be more specific, existing explanations do not consider the interconnectedness of global markets in explaining industrialization. They do not consider how changes in the growth and organization of one economy, the U.S. economy, can shape the growth and organization of other economies, the Asian economies. The possibility of this proposition is implicit in our revised Walrasian perspective that we outlined in Chapter 1. Insofar as markets are interconnected, then a change in one market should result in changes in other markets. Within this perspective, theoretically speaking, markets should not be confined artificially to only markets within a national economy. Rather, the test of the extent of interconnectedness is empirical: Are markets actually linked in fact, and if so, with what consequence for all markets so linked? We demonstrated in the last chapter that changes in the organization of retailing in the United States is directly related to changes in the composition of international trade between the United States, on the one hand, and South Korea and Taiwan, on the other. [ABSTRACT FROM AUTHOR]

Why do business groups in South Korea and Taiwan, as well as the organization of economies in which they are embedded, differ from each other? Why should Korea have moved along a path toward an economy where so much production, especially in the export sectors, is concentrated in only a small number of vertically integrated chaebol? Why should Taiwan have taken a very different path, one where business groups firms assemble parts made by unaffiliated firms or where they occupy upstream and service niches in an economy pulled along by downstream demand, mainly from small and medium-sized firms? In the language of our model, why was the “high concentration” equilibrium set selected in Korea and the “low concentration” set selected in Taiwan? The answers to these questions are the subject of Part II. In the opening chapters of this book, we covered a number of answers that various writers have given to explain the presence of business groups, rather than the differences among them. These answers usually represent one or a combination of either strong-state, market-failure, or institutional explanations. Although we do not deny the importance of political policies or of problems with capital markets in developing economies, we believe that such factors should be seen as proximate causes, as occurrences or events that trigger economic changes, often extremely important ones, without actually dictating the organizational medium of that change. [ABSTRACT FROM AUTHOR]

If our Walrasian view of economic organization is correct, then business groups can be thought of as causative forces in economic systems that also cause them. Before testing this idea empirically, we needed first to develop a theory of business groups. To this end, in the last chapter, we constructed a highly stylized economic model consisting of upstream sectors producing intermediate inputs and downstream sectors using those inputs to produce final consumer goods. In the model, manufacturing firms decide whether to buy intermediate products at zero markups from a firm within a group, or at full markups from unaffiliated firms. Solving this model based on pricing decisions of firms in general equilibrium reveals multiple equilibria in the form of two distinct and economically stable solutions to business group integration in an organized economy: a high and a low concentration set of groups. We can think of these two stylized economies as both consisting of interconnected networks of firms where authority and economic power interact in the context of a price structure. In one solution, the few very large business groups organize an economy in which they remain the stable elements, pushing other groups and independent firms into niches that the large groups do not dominate. In the other solution, many business groups coexist by occupying different distinct upstream or downstream niches and by trading with unaffiliated firms. The idealized model, therefore, predicts that business groups, which represent concentrated and authoritatively held assets, organize themselves quite differently across economies. [ABSTRACT FROM AUTHOR]

“In many successful late-industrializing countries in the 20th century … business groups with operating units in technologically unrelated industries have acted as the microeconomic agent of industrial growth” (Amsden and Hikino, 1994, p. 112). This is Alice Amsden's conclusion, presented here in an article with Takashi Hikino, but also found in many of her other writings (2001, 1989, 1985). She shares this opinion with many political economists (Cumings, 1985, Wade, 1990, Fields, 1995, Evans, 1995, Woo-Cumings, 1991, 1999), who, like herself, have been instrumental in making the strong state interpretation the most prominent explanation of Asian development. A number of economists (Leff, 1976, 1978, Aoki, 1984, 1988, Jorgensen, Hafsi, and Kiggundu, 1986, Ghemawat and Kanna, 1998, Khanna and Palepu, 1999, 2000a, b, c), while willing to concede the potential role of government policy, instead list market failures and transaction cost savings as the primary reasons for the emergence of business groups. Not to be outdone, sociologists (Granovetter, forthcoming, 1995b, 1994, Chung, 2001, 2003, Whitley, 1990, 1992, Gereffi and Wyman, 1990, Orrù, Biggart, and Hamilton, 1997, Hamilton, Zeile, and Kim, 1989) see business groups as embodiments of social networks and institutions rather than as outcomes of political or economic processes. That scholars from such diverse disciplines have zeroed in on business groups from different disciplinary angles testifies not only to their actual importance in Asian economic development, but also to their theoretical ambiguity. [ABSTRACT FROM AUTHOR]