The idea of different varieties of capitalism (VOC) has emerged and developed significantly in last two decades. It first established itself in the 1980s, when significant differences were noted in the economic development of Germany, Japan, the UK and the US. These were more and more frequently attributed to different institutional frameworks in these countries. The demise of communism (Soviet Union) sparked further debate about whether there were different varieties of capitalism, and whether or not the Anglo-Saxon model would be the best choice for transitional economies.
There are several ways to organise typologies that picture different variations of capitalist systems. Different classifications were suggested by different writers: Streeck/Crouch, Boyer, Whitley and others. One of the most popular theories on the varieties of capitalism, however, was suggested by Hall and Soskice. Their Varieties of Capitalism Theory is an important and insightful attempt to develop a new framework to understand differences and similarities between institutions in different developed economies.
LMEs Vs CMEs
Hall and Soskice place companies at the centre of their analysis. According to authors, national political economies can be compared by reference to the way in which firms manage their relationships in the following five main spheres of the political economy: industrial relations, vocational training and education, corporate governance, inter-firm relationships and relationships with employees.
Using these five dimensions, Hall and Soskice differentiate between two main ideal types that can be pictured as being located at two ends of a wide spectrum: liberal market economies (LMEs) and coordinated market economies (CMEs). Later, Hall and Soskice also added a third Mediterranean type of economies, that are hybrids of the two former typologies and include the mix of the features of the two.
Liberal market economies are different from coordinated market economies, in that activities in LMEs are coordinated via hierarchies and competitive market arrangements. The impact here is on arm’s length exchange of goods, fierce competition and formal contracting. In the employee relationships, sphere wage setting is typically on the individual/firm level which is market influenced.
The firms are typically willing to invest in general skills only, as labour markets are very flexible, hire and fire easy, and job tenures are not long enough to justify investment in specific training. There is, thus, also a high risk of worker poaching by competitor firms. In the area of corporate governance, the emphasis is largely on immediate short-term results, profitability.
Inter-firm relationships with other companies in the industry are very competitive and adversarial. The typical examples of LMEs are the US, Britain, Australia, Canada, New Zealand, Ireland and others.
Coordinated market economies, on the other hand, rely on non-market relationships in their governance. Associations, trade unions and specific legal and regulatory systems play a large role. There is a greater reliance on cooperation networks rather than purely market competition. These provide the means of reducing uncertainty by encouraging information sharing and providing means of monitoring and sanctioning.
Frequently, wage setting in CMEs is national or sector based, so there is a big opportunity for collective wage bargaining. Relationships between companies within industries are cooperative. There is a lesser emphasis on immediate profitability. Long-term investments on assets are accepted.
According to Hall and Soskice, in any national economy, firms entering the market will tend to adopt coordination methods for which there is institutional support. Thus, there is a degree of path dependency. Considerable resources are invested into certain ways of doing things, and the pattern, therefore, is costly to break, as there are big sunk costs.
The theory assumes that because institutions are sticky in this way, institutional differences are likely to persist. Institutions, thus, provide firms with particular opportunity sets, and firms will gravitate towards strategies that take advantage of these opportunities. Therefore, there are likely to be differences in corporate strategies in the firms in different nations (LMEs and CMEs).
For example, in LMEs higher business costs are likely to be largely passed on to consumers, emphasis on short-term profitability and flexible labour markets make it easier to do so, as firms can then quickly layoff workers and cut operations if the demand drops.
In CMEs, however, layoffs are much harder. As the companies are unlikely to be as successful in quickly adapting to output changes, they will tend to accept lower profit margins rather than pass on the cost increase to consumers by raising their prices.
According to Hall and Soskice, different institutions can also enhance the effects of each other (institutional complementarity). The presence of one particular institution can increase the returns from another. In this way, nations with a particular type of coordination in one sphere of the economy should and is likely to develop complementary practices in other spheres as well.
Thus, there is evidence of “clustering” of various institutions within different countries, whereby institutions occur “in bundles.” For example, efficient liquid financial systems that emphasise profitability to provide capital to firms are frequently complemented by flexible labour markets. Where financial markets provide finance on terms not always only linked to immediate profitability, long-term employment is more feasible.
Comparative Institutional Advantage
The theory concludes that the institutional structure of a particular nation provides firms with advantages for engaging in specific types of activities (comparative institutional advantages). In the presence of trade, these advantages can give rise to cross-national patterns of specialisation.
For example, in the sphere of innovation, liberal market economies are better in radical innovation which entails substantial shifts in production lines, development of completely new goods. This is largely because of their institutional structure. Thus, higher rates of labour mobility, M&A activity and risk taking in LMEs lead to specialisation in industries that involve rapid product development: semiconductors, biotechnology, software, advertising, entertainment, finance and airlines.
On the other hand, coordinated market economies are better in incremental innovation – small-scale improvements to existing lines. CME’s workforce is skilled enough to come up with such innovations. Thus, these economies have advantages in the production of capital goods, machine tools, equipment, engines, consumer durables, etc. This way, national patterns of specialisation in particular products emerge.
Criticisms Of The VOC Approach
Although the theory offers very useful insight into the nature of institutional differences, there are a number of criticisms of this approach. Liberal convergence theorists question the very idea of institutional divergence among capitalist economies.
According to Nobel prize winners Edmund Phelps and Barry Eichengreen, non-market coordination only brings substantial benefits for extensive growth (a larger number of inputs leading to more outputs). However, for intensive growth to take place, there needs to be market coordination.
So in a more volatile environment, where intensive growth is needed, the liberal market model will be more effective than that of CMEs. There will be convergence to LMEs as globalisation takes its hold. VOC, thus, assumes that countries diverge in their economic models when in fact they might all just be at different stages of moving towards market coordination, becoming LMEs.
Also, other critics argue that instead of one or two types, there are many governance mechanisms at local, regional, and national level. It is wrong to aggregate them all together, focus only on a national level and categorise nations strictly into LMEs or CMEs, thus overly generalising across countries and sectors.
VOC also does not acknowledge the institutional change. Streeck claims that Germany that frequently appears in VOC literature as a CME is no longer that highly coordinated and it was transformed because of the many small changes in the underlying institutional framework.