RENTS, RENT-SEEKING AND

ECONOMIC DEVELOPMENT
Theory and Evidence in Asia

The concepts of rents and rent-seeking are central to

any discussion of the processes of economic develop-
ment. Yet conventional models of rent-seeking are
unable to explain how it can drive decades of rapid
growth in some countries, and at other times be associ-
ated with spectacular economic crises. This book argues
that the rent-seeking framework has to be radically
extended by incorporating insights developed by politi-
cal scientists, institutional economists and political
economists if it is to explain the anomalous role played
by rent-seeking in Asian countries. It includes detailed
analyses of Thailand, Malaysia, the Philippines, the
Indian sub-continent, Indonesia and South Korea. This
new critical and multidisciplinary approach has impor-
tant policy implications for the debates over institu-
tional reform in developing countries.

Mushtaq H. Khan is Lecturer in the Economics Depart-

ment, School of Oriental and African Studies, Univer-
sity of London, UK He has an undergraduate degree
from Oxford and a doctorate from Cambridge. He has
also taught at both Oxford and Cambridge. His main
work is on the institutional political economy of devel-
opment, and he has published extensively on South
and East Asia as well as on corruption, clientelism and
rent-seeking.

Jomo K.S. is Professor in the Applied Economics

Department, University of Malaya. He has taught at sev-
eral Malaysian universities and at Harvard, Yale, Cam-
bridge and Cornell. He is president of the Malaysian
Social Science Association as well as author and editor
of many books, notably A Question of Class: Capital, the
State, and Uneven Development in Malaya (1988).
 Dedicated to our fathers,
Akram Husain Khan and S.K. Sundaram
RENTS, RENT-SEEKING AND
ECONOMIC DEVELOPMENT
Theory and Evidence in Asia

EDITED BY
MUSHTAQ H. KHAN
School of Oriental and African Studies
University of London

AND
J O M O KWAME S U N D A R A M
University of Malaya

CAMBRIDGE
UNIVERSITY PRESS
CAMBRIDGE UNIVERSITY PRESS
Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, Sao Paulo, Delhi

Cambridge University Press

The Edinburgh Building, Cambridge CB2 8RU, UK

Published in the United States of America by Cambridge University Press, New York

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Information on this title: www.cambridge.org/9780521788663
© Cambridge University Press 2000

This publication is in copyright. Subject to statutory exception

and to the provisions of relevant collective licensing agreements,
no reproduction of any part may take place without the written
permission of Cambridge University Press.

First published 2000

Re-issued in this digitally printed version 2009

A catalogue record for this publication is available from the British Library

National Library of Australia Cataloguing in Publication data

Rents, rent-seeking and economic development : theory
and evidence in Asia.
Bibliography.
Includes index.
ISBN 0 521 78302 X
ISBN 0 521 78866 8 (pbk.).
1. Rent (economic theory). 2. Rent (economic theory) — Political
aspects - East Asia. 3. Economic development - Political aspects -
East Asia. I. Jomo K.S. (Jomo Kwame Sundaram). II. Khan, Mushtaq H.
333.012095
ISBN 978-0-521-78302-6 hardback
ISBN 978-0-521-78866-3 paperback
 Contents

List of Figures viii

List of Tables x
List of Contributors xi
Acknowledgements xiii
List of Abbreviations xiv
Introduction 1
086+7$4+.+$1$1'-202.6
Rents and rent-seeking 5
Corruption 8
Patron-client exchanges 10
An outline of the chapters 12
1 Rents, Efficiency and Growth 21
086+7$4+.+$1
Monopoly rents 26
Natural resource rents 33
Rents based on transfers 35
Schumpeterian rents 40
Rents for learning 47
M onitoring and m anagem ent rents 53
Rents, rights and the surplus 63
Characteristics of rents: a summary 66
2 Rent-seeking as Process 70
086+7$4+.+$1
Inputs and rent-outcomes in the rent-seeking process 74
Rent-seeking: the evidence 82
v
vi CO N TEN TS

Patron-client networks and the organization of

rent-seeking 89
The input cost of rent-seeking 104
The rent-outcomes of rent-seeking 118
Conclusion 139
3 Rent-seeking and Economic Development in Thailand 145
R,&+$5')'21(5$1'$16,/5$06$<
Institutions and politics in economic growth 147
The textile and garm ent sector: a case study 156
The financial crisis 168
Conclusion 174
4 Thailand’s Old Bureaucratic Polity and Its New
Semi-democracy 182
0,&+$(/752&.
A short history of rent-seeking in Thailand 183
An alternative explanation 186
Productive and unproductive rents 196
5 Obstructive Corruption: The Politics of Privilege in the
Philippines 207
3$8/'+87&+&52)7
Surveying the paradigms 210
Surveying the landscape of privilege in the Philippines 216
Towards new terrain? 239
6 Funny Money: Fiscal Policy, Rent-seeking and Economic
Perform ance in Indonesia 248
$1'5(:0$&,17<5(
Government spending: the official story 252
Off-budget fiscal activity 255
Off-budget activity and economic perform ance 260
Institutions and efficiency in rent-seeking 264
Conclusions: before and after . . . 268
7 The Malaysian Development Dilemma 274
J202.6$1'(7*20(=
Colonial heritage 278
Resource rents 279
Post-colonial economic diversification 282
Increased state intervention, 1970-85 287
Deregulation and new regulation 291
 CO N TEN TS v ii

Rents, developm ent and redistribution 294

Conclusion 299
8 Financial Sector Rents in Malaysia 304
C+,1.2.)$<$1'-202.6
Financial restraint 305
Financial sector rents and their deploym ent 310
Conclusion 320
Index 327
 Figures

1.1 The competitive m arket equilibrium 27

1.2 Rents created by monopolistic restrictions 31
1.3 Rent, consum er surplus and producer surplus under a
monopoly 31
1.4 Natural resource rents 34
1.5 Deadweight losses due to transfers, in the neo-classical model 37
1.6 Schumpeterian rents 42
1.7 Dynamic net social benefits with Schum peterian (and
learning) rents 45
1.8 Conditional subsidies as rents for learning 49
1.9 Market disequilibrium with efficient m onitoring 57
1.10 Financial sector rents as incentives for portfolio m onitoring 59
2.1 Rent-seeking process com pared with a conventional
production process 73
2.2 Input costs, rent-outcomes and net effects of rent-seeking 76
2.3 The interface of conventional production and rent-seeking 79
2.4 The net effect of rent-seeking with value-reducing rents 81
2.5 The net effect of rent-seeking with value-enhancing rents 82
2.6 Rent-seeking in Asian industrial sectors in the 1970s and 1980s 90
2.7 Resource flows in patron-client networks since the 1960s:
Indian subcontinent 94
2.8 Resource flows in patron-client networks in the 1970s:
South Korea 96
2.9 Resource flows in patron-client networks in the 1970s:
Malaysia 100
2.10 Resource flows in patron-client networks in the 1970s:
Thailand 103
2.11 Rent-seeking game involving co-ordination and conflict 116
v iii
 F IG U R E S ix

2.12 Decomposing the value of the rent-outcomes of

rent-seeking 119
5.1 Four major categories of beneficiaries of Marcos regime 224
6.1 Inflation comparators, 1970-96 263
7.1 Khan’s rent-seeking process 277
7.2 Resource allocation involving alternative investment
options 277
8.1 Simple supply-dem and model of the m arket for loans 306
8.2 Rent effect of financial restraint 307
 Tables

1.1 Rents and the rights sustaining them 65

1.2 Commonly identified but misleading ‘differences’
between rents 67
1.3 Relevant growth and efficiency implications of different rents 68
2.1 Growth rates of GDP and industrial output, with corruption
indicators 83
2.2 Conditions for the creation of value-enhancing
rent-outcomes 121
2.3 Key conditions explaining differences in rent-outcomes 138
3.1 Market types and functions 152
3.2 Thailand: clothing and textile production, 1975-93 157
3.3 Thailand: clothing exports by type of agreem ent, 1987
and 1993 167
6.1 Off-budget capital expenditure, 1991-92 261
7.1 Malaysia: contribution of petroleum to governm ent
revenue,1963-96 281
7.2 Malaysia: tim ber export duty revenue, 1968-96 283
8.1 Malaysia: interest margins of commercial banks, 1984-95 312
8.2 Malaysia: priority-sector guidelines and achievements of
commercial banks, 1979-91 313
8.3 Malaysian commercial banks: lending to Bumiputra
community, 1986-95 314
8.4 Malaysian banking system: loans and advances outstanding
by sector, 1978-90 316
8.5 Malaysia: financing of private capital expenditure, 1986-90 317
8.6 Malaysian listed companies: average cost of credit, 1983-90 318
8.7 Malaysia: commercial banks’ and stock exchange’s market
share of funds, 1990-94 319
x
 Contributors

Chin Kok Fay is Lecturer in Development Economics in the Faculty of

Development Sciences, Universiti Kebangsaan Malaysia, Bangi, Selan-
gor, Malaysia. His main research interests have been in Malaysian
finance, looking at both banking and the stock market.

Richard F. Doner is Associate Professor in the Political Science Depart-

ment, Emory University, Atlanta, Georgia, USA. He is the author of Driving
a Bargain (1991) and various articles on the political economy of Southeast
Asia, especially Thailand. His current projects focus on the roles of institu-
tions in Thai economic growth, the hard disk drive industry in Southeast
Asia, and the role of business associations in Thai economic growth.

E.T. Gomez is Lecturer at the Faculty of Economics and Administration,

University of Malaya. He is the author of Politics in Business: UMNO's Cor-
porate Investments (1990), Money Politics in the Barisan Nasional (1991),
Political Business: Corporate Involvement of Malaysian Political Parties (1994)
and Chinese Business in Malaysia: Accumulation, Ascendance, Accommodation
(1999), and co-author of Malaysia's Political Economy: Politics, Patronage
and Profits (Cambridge University Press 1997, 1999), and Ethnic Futures:
The State and Identity Politics in Asia (1999).

Paul D. Hutchcroft received his Ph.D. from Yale University in 1993, and
is an Assistant Professor in the Department of Political Science at the
University of Wisconsin, Madison. He has written extensively on Philip-
pine politics and political economy, as well as on the politics of corrup-
tion, and is the author of Booty Capitalism: The Politics of Banking in the
Philippines (1998). His current research examines central-local rela-
tions in the Philippines in historical and comparative perspectives.
xii CONTRIBUTORS

Jomo K.S. is Professor in the Applied Economics Department, Univer-

sity of Malaya. He has taught at several Malaysian universities and at
Harvard, Yale, Cambridge and Cornell. He is president of the Malaysian
Social Science Association as well as author and editor of many books,
notably A Question of Class: Capital, the State, and Uneven Development in
Malaya (1988).

Mushtaq H. Khan is Lecturer in the Economics Department, School of

Oriental and African Studies, University of London, UK. He has an
undergraduate degree from Oxford and a doctorate from Cambridge.
He has also taught at both Oxford and Cambridge. His main work is on
the institutional political economy of development, and he has pub-
lished extensively on South and East Asia as well as on corruption, clien-
telism and rent-seeking.

Andrew Maclntyre holds a doctorate from the Australian National Uni-

versity and is Associate Professor in the Graduate School of Interna-
tional Relations and Pacific Studies at the University of California, San
Diego. He also serves as director of the School's ASEAN-Pacific Project.
His publications include Business and Politics in Indonesia (1991) and
Business and Government in Industrializing Asia (1994).

Ansil Ramsay holds a doctorate from Cornell University and is Munsil

Professor of Government at St Lawrence University. He is the editor of
Thailand-U.S. Relations (1988) and his work has appeared in Asian Sur-
vey, The Journal of Asian Studies, The Journal of Developing Areas, Pacific
Affairs, and World Development. He is currently working on a book with
Richard Doner examining how the Thai economic and political institu-
tions that contributed to the rapid growth and diversification of Thai
industries in the 1970s and 1980s have not proved compatible with
upgrading productivity in the 1990s.

Michael T. Rock is Senior Economist at Winrock International and Pro-

fessor of Economics and Chair of the Department of Economics and
Management at Hood College. Professor Rock's published research
focuses on the environment and development, and the role of indus-
trial policy in the second tier NIEs. His work has appeared in World
Development, Development Policy Review, Ecological Economics, Journal ofEnvi-
ronment and Development, Journal of Industrial Ecology, Journal of Interna-
tional Development, and Studies in Comparative International Development.
He is currently working on a book of comparative case studies of indus-
trial pollution management in East Asia.
 Acknowledgements

The editors would like to thank the Asia Center of the Japan Founda-
tion and the Social Science Research Council for financial support.
Jomo gratefully acknowledges the expert assistance of Foo Ah Hiang.
Mushtaq would like to thank Asma Khan for her constant support, and
Ben Fine, Anwar Shaikh, Ali Cheema and Stephanie Blankenburg for
commenting on and discussing parts of the chapters he wrote. Two con-
secutive years of Economics Masters students at the School of Oriental
and African Studies gave the arguments in this book a trial run as part
of their course in the political economy of institutions. Their enthusi-
asm, support, comments and criticisms were invaluable.
 Abbreviations

BIBF Bangkok International Banking Facility

BNM Bank Negara Malaysia
GATS General Agreement on Trade in Services
GDP gross domestic product
GNP gross national product
ICOR incremental capital-output ratio
IMF International Monetary Fund
ITA Information Technology Agreement
JICA Japan International Cooperation Agency
LDC less developed country
MFA Multi-fibre Arrangement
MP member of parliament
NIC newly industrializing country
NSB net social benefit
OPEC Organization of Petroleum Exporting Countries
R&D research and development
RM ringgit
Rp rupiah
SOE state-owned enterprise
TRIM Trade-related Investment Measure
TRIP Trade-related aspect of Intellectual Property
UMNO United Malays National Organization
WTO World Trade Organization
 Introduction

Mushtaq H. Khan and Jomo K.S.

The rapid economic development of a number of Asian countries over

the past three decades lulled many observers into taking excessively com-
placent positions about the new 'emerging markets'. The financial crisis
of the late 1990s, which brought this period of growth to a temporary
halt, resulted in an equally dramatic change of mood about the prospects
of these countries. Led by the International Monetary Fund (IMF) and
many academics, there was a widespread feeling that rent-seeking and
corruption underpinned the crisis, and that without uprooting the insti-
tutional structure of 'crony capitalism', the prospects for the region were
dim. The period as a whole thus provides a rich source of evidence with
which to examine the role of rent-seeking in economic development.
How important have corruption, patronage, lobbying and kickbacks
been in developing countries? Have they been responsible for slow
growth or the reverse? What determines the magnitude and effects of dif-
ferent types of rents, of corruption and of patron-client exchanges? How
did Asian countries grow so rapidly in the 1980s despite an apparently
widespread problem with rent-seeking? To answer these questions, we
start by examining theoretical models and asking how they need to be
amended and extended. Corruption, clientelism and other forms of
rent-seeking were widespread during Asia's high-growth period and it is
this experience which most of our case studies address. Understanding
the role of rent-seeking in the period of growth is critical for assessing the
adequacy of explanations of the subsequent crisis in terms of crony cap-
italism which many commentators were quick to offer ex post. The main
thrust of our story is that rent-seeking was, and is, endemic in both devel-
oping and developed countries. The difference is that in developing
countries the rent-seeking can be more extensive, can include illegal
forms and is more often damaging for growth. At the same time, many

1
2 MUSHTAQ H. KHAN AND JOMO K.S.

types of rents and rent-seeking played a key role in processes of develop-

ment and are likely to do so again in the future. Understanding this para-
dox is of great importance for policy-makers.
The book is aimed at audiences across the social sciences, in particu-
lar, economists, political scientists, development professionals and polit-
ical economists. The interdisciplinary approach was motivated by a
convergence in the types of questions being asked and the types of
explanatory variables being identified across social science disciplines to
explain related phenomena. We feel very strongly that further progress
is contingent on active cross-fertilization across disciplinary frontiers.
The authors contributing to this book are economists and political
scientists working on the effects of rent-seeking, corruption and
patron-client exchanges. But rather than being a collection of pieces
addressing similar questions in different disciplines, the authors have
addressed this interdisciplinary audience. In addition, the book is dis-
tinctive in that all our authors have regional specializations in one or
more of the Asian countries discussed. As a result, our theoretical ques-
tions have been motivated by historical observations to a much greater
extent than is typical in the analytical literature.
Chapters 1 and 2 provide an overview and critical extension of the
analysis of rents and rent-seeking. The mainstream economic analysis is
shown to be far too narrow. Advances in information economics and in
institutional economics as well as insights from classical political economy
are used to extend and amend the standard model to make it more appro-
priate for analysing the historical evidence. Chapters 3 to 8 address the
experience of rent-seeking, corruption and related processes in a number
of Asian countries. These chapters are interesting in their own right as an
analysis of rent-seeking in these countries, but, in addition, they also test
the validity of the narrow rent-seeking framework and our claim that this
framework has to be radically amended and extended.
The mainstream framework used for analysing rent-seeking has (a)
focussed on some very specific types of rents, and (b) assumed very specific
political and institutional conditions under which rent-seeking (the com-
petition over rents) takes place. There are two possible responses to the
limitations of these theories. One is to abandon the rent-seeking frame-
work altogether and to derive analytical generalizations about the effects
of processes like corruption and patronage from the empirical evidence.
This approach is often adopted by critical political scientists. The other is
to preserve the overarching analytical framework of the rent-seeking
approach but to extend the range of rents and types of rent-seeking which
are analysed. These two approaches are actually complementary because,
if the rent-seeking model is to be extended, it has to incorporate the
insights coming from political science and political economy.
 INTRODUCTION 3
Chapter 1 shows that, while many rents are harmful for developing
countries, others are essential for both efficiency and growth. As a
result, Chapter 2 shows that the rent-seeking which seeks to preserve or
destroy particular rents can be growth-promoting or growth-retarding,
depending on the circumstances. To have an effective analytical
approach we need to look not only at the determinants of the rent-seek-
ing cost hut also at the determinants of the types of rents which are being
created or preserved. Since institutional change almost always involves
the creation or destruction of rents, and since distributive conflicts can
also be described as conflicts over rents, rent-seeking can provide an
overarching framework for examining many questions which have con-
cerned institutional economics and political economy. By drawing on
the insights of these disciplines, we see that the outcomes of rent-seek-
ing must also depend on institutional and political variables. Although
conventional rent-seeking theories have not significantly borrowed
from these disciplines, the first two chapters show that an analysis of
political and institutional variables is essential for making sense of rent-
seeking in the real world. Chapters 3 to 8 provide detailed case studies
of rent-seeking processes in a number of Asian countries. The experi-
ences of the Philippines, Thailand, Malaysia and Indonesia receive par-
ticular attention. The theory chapters draw on the experience of South
Korea and the Indian subcontinent as well. Each of these chapters
focusses on particular economic, political and institutional variables
which the authors think are essential for explaining the effects of rent-
seeking in that country.
The economic theory in Chapters 1 and 2 aims to be accessible to
social scientists with an interest in economics. But as these chapters also
challenge the standard rent-seeking model by incorporating results from
institutional economics and political economy, they will be of interest to
economists as well. Similarly, the case studies in Chapters 3 to 8 should
be of interest both to economists working on rent-seeking and to politi-
cal scientists and area specialists with an interest in these countries. In
addition, graduate students and advanced undergraduates across the
social science disciplines are likely to find the book useful for its critical
development of the theory of rent-seeking and as a source of case stud-
ies of rent-seeking in Asian countries.
The Asian financial crisis of the late 1990s intensified the debate over
how governance structures and political processes need to be reformed in
developing countries. The contributors to this volume ask how substantial
rent-seeking could have coexisted with high growth for so long, indeed
how rent-seeking appears to have driven growth in some cases. Our authors
suggest that rent-seeking describes a wide range of processes which are
sometimes critical for growth and sometimes severely growth-retarding.
4 MUSHTAQ H. KHAN AND JOMO K.S.

The link between crony capitalism and the financial crisis which was fre-
quently made in the aftermath of the 1997 crisis seemed compelling at the
time, but was certainly too simplistic in view of the longer historical
record. The significance our authors attach to the financial crisis for the
analysis of rent-seeking varies. The consensus, rather, is that a policy
response to rent-seeking cannot be developed by looking at the financial
crisis in isolation. Looking at the rent-seeking process historically con-
firms the need for a more sophisticated analysis if future policy responses
are to be appropriate.
The longer-term Asian experiences which this book draws on chal-
lenge many of the established models of the effects of corruption and
rent-seeking. Corruption, patron-client exchanges and other forms of
rent-seeking have been rife in many of these countries. All of them have
also had periodic ups and downs, but more interesting is the variation in
their long-run performance. In many cases, long-run performance has
been dramatic, in other cases quite poor. It has ranged from the relatively
poor performance of the Indian subcontinent and the Philippines to the
very high growth rates of Northeast Asian countries, such as South Korea.
Most Southeast Asian countries, such as Indonesia, Malaysia and Thai-
land, fall somewhere in between. Even allowing for other factors explain-
ing differences in growth rates, this range of experience raises questions
about the adequacy of the standard economic models of rent-seeking.
Not only was there no simple correlation between the extent of rent-seek-
ing and long-run economic performance, there was also little correlation
between the intensity of rent-seeking and the country's vulnerability to the
financial crisis of 1997. Chapter 2, in particular, looks at the analytical
implications of these puzzles. With comparable amounts of rent-seeking
and corruption, many East and Southeast Asian countries did significantly
better than the South Asian countries of the Indian subcontinent. More-
over, while corruption increased much more rapidly in the 1990s in the
Indian subcontinental countries, the financial crisis hit only the Southeast
Asian countries with ferocious severity. Clearly, the interaction of short-
term capital flows, problems of political legitimacy as well as problems
related to some types of rent-seeking produced a particularly severe crisis in
some Asian countries. But it is also important to understand rent-seeking
as a longer-term process, with implications and effects which should not be
read off from a single shock.
Comparisons of the extent of rent-seeking and corruption across
countries are, to say the least, not a precise science. The contributions to
this volume are a response to the observation that corruption and polit-
ical transfers have been significant in virtually all Asian countries. They
challenge the interpretation, widely shared among policy-makers, that
developmental success is related to the absence of rent-seeking and the
 INTRODUCTION 5
conditions which give rise to it. A common theme running through the
contributions in this volume is that this view is unrealistic. The effects of
extensive corruption, clientelism and other forms of rent-seeking differ
across countries, and the analytical task is to identify the determinants of
these differences. By examining rent-seeking processes in greater detail,
the volume questions many widely held conceptions about rent-seeking
which have gained uncritical currency. The next three sections summa-
rize, in turn, a number of issues in our discussion of rent-seeking, cor-
ruption and patron-client exchanges which recur throughout the book.
The fourth section provides a plan for the subsequent chapters and an
outline of the main arguments.

Rents and rent-seeking

The term 'rent' is used to describe (not always very precisely) incomes
which are above normal in some sense. But what is a 'normal' return?
Often the benchmark used is the income which an individual or a firm
would have received in a competitivemarket. But since the competitive mar-
ket of theory does not usually exist, a more useful definition is an income
which is higher than the minimum which an individual or firm would have
accepted given alternative opportunities. However defined, a moment's
reflection should tell us that a very wide range of critically important real-
world incomes have the character of rents. Rents include not just monop-
oly profits, but also subsidies and transfers organized through the political
mechanism, illegal transfers organized by private mafias, short-term super-
profits made by innovators before competitors imitate their innovations,
and so on. Some rents are legal while others can be illegal. Some, such as
monopoly rents, may signal inefficiency; others, such as rents for innova-
tors, subsidies to infant industries or the rents earned by owners of scarce
natural resources, may signal either efficiency or the successful exploita-
tion of growth opportunities. The wide range of incomes which have the
character of rents raises questions about the usefulness of the term. A
broad definition does have the advantage of allowing us to focus on com-
mon features relevant for an analysis of all rents. On the other hand, dif-
ferences between rents are also very important, as we will see in Chapter 1.
Since rents loosely represent incomes which are higher than would
otherwise have been earned, they create incentives to create and main-
tain these rents. These activities can range from bribing or even coercion
at one extreme, to perfectly legal political activities such as lobbying or
advertising at the other. Collectively, these activities are known as rent-seek-
ing activities, and they raise a further set of questions. Rent-seeking can
be broadly interpreted as activities which seek to create, maintain or
change the rights and institutions on which particular rents are based.
6 MUSHTAQ H. KHAN AND JOMO K.S.

However, once we define it in this way, we see that rent-seeking describes

a significant part of social activity. This is because almost all institutional
change involves creating or destroying rents and almost all distributive
conflicts can be described as conflicts where one or both sides are seek-
ing rents. Thus, much of the subject matter of institutional economics
and political economy can inform a broader and more encompassing
rent-seeking approach. If we take this route, the rent-seeking approach
can provide a framework for incorporating theories of institutional
change as well as the political economy of distributive conflicts. It can
also provide a framework for incorporating the insights of theories of
state performance.
The encompassing approach to rent-seeking suggested in the last
paragraph is a far cry from early rent-seeking theory. Rent-seeking theo-
ries were initially constructed by liberal economists who wished to show
that state intervention induced additional rent-seeking costs by artifi-
cially creating rents (Krueger 1974; Posner 1975; Buchanan 1980).
These arguments were meant to strengthen the case for free markets
where, in theory, no-one would earn any rents. While other economists
challenged these conclusions, their responses in turn enriched the rent-
seeking literature (Mueller 1989: 229-46). Statist economists supporting
intervention had to explain how the damage due to rent-seeking could
be limited by interventionist states. The use of the rent-seeking frame-
work by competing schools to reach widely different conclusions shows
that the rent-seeking approach can only have relevance if it makes
explicit the institutional and political assumptions on which radically dif-
ferent conclusions can be based. Chapter 2 lays the foundations for such
an extended approach to rent-seeking.
Like rents, rent-seeking can refer to a wide range of expenditures and
activities. And as with rents, the broad scope of what can be incorporated
within the rent-seeking framework can be a strength if used properly but
a serious weakness if used loosely and without refinement. Chapter 2 dis-
cusses the variables and conditions which can determine whether rent-
seeking is value-enhancing or value-reducing for society. The framework
is then used to compare rent-seeking processes in the Indian subconti-
nent, South Korea, Malaysia and Thailand. The chapter brings together
approaches developed quite separately by economists and political sci-
entists, and shows how they may be integrated in a broadly defined polit-
ical economy framework.
There is clearly an overlap between rent-seeking and processes such as
corruption and patron-client exchanges which have long attracted the
attention of political scientists. The resources spent on corruption, or
spent within patron-client networks, are sometimes (but not always)
expended to capture rents. If so, these expenditures too are variants of
 INTRODUCTION 7
rent-seeking. This has led to fruitful exchanges between political scien-
tists who have studied different types of corruption and patron-client
exchanges, and economists who have been interested in incentive struc-
tures and their implications.
While the rent-seeking argument was initially developed within neo-
classical economics, it has striking similarities with the analysis of unpro-
ductive activities in classical political economy. The classical concern was
that some activities used up resources as inputs without adding to the net
value of the outputs produced. For Adam Smith the service sector was
unproductive in this sense, while for Marx it was a number of sectors
including the financial sector (Boss 1990). The sectors identified as
unproductive by the classical economists were too broadly defined, but
their analytical concern has been rediscovered by modern economists.
In much the same way, the rent-seeking literature has identified sets of
activities which are unproductive. These are typically 'political' activities
which seek to protect, maintain or change rent-generating rights. Never-
theless, the problem of determining which of these activities is unpro-
ductive is very similar to the classical problem. Just as some service sector
or finance sector activities can add to net value even though they use up
inputs, some rent-seeking activities can add to net value even after allow-
ing for the cost of the inputs they use up. This is because some rent-seek-
ing may be about creating or protecting 'useful' rents. This possibility
makes the analysis of rent-seeking much more challenging, and also
much more policy relevant.
Despite the growing sophistication of the rent-seeking analysis, the
mainstream policy discussion is often based on the earliest and simplest
models. These early models assumed that rent-seeking entailed large
wasteful expenditures to create or protect value-reducing rents. If rents
are always value-reducing and if the effects of rent-seeking are also nega-
tive, rent-seeking must, on the whole, have seriously bad effects. Not sur-
prisingly, the rent-seeking models used in policy prescriptions generally
predict that the existence of rents will result in inefficiency and low
growth. This policy consensus is strengthened by an overwhelming but
partial set of observations from low-growth economies in Asia and Africa.
The evidence is drawn from countries which suffered from substantial
amounts of rent-seeking and were poor economic performers. The con-
clusion that rent-seeking is a major cause of poor performance is based
on this evidence.
This is why the East Asian and, more recently, the Southeast Asian
experiences are important. They suggest a more complex story about the
efficiency and growth implications of rents and rent-seeking. They show,
first, that the simplifying assumption that all rents are always bad is ques-
tionable. In a world where learning and innovation have to be rewarded,
8 MUSHTAQ H. KHAN AND JOMO K.S.

distributive conflicts dealt with, where incentives have to be created to

deal with asymmetric information and where scarce natural resources
have to be conserved, many types of rents are socially desirable. While
many of these rents are recognised as useful in neo-classical theory, redis-
tributive transfers have not been adequately analysed within the main-
stream economics tradition. Redistribution is often involved in 'creating'
the concentrations of wealth on which capitalism is based and may also
be essential for maintaining the social order necessary for growth. On
the other hand, some redistributive rents can be particularly damaging
in developing countries. The theoretical challenge is to identify the con-
ditions which determine whether value-enhancing or value-reducing
rents are created and the magnitude of the rent-seeking cost.

Corruption
The study of corruption has a parallel literature, with obvious overlaps
with the literature on rents. The interest in corruption as a factor affect-
ing development has a long history (Heidenheimer et al. 1997 provide a
collection of some of the classic articles). Corruption is usually defined
as the transgression of formal rules governing the allocation of public
resources by officials in response to offers of financial gain or political
support (for a discussion of alternative definitions of corruption, see Nye
1967 and Khan 1996b). From the outset, this literature too has been con-
cerned with whether corruption could be beneficial and under what cir-
cumstances. In an early contribution, Leff (1964) argued that corruption
could have beneficial effects in developing countries suffering from
oppressive state intervention. By allowing entrepreneurs to side-step
restrictive rules, corruption could induce faster growth and higher effi-
ciency. This perspective has become increasingly unpopular as the evi-
dence of beneficial corruption has been very scarce. In the African
countries which Leff was interested in, the beneficial effects of corrup-
tion have been least apparent.
In contrast, Myrdal (1968) argued that the possibility of corruption
may induce bureaucrats to deliberately introduce legislation which cre-
ates new obstacles. Myrdal's argument anticipated the early rent-seeking
literature of the 1970s and 1980s. The possibility of taking bribes could
create incentives to seek bribes by creating new restrictions. Bureaucrats
and politicians could be creating new hurdles to maximize their bribe
take. While this qualifies Leff s argument, it does not necessarily overturn
it. If some rents are socially useful, one can imagine circumstances under
which a bribe-seeking bureaucracy could increase growth by creating
value-increasing rents to collect bribes. Indeed, when one looks at the
few examples of successful developmental states in the second half of the
 INTRODUCTION 9
twentieth century, one finds that most of them were also very corrupt.
Explaining the differences in the effects of corruption in different coun-
tries is thus closely related to our suggested extension of the rent-seeking
framework to take into account differences between types of rents and
rent-seeking processes.
The modern economics literature on corruption also includes a paral-
lel literature which looks at how institutional and incentive structures can
determine the magnitude and effects of corruption (Rose-Ackerman
1978; Shleifer and Vishny 1993; Bardhan 1997). These authors share with
the rent-seeking school an interest in modelling the incentives which
determine the extent of expenditures on corrupt transactions. As in the
rent-seeking models, the key questions are: what determines the magni-
tude of the rent-seeking expenditures (in this case, bribes), and does the
corruption result in value-enhancing outcomes (as in Leff's argument),
or the reverse (as in Myrdal)? Shleifer and Vishny's (1993) contribution
is particularly important because it suggests that states with a very central-
ized institutional structure and those with a very decentralized institu-
tional structure may suffer less from the damaging effects of corruption
than states with an intermediate level of institutional centralization.
The interest in corruption has increased as Cold War alliances no
longer protect developing country governments from scrutiny. In addi-
tion, a number of econometric studies have shown the negative effects of
corruption, using subjective corruption indices as explanatory variables
(Ades and Di Telia 1996; World Bank 1997). Correlations of these cor-
ruption indices with development indicators such as investment and
growth rates tend to show that corruption has a negative effect on devel-
opment (for instance, Mauro 1996). While providing useful empirical
results, these regression results have to be interpreted with care, and we
would argue that they are not a substitute for historical analysis.
The regression approach assumes that there is an underlying in-
variant relationship between the degree of corruption and economic
performance. Corruption across countries in these studies is measured
in terms of the subjective assessments of international businesspeople.
These subjective estimates raise problems of objectivity and compara-
bility which are fairly serious (Khan 1999a, 1999b). They do not distin-
guish between corruption per transaction and total corruption, between
economic and political corruption, and businesspeople may subjectively
assess corruption to be less serious if the system works and they are mak-
ing large profits. Leaving these measurement issues aside, the econo-
metric approach has a more serious problem. The regression results are
based on comparing countries to see if more corrupt countries are, on
average, doing better or worse. In general, they find that more corrupt
countries do perform less well. But suppose that high levels of corruption
10 MUSHTAQ H. KHAN AND JOMO K.S.

are associated with low growth in some countries, but with high and
sometimes very high growth in others. In this case, the relationship
picked up in the cross-section regression may depend on the selection of
corrupt countries in each category.
The first and most numerous group of countries in any sample is likely
to consist of developing countries, most of which have, by and large, not
done too well in terms of development over the last three decades. Most
are very corrupt, and the corruption seems to have had very damaging
effects on growth. But there is a second and smaller group of developing
countries where growth has been very high despite the presence of
substantial corruption. But these countries are few in number simply
because very few countries have been successful developers. Finally,
there is a third group of relatively more advanced countries where cor-
ruption is low and economic growth is moderate.
It follows that, in a cross-section study, the second group is typically
swamped out as a set of outliers because of their small numbers (though
not necessarily their population size or significance in terms of what we
can learn about development). The strong negative relationship picked
up between corruption and low growth is then effectively based on a
comparison of the first and third groups. This book concentrates on the
countries within the critically important second group, many of which
happen to be in Asia. It compares them with each other and with the less
dynamic Asian countries in the first group. A case study approach is used
to understand the mechanisms through which corruption and other
forms of rent-seeking can affect growth differently in different countries.
If we are right, it makes no sense to conclude, as the regression analysis
does, that a 1 per cent reduction in corruption will result in an x per cent
increase in the growth rate, irrespective of the country. Finally, the direction
of causation is not revealed by correlation. In the long run, development
and social maturity are very likely to result in declining corruption, but
this does not mean that reducing corruption by any means right now will
increase growth rates (Khan 1999a, 1999b). We believe that the case
study approach is important to complement and challenge some of the
effects of corruption identified by regression analysis which now widely
influence policy-making. This is not to condone corruption or to suggest
that it can be 'useful' in the way Leff did, but to come up with a better
understanding of developmental processes and policy responses which
may actually work.

Patron-client exchanges
Patron-client exchanges are another set of transactions which overlap
with both rent-seeking and corruption. Patron-client relationships are
 INTRODUCTION 11
repeated relationships of exchange between specific patrons and their
clients. A number of features distinguish patron-client exchanges from
other types. First, such exchanges are usually personalized; they involve
an identifiable patron and identifiable clients. While there is always some
freedom of entry and exit, entry and exit from patron-client networks is
considerably less frequent than in normal market transactions. Second,
the exchange is between two distinct types of agents, distinguished either
by status, power or other characteristics (Lande 1977). Typically, the
superior member is called the patron and the inferior member the
client. Nevertheless, the power or status of the patron can vary across a
broad range, and these differences may be important for understanding
the types of exchanges taking place within different patron-client net-
works (Khan 1996a, 1996b).
When patron-client exchanges overlap with rent-seeking or corrup-
tion, an examination of the patron-client networks can give us important
additional information about the types of transactions going on. Several
authors in this volume have examined such networks in particular coun-
tries and have suggested different mechanisms through which the type
of patron-client network may explain features of the rent-seeking or cor-
ruption going on. In Chapter 2, Khan argues that both the magnitude of
rent-seeking expenditures and the types of rights created through rent-
seeking can depend on the distribution of power within patron-client
networks. In their chapter on rent-seeking in Thailand, Doner and Ram-
say argue that the structure of such networks can determine the degree
of competition in the market between competing networks. The more
competition there is between networks, the more difficult it is to keep
out new entrants, with important implications for market outcomes.
Hutchcroft, in his chapter on the Philippines, looks at the degree of
consonance or dissonance between the power structures within patron-
client networks and the formal authority structures of bureaucratic insti-
tutions. The closer the overlap, the more likely it is that bureaucratic
structures will be able to implement coherent and predictable decisions
efficiently and at low cost, and vice versa.
While all our authors agree about the importance of patron-client net-
works, there are differences in the way in which these insights are incor-
porated into the analysis of rent-seeking. Hutchcroft points out that the
analysis of power, which is the hallmark of the analysis of patron-client
networks, is typically bypassed in the standard rent-seeking model used by
economists. His response to the shortcomings of the narrow approach to
rent-seeking in traditional economics is to overlay this with a parallel
analysis of patron-client networks. On the other hand, Khan incorporates
the patron-client analysis into an extended analysis of rent-seeking.
These positions are ultimately complementary as all our authors agree
12 MUSHTAQH. KHAN AND JOMO K.S.

that the narrow interpretation and analysis of rent-seeking found in con-

ventional economic approaches is not very useful for making sense of the
experiences of rent-seeking and corruption in these countries. They also
agree that the insights which the patron-client approach provides are crit-
ical for an analysis of the processes of corruption, transfers and interven-
tion which have characterized Asian development.

An outline of the chapters

The book roughly divides into a first part, consisting of the first two chap-
ters which deal largely with theoretical and analytical issues, and the next
six chapters which are case studies of rents and rent-seeking. The division
is not exact since the empirical chapters deal with many theoretical issues
and the theory chapters draw heavily on these and other empirical exam-
ples. The first two chapters are by Khan. The first examines the efficiency
and growth implications of different types of rents, drawing on both the
neo-classical and classical traditions. Modern neo-classical economics
makes distinctions between monopoly rents, natural resource rents, rents
based on political transfers, and Schumpeterian rents. To these may be
added a range of informational rents, such as rents for monitoring, as well
as subsidies for learning, which are important in developing countries.
The efficiency and growth implications of each are quite different. Yet
much of the rent-seeking analysis is based on the efficiency implications of
monopoly rents alone. Chapter 1 draws on both the neo-classical and clas-
sical traditions to argue that rents play a critical role in the normal opera-
tion of market economies and play a potentially substantial role in
processes of development. At the same time, rents can also be associated
with massive economic failure. Being able to distinguish between rents is
an essential precondition for any analysis of rent-seeking.
Chapter 2 presents a general framework for analysing the effects of
rent-seeking. It draws on existing rent-seeking models as well as on insti-
tutional economics, political economy and economic history. It examines
ways in which the conventional analysis of rent-seeking can be extended
using insights from other approaches, including, in particular, institu-
tional economics and the analysis of patron-client networks by sociolo-
gists and political scientists. Its starting point is the observation that rents
are generated through the creation, maintenance or transfer of rights.
Rent-seeking is the activity which seeks to bring about the configurations
of rights which generate rents for particular individuals or groups. The
focus of conventional rent-seeking theories is the cost of using up inputs
in rent-seeking, which is the rent-seeking cost. This is an additional social
cost which adds to the social cost of any harmful rents or reduces the
social benefit of any beneficial rents created by the rent-seeking.
 INTRODUCTION 13
While the conventional analysis of rent-seeking has concentrated on
the input costs of rent-seeking, far less attention has been devoted to dif-
ferences in the rent-outcomes of rent-seeking in different countries. These
outcomes are the rents which are created or maintained by rent-seeking
which in turn can have very different efficiency and growth implications.
It follows that the net effect of the rent-seeking process will depend not
only on the rent-seeking cost but also on the efficiency and growth impli-
cations of the rents which are created or maintained through this
process. The chapter then examines rent-seeking in the industrial sec-
tors in the Indian subcontinent, South Korea, Malaysia and Thailand.
The available evidence suggests that differences in rent-seeking costs
were less important as an explanation of the substantial differences in
their performance than were differences in the types of rents created by
the rent-seeking in each country.
The theoretical part of the chapter examines the variables which
could explain difference in both the input costs and the rent-outcomes
of the rent-seeking process across countries. Some of these variables are
well known in the rent-seeking literature, such as the competitiveness of
the rent-seeking process. Others are drawn from the institutional eco-
nomics literature, such as the institutional structure of the state and the
organization of collective action by different groups of rent-seekers. Yet
others are political variables. In particular, a comparative analysis of the
distribution of power within patron-client networks is developed to
explain differences in the net effects of rent-seeking across countries.
Evidence from these countries suggests that both institutional and polit-
ical differences were important for the overall effects of rent-seeking,
with political differences playing a significant role. The importance of
differences in the rent-outcomes associated with rent-seeking and of the
political variables determining these outcomes has not been adequately
addressed in the conventional literature. By filling this gap, the chapter
makes a contribution to the economic analysis of rent-seeking.
These results have policy implications. On the one hand, if differences
in rent-seeking costs played a relatively small part in explaining perfor-
mance differentials, then concentrating too much on the rent-seeking
cost may be focussing on the wrong problem. On the other hand, if rent-
outcomes are important, the political variables which determine these
differences may be very important for explaining differences in the over-
all effects of rent-seeking. If this is true, the long-run solutions to poor
performance may have to involve a much greater understanding of the
political dimension of the problem in poorly performing countries.
Effective responses may have to involve the construction of political solu-
tions which make rent-seeking consistent with economic growth rather
than a fetter.
14 MUSHTAQ H. KHAN AND JOMO K.S.

In the case study section of the book, our authors look in depth at the
experience of rent-seeking in a number of countries. Thailand poses a
fascinating challenge for the conventional rent-seeking methodology.
While its long-term performance before the financial crisis was very
good, it did not have a strong developmental state of the Northeast Asian
type, and it seemed to suffer from extensive clientelism and rent-seek-
ing. Chapter 3 by Doner and Ramsay and Chapter 4 by Rock present two
contrasting, but ultimately complementary, interpretations of how Thai
rent-seeking generated high growth. Both agree that rent-seeking costs
were not low in Thailand and that the important question is why exten-
sive rent-seeking and clientelism nevertheless resulted in the creation of
socially valuable rents to outweigh these costs. However, the reasons they
identify for this are somewhat different.
Doner and Ramsay argue that the outcome of clientelism was enrich-
ing for the Thai economy because its clientelist structure resulted in a
competitive industry structure. This was because Thai clientelism was
itself competitive. Patrons within the state were not able to protect rents
for their clients by stopping other patrons allowing their clients to enter
lucrative markets. The authors illustrate this with reference to the Thai
textile industry. Different state agencies failed to impose capacity con-
trols, which in turn led to rapid growth in the sector. The political and
institutional failure of the state to limit entry into particular markets was
not entirely benign. When serious excess capacity emerged in the textile
industry, the industry had to mobilize to respond. It was fortunate for the
industry that its attempt at collective action was eventually successful.
Moreover, if competitive clientelism was all-pervasive, it would have pre-
vented the state from enforcing any property rights or managing fiscal
and monetary policy. This would have been disastrous for economic per-
formance. Doner and Ramsay argue that Thai competitive clientelism
did not descend into anarchy because, for historical reasons, key gov-
ernment departments making macroeconomic decisions about fiscal
and monetary policy remained immune to clientelism and rent-seeking.
This is why they alternatively describe Thai clientelism as 'competitive'
clientelism and 'hard-budget' clientelism.
In the second piece on Thailand, Rock disputes the separation sug-
gested between micro policy in industry and macroeconomic policy-
making. He argues that there is evidence that the state was able to direct
the pattern of industrial development in Thailand to a far greater extent
than is suggested by the competitive clientelism story, and also that the
macro policy institutions were not as insulated from rent-seeking as is
suggested. Rock argues that a relatively small number of big capitalists
were able to use their contacts with the state to get privileged access to
rents, which accelerated technology acquisition and industrialization.
 INTRODUCTION 15

This qualifies the unrestricted access suggested by the competitive clien-

telism story. Since a formal institutional structure of industrial policy did
not exist, how was this de facto access to rents organized?
Rock's answer has a number of components which include, in partic-
ular, the relative strength of the Thai bourgeoisie. Thailand developed a
more numerous and relatively more powerful capitalist class as a result of
its relatively long history of accumulation. Its capitalists responded to
clientelism by themselves becoming patrons of clientelist factions rather
than simply being clients of non-capitalist political entrepreneurs. This
explains why the biggest capitalists in Thailand were able to wield con-
siderable political power. It probably also explains why competition
between clientelist factions resulted in capitalist growth in Thailand and
not structural sclerosis, as in the Indian subcontinent. By introducing the
political power of Thailand's capitalists into the clientelism story, Rock's
analysis complements that of Doner and Ramsay. Thai rent-seeking was
not just led by competitive factions, many of the important factions were
led by big capitalists. The significance of these features becomes clear in
a comparative context and is also developed in Chapter 2.
In Chapter 5, Hutchcroft looks at rent-seeking, corruption and clien-
telism in the Philippines where performance has been relatively poor.
He contrasts that country with Thailand and Indonesia, where perfor-
mance was significantly better during the high-growth period of the
1980s. Hutchcroft argues that the narrow rent-seeking framework used
by economists is of limited use. However, instead of extending that
framework, he argues that we need to develop a parallel analysis of cor-
ruption and of patron-client networks. An argument sometimes put for-
ward in rent-seeking theories is that the allocation of rents by an
authoritarian state will lower rent-seeking expenditures. Hutchcroft
argues that this is not convincing in the Philippines, where Marcos
attempted to restrict allocations in just this way. Here there are parallels
between Hutchcroft's argument for the Philippines and Khan's discus-
sion of authoritarian regimes in Pakistan and Bangladesh which also
failed to reduce rent-seeking costs.
To explain the Philippines' performance, Hutchcroft looks at political
factors which may have affected the rights created as the outcome of rent-
seeking. He argues that corruption in the Philippines was more damag-
ing than in Thailand because it was less predictable and therefore had
more serious effects on the decisions of entrepreneurs. The unpre-
dictability, in turn, is explained in terms of a greater mismatch in the
Philippines between patron-client power structures and bureaucratic
authority structures than in Thailand. In the Philippines, powerful
patrons were often located outside the bureaucratic structure and could
overturn decisions made by the latter, while, in Thailand, patrons were
16 MUSHTAQ H. KHAN AND JOMO K.S.

more often located within bureaucratic structures and could use their
power to reinforce the bureaucracy's power to implement decisions.
In addition, drawing on Doner and Ramsay's work on Thailand,
Hutchcroft argues that another important difference between the Philip-
pines and Thailand was in the organizational structure of patron-client
networks in the two countries. Clientelism in Thailand was competitive
and networks were unable for long to prevent entry by other groups into
rent-generating markets. This resulted in high levels of investment and
output, despite substantial kickbacks and rent-sharing within these net-
works. In contrast, the Philippines is described as having 'monopoly clien-
telism', where patrons could effectively exclude entry and were under no
competitive pressure to invest in production.
Why did monopoly clientelism in the Philippines have such negative
effects compared with the centralized clientelism of Malaysia, described by
Khan in Chapter 2 and by Jomo and Gomez in Chapter 7? Hutchcroft
argues that part of the answer may lie in the disjuncture in the Philippines
between relatively powerless bureaucratic structures and patron-client
structures run by the oligarchs, where real power resides. While liberaliza-
tion reduced the number of rent havens, and apparently reduced some of
the more overt rent-seeking activities, it has not yet attacked these inde-
pendent oligarchic power structures. Reading these chapters together sug-
gests that very centralized patron-client networks (as in Malaysia) and
relatively decentralized networks (as in Thailand) were better at creating
value-increasing rent-outcomes than networks with an intermediate
degree of centralization (as in the Philippines and in the Indian subconti-
nent). This analysis of the distribution of power has parallels with the analy-
sis of the effects of the degree of centralization of the state's institutional
structure provided by Shleifer and Vishny (1993). But there are also impor-
tant differences between Shleifer and Vishny's analysis and the analysis of
political power which our authors explore.
In Chapter 6, Maclntyre addresses rent-seeking in pre-crisis Indonesia
and the transition to crisis in this high-growth economy. Despite its size
and importance, rent-seeking involving the Indonesian state has proved
to be particularly difficult to open up to scholarly study. Maclntyre sug-
gests one reason: an important part of the state's spending did not pass
through the budget at all, and records for these expenditures are not
easy to find. Maclntyre's indirect estimates of these 'off-budget' expen-
ditures suggest that they were large. Yet the presence of these large
potential redistributive rents did not result in equivalent rent-seeking
costs, which would have had a much more serious effect on economic
performance. Maclntyre suggests that the answer may lie in the central-
ized co-ordination of rent allocation in Indonesia, drawing on the co-
ordination model developed by Shleifer and Vishny (1993). While the
 INTRODUCTION 17
latter focus on institutional centralization, Maclntyre applies the model
to look at (the perhaps paradoxical) positive effects of political central-
ization for rent-seeking outcomes.
Chapters 7 and 8 deal with Malaysia. In Chapter 7, Jomo and Gomez
discuss the effects of the tension between the creation of redistributive
rents for ethnic Malays, especially the Malay middle class, and attempts by
the state to modernize the economy by using rents as incentives for indus-
trialization and technology acquisition. They argue that, despite some
positive effects of the redistribution (particularly in enhancing human
resource development within a segment of society which was initially edu-
cationally backward), the overall effect was to reduce the rate of invest-
ment by the ethnic Chinese capitalists and to encourage growing
rent-seeking by ethnic Malay political intermediaries. The chapter thus
provides a detailed account of the evolution of rent-seeking in Malaysia
during its high-growth period. While Khan argues in Chapter 2 that the
pattern of Malaysian redistributive flows had relatively fewer damaging
effects than in India, Jomo and Gomez point out that rent-seeking was
more damaging to growth and technology acquisition in Malaysia than in
the East Asian newly industrializing countries. The two positions are
clearly complementary. Khan's argument is that ethnic politics allowed
Malaysia to centralize its clientelism and achieve better growth, in contrast
to the intermediate level of centralization of patron-client networks in
the Indian subcontinent. Jomo and Gomez point out the greater frag-
mentation and higher degree of politically motivated transfers in Malaysia
compared with, say, the South Korea of the 1970s.
In the final chapter, Jomo and Chin take a closer look at rents in the
financial sector in Malaysia. They draw on the argument developed by
Hellman et al. (1997) which shows the useful role that financial sector
rents can play in creating incentives for more effective monitoring by
banks. Banks can ensure their rents over time only if they make the
effort of monitoring the firms they lend to. This suggests that govern-
ment intervention which creates a rent margin for banks may be value-
enhancing for the economy. The authors show that such a rent margin
existed in Malaysia over the 1984-95 period, but question whether this
had the positive effect suggested by Hellman et al. (1997). Once again,
the culprit is the redistributive agenda of the state based on ethnic pol-
itics. Jomo and Chin argue that the state's use of the banks to allocate
redistributive rents prevented the rents in the financial sector from hav-
ing the expected efficiency effects on the quality of industrial lending.
The overall effect was a substantial amount of poor lending, despite the
existence of financial sector rents. Their analysis suggests that the polit-
ical context in Malaysia must play a part in explaining the limitations of
such rents.
18 MUSHTAQH. KHAN AND JO MO K.S.

The financial crisis of 1997 brought the issue of rent-seeking in devel-

oping countries to centre stage. Most economists agree that the Asian cri-
sis was primarily a financial crisis and only indirectly a crisis caused by
rent-seeking (see, for instance, the collection of articles in Jomo 1998
and Stiglitz 1998). At the same time, the depth of the crisis offers an
opportunity to investigate the underlying processes of rent-seeking in
these countries, if only to understand better the prospects for the future.
Clearly, the financial crisis had a major component of regulatory failure
behind it, and this failure could have been caused by rent-seeking pres-
sures from the beneficiaries of financial sector rents. Some of the
changes in the context of rent-seeking which could have contributed to
the crisis are examined in our theory and empirical chapters. Even so,
the rent-seeking going on in financial markets was only part of that
occurring in these countries.
The long-run relationship between rent-seeking and growth will
remain of interest, regardless of the eventual performance of these
countries in responding to the financial crisis. Moreover, there are
unlikely to be simple solutions to the rent-seeking problem based on lib-
eralization or the globalization of capital. This is because, as our theo-
retical chapters take pains to point out, rents are ubiquitous and
economies have to learn to live with them. There are good rents, and
the institutions which promote them advance development in the pres-
ence of rent-seeking. But there are also bad rents, promotion of which
results in damaging rent-seeking. There are no societies, developing or
developed, which have resolved the rent-seeking problem by abolishing
rents. The historical experience of the fast-growing Asian economies
when seen over a period of several decades is important for establishing
these analytical points.
On the other hand, the 1997 crisis provided a dramatic shock to the
pattern of redistribution and rent flows in these countries. It is
inevitable that one result of this will be the restructuring of political
arrangements within these countries as new political settlements are
constructed to allow a new phase of accumulation to begin. Whether the
new phase will be as successful as the old one which collapsed remains
to be seen. There are certainly many examples of regions where rent-
seeking and primitive accumulation have resulted in much poorer per-
formance than in the East and Southeast Asian countries of the 1980s
and early 1990s, so there is no guarantee that the next phase of growth
will be as dramatic as the last one. Rather than identifying rent-seeking
in general as the villain responsible for the crisis, policy-makers would
be wise to ask, instead, a different set of questions. Why did rents and
rent-seeking in this region once promote such rapid development and
why did that period end? The work of our authors should shed some
 INTRODUCTION 19

light on a unique period of development when rapid growth was

achieved in the real world where rents exist and are, indeed, required
to exist. This experience may help in the construction of analytical mod-
els more suited to the real world in which developing countries live.
Indeed, understanding their own history better may be a precondition
in many of these countries for constructing new arrangements which
can allow growth to begin once again.

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 CHAPTER 1

Rents, Efficiency and Growth

Mushtaq H. Khan

For the economist, rents refer to 'excess incomes' which, in simplistic

models, should not exist in efficient markets. More precisely, a person gets a
rent if he or she earns an income higher than the minimum that person would have
accepted, the minimum being usually defined as the income in his or her next-best
opportunity. A glance at the real world tells us that rents as excess incomes
are widespread in all types of economies. Rents may take the form of
higher rates of return in monopolies, the extra income from politically
organized transfers such as subsidies, or the extra income which comes
from owning scarce resources, whether natural resources or specialized
knowledge. What does economic theory say about the effects of such
excessive incomes or 'rents'? This chapter begins with an analysis of rents
in conventional neo-classical economics and proceeds to examine how
this analysis needs to be extended (and, to some extent, has already been
extended in recent years) to analyse the different types of rents which
exist in real economies. Drawing on both neo-classical and non-neoclas-
sical economic theories, we see that the efficiency and growth implica-
tions of different rents can be very different.
While some rents are indeed inefficient and growth-retarding, other
rents play an essential role in growth and development. This variability
has important policy implications. The identification of some rents as
'efficient' challenges the policy rule-of-thumb of the liberal market
model which says that the removal of institutions and rights which pro-
tect rents is always desirable as a way of moving towards greater efficiency
and better economic performance. While this model has the seductive
advantage of simplicity, it is often wrong. If some rents are essential for
efficiency and growth while others are damaging, more complex institu-
tional and market reforms may be required. Managing development
may, in fact, require the continuous discrimination of efficient from

21
22 MUSHTAQ H. KHAN

inefficient rents by policy-makers and analysts. Consequently, getting the

institutional framework right may be more complicated than simply try-
ing to move towards the benchmark of a no-rent competitive market
economy. Conversely, the absence of diligence by policy-makers, changes
in political and technological conditions or even unplanned institutional
evolution may easily make an efficient system of rents inefficient over
time. These possibilities clearly have important policy implications for
contemporary development debates.
The definition of rent as excess income should not be understood to
imply that rents are always wasteful or inefficient. A typical textbook def-
inition of a rent is 'the portion of earnings in excess of the minimum
amount needed to attract a worker to accept a particular job or a firm to
enter a particular industry' (Milgrom and Roberts 1992: 269). But note
the precise form of words used by Milgrom and Roberts. The 'minimum
amount needed to attract suppliers of inputs (such as workers and capi-
talists) to particular industries should not be confused with the payments
which may actually be necessary to induce them to produce the good or
service. The difference between the two is not always clearly made but is
central to the analysis of the efficiency and growth implications of rents
and deserves careful attention.
The economists' notion of the 'minimum amount' necessary to attract
inputs which go into the production of a good or service is usually based
on looking at what the providers could have earned in their next-best
alternative. Consider the following example of earnings in the steel
industry. If capitalists earn a return of 5 per cent and workers earn
$15,000 a year when the next-best alternative of the same capitalists
would be to earn a return of 4 per cent in coal production, and for the
same workers, wages of $14,000 a year elsewhere, then our definition tells
us that the steel industry earns rents for both its capitalists and workers.
What we do not yet know is whether steel could actually have been pro-
duced if capitalists were forced to accept 4 per cent and workers $14,000
a year in the steel industry. If, indeed, steel could actually have been pro-
duced for less, the rents then signal inefficiency because overall produc-
tion in the economy is lower than would have been the case. If, on the
other hand, steel of the appropriate quantity and quality would not be
produced if capitalists and workers were only paid what they could earn
elsewhere, paying them these rents may not be inefficient, even though
they would still be rents. Later, we will see a number of reasons for such
rents being necessary in many cases.
Thus, while rents are always excess incomes in terms of what the recip-
ients would have accepted given their next-best alternative, they are not
always excess payments in terms of what it is necessary to pay them to pro-
duce the good, provide the service or carry out the activity in question. It
 RENTS, EFFICIENCY AND GROWTH 23

follows that rents can sometimes be efficient, and in other cases may be
essential, for promoting growth and development. This distinction was
often glossed over in the older analysis of rents within neo-classical eco-
nomics. The earlier analysis was dominated by a model of perfectly com-
petitive markets as the benchmark for studying market economies. In
this model, there is no difference between the minimum amount which
labour or capital would notionally accept and the amount which they
would actually accept to provide the good or service in question.
This is because the early neo-classical model did not consider any of
the reasons for which capital or labour may require special rewards in
particular sectors. New technology simply appeared from nowhere and
did not have to be produced or learned, property rights already existed
and did not have to be created, labour could be costlessly managed,
information was free and symmetric, so no incentives had to be created
for information to be efficiently used and, most important of all, conflicts
over property rights did not exist and so transfers to maintain political
equilibrium were not necessary. In fact, all the features of society which
we would describe as the subject of institutional economics or political
economy were deemed to be irrelevant for analysing production and
exchange. In this imaginary world, to get any good, it was only necessary
to pay the producers what they could earn in their next-best alternative.
Any payment higher than this (in other words, any rent) was an unnec-
essary waste. It followed that rents were always inefficient in the simple
neo-classical model of a competitive economy and, conversely, ineffi-
ciency could be identified by looking for rents.
While these policy implications persist even today, they are based on a
selective reading of the neo-classical analysis of rents. Even the older neo-
classical analysis recognized that there were some types of rents (such as
natural resource rents) which could not be removed without reducing
the efficiency of resource use. More recent developments within neo-
classical economics in the analysis of asymmetric information (summa-
rized in Stiglitz 1996) and institutions (see Milgrom and Roberts 1992)
have shown that the competitive market model may be more fundamen-
tally flawed. These developments suggest that rents may be essential for
ensuring that markets work by creating incentives for information gen-
eration and monitoring. In fact, the role of super-profits in inducing
technical progress in market economies can be traced back at least to
Schumpeter (1994, first published 1943), and, in fact, to Marx's analysis
of innovation in a capitalist economy (in Capital, vol. 1). These argu-
ments showed long ago why some rents are necessary to ensure that par-
ticular types of goods or services are provided.
Our analysis of rents can be substantially extended by introducing
some insights from classical political economy. Classical economists were
24 MUSHTAQ H. KHAN

interested in the size and allocation of the economic surplus which consti-
tutes the potential investment fund of a society. In particular, they were
concerned with the allocation of the surplus since this determined
growth. The surplus could be productively invested, or 'wasted' in luxury
consumption, and, even when it was invested, its allocation across sectors
could determine the rate of growth achieved. While there were differ-
ences between classical economists, they defined the surplus not as the
excess income of any group but, rather, as the income accruing to property
owners after paying the direct costs of production. In a capitalist economy,
the principal property owners are capitalists, but landlords and some of
the middle classes may also be recipients of parts of the economic sur-
plus. What is interesting about the classical analysis is that distributive
conflicts and the associated re-allocations of the 'economic surplus' can
determine the rate of growth. Thus, like rents, surpluses can be associ-
ated with a wide-range of economic outcomes, depending on the tech-
nological context, and the type of distributive conflict going on over the
allocation of the surplus. Since rents too can be the subject of distribu-
tive conflicts, the classical analysis is of immediate relevance.
In this chapter, we will compare a number of different types of rents
and outline their possible efficiency and growth implications. Some forms
of rent can signal inefficiency or lost growth opportunities while others
may signal the reverse. Indeed, some rents may be essential for growing
and efficient economies, particularly in the context of development. How-
ever, 'good' rents are often only effective under well-defined conditions
and can become 'bad' rents if these conditions change. The existence of
rents may also result in a further set of potentially wasteful activities which
seek to create, maintain or redistribute these rents. These rent-seeking
activities are discussed in the next chapter. The discussion in this chapter
is important for the next because the rent-seeking literature has often
assumed that rents are always socially harmful and that their existence sig-
nals adverse effects for efficiency or growth. This is a misleading and
restrictive view of rents in general, particularly in developing countries,
and has important implications for the analysis of rent-seeking.
The first six sections in this chapter look in turn at a number of dif-
ferent types of rents: monopoly rents, natural resource rents, rents based
on transfers, Schumpeterian rents, rents for learning, and monitoring
and management rents.
The negative efficiency implications of monopoly rents have informed
much of the neo-classical analysis of rents. The limitations of this analysis,
particularly for analysing growth, are by now well known and will be
briefly reviewed. Natural resource rents accrue to owners of privately
owned natural resources in scarce supply. In contrast to monopoly rents,
the existence of natural resource rents often signals efficiency in resource
 RENTS, EFFICIENCY AND GROWTH 25

allocation and may be a precondition of growth. Politically organized

transfers constitute another type of rent. Their efficiency and growth
implications can vary widely across countries. In developing countries, the
state is involved not only in redistributing incomes (as in advanced coun-
tries) , but also in creating new property rights, and often entirely new eco-
nomic classes. This type of 'redistribution' was described by Marx as
'primitive accumulation'. The same process of seizure or transfer of assets
in developing countries is nowadays often described in the language of
rent transfers and rent-seeking. Ugly as they are, these processes are
closely associated with the emergence of the first few generations of capi-
talists. But such transfers can also result in tremendous wastage and theft
without anything like a productive capitalist class ever emerging. Why the
outcomes of primitive accumulation differ across countries is one of the
key questions facing political economy. At the same time, political stabil-
ity in developing countries often requires redistributions of income, often
not to the very poor but to emerging middle classes who have organiza-
tional and political power. The rent allocations to these classes can have
additional negative implications for efficiency and growth.
The last three types of rents are closely related in that each has some-
thing to do with information and institutions. They are the subject of the
new institutional and information economics. Schumpeterian rents
reward innovations. These rents can be both efficiency- and growth-
enhancing, but not in all circumstances. 'Rents for learning' are particu-
larly important in developing countries. The main difference from the
Schumpeterian rent is that these rents are artificially created by states to
accelerate learning in infant industries. While, in theory, rents for learn-
ing can enhance growth and efficiency, compared with Schumpeterian
rents, they can more often become counter-productive. Finally, there are
rents which reward good management. This is an area where extensions
of the efficiency analysis of neo-classical economics have begun to over-
lap to some extent with the surplus approach of Marxian economics. In
both frameworks, part or all of the surplus which capitalists earn can
sometimes be functionally necessary for growth and efficiency. The cap-
italist surplus is certainly associated with growth in the Marxian analysis,
even though the surplus is not justified by this functional role.
Each of these rents is relevant for understanding the role of rents in
economic development and, therefore, the consequences of rent-seeking,
which are examined in the next chapter. In presenting this analysis we
will use some simplified diagrams to illustrate the consequences of dif-
ferent types of rents. Economists may find large parts of the first two sec-
tions (monopoly rents and natural resource rents) to be well-known
territory and may want to skim through them. The subsequent sections
should be of interest as they go beyond the conventional analysis of rents.
26 MUSHTAQ H. KHAN

Some non-economists may find the diagrams difficult, though we have

tried to keep them as simple as possible. They are not absolutely essen-
tial, so such readers can skim through the paragraphs dealing specifically
with diagrams without losing much of the story.
The last two sections discuss the classical economic surplus and the
insights it can provide for the contemporary analysis of rents, and com-
pare some of the characteristic features of the types of rents described
and the underlying property rights which sustain them.

Monopoly rents
The most commonly used assumptions about rents come from the analy-
sis of monopoly in contemporary neo-classical economics, in which mar-
ket restrictions and the resulting monopoly rents are counterposed to
competitive rent-free markets. To understand the limitations of this
analysis of rents, it is best to remind ourselves of the underlying neo-clas-
sical analysis of markets. In this analysis, competition is defined by the
absence of barriers to entry and exit. Profit-seeking firms produce more
of a product if its price is higher than the cost of producing one more
unit (the marginal cost), or they reduce output if the price falls below the
cost of producing the last unit. Freedom of entry and exit ensures that
no rents are earned because if any producer is earning a rent, others will
enter, driving down the price. The analysis then focusses on a narrow def-
inition of efficiency which is achieved when competition wipes out all
rents. In the no-rent situation, it must be the case that, for every product,
the cost of producing the last unit is exactly equal to its price. Once this
position is reached, if more of any product was to be produced, its price
would fall below its marginal cost and society would be producing a prod-
uct at a higher cost than it was worth. If less of any product was produced,
its price would rise above cost, and society would forgo the opportunity
of producing a product which was worth more than it cost to make. Thus,
net social benefit (the difference between the social value of the output
and its cost) is maximized at the no-rent position.
This analysis of the benefits of competition ignores the important
process through which competition ensures that technologies improve
over time. The neo-classical analysis of efficiency is therefore often
described as a static analysis. The implications of this analysis for rents
can be very misleading, as we will see later. Nevertheless, this static story
has played a central role in policy and is summarized in Figure 1.1. The
demand curve shows the price consumers are willing to pay as the quan-
tity marketed changes. Since the price usually has to fall to attract addi-
tional consumers, the demand curve is typically downward sloping. In
contrast, the marginal cost curve is typically shown to be upward sloping
 RENTS, EFFICIENCY AND GROWTH 27

Price

Marginal cost/Supply price

Quantity

Figure 1.1 The competitive market equilibrium

because it is assumed that the cost of producing additional units will

increase as more are produced. But marginal costs may remain constant,
or even fall, if there are economies of scale. Falling costs can create prob-
lems for a competitive market. With falling costs, larger producers have
a cost advantage, allowing them to dominate the market and eventually
behave like a monopoly. We will return to this problem in a while.
With unrestricted entry and exit, if the price consumers are willing to
pay (shown on the demand curve) is higher than the marginal cost, the
quantity supplied will increase, and vice versa, so that, in equilibrium, the
quantity produced is OQ p at price OP r The last unit sold now costs OPj
to produce and sells exacdy at this price. The producer of the last unit
can exactly cover all costs and therefore earns no rent. This is the basis
of the claim that there are no rents in competitive markets.
The area under the demand curve in the figure shows the total value
to consumers of different levels of output (the value of output OQj is
thus OFEQ^). The area under the cost curve shows the total cost incurred
at that level of output (OAEQ2 at output OQj). Since the net social ben-
efit is the difference between the social value of the output and the cost
of production, the diagram allows us to read off the net social benefit at
each level of output as the area between the two curves (as long as there
are no external costs or benefits). Thus, at output level OQ2 the net
28 MUSHTAQ H. KHAN

social benefit is OFEQj - OAEQj = AEF. By comparing different levels of

output, we see that the net social benefit is highest at output O Q r The
competitive market achieves this simply through the profit-seeking entry
and exit of producers and the free adjustment of prices. The no-rent
competitive outcome is thus 'efficient', where efficiency means the max-
imization of net social benefit with given technologies. This is the most
important result of the neo-classical analysis of markets.
An important qualification needs to be made here. The claim that
there are no rents in a competitive market is actually a shorthand for a
much more limited claim which is that there are no rents in the produc-
tion of the last (or marginal) unit. The absence of rents for the marginal
producer in a competitive market does not mean that no-one earns more
than the minimum they would have asked for. In fact, if marginal costs
are rising, as in Figure 1.1, it means that all but the last unit could have
been produced at a cost lower than the final market price. But why
should marginal costs be rising? After all, if existing production facilities
can be replicated, it should be possible to produce additional units at the
same cost as previous units. Ultimately, rising marginal costs must be due
to some resources being in limited supply, so that, when production
increases, the price of these inputs is bid up, increasing the cost of pro-
ducing additional units.
When the price of an input of a particular kind is bid up, those already
supplying it experience a windfall increase in their incomes. These sup-
pliers now earn more than the minimum they would have accepted in
the past, though in this case they are not earning more than in their next-
best opportunity because the price of what they supply will go up across
the board. For instance, if wages rise to attract more of a particular type
of labour, workers already in work get a windfall. Graphically, this surplus
is shown in Figure 1.1 by the triangle AEP p which is the cumulative sur-
plus which earlier factor providers collect at the output level O Q r This
surplus has a rent-like character and is called the 'producer surplus'. It
measures the difference between what firms actually get paid, O P J E Q J
(the price OPl x the quantity OQT sold) and the notional minimum total
cost of producing OQ} (the area OAEQj).
The minimum cost OAEQj is notional and is not necessarily the cost
which the firm is actually able to pay. It would only be the actual cost if
each unit could be produced at the cost shown along the marginal cost
curve. This could only happen if workers (or owners of other resources)
who are already employed are prevented from raising their wages when
they rise to attract new workers. This would be extremely difficult to orga-
nize, as there would undoubtedly be a strong perception of injustice.
Nevertheless, if the firm could pay identical factor suppliers differen-
tially, the producer surplus would accrue to the firm and would be a rent
 RENTS, EFFICIENCY AND GROWTH 29

for the owners of the firm. More likely, the producer surplus remains a
notional rent which is captured by 'factor providers' in the form of wind-
fall gains when their resource becomes more expensive.
Consumers capture an equivalent surplus, known as the 'consumer
surplus', which is shown by FEPj in Figure 1.1. This surplus arises because
it is not usually possible to charge each consumer a different price,
despite the fact that different consumers value the product they pur-
chase differently. All but the last consumer would actually have been will-
ing to pay a higher price for the product they purchase than the price
OPj which everyone ends up paying. This is the source of the consumer
surplus which is a collective welfare gain for consumers, just as the pro-
ducer surplus is a gain for producers. The consumer surplus is important
in welfare economics but will not concern us further. Unlike the pro-
ducer surplus, the consumer surplus does not have a rent-like character,
given our definition of rent.
The producer surplus is not given much attention in textbooks and is
not treated as a rent because it is usually unavoidable, given factor scarci-
ties. An unavoidable rent is not inefficient in the sense that net social ben-
efit cannot conceivably be increased. Moreover, as we can see in Figure
1.1, the producer surplus is itself a part of the net social benefit which is
maximized by the competitive market. Clearly, the existence of the pro-
ducer surplus is not in itself a problem. Its existence, like that of any other
rent, would only be a problem if it signalled a lower net social benefit.
This competitive market model, static though it is, provides the bench-
mark for the neo-classical analysis of rents and, in particular, of monop-
oly rents. This is unfortunate because this model ignores some of the
important benefits of competition and markets in the real world, while
identifying a number of conditions under which markets achieve effi-
ciency which are not relevant in reality. We will return to these problems
in our subsequent discussion. We now turn to how this static approach
models the implications of monopolies and monopoly rents. While the
existence of the producer surplus appears not to detract from the effi-
ciency of the free-market outcome, the existence of monopoly rents
does. Monopoly rents for firms emerge as a result of entry barriers which
allow firms in protected markets to charge higher prices for their prod-
ucts. Entry barriers can be 'natural' when the technology of production
involves large economies of scale such that a single large producer can
undercut newcomers. More importantly, entry barriers can also be state-
created, based on exclusive production rights for particular producers.
Figure 1.2 shows the case of a state-created monopoly, where one pro-
ducer is given the right to determine the level of output in that market.
The monopoly can restrict output and raise prices and other suppliers
cannot enter. While it is rarely the case that there is only one producer in
30 MUSHTAQ H. KHAN

any market, monopolistic behaviour only requires 'market power'. Mar-

ket power is the ability of one or more firms to raise prices by restricting
output in a context where new entrants cannot enter, for whatever rea-
son, to reduce prices.
The restriction of supply, say to OQ2, raises the price which consumers
are willing to pay to OP2, while the marginal cost of producing the
smaller output is OB. As a result, the last unit produced by the firm now
costs less to produce than its price. The difference gives the firm an
above-normal profit of CD on the last unit, which is technically a rent
because the firm earns a return higher than it could have earned in its
next-best alternative (which is the rate of return in a no-rent market).
Since this above-normal profit is earned on each of the OQ 2 units pro-
duced, the total rent earned by the firm is shown by the shaded rectan-
gle BCDP2. The level of output OQ 2 is determined by the monopolist to
maximize the size of this rent. The monopoly profit is a rent which
enriches the firm at the expense of a lower producer surplus and a lower
consumer surplus. Technically, the monopoly rent itself (like the pro-
ducer surplus) is not a problem, because it is part of the net social bene-
fit of producing OQ» of output. However, it does signal an inefficiency
which is attributable to the reduction in production from OQ2 to OQ^.
Consider Figure 1.3, which is similar to Figure 1.2, but which shows, in
addition, what happens to the consumer and producer surplus as a result
of the monopolistic restriction. The net social benefit (the area between
the demand and cost curves) when output is OQ 2 is the area ACDF. This
can be broken down into the remaining consumer and producer surplus
and the rent. It is worth repeating that the rent itself is not a loss as far as
society is concerned. It is notionally a transfer from consumers and fac-
tor suppliers to the owners of the firm, since it is composed of what was
previously part of the consumer and producer surplus.
The social cost of the monopoly is the net social benefit which is lost as
a result of the monopoly. In Figure 1.3 the lost net social benefit (known
as the 'deadweight welfare loss') is measured by the little triangle CDE.
The monopoly results in lower output, compared with the competitive
market, and CDE measures the net social benefit which is lost as a result of
this lower production. Thus, the rent BCDP2 does not directly measure the
cost of the monopoly. It signals an allocative inefficiency (too few resources
are devoted to producing this particular product) whose social cost is mea-
sured by CDE. This is the net social benefit lost to society collectively.
This measure of the social cost of the monopoly is only a first approx-
imation. An implicit assumption in the argument so far is that a compet-
itive structure of industry is possible which could produce OQl of output
- in other words, that the monopoly is avoidable. In fact, many monopo-
lies are natural monopolies, which means that they are created not by
 RENTS, EFFICIENCY AND GROWTH 31

F
Price

Marginal cost/Supply price

Demand price

Q2 Q1 Quantity

Figure 1.2 Rents created by monopolistic restrictions

Price

Consumer
surplus Marginal cost/Supply price

Producer
surplus

Q2 Q, Quantity

Figure 1.3 Rent, consumer surplus and producer surplus under a monopoly
32 MUSHTAQ H. KHAN

artificial entry barriers but by economies of scale in production, which

result in one producer dominating the market because of lower costs. In
this case, the deadweight welfare loss due to the monopoly has to be com-
pared with the social cost of breaking up the monopoly into smaller
units, each of which has higher marginal costs. The best policy response
in this case may be to allow the monopoly to exist but to regulate its
prices and, if necessary, to subsidize it to produce the optimal quantity.
The static welfare analysis, on which the neo-classical critique of
monopoly has been based, misses a number of key features of real-world
competition and monopolies. First, it misses one of the main benefits of
competition, which is to create strong incentives for cost reductions. The
cost curve in the diagrams so far appears to be technically determined,
but, in reality, the level of cost depends on how much effort management
makes in keeping costs down. Management is more likely to make an
effort if it faces competitive pressures than if it is a monopoly. The inef-
ficiency due to higher costs under monopoly is sometimes described as
'X-inefficiency' to distinguish it from the allocative inefficiency which
the static analysis looks at. If the absence of competition keeps costs high,
the actual social cost of a monopoly may be higher than is suggested by
the deadweight welfare loss of CDE (see Figure 1.3). However, while
competition may be important for reducing X-inefficiency, this does not
mean that we need the perfect competition of the neo-classical model
where all rents are absent. In the real world, a small number of firms,
each of which exercises market power (in that they can keep prices above
marginal cost), may be engaged in vigorous competition which keeps
their cost curves low. Indeed, we will see later in our discussion of moni-
toring rents that a real-world competitive economy often relies on rents
to maintain cost efficiency, a feature which is missed in the standard neo-
classical model.
Second, the simple neo-classical analysis ignores the incentives
necessary for technical progress which reduces costs over time. In the long
run, cost reductions depend on a number of factors and, in particular, on
investments in new technologies. The growth implications of monopolies
in a dynamic analysis are less clear-cut. On the one hand, if monopolies
reduce the net social product, this can result in lower levels of investment
throughout the economy, and thereby in lower growth. On the other
hand, the accumulation of large profits by monopolistic firms may induce
more investment, particularly if deficiencies in capital markets make it dif-
ficult for smaller producers to raise capital collectively. As for the incen-
tives for investment, we will see later in our discussion of Schumpeterian
rents that investments in new technologies usually require rewards for
innovators, and these rewards also have the character of rents. What is
more, these rents are often indistinguishable from monopoly rents, as
 RENTS, EFFICIENCY AND GROWTH 33

innovators often enjoy a monopolistic position in the market, if only tem-

porarily. Thus, monopolies may reduce investment and make investment
allocation worse, but, if they are not permanent monopolies, they may
sometimes result in increased investment and create incentives for tech-
nical progress. The overall effects of monopolies can therefore vary from
case to case and will depend on the specific technologies, markets and
firms involved.
In developing countries, the discussion of rents often assumes that all
rents are monopoly rents and, furthermore, that the effects of these
monopoly rents can be adequately analysed in terms of the static neo-clas-
sical model. Even in the extreme case of monopoly rents created by gov-
ernment protectionism to favour cronies, their dynamic effects are not
always clear-cut. There may be genuine economies of scale in these indus-
tries, and super-profits may create incentives for greater investment, which
can counter to some extent the static inefficiency and X-inefficiency effects
of the monopoly. In other cases, monopoly rents may indeed signal lost
output and growth opportunities. To examine these possibilities, we have
to press on with our examination of other types of rents.

Natural resource rents

The role of rents is very different in the case of scarce natural resources,
such as fishing waters or pasture lands, which produce a stream of renew-
able benefits. Here, the existence of rents signals efficiency, and the max-
imization of rents is socially desirable. If the rate of renewal of the
resource is fixed, increasing the rate of extraction will raise marginal
costs. For instance, in the case of a fishing lake, increasing the number of
fish caught per period may require more and more time in finding fish
as the supply is depleted. The efficient allocation of resources requires
that, in each period, the natural resource is exploited to the point where
the marginal cost, in this case of producing fish, is just equal to the mar-
ginal benefit.
In Figure 1.4, the demand price offish (its marginal benefit to con-
sumers) remains constant at OB. This means that producers can sell as
much fish as they like at this price, say because the fish from this source
are a small part of the total demand for fish. This is a simplifying assump-
tion; introducing a downward sloping demand curve in this case makes
the analysis more complicated without changing the essential result. The
marginal cost of fishing is shown by the line AD which is rising for the rea-
sons explained. The efficient allocation of resources requires OQT offish
to be harvested in each period. This level of output equates marginal cost
to price. The big difference from the competitive output discussed in the
last section is that now, at the efficient level of output, the owners of the
 MUSHTAQ H. KHAN

Marginal cost

Average cost

Q2 Output (fish)

Figure 1.4 Natural resource rents

fishery earn a rent shown by ABC which is similar to the producer surplus
in Figure 1.1. Unlike the usual producer surplus, this surplus accrues to
the owners of the fishery (the equivalent of the firm). It is a return for
the owners which is higher than their income in their next-best oppor-
tunity if they did not own the lake. Thus, this rent is clearly predicated on
asset ownership in the classical sense. Yet it is a rent which (like the pro-
ducer surplus in a competitive market) exists despite efficient allocation.
If the fishery did not belong to anyone, and if as a consequence any-
one could go and fish in its waters, the rents which accrue to the fishery
would be 'dissipated' as a result of overfishing. Any output greater than
OQj earns a negative rent, as cost is higher than value, and this reduces
the total rent depending on the extent of overfishing. The extent of over-
fishing will depend on the assumptions made about the number of fish-
ers, and their expectations about the behaviour of other fishers (see, for
instance, Dasgupta and Heal 1979: 55-73). Each fisher enjoying free
access to the lake will fish as long as the price of the last fish caught cov-
ers the cost of fishing. With a large number of fishers, each catching a
large amount of fish, the cost of catching the last fish appears to each
 RENTS, EFFICIENCY AND GROWTH 35

fisher to be the 'average cost' of fishing. What this means is that, with
large numbers fishing, no fisher is concerned with the marginal cost of
fishing, which may not be known to anyone. Instead, fishers will fish as
long as the selling price covers the average cost of fishing which they
each face. With rising marginal costs, the average cost is arithmetically
always below marginal cost.
In this case, fishing will continue up to the point OQ^ where price
equals average cost. At this point, the total rent is ABC minus CDE (since
CDE is a negative rent). The aggregate rent is therefore much lower and
could, in principle, be zero. In stark contrast to the monopoly case, rent
dissipation here does not lead to efficiency but, rather, the reverse. With
OQg fish being caught, social resources are being mis-allocated, as the
marginal cost of fishing exceeds the marginal benefit. Society would be
better off with fishing resources allocated elsewhere. This is a simple ver-
sion of what is known as the 'free access problem' or the 'tragedy of the
commons'.
The inefficiency which results from rent dissipation in the tragedy of
the commons is widely recognized by economists, who point out the effi-
ciency-enhancing role of maintaining scarcity rents through the creation
of property rights. The damaging effects of rent dissipation due to inad-
equate or absent property rights over natural resources are particularly
important in developing countries. The preservation of rents in this case
not only results in allocative efficiency but may also be a precondition for
investment in, and the growth of, the natural resource sector. On the
other hand, the creation of new property rights is inevitably associated
with the creation of substantial rents for beneficiaries. Note that this is
not an argument in favour of private property rights, since communal or
collective property rights may in some cases be more efficient in creating
the right incentives for monitoring and preventing the overuse of
resources. What it does mean is that sometimes it may be efficient to cre-
ate property rights which generate rents, even though the creation of
such useful rents may involve just as much rent-seeking (see Chapter 2)
as the creation of wasteful rents.

Rents based on transfers

Rent-like incomes can also be created by transfers organized through the
political mechanism. Even in developed countries, income from produc-
tion is often supplemented or lost as a result of transfers through taxes and
subsidies. In developing countries, these transfers are not just additional
sources of income, but are often the basis for asset accumulation and,
indeed, the emergence of new capitalists and of middle classes. Clearly,
these transfers describe some of the phenomena of greatest interest in a
36 MUSHTAQ H. KHAN

development context. The transfer mechanisms include not just taxes and
subsidies, but also transfers (both legal and illegal) which convert public
property into private property. These transfers are rents, since the income
flows being engineered (which are sometimes converted into assets) are
greater than any alternative incomes of the recipients.
Not all transfers are necessarily rents. Welfare benefits or subsidies to
interest groups are transfers through the fiscal mechanism, but they need
not be rents in their entirety. For instance, pensions where the recipient
has made a contribution earlier in the form of pension contributions are
a form of saving and not a transfer-based rent. Similarly, unemployment
benefits are payments to unemployed workers for which, on average, they
contribute through taxes during their working periods. In these cases, the
transfer is not a pure rent for the recipient because it has a large compo-
nent based on prior savings or contributions similar to insurance premi-
ums. However, in other cases, transfers may be pure rents for which no
contribution has been made or is likely to be made in the future. Even in
these cases, most economists would exclude transfers made largely for
welfare reasons from the category of rents, though there is clearly an area
of ambiguity here. For instance, should we classify subsidies which keep
alive declining industries as rents, if they also prevent workers from suf-
fering sharp falls in income and welfare? By definition, these transfers are
rents, even though they are not usually treated as such.
The economic effect of a transfer has two components. First, the change
in welfare depends on the valuation of the transfer by losers and gainers.
In theory, if the losers and gainers valued the transfer equally, there would
be no welfare effect for society. However, this is usually not the case, since
a poor person would normally be considered to value a dollar higher in
utility terms than a rich person, if we are willing to make interpersonal
comparisons of utility. In other words, a transfer from the poor to the rich
should lower social welfare, and vice versa. Second, the welfare effect of the
transfer has a second component, which works through the effect of the
transfer on the incentives of those being taxed. This is usually negative.
Figure 1.5 shows how the incentive effects are modelled in neo-classi-
cal economics for a single individual or firm being taxed to provide a
transfer to some other individual, firm or sector. Ignoring for the
moment any differences in the valuation of the dollars transferred from
the loser to the gainer, the figure shows that there will be an incentive
effect as a result of the tax on the losers, which will result in reduced
effort and output. The fall in output occurs because the tax effectively
puts up the marginal cost of production and it is then no longer prof-
itable for the individual or firm to keep producing OQ} any more. So
even if the transfer itself would have left society as well off as before, rais-
ing the funds for the transfer makes society poorer if those who have to
 RENTS, EFFICIENCY AND GROWTH 37

Price in taxed
sector

Tax raised (and transferred

as rent to other
sectors)

Q2 Q1 Output of taxed sector

Figure 1.5 Deadweight losses due to transfers, in the neo-classical model

pay the tax work less hard and output produced declines from OQj to
OQg. The social cost of this fall in output is, as before, equal to the small
deadweight welfare loss triangle.
In fact, the monopoly rent discussed earlier was also a transfer from
consumers and factor owners to firms. The difference is that, there, the
transfer was organized by the price mechanism, while, here, we are dis-
cussing transfers through the political mechanism. However, there is a
parallel because, in that case too, the welfare loss due to the monopoly
came from the deadweight welfare loss and not the redistribution itself.
In both cases, the negative efficiency implications of the transfer are
likely to be smaller in magnitude than the transfer itself.
While this is the standard analysis of the effect of transfers in neo-clas-
sical economics, it may not be entirely relevant for developing countries.
First, it may not be adequate for analysing the implications of a range of
transfers in these countries through which new classes, and particularly
capitalist classes, are being created. Second, the standard analysis also
ignores the associated transfers required to make this process politically
38 MUSHTAQ H. KHAN

manageable. During the early stages of development, transfers (usually

from the poor to the rich) are often instrumental in creating a future
capitalist class. In advanced countries, one would have to go back further
in history to find evidence of similar processes, but this is the only dif-
ference. Thus, transfers in developing countries in the form of soft loans
from state-owned banks or allocations of state-controlled land are often
similar in this respect to, say, the enclosures of common lands in England
by emerging capitalists with the connivance of the state from Tudor times
to the beginning of the Industrial Revolution. The major difference is
that, in most developing countries, these processes are happening at a
much more accelerated pace and with much greater public awareness of
the injustices involved.
To the extent that the creation of capitalist property is a necessary pre-
condition for capitalist development, the transfers which underpin the
creation of these property rights may be a necessary stage in the devel-
opment of a capitalist economy. While these processes are taking place,
societies are likely to be in political turmoil. Traditional sectors, like the
peasant economy or small-scale informal manufacturing, are likely to suf-
fer from the transfers, with the attendant loss of incentives. On the other
hand, in many if not most cases, these transfers do not succeed in creat-
ing a productive capitalist class, in which case they do not constitute 'nec-
essary' primitive accumulation but, rather, primitive accumulation which
has gone wrong and has descended into 'unnecessary' theft and looting.
The efficiency of primitive accumulation is clearly never going to be easy
to assess. In some countries, these processes fail entirely and only create
an 'unproductive' capitalist class. In others, a productive capitalism does
emerge, but the theft and corruption associated with primitive accumu-
lation get embedded in the social system and are difficult to stop, well
after their social 'usefulness' has become history.
A second and equally important set of transfers in developing coun-
tries are transfers to maintain political stability while primitive accumula-
tion is going on. The magnitude and allocation of these transfers vary
widely because developing countries differ in their social structures and
the traditions of legitimacy which they have inherited. Nevertheless, in
many developing countries, classes of political intermediaries play an
important role in managing the political system and in appropriating
and allocating substantial transfers to maintain a minimum degree of
political stability. Given the inherent unfairness involved in processes of
primitive accumulation, it has been relatively easy for political interme-
diaries from the urban petty-bourgeoisie, the rich peasantry and other
emerging middle classes to organize popular opposition to the more
brazen aspects of early capitalist transition. Since this opposition has typ-
ically been led and organized by members of emerging middle class
 RENTS, EFFICIENCY AND GROWTH 39

groups left behind in the development process, it is more intense in soci-

eties where these groups are better organized and entrenched.
States in developing countries thus face intensely conflicting demands
while allocating public resources through transfers. On the one hand,
there are economic imperatives to develop a capitalist class and to make
sure that, in the process, the transfers are not in turn transferred to Swiss
banks but actually help to generate growth. On the other hand, there are
political imperatives which mean that transfers have to be organized to
benefit those with the greatest ability to create political problems, often
members of the emerging middle classes or multi-class factional coalitions.
The growth implications of the overall structure of transfers can be
positive or negative. The outcome depends on how much of the transfers
goes to individuals or groups who have the incentive and opportunity to
make the transition to productive capitalism. It would also depend on
the configuration of political forces which determines the structure of
the transfers to political intermediaries and their factions, since these
transfers can also have effects on incentives and opportunities. In some
countries, transfers were associated with rapid accumulation and capital-
ist growth. In others, the result has been large-scale theft and the onward
transfer of resources to foreign banks. The problem is that transfer-based
rents were ubiquitous in all developing countries, not just in the stagnat-
ing ones. Thus, it is misleading to argue that economic success required
the absence of rents based on transfers. To make matters more compli-
cated, the patterns of economic and political transfers which have
resulted in successful transitions have varied quite a lot. What works
depends not only on the strategy of accumulation but also on the under-
lying balance of political forces. This makes it difficult to analyse in a gen-
eral way the efficiency and growth implications of transfer-based rents.
Recent events in Southeast Asia underline how easily processes of capi-
talist accumulation which are well advanced can suddenly become
unstuck and face serious crises of legitimacy. In other countries, the
structure of political payoffs which ensures legitimacy may be such that
the accumulation process is much slower to start with. The Indian sub-
continent provides an example of this more typical story of intensely con-
tested and inefficiently allocated transfers (Khan 1996a, 1996b).
While we do not yet have general analytical models with which to assess
the economic implications of these types of transfers, we have to include
them in our analysis of rents. Since the pattern of economic and political
transfers matters much more than the fact that transfers take place, and
since the pattern depends on how competing groups are organized, we
will look at these processes in greater detail in Chapter 2 when we con-
sider the process of rent-seeking. There we will compare differences in
the patterns of redistributive transfers within patron-client networks in
40 MUSHTAQ H. KHAN

the Indian subcontinent, South Korea, Malaysia and Thailand at critical

points in their development history. For now, we only need to note that
these transfers have the character of other rents, in that they are incomes
higher than the recipient would otherwise have had. Also, the implica-
tions of these transfers are much more complex than the incentive analy-
sis of neo-classical economics suggests, once we understand that transfers
underpin both early capitalist accumulation and the political processes of
maintaining legitimacy.

Schumpeterian rents
The rents we discuss in this and the next three sections are closely
related in that information costs or information failures are at least par-
tially implicated in each case. In this section, we will define Schum-
peterian rents as rents which emerge due to innovation and information
generation. The generation of new information, in the form of innova-
tions involving new technology, new institutional arrangements or even
the use of information which notionally already exists, is not costless.
The innovation or discovery process costs effort and may involve sub-
stantial risk. In such contexts, a type of rent which we will call Schum-
peterian rent plays a key role in ensuring that efficiency and growth are
sustained. Like natural resource rents, Schumpeterian rents create
incentives for the efficient use of a scarce resource, in this case the abil-
ity to find and use existing information or generate entirely new infor-
mation. We first look at the role of Schumpeterian rents in the case of
new innovations. We then see that a similar set of rents is implicated in
the everyday generation of information in all markets, which traditional
neo-classical economics ignored.

Schumpeterian rents for innovators

Suppose an entrepreneur has invented a better product, or a way of mak-
ing an existing product more cheaply, which other entrepreneurs cannot
instantly copy. The innovating firm then has an advantage over its com-
petitors and is able to earn a rent. The rent is generated because the firm
has either a cost or a quality advantage over its competitors, which allows
it to earn a higher return for some factor owners compared with their
next-best alternatives. These rents, which we will call Schumpeterian
rents (following the analysis of innovation by Schumpeter 1994: 72-106),
are very similar to the excess returns or super-profits which Marx identi-
fied as the driving force behind technical progress in capitalism (1979:
esp. 429-38). Although Schumpeter is widely credited for having made
the link between the search for excess profits and innovation, in fact
 RENTS, EFFICIENCY AND GROWTH 41
Marx made this point well before Schumpeter. Marx's analysis is richer
in a number of respects, including the way in which innovation in his
analysis can be both technical and institutional. A reorganization of work
in the factory which uses existing capital and labour differently could be
partly a technological and partly an institutional innovation. What is
important is that the innovating entrepreneur earns a return higher than
the next-best (or average) entrepreneur.
The source of the rent in this case is that the entrepreneur has a
resource (knowledge, often embodied in a machine) which is non-repro-
ducible in the short run. Like the owners of factors of superior quality or
in scarce supply who are earning a producer surplus in Figure 1.1, firms
which 'own' the innovation are able to earn a rent which is very much
like a producer surplus. In Schumpeter's story, or in Marx's description
of capitalist innovation in Capital, the scarcity of the innovation is 'nat-
ural' and is based on the fact that other entrepreneurs cannot imitate the
innovation very rapidly. In other cases, particularly where innovations
can be easily copied, the scarcity may have to be 'artificially' protected
through patents. This is because, in many cases, an invention or innova-
tion, once it has been made, has the nature of a public good. It could
potentially be rapidly copied, in which case patent laws may be necessary
to prevent this from happening. Thus, the Schumpeterian rent, like the
monopoly rent, may be natural in some cases or protected by the state in
others. What distinguishes the Schumpeterian rent from monopoly rents
is that the above-average profit the firm earns is due to innovation.
Figure 1.6 shows the simplest case of innovation, where the innovating
firm is able to produce an identical product at a lower cost. In reality, the
innovator usually produces a product of higher quality as well, which
complicates the analysis, but the simpler story captures the essentials.
The marginal cost in the industry now has a discontinuity which is easi-
est to see if the marginal cost simply has two levels: a lower one for the
innovator, and a higher one for the older producers. The innovating
firm has a production capacity, so it can produce an output of OQ2 at
most, at the lower marginal cost of OP2. The rest of the market demand
up to OQj has to be met by higher-cost producers and this results in the
price of the product being set at OP r This is*simply a special case of an
upwardly sloping marginal cost curve. Since the price for the good is
higher than the marginal cost of the innovating firm, the latter earns a
producer surplus shown by the area PjADPc, which is the Schumpeterian
rent in Figure 1.6.
Marx's analysis is somewhat more complicated. Instead of the indus-
try price being determined by the marginal or high-cost firm, it is set by
the average cost of production. The post-innovation price is thus lower
than OPT but higher than OP2. This is more realistic in many contexts
42 MUSHTAQ H. KHAN

Price

Consumer
surplus
Marginal cost

Notional
Schumpeterian
deadweight
rert
welfare toss

i
i Demand

CU Quantity

Figure 1.6 Schumpeterian rents

because we often observe innovating firms engaging in price-cutting and

non-innovating firms making losses. In reality, particularly in oligopolis-
tic markets, all firms have some spare capacity and can increase sales by
cutting price. The innovating firm may have an incentive to cut price if
it can increase sales and make even bigger profits after a small price cut.
With price-cutting innovators, the story becomes too complicated for our
simple diagram but the essential story is unchanged. The innovator still
earns a super-profit of the same order of magnitude as PjADP2. It would
only be much larger in the exceptional case where the innovator had sig-
nificant spare capacity and could capture a very large market share after
a price cut. In the more usual case, price-cutting by the innovator will not
materially change the simpler analysis except in one important respect.
With price-cutting, the pressure to catch up is much more intense. Older
firms have to innovate rapidly or perish because, when there are price
cuts, they will be making reduced profits or even losses instead of just
normal profits.
The more rapidly other firms can imitate the innovation, the greater
the benefit for consumers. Once all firms have imitated, the price drops
to OP2 and the quantity purchased increases to OQ3. Not only would
 RENTS, EFFICIENCY AND GROWTH 43

consumers gain the Schumpeterian rent as part of the consumer surplus,

there would be an additional net social benefit in the form of an addi-
tional gain to the consumer surplus shown by the hatched area ABCD,
which we have called the 'notional deadweight welfare loss' which exists
prior to the imitation of the innovation. This is the loss of net social ben-
efit attributable to the absence of imitation by competitors. The term
'notional' indicates that this is a loss for consumers but only to the extent
that other firms could actually have imitated the innovator. In some
cases, they may be unable to imitate even if they tried because learning
takes time. In this case, the Schumpeterian rent is not actually reducing
net social benefit below any attainable level, and is therefore not associ-
ated with inefficiency. In other cases, imitation may be prevented by law.
In these instances, the net social benefit in a static sense is lower due to
the Schumpeterian rent, by the amount ABCD, and strictly speaking the
rent is associated with 'static' inefficiency.
Whether or not Schumpeterian rents are associated with static ineffi-
ciency, the dynamic implications for net social benefits, or in other words
the implications for growth, are quite different. While both Marx and
Schumpeter point out the spur which excess returns give to innovation,
Schumpeter is more explicit in pointing out that it may not be desirable
to try to get rid of these rents too rapidly. This may seem paradoxical,
given the potential gain to society from the dissemination of the new
innovation. The paradox is resolved if we see the process of innovation
as one which is happening over time, is risky, and requires effort and
investment. Many would-be innovators actually find that their invest-
ments fail. As a result, the rewards for the successful have to be above
average to keep attracting risk-takers. In the extreme case, if any innova-
tion can be instantly copied and the excess profit wiped out, what would
be the incentive to innovate? Admittedly, there are very few sectors where
such rapid imitation can take place, so, in most cases, sufficient incen-
tives will remain for potential innovators. But there may be plenty of sec-
tors where, even though imitation is not instantaneous, it is rapid enough
to significantly dampen innovation. In these cases, institutional and pol-
icy protection of rents may be socially desirable if they sustain the incen-
tives for technical progress.
The policy question is whether the length of time over which Schum-
peterian rents are observed to exist (due to, say, natural delays in imita-
tion) is too long or too short. It is too long if the persistence of the
notional welfare loss for consumers due to slow imitation outweighs the
benefit from the additional innovation which the protection calls forth.
It is too short if rents disappear so rapidly that the loss of future innova-
tions outweighs the immediate gains to consumer welfare. All govern-
ment policies which affect the profits of innovators can increase or
44 MUSHTAQ H. KHAN
decrease Schumpeterian rents. Thus, tax rules which give tax breaks to
innovators, competition policies which prohibit or allow restrictive prac-
tices by innovators to maintain their profits, or patent laws which directly
restrict imitation for a certain number of periods are all effectively deter-
mining the length of time for which innovators can earn extra profits.
Figure 1.7 shows the outline of the policy problem.
In Figure 1.7, the overall net social benefit over time from the protec-
tion of Schumpeterian rents is broken down into the sum of net social
benefits over time due to faster innovation and the sum of net social costs
over time due to the persistence of notional deadweight welfare losses for
consumers. The sum of net social costs over time (the lower of the two
curves in Figure 1.7) increases with the period of protection. To see why,
recall that the area ABCD in Figure 1.6 is the welfare loss in one sector
and in one period as a result of rent protection for innovators. As the
period of protection increases, this welfare loss lasts for longer and the
net social cost increases. However, costs in the distant future count for
less, as they are discounted using society's time preference, so costs
aggregated over time do not rise at the same rate as the period of pro-
tection. The shape of this curve will depend on the magnitude of the
notional welfare loss in each sector and society's rate of time discount.
The higher curve in Figure 1.7 shows how the additional net social
benefit over time due to faster innovation changes with the period of
protection of rents. In the single sector shown in Figure 1.6, this benefit
is initially the rent P1ADP2 for the innovator over a few periods, followed
by the additional consumer surplus of PjBCP2 for consumers thereafter.
The discounted present value of this flow of benefits is a measure of the
value of the innovation in one sector. For each period of protection, we
sum these flows of benefits across all sectors to plot the curve. The shape
of the curve depends on how the rate of innovation changes with the
period of protection. If rents last for a negligible period, there may be no
innovations which are attributable to the incentives created by these
(non-existent) rents. As the period over which rents last increases, there
may be a faster and faster rate of innovation due to increased incentives
and the net present value of the innovations due to the rents will rise.
However, after a certain level of protection, these rents may become like
monopoly rents and the rate of innovation may actually decline because
existing rent-recipients lose incentives for further innovations. The curve
can therefore start declining after a point. The optimal period of pro-
tection for society is P*, where the net social benefit over time, measured
by the gap between the benefit and cost curves, is maximized. This
ensures that the growth rate is optimal. However, if the period of protec-
tion is wrong, Schumpeterian rents may be associated with both static
inefficiency and sub-optimal growth rates.
 RENTS, EFFICIENCY AND GROWTH 45

Net social cost/benefit

overtime
Sum of net social benefits over
time due to faster innovations

Sum of net social costs over

time due to the persistence of
notional welfare losses

P* Period of rent protection

Figure 1.7 Dynamic net social benefits with Schumpeterian (and learning) rents

The problem is that there is no precise way to determine the period of

protection which will ensure the optimal growth rate. Estimating the
optimal period of protection can, at best, be very approximate, particu-
larly since the shape of the benefit-from-innovation curve in Figure 1.7 is
a matter of speculation. The shape of this curve depends on how the rate
of innovation changes with the period of protection for rents. Among
other things, this relationship will depend on: (a) the riskiness of inno-
vation given particular technologies, and (b) the 'animal spirits' and
degree of risk-taking of entrepreneurs in the sector. These may vary
across countries and sectors, and, as a result, the optimal period of pro-
tection can also vary. For instance, if innovation in some sectors is more
risky, or if entrepreneurs are more risk-averse, longer periods of protec-
tion may be optimal.
As the characteristics of technologies or the risk-aversion of investors
change, the period of protection for Schumpeterian rents offered by
patent laws and other mechanisms has to be periodically reviewed.
Moreover, patent laws can easily be misused to maintain profits without
46 MUSHTAQ H. KHAN

innovation, in which case they effectively support monopoly profits

rather than Schumpeterian rents. For instance, Dasgupta and Stiglitz
discuss the case where R&D (research and development) involves 'sunk
costs' (costs which once incurred cannot be recovered). Sunk costs
increase entry barriers and, as a result, the rate of innovation can actu-
ally drop with patent protection. Insiders in a sector who have a slight
advantage in research over their rivals can threaten to speed up research
and win the patent race if newcomers try to enter. Since the newcomers
stand to lose their R&D investments as sunk costs if they lose the race,
and since they know that insiders have a slight advantage, they may well
not enter the innovation race in that sector, allowing the insiders to
enjoy their existing rents for much longer than was intended. These
rents then have the character of monopoly rents rather than Schum-
peterian rents (Dasgupta and Stiglitz 1988; Stiglitz 1996: 139-52). For
this reason, Stiglitz argues that policy should err on the side of promot-
ing competition, although, in theory, too much competition can often
be as bad as too little. The optimality of patent laws is less significant in
developing countries, where learning (see next section) rather than
new innovation is more important.

Information rents as a variant of Schumpeterian rents

While Schumpeterian rents have usually been examined in the context of
incentives for innovation, in fact, the logic applies equally to the incentives
required to generate and use all types of information. Real-world markets
can only work if someone has the incentive to generate information about
opportunities. No-one could possibly have the incentive to spend time
and effort digging up this information if, as a result, they could not make
something extra. In reality, those who possess information, say about price
differences across markets, do make money. They earn a higher return by
using that information than in their next-best employment and so, by def-
inition, they earn rents. Yet, far from signalling inefficiency, these rents
are critical for making markets work efficiently.
The role of information rents may seem to offer a qualifier rather than
a knockout blow to the no-rent neo-classical model which informs much
of policy-making in market economies. But many information econo-
mists think otherwise. Thus, Greenwald and Stiglitz (1986) argue that
the presence of asymmetric information effectively destroys the useful-
ness of the general equilibrium (zero-rent) benchmark. Their claim is
that with information costs, even if there were no innovations, the econ-
omy would require a wide range of rents. These rents are inefficient only
in terms of the irrelevant benchmark of general equilibrium, but in the
real world such rents are efficient because they are necessary to make
markets work and there is no feasible alternative.
 RENTS, EFFICIENCY AND GROWTH 47

In developing countries, asymmetric information is pervasive, and so

are information rents. Weak institutions for information dissemination,
together with weak regulation (which allows information to be monopo-
lised) , often result in information rents much higher than in advanced
countries. Some of these rents may still be 'efficient', given high infor-
mation costs but, if better information dissemination can be developed,
these rents may signal inefficiency. The question for policy is whether it
is feasible to construct better institutions for reducing information costs
in the short run. If yes, high information rents may be inefficient, but
otherwise some of them may not be.
As with the more conventional Schumpeterian rents for innovations,
information rents may or may not be efficiency-enhancing over time. If
information is monopolized and does not eventually diffuse, informa-
tion rents can be very damaging. As with Schumpeterian rents for inno-
vations, the condition for dynamic efficiency is that there has to be
eventual freedom of access to the information, but not instantaneous
access. If access is instant, the result will be an immediate competing
away of the rents, and generators of information will not be able to make
additional money for their effort. As with innovation rents, the judge-
ment about the optimal period of protection beyond which information
rents become inefficient is not a precise science.

Rents for learning

In developing countries, productivity growth is usually led not by innova-
tion but by learning. Firms and entrepreneurs can dramatically increase net
social benefit by adopting and adapting technologies which may be well
known in more advanced countries. In this case too, rents may have an
important role to play in facilitating the process of learning (Amsden 1989).
In fact, it is often difficult to distinguish between innovation and learning.
Learning involves not just the copying of existing technologies, but also sig-
nificant amounts of adaptation to local conditions, available capital stock,
institutions, and so on. In other words, learning can involve substantial
amounts of innovation. Like innovators, the entrepreneurs or firms who
learn faster will be able to reduce their marginal costs and/or improve qual-
ity. But, like innovation, learning takes effort and can be risky. In theory, the
risk-aversion of entrepreneurs need not stop investments in risky sectors if
there are good capital and insurance markets. But capital markets are typi-
cally weak in developing countries and insurance markets which can take
the risk out of investing in new sectors are a theoretical fiction even
in advanced countries. Left to their own devices, developing country entre-
preneurs may prefer low productivity but safer locally known technologies
to high productivity but risky new ones. The latter may eventually be socially
beneficial but may befinanciallyruinous for the entrepreneurs involved if
48 MUSHTAQ H. KHAN

things go wrong. The divergence between the social and private benefit
from learning thus provides a justification for subsidizing learning.
To accelerate technological learning, rents in the form of policy-
induced 'conditional subsidies' may be created by a developmental state,
as Amsden outlined in the case of South Korea. The analytical similarity
between innovation (both technological and institutional) and learning
is that, in each case, rents can provide incentives for cost reduction over
time. In the case of learning, the rents in question are usually conditional
policy-induced subsidies which we will call 'rents for learning'. Unlike
Schumpeterian rents, rents for learning are created ex ante by a policy
decision rather than ex post as a result of an innovation. Schumpeterian
rents reward investments which have already been made, so their incen-
tive effect is to create expectations of rewards for future innovators. In
contrast, rents for learning allow producers in the learning sectors time
to catch up. Rents for learning have been referred to by a number of
other names, including 'contingent rents' by Aoki et al. (1997: 14-18)
and, somewhat less elegantly, as 'performance-indexed rewards' by the
World Bank (1993). The key difference between subsidies which are
rents for learning and those which are simply transfers is that the former
are conditional on the achievement of learning over a specified time
frame, while the latter may have any of a number of other motivations.
Figure 1.8 shows an industry in a developing country where the domes-
tic marginal cost curve DCE is higher than the foreign marginal cost curve
ABQ, due to backward domestic technology. In other words, productivity
in the developing country is so low in this sector that its costs are higher
despite its lower wages. The world market price of the product is shown
by PP'. With this configuration, the domestic industry will not produce
any of the product and the country will import any domestic requirement.
In many cases, high costs in the developing country are not due to any
intrinsic inability to handle high technology but reflect the fact that learn-
ing to use technology takes time. In theory, capitalists should be willing to
finance this short-term loss. After all, given lower wages, if productivity
could be raised even partially, they would be able to undercut the
advanced countries. The private sector may, nevertheless, be unwilling to
invest because of imperfections in the capital market which make it costly
to raise funds for such investments. Investors generally do not like the
combination of risk and illiquidity which infant industry investment rep-
resents. The grounds for intervention are strengthened if there are posi-
tive externalities for this sector. These externalities could take the form of
labour being trained or international reputation being established for the
country by the learner, which then benefits learners in other sectors.
In the simplest case, suppose the government offers the industry a sub-
sidy of AD per unit of output, with a cap on the total subsidy offered set
 RENTS, EFFICIENCY AND GROWTH 49

Price
Domestic marginal cost

Learning effect

Marginal cost with

foreign technology
Rent for learning/
conditional subsidy Q

Q2 Quantity

Figure 1.8 Conditional subsidies as rents for learning

at ABCD. This is effectively a rent for thefirmsin the industry since it is

an income higher than their next-best income, which would involve sell-
ing their product in world markets. Note that factors of production like
labour need not be earning rents, provided they could have earned the
same elsewhere. In this case, the subsidy simply compensates for the
lower productivity of the firm. In other cases, say where labour would
otherwise have been unemployed or where workers earn more in subsi-
dized enterprises, labour may be earning rents as well. For our purposes,
it is the rent directly earned by the firm which is relevant. The subsidy
lowers the marginal cost of domestic production over part of the range,
giving an effective domestic cost curve along ABCE. This allows domes-
tic production of OQj of the product. On the face of it, such a subsidy is
inefficient because it allows production in a sector where the actual cost
of production is higher than the price of the output, involving a social
cost of PFCD. In addition, the subsidy for this sector involves an explicit
or implicit tax for some other sector, which implies deadweight welfare
50 MUSHTAQ H. KHAN

losses due to incentive effects in the other sector, as shown in Figure 1.5.
The subsidy therefore implies immediate negative net social benefits and
is therefore inefficient in a static calculation.
Over time, the subsidy may ^justified if it is conditional on learning
(for instance, restricted to a specified time frame or conditional on
export growth), and if the conditionality is credible. If so, the subsidy
may create incentives for accelerated learning-by-doing. If successful,
learning would lower the domestic marginal cost to at least the interna-
tional level or lower. It is possible that domestic costs fall below the inter-
national level because the developing country most probably has lower
wages and could produce at lower cost if it could attain international
standards of productivity. Once this happens the subsidy ABCD is no
longer required, domestic production can increase to OQg, and the
industry can, on its own, capture the producer surplus of APQ thereafter.
The social benefit of learning is the discounted value of the stream of
future producer surpluses APQ plus any positive externalities (spillover
effects) for other sectors. The social cost over time is the discounted value
of the stream of temporary social costs of PFCD plus the social cost of
transferring ABCD to this sector in the form of temporary disincentive
effects elsewhere in the economy. Provided that the costs do not have to
be sustained for too long, and provided that the learning gains are large,
the net social benefit over tomay be positive, implying that the learning
subsidy is dynamically efficient.
Learning rents may be delivered to the firm through a number of pol-
icy mechanisms. These include the provision of subsidized credit, or pro-
tection which allows it to charge higher prices in the domestic market
and, of course, the straightforward subsidy which we have looked at. The
latter is easiest to analyse but similar issues are raised in the other cases.
The critical question is, once again, the time frame over which the subsidy
or protection is offered to the learning sector. The issues are very similar
to Schumpeterian rents, and so Figure 1.7 can be used with some re-
labelling. The overall net social benefit from the learning rent can simi-
larly be broken down into the sum of net social costs due to the
persistence of inefficiencies and the sum of net social benefits due to
accelerated learning. As the period of protection increases, the sum of net
social costs due to the subsidy is likely to increase in the same way as the
cost curve for Schumpeterian rents in Figure 1.7. The sum of net social
benefits due to accelerated learning due to learning rents is also likely to
have a shape similar to the benefit curve in Figure 1.7. Too short a period
of protection would result in very low benefits in terms of future producer
surpluses, as domestic entrepreneurs would have insufficient time to
learn. But too long a period can also result in waste, as infants know they
will never have to grow up and learning can actually slow down. Thus, as
 RENTS, EFFICIENCY AND GROWTH 51

before, there is an intermediate period of protection which is optimal for

each sector. But, in this case, enforcing this period is more difficult. The
state has to be clear about the kind of performance it expects from learn-
ers, and it has to be able to withdraw rents if performance is poor. Other-
wise the subsidy can become a permanent drain, which is frequendy
observed in many developing countries in the form of 'infant industries'
which refuse to grow up. In such cases, rents for learning will be associ-
ated with both static inefficiency and low-growth rates.
The state has to make decisions about specific firms and sectors ex
ante, and has to be able to correct decisions rapidly if they turn out to be
mistaken ex post, or if the recipients fail to perform. Compared with
Schumpeterian rents, there is a greater likelihood that learning rents will
fail to generate growth. Not only must the period of protection be right,
the sectors and firms selected for support must also be more or less right.
This requires not only a high degree of competence among state bureau-
crats but, more importantly, the state has also to be able to correct mis-
takes once they have been identified.
The quality of the bureaucracy is clearly an important variable but not the
only important one. The state's ability to pick potential winners can
become more difficult as technology becomes more complex. In gen-
eral, learning rents are easier to administer during the earlier stages of
development, when the next steps up the technology ladder are rela-
tively obvious and performance criteria can be set by looking at the next
tier of countries. Here, exposing domestic firms to international compe-
tition over a pre-set time frame may be sufficient to monitor perfor-
mance. As technology becomes more sophisticated and products more
differentiated from those of competitors, it becomes more difficult to
specify the performance expected under all future contingencies. This
brings us to the most important variable: the state's ability to enforce the
allocation and withdrawal of subsidies, which depends on the political con-
text in which industrial policy is conducted. For all but the simplest tech-
nologies, the successful operation of the system depends on the ability of
the state to make pragmatic judgements about when performance is
unacceptable and to take action without the losers being able to contest
the decision indefinitely. The recipient of the learning rent has to accept
that the state will have to use its judgement if things go wrong to decide
whether to keep subsidizing, to restructure or even to terminate the pro-
ject. This implicit contract between the state and the firm is difficult to
convert into a formal contract since the latter would have to cover all
contingencies which may arise and the course of action to be followed in
each contingency. It follows that any industrial policy system has to be
based on trust, to some extent, and good networks of communication
between the state and the recipient capitalists can help. But, critically, it
52 MUSHTAQ H. KHAN

is dependent on the political power of the state to enforce the decisions

it takes. Industrial policy is unlikely ever to be entirely based on formal
contracts, simply because the transaction costs of formally specifying
all contingencies in the learning game and resolving future disputes
through third-party arbitration in courts would probably be prohibitive.
Countries differ very significantly in the power which their states have
to enforce decisions about subsidy withdrawals. This political ability to
discipline can also decline in successful industrial policy countries such
as South Korea when business and civil society become more assertive of
their legal rights. The growing demand that the rule of law should be
adhered to could, paradoxically, have made the pragmatic re-allocations
of subsidies and property rights which characterized early South Korean
industrial policy increasingly more difficult. In the late 1980s and 1990s,
there was growing evidence that South Korean business was increasingly
unwilling to submit to what it saw as the arbitrary power of the state. Rev-
elations about the misuse of political power by the state in its conduct of
industrial policy became more frequent. Business houses like Hyundai
began to play a more assertive role in politics, arguing for greater trans-
parency and the formalization of state-business relationships. While it is
clear that the power of the state to make pragmatic decisions about sub-
sidies (and resource allocation in general) can be misused, and was mis-
used to some extent in South Korea, it is also clear that a transition to a
more transparent and formal set of contracts for allocating learning
rents would be much more expensive in terms of transaction costs.
Whether such a system can be developed remains one of the key ques-
tions for the next tier of developing countries.
Since the social desirability of rents for learning depends crucially on
the 'efficiency' of the state in managing these rents, the optimal technol-
ogy trajectory of a country is not independent of the type of state it has. If
the state is unable to efficiently grant and withdraw subsidies for learn-
ing, it may be better for economic performance if the state limits
learning rents to very few sectors and thereby avoids the inefficiency of
building up an inefficient, but subsidized, industrial sector. The econ-
omy would undoubtedly move up the technology ladder much more
slowly, but this may be better than getting stuck with the third-best, which
is an attempted catching-up strategy which fails.
While all developing countries had substantial transfers supporting
primitive accumulation, they differed a lot in their learning strategies
and technology trajectories. South Korea in the 1960s and 1970s exten-
sively used state-managed subsidies for learning and it had a state which
could effectively manage these rents, at least in the early years (Amsden
1989; Aoki et al. 1997). Its performance was dramatic. In contrast, Thai-
land in the 1980s (see Doner and Ramsay, and Rock, this volume) relied
 RENTS, EFFICIENCY AND GROWTH 53

less on state-led learning, even though primitive accumulation was rife.

Thailand's loss was less serious than it may seem, as it is unlikely that the
Thai state could have effectively disciplined industry in the same way,
given its internal politics. Given the constraints facing the Thai state, a
lower reliance on learning rents for industry and a more decentralized
set of transfers supporting primitive accumulation kept the Thai rent sys-
tem relatively dynamic. On the other hand, compared with South Korea,
its progress up the technology ladder was slower. In contrast, India and
Pakistan did attempt to manage substantial learning rents for infant
industries in the 1960s and 1970s, but lacked states which could effec-
tively manage these rents. In these countries not only was technical
progress slower than in South Korea, performance was also worse than in
Thailand. In effect, the Indian and Pakistani states ended up creating
vast rents for 'infant' industries which were difficult to remove for rea-
sons of domestic politics. Thus, the type of state (and the feasible ways in
which it can be changed) will determine whether learning rents can be
effectively managed, and therefore the most appropriate technology tra-
jectory for a particular country (see also Khan 1995).

Monitoring and management rents

The analysis of rents has also progressed to exploration of the role of
rents in creating incentives for management. This analysis is based on
the view that part or all of profit is a surplus, much like a rent. This view
of profit is itself a radical departure from conventional economics since
the surplus view of profit is associated with Marx and the classical econ-
omists. The latter explained profit as a surplus, or residual, left over
after other factors, in particular labour, had been paid. Profits therefore
depended critically on the degree to which the capitalist could control
the labour process in the factory. In contrast, in the neo-classical model,
the rate of profit was determined by the value of the marginal product
of capital (the value of output produced by the last unit of capital). Here
the capitalist plays no role in determining profits since the value of the
marginal product of capital depends only on technology, the number of
workers working the capital stock and the price at which the product
can be sold. The first serious criticism of this analysis by neo-classical
economists came from Alchian and Demsetz (1972). They recognized
that the profit rate is not determined in this way because the marginal
product of capital is impossible to measure independently of how well
the production team as a whole is working. Instead, they argued that
profits must be a residual after workers and suppliers have been paid.
Profits can therefore vary greatly depending on the competence of man-
agers and the discipline of workers.
54 MUSHTAQ H. KHAN

If profits are a residual, do they have any function, and can they be jus-
tified? Alchian and Demsetz argued that profit as a residual played a crit-
ical function as a reward for good management. Organizing teamwork in
the workplace is a difficult job. For Alchian and Demsetz, the manage-
ment problem is entirely due to asymmetric information. It is cosdy to
find out how much effort each individual worker has put in. Even other
workers would not know whether someone in their team was free-riding
unless they spent time observing their colleagues. The role of manage-
ment is to do this observation ('monitoring' is the North American term)
and the profit which owners and managers earn as a residual after paying
all direct costs is their reward for monitoring. Much earlier, Marx, too,
had pointed out that the capitalists' search for profit played a function. It
created incentives for managing the labour process but, more impor-
tantly, it drove technical innovation, which was later picked up, as we have
seen, by Schumpeter. An important difference with Alchian and Demsetz
is that Marx added that capitalist profits were not always functional in gen-
erating economic dynamism. In any case, he was willing to make a politi-
cal critique of the capitalist's claim to be exclusively entitled to manage
and make decisions about what to do with the subsequent surplus.
A more important difference is that, for Alchian and Demsetz, the
role of management is entirely defined by the problem of asymmetric
information. Workers can hide information about the effort they have
put in, and uncovering this information requires effort by management.
In contrast, Marx's analysis suggested that the labour process involved
more serious conflicts, in particular, distributive conflicts over wages, and
worker resistance to technologies which dehumanized work (Marx 1979:
975-1038). Thus, in both these traditions, management plays a role in
disciplining the labour process. In both, management has an incentive to
manage because its rewards are based on the surplus which depends on
how well they manage. But, in the neo-classical tradition to which
Alchian and Demsetz belong, the overcoming of information failure
through better monitoring by capitalists increases efficiency in the sense
that both capitalists and workers are better off. Even workers are better
off because if all workers 'shirk', they suffer collectively. For Marx, the
capitalist drive for profit is a double-edged sword because, on the one
hand, it increases production but, on the other hand, it sacrifices work-
ers' autonomy and their right to participate. Nevertheless, particularly in
the early stages of development, the rapid growth in production under
capitalism was welcomed by Marx.
Alchian and Demsetz's analysis of profit has implications for our dis-
cussion of rents. If profits were determined by technological conditions
alone, variations in profit rates across sectors would be rapidly corrected
by the entry and exit of physical capital. In the Alchian and Demsetz
 RENTS, EFFICIENCY AND GROWTH 55
story, a somewhat greater variation in profit rates is allowed because man-
agement matters, and better managers cannot physically take over every-
one else. Thus, there will be a range of returns to capital around some
average rate, and only those managers who are so bad that their profits
fall below a minimum will actually go out of business. Capitalists who are
(or can hire) better managers will earn higher than the minimum return
in each sector. Since the minimum return would be sufficient to keep
capital in that sector, good management ensures rents for owners and
managers. It is precisely the search for these rents that keeps manage-
ment on its toes.
Clearly, there are close analytical links between the role of rents in cre-
ating incentives for managing the work process, and the role of rents in
generating information or innovations, which we discussed earlier. In all
these cases, rents create incentives for certain types of actions which are
efficient given the costliness of information. Having said that, we should
also say that the rents to management are based on more than overcom-
ing asymmetric information problems (as suggested by Alchian and
Demsetz 1972). The success of management can also be based on its
'political' role in disciplining labour and suppressing contestation in the
workplace (which Marx pointed out). Nevertheless, in all these cases,
rents which appear to signal inefficiency according to the no-rent bench-
mark of competitive markets may be growth- and efficiency-enhancing
when we look at the incentives they create for particular types of actions.
It is worth pointing out the degree to which the neo-classical analysis
of profits has taken on board the insights of the classical and, in particu-
lar, the Marxist analysis. If we combine the separate points made by the
neo-classical analysis of natural resource rents, Schumpeterian rents, and
now monitoring and management rents, we see a range of arguments
linking the incomes of property owners to static and dynamic efficiency.
However, this has only been achieved by recognizing that the incomes of
these property owners have the nature of rents, that is, they are surpluses
even using the narrow benchmark of the alternative opportunities of the
recipients. The property rights system which underwrites these incomes
can, under certain conditions, generate efficient outcomes, but only at the
cost of creating classes of surplus income earners.

Monitoring rents and financial institutions

The analysis of monitoring rents has provided new tools for investigating
the role of financial institutions in developing countries. It has been
argued that rents for financial institutions may be efficient if they induce
efficient monitoring of credit portfolios (Stiglitz and Weiss 1981; Hell-
man et al. 1997). Financial sector rents were widespread in East Asia
56 MUSHTAQ H. KHAN

when many of these countries were achieving rapid industrialization. On

the other hand, their financial sectors were also at the centre of the cri-
sis which hit many of them in 1997. The management incentive models
are a starting point for the analysis of financial sector rents, though they
do not identify important aspects of the role of these rents in the growth
phase of the Asian countries, or their role in the subsequent crash.
The monitoring perspective is certainly a useful break from the older
neo-classical approach which argued that developing country financial
sector rents were always inefficient. Developing country governments
often held down interest rates for savers with the intention of giving
industrial borrowers windfall incomes to encourage them to borrow and
invest. This was called 'financial repression', and the strategy was criti-
cized for creating a deadweight welfare loss by creating a gap between
the supply and demand price of credit (in the same way that a monopo-
list creates a gap between price and marginal cost). The important point
was that, in the financial repression models, the rents created played no
useful function and simply signalled allocative inefficiency (see Hellman
et al. 1997 for a critique of these models).
The new approach based on monitoring costs suggested that financial
sector rents may, under some conditions, be useful. Financial markets
are particularly subject to problems of asymmetric information, which in
turn can lead to a market breakdown (Stiglitz and Weiss 1981). Bad bor-
rowers can drive out good borrowers because bad borrowers are often
willing to agree to higher interest rates since they have no intention of
actually repaying. Unless financial institutions are good at monitoring to
distinguish between good and bad borrowers, they are likely to eventu-
ally become bankrupt.
As interest rates for borrowers become higher, it becomes more and
more likely that only risk-loving borrowers or borrowers with no inten-
tion of repaying will keep borrowing. The 'expected return' to the bank
will then be lower than the 'nominal interest rate' because of default,
and the expected return may actually start falling at high rates of inter-
est. It follows that if the market-clearing interest rate is high, banks may
not actually want to lend at that rate. To maximize expected returns,
banks may then lend below the market-clearing interest rate to keep out
risky borrowers. When this happens, the financial market can appear to
be superficially similar to the financial repression case. However, here,
the interest rate ceiling is set not by the government but by the banks who
decide to ration credit.
The lower diagram in Figure 1.9 shows that the expected return to the
bank, r, is not the same as the nominal interest rate, i, charged to bor-
rowers. After a critical interest rate of i*, the expected return, r, starts
dropping because too many bad risks are attracted at higher rates of
 RENTS, EFFICIENCY AND GROWTH 57

Nominal
Expected interest rate i
return r

Nominal
interest rate i

Figure 1.9 Market disequilibrium with efficient monitoring (Stiglitz and Weiss
model)

interest. This is the 'adverse selection' problem. In addition, there is a

'moral hazard' problem, as even good borrowers may be forced to act in
riskier ways than the bank would like at high rates of interest and find, as
a result, that they go bankrupt. There is thus an interest rate i* which
maximizes returns for the bank; the problem is that this need not be the
market-clearing rate.
This possibility can be seen in the upper diagram, which shows the
standard demand and supply for loanable funds, but with the interest
rate along the horizontal axis. As it is drawn, i* is below the market-clear-
ing rate and, at this lending rate, there is an excess demand for funds. At
the interest rate i*, banks are only willing to lend Ls while the demand is
for LD of loans. The excess demand is dealt with by 'non-price' rationing
of credit by banks, in other words by bank monitoring which aims to
58 MUSHTAQ H. KHAN

separate good from bad borrowers to allocate credit to the good bor-
rowers alone. This model shows that efficient financial markets will not
necessarily be in equilibrium in the standard fashion.
The Stiglitz and Weiss model indicates how information problems in
financial markets can lead to credit rationing by banks. Hellman et al.
(1997) extend this argument to developing countries by arguing that,
where the banking sector is weak, government regulations which create
rents for banks can strengthen their incentives to monitor their portfo-
lios better. The availability of these rents makes banks more valuable for
their owners by giving the bank what these authors call 'franchise value'.
If the protection of this value requires good portfolio management in the
future, the rents sustaining franchise value may create incentives for bet-
ter monitoring.
Their argument is that a government-created ceiling on the interest
rate paid on savers' deposits which is below the market-clearing rate can
create rents, and so franchise value for banks, and therefore stronger
incentives for portfolio management (Hellman et al. 1997). In Figure
1.10, the gap between the regulated deposit rate, rd, and the market lend-
ing rate, rL, is the source of the rent for banks. The only way that these
rents will continue to be available for the owners of the bank is through
the bank's survival, which in turn is only assured if its managers manage
its portfolio well.
Banks have played an important role in East Asia, both in the high-
growth phase as well as in the runup to the financial crisis of the late
1990s. But to what extent does the Hellman et al. 'financial restraint'
model contribute to our understanding of the role of financial rents in
the growth and eventual crisis in East Asia? The financial restraint model
is important because it challenges the assumption that a no-rent com-
petitive equilibrium in the financial market is possible and efficient. On
the other hand, the model does not identify important institutional and
political features of East Asian financial markets and therefore is not ade-
quate on its own.
First, the monitoring-efficiency model assumes that the banks' owner-
ship structures were such that the rents earned provided an incentive to
monitor their portfolios effectively. The institutional structure which
would best achieve this would be one where banks were owner-managed
and the owners appropriated the rents. A second-best structure would be
one where banks were not owner-managed, but the owners could co-
ordinate their actions to hire and fire managers to maximize rents.
Neither of these ownership structures characterized the bulk of the
banking sector in East Asia. In some countries, like South Korea, banks
were owned by the state throughout much of their high-growth period.
Even after the partial privatizations of the 1980s, South Korean banks
 RENTS, EFFICIENCY AND GROWTH 59

Interest
rates

Rent which contributes

to the franchise value of
the bank

Loanable funds

Figure 1.10 Financial sector rents as incentives for portfolio monitoring

remained under state guidance and control until the early 1990s. The
existence of rents in public sector banks will not provide incentives for
managers unless we believe that public sector bank managers are able to
appropriate a large part of these rents. In other Asian countries, when
banks were privately owned, they often had ownership links with indus-
trial conglomerates. This type of ownership structure would also dilute
the incentives of bank managers to monitor since a significant part of the
bank's lending could be to the owners of the bank themselves.
Second, a related problem is that the incentive to monitor can be sig-
nificantly diluted if the bank does not face a credible threat of bank-
ruptcy, which is how franchise value can be lost. It is more likely that
banks will face bankruptcy if they are small banks whose collapse will not
affect the financial market as a whole. The social cost of bankruptcies
increases if banks are very large, as they typically are in both developed
and developing countries. In terms of the information argument, this
can result in a moral hazard problem since managers and owners know
that their bank will not normally be allowed to go bust without an
attempt at a bailout by the government. If this is the case, rents may not
provide a sufficient incentive for the good management of banks.
Third, even if bank managers did have the incentive to monitor to
maintain their rents, the information-centred models assume that banks
60 MUSHTAQ H. KHAN

also had an effective (as opposed to simply a legal) power to monitor bor-
rowers. In fact, the effective power to monitor varied widely and did not
correlate with the existence of incentives to monitor. The difference
between efficient and inefficient bank-based lending often had more to
do with the effective power of banks to monitor and discipline borrowers
than with the incentives they had. Once again, South Korea provides a
useful case. Here, although banks were publicly owned during much of
the high-growth period (and therefore could be expected to have weak
incentives to monitor), they did have the power to monitor and disci-
pline borrowers and seem to have used this power effectively. South
Korean banks were used by the state to direct credit to priority sectors
and to monitor performance, and they could do this during the 1960s
and 1970s because they had the power of the state behind them to disci-
pline poorly performing loan recipients. We have already suggested that
the politics of South Korean industrial policy was changing during the
1980s as business became more assertive and less willing to accept the
high-handed interventions of the state. This must be part of the story
behind the declining efficiency of its banking system in the 1990s. Para-
doxically, at the same time, financial liberalization and privatization of
the banks were transferring bank rents to private owners, which, accord-
ing to the franchise value theory, should have strengthened the incen-
tives for good management by the new owners of the banks. Instead, we
see declining financial sector performance and eventually a crisis, which
suggests that monitoring theories of financial sector rents must be inad-
equate on their own.
In most Asian countries, banks never enjoyed the same degree of
effective power to monitor and punish as their South Korean counter-
parts. The inability of banks to discipline borrowers in most developing
countries is most often due to the political and social power of borrowers
to protect themselves, usually by mobilizing rival political constituencies.
Thus, in addition to the incentive which lenders must have to monitor,
perhaps a more important variable is likely to be the effective power of the
lender to discipline recipients.
Finally, and closely related to the previous points, the financial restraint
model understates the role of the state in regulating firms (and banks). It
focusses only on the role of the state in creating rents for banks, with the
rents creating sufficient incentives for banks themselves to monitor. This
is considered to be desirable since banks are assumed to have better infor-
mation than the state and are therefore likely to do better monitoring.
However, this representation is misleading because the government is typ-
ically very closely involved in the operation of the financial sector. It has
to regulate the size and ownership structure of banks and these determine
the effectiveness of rents as incentives for management. The effective
 RENTS, EFFICIENCY AND GROWTH 61
power of the banking system to monitor, which we have already seen is
critical, depends on the state's ability to enforce contracts and implement
policy decisions. Thus, the technical capacity of the state to regulate, and
its political ability to overcome resistance and enforce decisions on both
borrowers and banks, are critical variables. The state may also have other
political objectives in allocating finance which can also significantly
reduce the efficiency of financial allocation, as Chin and Jorno (this vol-
ume) discuss in the case of Malaysia.
If the role of rents in providing incentives for good monitoring are
subject to such important qualifications, how can we account for the
simultaneous existence of high financial sector rents and good economic
performance in East Asia over a period of more than two decades in
some cases? We would argue that financial sector rents did play an impor-
tant role in these countries, but not primarily through the mechanism of
creating monitoring incentives. First, in many cases, financial sector
rents were being created for onward transfer to emerging classes in ways
which are more accurately described as primitive accumulation. The suc-
cess or failure associated with such 'financial sector rents' has to be
assessed by looking at the viability of these broader processes of accu-
mulation, and not just at the incentives for portfolio management.
Thus, financial institutions were used in all these countries to manage
transfers to emerging capitalists engaged in primitive accumulation as
well as to political clients of the state from the intermediate classes to
maintain political stability. The latter sometimes acquired significant
proportions in countries like Malaysia (Chin andjomo, this volume). In
the East Asian countries, this process of capitalist transformation was for
a long time tremendously successful. While the process was vulnerable
and based on fragile political compromises, the performance of these
countries over several decades means that capital could not have been
allocated that badly over such a long period.
Second, in addition to primitive accumulation and political transfers,
state controls over interest rates were often used to simultaneously create
learning rents for infant industries by keeping borrowing rates low. This
possibility is recognized by Hellman et al. (1997). Thus, the role of the
financial sector in many East Asian countries, and in particular in South
Korea, was not just to monitor portfolios, but also to create learning rents
for industry. The associated economic performance may have had more
to do with the success with which these rents for learning were being
administered by the state than with any monitoring incentives simulta-
neously created for banks. The success or failure of learning rents over
time depends, as we have seen, on the administrative ability of the state
to identify strategic sectors and monitor performance, and on its politi-
cal ability to grant and withdraw rents as necessary.
62 MUSHTAQ H. KHAN

The increasing technical complexity of industry, which was partly a

direct result of the success of some Asian countries, and the growing
political constraints facing 'arbitrary' state actions, eventually made
effective policing by the state more and more difficult. This may explain
why rents for learning eventually failed to be associated with rapid
growth in many of these countries. In other words, in many of the high-
growth Asian countries, a growing proportion of the rents transferred
through the financial sector were, by the mid-1990s, becoming monop-
oly rents or inefficient and growth-retarding political transfers, rather
than remaining efficient rents for learning. This more complex story,
which looks at the role of the financial sector in managing political trans-
fers, learning rents and monitoring rents, can capture more accurately
the initial association of financial sector rents in East Asia with good eco-
nomic performance, and the subsequent weakening of this link to vary-
ing extents by the mid-1990s.
The decline in the efficiency of bank allocation of credit should not
be solely blamed for the declining efficiency of capital allocation in the
late 1990s. A further complicating part of the story in many of these
countries was the growth of the stock market during the 1990s. Stock
markets can also generate variants of information rents for those who
own particular stocks, or invest in particular countries, if their judgement
in choosing stocks and countries has been good. One of the features of
the early 1990s in many developing countries was the growth of stock
market information rents relative to long-term state-created bank-based
rents in the financial sector which we have been discussing so far. In prin-
ciple, the search of stock owners for information rents should drive cap-
ital towards more efficient firms because they would offer higher returns
in the long run. If this were true, stock market information rents could
indirectly perform a useful function in capital allocation. However, while
financial liberalization proceeded rapidly in many Asian countries in the
1990s, there are reasons to doubt whether the growth of the stock mar-
ket contributed to performance.
The relative weakness of stock market information rents in inducing
efficient investment allocation has been extensively discussed in the
literature on financial markets. Stiglitz (1996: 92-6) follows Keynes in
questioning whether stock market returns can generate impartial infor-
mation about investment prospects and the creditworthiness of compet-
ing groups of borrowers. Stock prices tell investors what the stock market
thinks a company's prospects are and not what its prospects actually are.
This distinction was behind Keynes' famous analogy between a stock
market and a beauty contest. To predict who will win a beauty contest,
one does not have to judge the absolute beauty of any individual, but one
does have to guess whom the judges will think is beautiful. The stock mar-
ket is similar in that making money requires a good sociological under-
 RENTS, EFFICIENCY AND GROWTH 63
standing of what the market thinks is important, and not always, or nec-
essarily, a good analysis of fundamentals.
As a result, whatever affects sentiment in stock markets can affect cap-
ital allocation, regardless of changes in fundamentals. Thus, in advanced
countries, market sentiment has often forced managers of firms to pay
high dividends, even when that was not in the long-run interest of the
company. Such behaviour was often a response to the prevailing percep-
tion in their stock markets that dividends were a good indicator of man-
agement performance. This perception led to the allocation of stock
market capital towards high-dividend companies, and managers paid low
dividends at their peril. More recentiy, the focus on dividends has become
less as sentiment has swung towards 'technology' stocks, with similar ques-
tions being raised about their fundamentals in many cases. In developing
countries, information on which to base stock market valuations may be
much more limited and easily manipulated by insiders. As a result, capital
allocation is less rational and fluctuations in value more severe. The rapid
move towards the deepening of stock markets in East Asia in the 1990s was
no doubt partly driven by the global move towards financial liberalization,
but, in addition, it often had strong domestic political support from
groups which sought to capture stock market rents.
East Asian stock market rents in the early 1990s were very largely based
on insider information and changes in international sentiment about
emerging markets, and played little if any role in improving perfor-
mance. The severity of the market crash of 1997 was to a large extent also
driven by rapid changes in sentiment which far outweighed underlying
changes in fundamentals (Jomo 1998; Palma 1998; Stiglitz 1998). The
1997 crash coincided both with the rapid growth and decline of ineffi-
cient stock market information rents (and other speculative rents) and
with a much more gradual and systemic decline in the efficiency of learn-
ing rents channelled through banks. The policy response to the first
involves better regulation of stock markets and of international capital
flows, such that valuations do not move greatly out of line with underly-
ing fundamentals. The policy response to the gradual decline in the effi-
ciency of learning rents is much more challenging. In some countries,
the decline was due to technological progress making investments more
complex; in others, it was the growth of political constraints preventing
the allocation of rents according to efficiency criteria. Constructing new
institutions which can manage learning rents in these changed circum-
stances presents an important challenge for developing countries.

Rents, rights and the surplus

Our discussion of rents has already drawn on the surplus approach of
Marxian economics and it may be useful to compare the neo-classical
64 MUSHTAQ H. KHAN

and classical approaches explicitly at this stage. The economic surplus

was the primary focus of classical economics which saw the surplus as the
key variable explaining long-run dynamics. Marxian economics, drawing
on Ricardo, defines the economic surplus as the income accruing to asset-
owning classes after paying for the direct costs of production (wages, raw materi-
als and the depreciation costs of machinery). Thus, the surplus is defined so as
to identify what a society could potentially invest. The surplus is essential
for growth but does not guarantee that growth will be achieved. Marx, in
particular, observed the role played by the search for super-profits in gen-
erating innovation and technical progress, but he also pointed out how
the search for profits can lead to crises.
Looking first at the similarities, the classical surplus and the broadly
defined notion of rent clearly describe an overlapping set of income
flows. The main difference is that the classical surplus is a broader cate-
gory than rent since it includes the normal returns to land and capital,
which are typically not considered to be rents. However, we have seen
that some neo-classical institutional economists have begun to treat even
normal profit as a surplus captured by managers, which can give much of
profit the character of a rent. At the same time, most rents are part of the
classical surplus as they usually accrue to capitalists and landlords. The
exceptions would be the relatively small rents accruing to some types of
specialized labour. Therefore, if we envisage the set of incomes compris-
ing the classical surplus as a big circle, the neo-classical rent would be a
slightly smaller circle located almost entirely within the bigger one.
Second, both rents and surpluses are sustained by an underlying struc-
ture of economic rights. The basis of the surplus in rights is explicit in
the Marxian analysis, but rights also underpin neo-classical rents. Making
this explicit will help us in our analysis of rent-seeking in the next chap-
ter, since changing the structure of rents almost always involves some
form of institutional change or re-allocations of economic rights. In the
Marxian analysis, the appropriation of the economic surplus by capitalist
or landlord is explicitly based on their ownership of capital and land,
respectively. In fact, Marx would argue that, without these specific prop-
erty rights, even normal profits and rents would not exist. Thus, allot the
economic surplus in the Marxian model is underpinned by the property
rights structure which describes capitalism. This is shown in the first row
of Table 1.1.
The parallel association of specific neo-classical rents with some set of
associated property rights is shown in the following rows. Monopolies are
either 'natural' monopolies based on economies of scale, or they are arti-
ficial monopolies created by legal restrictions on entry into markets. In
the case of natural monopolies, economies of scale exist because some
assets are 'lumpy' and cannot be divided. Lumpy assets have to be bought
 RENTS, EFFICIENCY AND GROWTH 65

Table 1.1 Rents and the rights sustaining them

Type of rent or surplus Structure of rights sustaining it

Classical economic surplus
Monopoly rent
Natural resource rent
Rents based on transfers
Schumpeterian rents
Rents for learning
Rents for monitoring
Property rights of capitalists over capital
equipment and of landlords over land
Indivisible rights over lumpy assets or legal
right to be sole supplier in market
Exclusive rights over natural resources
Transfers of rights through the political
mechanism
Rights over intellectual property
Transfers conditional on learning
Rights over residual earnings

for a fixed cost, which means that larger outputs can be produced at a
lower average cost. Ultimately, the indivisibility of an asset is due to the
difficulty of creating shared property rights over it. Artificial monopolies,
on the other hand, are more obviously based on the restrictive right of a
single producer to supply a particular market.
Natural resource rents require exclusive property rights which allow
the owners to monitor usage and to collect the surplus. The rents
implicit in subsidies are based on transfers of property rights through the
political mechanism. Schumpeterian rents are based on rights over intel-
lectual property, which may be 'artificial' rights created through patents
or 'natural' rights which innovators possess over their innovation before
others imitate them. Rents for learning are based on transfers of rights
through subsidies to induce learning. Finally, rents for monitoring are
rights over residuals which may induce more efficient monitoring. Thus,
each type of rent or surplus has an underlying structure of economic
rights which sustains it.
Third, while neo-classical analysis has traditionally been interested in
efficiency and classical analysis in growth, the extension of the neo-clas-
sical analysis to look at innovation and the labour process has brought
the two traditions closer together in the questions they address. In the
Marxian analysis, the economic surplus is not only not damaging for
growth, it is essential. What is damaging is its mis-allocation in unpro-
ductive expenditures or its excessive consumption by parasitic capitalists
or landlords (Baran 1973). Similarly, modern neo-classical analysis now
recognizes that, while some rents are damaging for growth, others are
essential (see, in particular, Stiglitz 1996: 89, 139-52). This convergence
is particularly interesting, given the differences in methods of analysis
and in political conclusions.
66 MUSHTAQ H. KHAN

However, fundamental differences remain between the two app-

roaches. In the neo-classical tradition, the role of rents is primarily to
provide incentives for innovation, learning, information generation or
efficient monitoring rather than directly to provide investment funds. In
contrast, in the classical approach, the role of the surplus is primarily to
provide the resources for accumulation, though the incentives created by
the underlying rights for investment of different types are also very
important. We believe that an eclectic approach which borrows insights
from both traditions can be richer than one which is exclusively based on
a single approach.
Another basic difference between the two approaches is in the role of
politics and power in determining the size of the surplus and its alloca-
tion. The Marxian approach was keenly interested in the ways in which
class conflicts might determine the overall magnitude of the surplus and
its allocation. In contrast, the neo-classical approach does not look at
rents as having a political determinant. We have argued that the distrib-
ution of power can determine the magnitude and allocation of rents and
also their efficiency implications (for instance, in the case of learning
rents). In this sense, we draw heavily on the classical tradition. Undoubt-
edly, there are fundamental differences between classical and neo-classi-
cal approaches to surplus and rent, but at this stage there is more to gain
by pragmatically drawing on both traditions.

Characteristics of rents: a summary

Since rents differ widely in their efficiency and growth implications, the
characteristics of one rent should not be extrapolated to other types. While
this is often recognized, some of the features distinguishing good from bad
rents in the literature are positively misleading. In Table 1.2, rents are com-
pared according to whether the rent is due to an artificial (government-
created) scarcity or a natural one and whether the rent is associated with
prices higher than marginal costs. But these frequently referred-to distinc-
tions do not, in fact, serve to separate good from bad rents.
The distinction between 'artificial' and 'natural' rents is based on the
claim that the first type of rent is inefficient while the second is not
(Buchanan 1980). This position, not surprisingly, is common among
market-supporting economists who accept the importance of some types
of rents. However, Table 1.2 shows that this distinction does not neces-
sarily separate efficient from inefficient rents. Schumpeterian rents may
be 'artificial', but they may sometimes be efficiency- and growth-enhanc-
ing. This is even more true for rents for learning, or some types of rents
for monitoring, which may be created by the state and yet be efficient
and growth-enhancing.
 RENTS, EFFICIENCY AND GROWTH 67

Table 1.2 Commonly identified but misleading 'differences' between rents

Type Created by Price more than

government marginal cost
Monopoly rents Maybe Yes
Natural resource rents Maybe No
Rent-like transfers Yes Irrelevant
Schumpeterian rents Maybe No
Rents for learning Yes Maybe
Rents for monitoring Maybe Maybe

Also, rents are often loosely interpreted as signalling a deviation from

competitive markets where price is equated to marginal cost in every
market. Since a deviation from this condition signals inefficiency in the
simple neo-classical model, all rents are sometimes associated with inef-
ficiently operating markets. A look at the third column in Table 1.2 tells
us that the existence of a rent does not always signal a divergence
between price and marginal cost. The price-marginal cost divergence is
always true only in the case of monopoly rents. Moreover, once informa-
tion asymmetries and monitoring problems are admitted, the equaliza-
tion of price and marginal cost may not even be required for efficiency.
We have seen that some rents created by market disequilibrium may be
efficient in generating useful information or in providing incentives for
efficient monitoring. Thus, rents do not always signal a divergence
between price and marginal cost, and even when they do, this may not
always be inefficient!
Table 1.3 summarizes the efficiency and growth effects of different
rents, based on the discussion in this chapter. Clearly, no simple efficiency
or growth implications can be read off from the observation that rents
exist. The presence of rents can sometimes signal a dynamic and efficient
economy, just as the absence of rents can sometimes signal inefficiency
and stagnation. To remind ourselves, the efficiency associated with a rent
is assessed by looking at the immediate, or static, net social benefit (NSB)
associated with the rent and comparing it with the net social benefit
achieved in its absence. The growth implications are assessed by looking
at the growth of output (or of net social benefits) in the presence of the
rent, compared with the growth achieved in its absence. The Observations
column in Table 1.3 tells us that the efficiency and growth implications of
many rents depend on more detailed conditions. We have seen that the
fulfilment of these conditions depends on the political, institutional and
technological contexts in which particular rents are located. These dif-
ferences between types of rents are the starting point for our analysis of
rent-seeking in the next chapter.
68 MUSHTAQ H. KHAN

Table 1.3 Relevant growth and efficiency implications of different rents

Efficiency Growth
implications implications
Type (static NSB) (NSB over time) Observations
Monopoly rent Inefficient Likely to be Sometimes difficult
growth-reducing to distinguish from
Schumpeterian
or learning rents
Natural Efficient Likely to be
resource rent growth-enhancing
Rent-like Neutral, with Indeterminate: May be essential
transfer possible maybe for primitive
incentive growth-enhancing accumulation
inefficiencies and to maintain
political stability,
but may also become
inefficient very
rapidly
Schumpeterian May be Likely to be May become
rent efficient growth-enhancing monopoly rent if
it persists for too
long
Rent for Inefficient May be growth- Efficiency may
learning enhancing depend on
monitoring and
enforcement
ability of the state
Rent for May be May be growth- Efficiency may
monitoring efficient enhancing depend on
monitoring and
enforcement
ability of monitors

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Organization, American Economic Review 62.
Amsden, A. 1989. Asia's Next Giant: South Korea and Late Industrialization. Oxford:
Oxford University Press.
Aoki, M., K. Murdock and M. Okuno-Fujiwara 1997. Beyond The East Asian Mira-
cle: Introducing the Market-enhancing View, in M. Aoki, H.-K. Kim and M.
Okuno-Fujiwara (eds) The Role of Government in East Asian Economic Develop-
ment: Comparative Institutional Analysis. Oxford: Clarendon Press.
Baran, P. 1973. The Political Economy of Growth. Harmondsworth: Penguin.
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Buchanan, J.M. 1980. Rent-seeking and Profit-seeking, in J. Buchanan, R.D.

Tollison and G. Tullock (eds) Toward a Theory of the Rent-seeking Society. Col-
lege Station: Texas A&M University Press.
Dasgupta, PS. and G.M. Heal 1979. Economic Theory and Exhaustible Resources.
Cambridge: Cambridge University Press.
Dasgupta, P.S. and J. Stiglitz 1988. Potential Competition, Actual Competition
and Economic Welfare, European Economic Review 32.
Greenwald, B. and J. Stiglitz 1986. Externalities in Economies with Imperfect
Information and Incomplete Markets, Quarterly Journal of Economics 101.
Hellman, T, K. Murdock and J. Stiglitz 1997. Financial Restraint: Towards a New
Paradigm, in M. Aoki, H.-K. Kim and M. Okuno-Fujiwara (eds) The Role of
Government in East Asian Economic Development: Comparative Institutional
Analysis. Oxford: Clarendon Press.
Jomo K.S. (ed.) 1998. Tigers in Trouble: Financial Governance, Liberalisation and
Crises in East Asia. Hong Kong: Hong Kong University Press, and London:
Zed Press.
Khan, M.H. 1995. State Failure in Weak States: A Critique of New Institutionalist
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tional Economics and Third World Development. London: Routledge.
— 1996a. A Typology of Corrupt Transactions in Developing Countries, IDS Bul-
letin 27(2).
— 1996b. The Efficiency Implications ofCorruption, Journal of International Devel-
opment 8(5).
Marx, K. 1979. Capital, vol. 1. Harmondsworth: Penguin.
Milgrom, P. and J. Roberts 1992. Economics, Organization and Management. New
Jersey: Prentice-Hall.
Palma, G. 1998. Three and a Half Cycles of 'Mania, Panic and (Asymmetric)
Crash': East Asia and Latin America Compared, Cambridge Journal of Eco-
nomics 22(6).
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October.
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mation, American Economic Review 71.
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York: Oxford University Press.
 CHAPTER 2

Rent-seeking as Process

Mushtaq H. Khan

So far in our analysis of rents, we have looked only at the implications of

the rents themselves and not at the implications of the processes through
which rents are created or maintained. In fact, since rents are, by defini-
tion, beneficial for the recipients, they are likely to spend resources to
create, maintain or transfer particular rents. Rent-seeking is the expenditure
of resources and effort in creating, maintaining or transferring rents. These
expenditures can be legal, as with most forms of lobbying, queuing, or
contributions to political parties. But they can also be illegal, as in the
case of bribes, illegal political contributions, expenditures on private
mafias, and so on. The processes are of tremendous significance because
the resources they use up are a social cost, and they determine the types
of rents which are created and maintained in a particular society.
Conventional rent-seeking theory, however, assumes that rent-seeking
only results in the creation or protection of monopoly rents, and, in addi-
tion, it makes restrictive assumptions about how the rent-seeking cost is
determined. Nevertheless, the contribution of this theory was to tell us
that the cost of rent-seeking was an additional cost of maintaining a
monopoly. However, the conventional rent-seeking framework has to be
radically extended if it is to be relevant for the real world. Institutional
economics and political economy both suggest directions in which the
rent-seeking framework can be extended. First, we have seen that rents
and the economic rights underpinning them are closely related. Rent-
seeking is, therefore, closely related to processes of institutional change
through which economic rights are altered. Institutional economics tells
us that the outcomes of institutional change are far from straightforward
and can depend on a number of variables, including the incentives set by
pre-existing institutions. Second, attempts to change the structure of
rents can also unleash distributive conflicts. Political economy tells us

70
 RENT-SEEKING AS PROCESS 71

that political variables and, in particular, the distribution of political

power can determine which individuals or groups are likely to win dis-
tributive contests. Thus, a more general approach to rent-seeking can
incorporate political and institutional variables to explain, first, how
much effort is actually expended in rent-seeking and, second, the types
of rights and rents which are created as a result.
The modern interest in rent-seeking emerged from a few seminal arti-
cles written in the 1970s (in particular, Krueger 1974; Posner 1975)
which argued that the costs involved in seeking monopoly rents were
much larger than the relatively small deadweight welfare losses associ-
ated with the monopoly rents themselves. Their purpose was to alert lib-
eral economists that the social cost of monopolies artificially maintained
by the state was much larger than conventional theory had established,
since there was an additional rent-seeking cost associated with monopo-
lies. While these early papers were limited in their assumptions, both
about the types of rents and the types of rent-seeking, they offered a
potentially fruitful way of thinking about processes of economic, political
and institutional transformation in an integrated framework. However,
much of the rent-seeking literature has remained limited in its assump-
tions and the development of an integrated approach has not made
much progress.
One problem in most of the rent-seeking literature has been that it
has concentrated almost exclusively on the social costs of the resources
used up in rent-seeking and very little on the different types of rents which
rent-seeking has created in different contexts. This is partly because an
analysis of the cost or 'input' side of the rent-seeking story is relatively
simple compared with an analysis of the 'rent-outcomes', equivalent to
the 'output' of rent-seeking, which are the different types of rents which
can be created, maintained or transferred as a result. Nevertheless, we
will argue that the overall effects of rent-seeking depend on both the cost
incurred and the rent created.
This chapter extends the rent-seeking approach by systematically deal-
ing with both the inputs and the rent-outcomes of rent-seeking. The eco-
nomic implications of the rent-outcomes can vary because any of the
rents discussed in Chapter 1 could be sought or protected through a
rent-seeking process. The rent-seeking cost, as conventionally defined, is
the 'input' cost of the process, which can also vary significantly. We are
particularly interested in political and institutional variables as determi-
nants both of the input cost of rent-seeking and also of the rent-out-
comes or 'outputs' produced by the rent-seeking. This is important
because political variables, in particular, have generally received little
attention in rent-seeking models developed by economists. On the
other hand, political scientists have looked at the effects of power and
72 MUSHTAQ H. KHAN

institutions in processes of institutional change, but largely in isolation

from the work of economists on rents. We argue that the insights of both
disciplines can be fruitfully integrated.
An integrated approach can also show the importance of evolution
and change. Rent-seeking processes which were growth-enhancing in
one period can cease to be so later on, or vice versa. This is because the
determinants of the input costs and the types of rents created are them-
selves changing. We use evidence from South Korea, Malaysia, the Indian
subcontinent and Thailand to illustrate how a number of variables can
explain the different outcomes associated with rent-seeking across coun-
tries and over time.
The core argument of this chapter is that rent-seeking has to be seen
as a process whose overall effect depends on its two related components.
The first is the net social cost or benefit associated with the rents which are
the outcome of the rent-seeking process. The very different net social ben-
efits which can be associated with some important types of rents were dis-
cussed in the last chapter. The second is the rent-seeking cost, which is the
social cost of the activities which aim to create, maintain or re-allocate
these rents. On the one hand, the analysis of the social desirability of dif-
ferent rents, as carried out in the last chapter, is misleading on its own
because each of these rents will call forth associated rent-seeking expen-
ditures. On the other hand, an analysis of the rent-seeking cost on its own
is also misleading, since the same cost can be associated with the creation,
maintenance or transfer of many different types of rent-generating rights.
There is a close analogy with the inputs and outputs in conventional
production. In everyday production processes, the net value added is
what matters. This depends not just on the total cost incurred but also on
the value of the output produced. Production can be profitable even with
very large costs if highly valued products are produced. Conversely, pro-
duction may be unviable even when costs are low if what is produced is of
no value. In exactly the same way it would be misleading to look at the
rent-seeking cost without asking what type of rent was created as a result.
Figure 2.1 shows this. The 'net effect' of any rent-seeking process depends
on both the rent-seeking cost, which is equivalent to the cost of inputs
used up in this process, and the value of the rights and rents produced as
the outcome, which is equivalent to the value of the 'output' in this case.
Unfortunately, much of the analysis of rent-seeking which has influenced
policy-making has typically ignored differences in the value of the out-
comes of rent-seeking and has concentrated exclusively on the rent-seek-
ing cost. The conventional analysis of this cost has also been very
simplistic, failing to address why it can vary signiflcandy from case to case.
The first part of this chapter discusses the distinction between the
inputs and rent-outcomes of rent-seeking and their role in explaining
 RENT-SEEKING AS PROCESS 73

Conventional Production Process

Inputs used up in Production Final Outputs
(Labour, Capital, Land) (Goods and Services)

Net Value Added - Gross Value of Final Output - Cost of Inputs Used Up

Rent-seeking Process
Inputs used up in Rent-seeking Rent-outcomes: Economic
(The Rent-seeking cost: Rights are created, maintained,
Inputs used up in Lobbying, destroyed or transferred to
Political Activity, Bribing and create specific Rents (for
other Influencing Activities) instance, Licences are
allocated, Monopolies and
Subsidies granted, Property
Rights created)

Net Effect = N e t Social Benefit Associated with _ Cost of Inputs Used in Rent-seeking
the Rent-outcome (the Rent-seeking cost)

Figure 2.1 Rent-seeking process compared with a conventional production

process

the differential performance of countries. We argue that rent-seeking

has to be looked at as a process, and that focussing only on its input costs
fails to explain the historical evidence and is misleading for policy.
The second section looks at the type of evidence which an integrated
rent-seeking framework must address. We consider the types of rents
which existed in the industrial sectors in the Indian subcontinent, South
Korea, Malaysia and Thailand during the 1970s and 1980s, the changes
happening over the 1990s, and the evidence about rent-seeking costs.
This evidence suggests that differences in such costs (the input costs)
were probably less important in explaining differential performance than
differences in the types of rents created as the outcomes of rent-seeking.
The third section discusses another aspect of the empirical evidence.
Knowing the types of rents and the rent-seeking costs is not enough, we
also want to know who was engaged in rent-seeking. The organization and
relative power of classes and groups varies greatly across countries. Since
a significant part of rent-seeking in developing countries takes place
through patron-client networks, looking at how they were organized
provides insights into the social and political aspects of the rent-seeking
process. We argue that this has important implications for the econom-
ics of rent-seeking.
The input side of the rent-seeking process and the determinants of the
rent-seeking cost are then examined. We begin with the conventional
rent-seeking analysis which says that the rent-seeking cost is equal to
the size of the rent being sought. This simple model is where much of
74 MUSHTAQ H. KHAN

rent-seeking theory stops. However, even if we focus on the input cost

of rent-seeking, much more needs to be said. We see that the conven-
tional model identifies only the rent-seeking expenditure and not the
rent-seeking cost. Furthermore, we see that the organization of state
institutions and the distribution of political power can significantly
increase or decrease the input cost of rent-seeking.
The subsequent section considers the factors which may explain why
rent-seeking can produce very different rent-outcomes in the form of dif-
ferent types of rents. Some rents add value for society, others do the
reverse. Why does rent-seeking sometimes produce one type of rent and
sometimes another? This section goes beyond the traditional rent-seeking
literature to look at what we can learn from institutional economics and
political economy. We distinguish between three different rent-seeking
scenarios and identify the conditions under which value-enhancing rents
will be created in each. In the first, individuals seek rents through private
negotiations in which the state plays no part. In the second, individuals
spend resources trying to influence the state to create the rents they want.
And in the third, the state takes the initiative in creating rents. In each
case, a different set of conditions is required to ensure that the rents cre-
ated promote growth and efficiency. These conditions can be classified
into a number of political and institutional conditions, and, once again,
the political variables emerge as substantially important. We then ask if
this list of theoretical conditions helps to explain the different overall
effects of rent-seeking observed in our countries. We argue that, by includ-
ing political and institutional variables in our explanatory framework, we
can make a start in understanding some of these differences.
In the conclusion, we argue that our extended framework can provide
a better explanation of difference in the net effects of rent-seeking and
can serve as the starting point for policy debates about the future direc-
tion of reform.

Inputs and rent-outcomes in the rent-seeking process

While rent-seekers are only interested in the rents which they can cap-
ture for themselves, the social value of these rents can vary widely. The
social value of any rent is our shorthand for describing the net social ben-
efit over time associated with the rights which generate the particular
rent. In Chapter 1 we saw that the net social benefit associated with dif-
ferent rents can vary widely, depending not only on the rent but also on
political and institutional conditions. Thus, rents could be associated
with very negative consequences for society (for instance, learning rents
which failed to generate learning because of the state's failure or inabil-
ity to monitor and allocate these rents effectively), as well as with very
 RENT-SEEKING AS PROCESS 75

positive consequences (for instance, learning rents which delivered

rapid technical progress). We shall see that the rent-seeking cost can also
vary. In some cases, the rights of the rent-seekers are assured and the
rent-seeking cost can be low (although it is still a cost). In other cases, the
rent-seeking cost may be very high. The net effect of rent-seeking
processes can thus vary both because of the value of the rent-outcome
and because of differences in rent-seeking costs.
Figure 2.2 shows how different combinations of rent-seeking costs with
different types of rents can result in very different net effects for the rent-
seeking process. The net effect is high and positive in quadrant IV where
high valued rents are created and maintained at low rent-seeking cost. The
net effect is less positive in quadrant I where the rent-seeking cost is high,
but the net effect can still be positive. Then comes quadrant III, where neg-
atively valued rents are created but, because the rent-seeking cost is low,
the negative net effect is not too bad. The worst is quadrant II, where neg-
atively valued rents are created and the rent-seeking cost is high.
Before the analysis of rent-seeking was developed, the market model of
neo-classical economics explained differences in performance solely in
terms of market inefficiencies. Not only was there no recognition of rent-
seeking costs, the range of rents recognized was also rather narrow. Some
positively valued rents were recognized, such as natural resource rents,
but most rents, like monopoly rents, signalled small negative net social
benefits. Differences in performance between countries were therefore
explained in terms of a small area of variation due to differences in gov-
ernment policy in the region marked 'Conventional market models' at
the bottom of Figure 2.2. Not surprisingly, these models could not satis-
factorily explain the large differences in the performance of countries.
The first generation of rent-seeking models addressed this problem by
arguing that, even if only mildly damaging rents exist, the net effect is
crippling because of high rent-seeking costs (Krueger 1974; Posner 1975;
Buchanan 1980; Tullock 1980a; see also Mueller 1989: 229-46 for a
review). These models combined high rent-seeking costs with monopoly
rents, locating the net effects of rent-seeking in the box marked 'Con-
ventional rent-seeking models' at the top of Figure 2.2 in quadrant II.
These models explained differences in performance by arguing that
interventionist countries were located in this rent-seeking box while free-
market economies were located in the right-hand corner of the 'Con-
ventional market models' box.
Tl>e high rent-seeking cost in the early rent-seeking models was soon
challenged in second-generation models which relaxed some of their
assumptions. It was shown that, under different institutional structures,
the rent-seeking cost could be much lower, despite intervention (for
instance, Congleton 1980; Rogerson 1982; reviewed in Mueller 1989).
76 MUSHTAQ H. KHAN

Social Value of the Rent-outcome

Negative Positive

Conventional
Rent-seeking
Models

.Net Effect Very Negative I. Net Effect Intermediate

because of High
Rent-seeking costs

Likely Range of Net Effects in Reality:

Rent-
seeking
Cost Variations largely due to Variations in Rents

III. Net Effect Negative IV. Net Effect Very Positive

because of Negatively
Valued Rents
Conventional
Conventional Developmental
Market Models State Models

Note: Net Effect of Rent-seeking = Social Value of Rent-outcome (Net Social Benefit associated with the Rent) - Rent-seeking cost

Figure 2.2 Input costs, rent-outcomes and net effects of rent-seeking

The rent-seeking cost could thus vary along a much wider range and the
existence of rents was not sufficient to imply large rent-seeking costs.
However, rent-seeking models still did not consider the full range of
rents which could be the outcome of rent-seeking.
The assumption that rent-seeking always results in the creation of
value-reducing rents was dropped in a few of the early models of rent-
seeking (for instance, Bhagwati 1982). Bhagwati considers a model
where rent-seeking results in the destruction of value-reducing rents.
Although this is equivalent to the creation of value-enhancing rights,
Bhagwati did not directly consider the latter possibility. Nevertheless, his
model showed that society can be better off after rent-seeking. The
insight that rent-seeking can produce an outcome of socially beneficial
rents and rights first began to emerge in the institutional economics lit-
erature, where rent-seeking was seen as a process through which the
structure of rights in society can change (see, for instance, North 1990).
Greater interest in differences in rent-outcomes also began to emerge
with the re-evaluation of the success stories of East Asia during their high-
growth period, which suggested that these countries were not really free-
market at all. To a greater or lesser degree, East Asian states had allocated
 RENT-SEEKING AS PROCESS 77

subsidies in socially beneficial ways (Amsden 1989: 145-7; Kim and Ma

1997). This evidence, together with developments within neo-classical
theory on the role of rents in generating innovation or in inducing bet-
ter monitoring, suggested that some rents could be associated with sub-
stantial value enhancement for society (Stiglitz 1996; Aoki et al. 1997).
But, if rent-seeking costs were high, the benefit of creating socially valu-
able rents would be cancelled out. Models of developmental states there-
fore drew on the analysis of rent-seeking to argue that institutions in
these countries had kept the rent-seeking cost low as well (for instance,
Chang 1994: 38-45; Kim and Ma 1997: 128-30). They described a com-
bination of rents and rent-seeking costs in the East Asian countries which
would have located them near the bottom right-hand corner of Figure
2.2, in the box marked 'Conventional developmental state models' in
quadrant IV. Differences in performance were explained by arguing that
the East Asian countries were in this region, while the typical developing
country was in the region identified by conventional rent-seeking mod-
els in quadrant II.
Paradoxically, both neo-classical and developmental state models
stressed low rent-seeking costs in dynamic economies. We argue that
focussing on the rent-seeking cost to this extent misrepresents the real
location of differences between dynamic and stagnant economies. The
evidence we will discuss suggests that Asian economies were located in
the narrow shaded region at the centre of Figure 2.2 marked 'Likely
range of net effects in reality'. The differences in rent-seeking costs
across our countries were relatively small. On the other hand, the types
of rents which they sustained were significantly different. Differences in
rents can have very substantial implications for performance, and a rent-
seeking approach which incorporates these differences can have signifi-
cant explanatory power. A failed strategy of learning with large,
inefficient rents has massively negative implications over time which can
dwarf the welfare costs of monopolies. On the other hand, rents associ-
ated with successful learning, innovation or monitoring can have very
large positive effects and play a critical developmental role.
This shifts attention from the high rent-seeking costs in poor per-
formers (which may still be quite high) to their failure to create and main-
tain socially valuable rents. This is important because, while both are
failures of rent-seeking, the determinants of the two failures are different
and may suggest different policy responses. Our perspective on the rela-
tive importance of these two components of the rent-seeking process is
consistent with the evidence of substantial rent-seeking activities, and in
particular of corruption, in the successful East Asian industrializers right
through their high-growth period. Their success seems to have been
based not on an unusually low level of rent-seeking but, rather, on the
creation of value-enhancing rents through their rent-seeking.
78 MUSHTAQ H. KHAN

The two components of the rent-seeking process are, in fact, closely

interlinked. Figure 2.3 shows the interdependence of conventional pro-
duction and rent-seeking processes. The existing structure of economic
rights (including property rights) is shown at the top of the diagram.
This determines the incentives governing resource allocation between
different types of production and rent-seeking activities. The allocation
of inputs in production results in 'final outputs' of goods and services and
an associated net social benefit. This is the 'conventional' production
process and is shown in the horizontal box with the horizontal arrow. Par-
allel to the allocation of inputs in production, inputs are also being allo-
cated to rent-seeking activities which seek to create, maintain or transfer
the rights on which rents are based. The rent-seeking process is shown in
the square box with the vertical arrow. The rent-outcome of rent-seeking
is either the reproduction of the existing structure of rights or the cre-
ation of a new one. This is the starting point for a new round of activity.
'Rent-seeking' in Figure 2.3 could describe the narrow activities which
seek to create monopoly rights, but it could also describe those that create
new property rights, as in primitive accumulation, or that seek to transfer
rights, as in subsidies to infant industries. This means that we could poten-
tially describe a wide range of political economy questions and processes
of institutional change within an integrated framework of rent-seeking
(Samuels and Mercuro 1984). Finally, Figure 2.3 can help to clarify how
rent-seeking affects the net social benefits associated with final outputs (at
the right-hand edge of the figure) through two possible routes which cor-
respond to the rent-seeking cost and the rent-outcome effects.
The first effect of rent-seeking is the loss of final output when inputs
are transferred downwards (in Figure 2.3) into rent-seeking rather than
horizontally into production. The input cost of rent-seeking (or the rent-
seeking cost) associated with a specific rent is the value of net social ben-
efits lost as a result of the withdrawal of these inputs from the production
of final outputs, holding the structure of economic rights constant. Stating it in
this way makes it obvious why looking only at the rent-seeking cost on its
own is unrealistic. If the specific rent-seeking cost we are looking at had
not been incurred, the structure of rights on which existing production
is based may also have been different with further effects on final output.
The second effect of rent-seeking is the creation, maintenance or
destruction of some sets of rents. This, in turn, has an effect on the final
net social benefit achieved. We saw in Chapter 1 that changes in the struc-
ture of rights and rents can have positive or negative effects on net social
benefits. The difference between the net social benefit with the rights cre-
ated by a specific type of rent-seeking, and the net social benefit which
would have obtained without these rights, gives us the value of the rent-
outcome, holding the rent-seeking cost constant. This is essentially the net
social benefit attributable to specific rents keeping the associated input
 RENT-SEEKING AS PROCESS 79

Structures of Rights
I
Determine Incentives
and hence

Final Outputs and

Allocations of Inputs (In Production) associated
Net Social Benefits
(Conventional Production Function)

(Inputs in Rent-seeking)

I
New Structures of Rights
and Rents
(The Rent-outcome)

Figure 2.3 The interface of conventional production and rent-seeking

withdrawal due to the rent-seeking constant. The analysis of Chapter 1 was

implicitly doing this. There we had been implicitly holding the rent-seek-
ing cost constant by ignoring it! Again, this is unrealistic, because each
rent has a specific rent-seeking cost, and a different rent would have a dif-
ferent cost. While each of the two effects is unrealistic on its own, by com-
bining the two, we get very close to the true net effect of a specific
rent-seeking process.
Note that any analysis of rent-seeking costs and rent-outcomes only
makes sense if we are asking questions about a specific part of the rent-
seeking process. The more narrowly we can define the rents being consid-
ered, the more precise the rent-seeking analysis. Thus, at the most specific
level, we could look at the rent-seeking process associated with the creation
or re-allocation of very specific rights, such as a particular type of import
licence. At the broadest level of application, we could look at a limited
range of rent-seeking in clearly defined sectors, such as the rent-seeking
associated with policies supporting industrialization in developing coun-
tries. This is the level at which much of the rent-seeking analysis in this
book is carried out. However, it makes no sense to ask what the total rent-
seeking cost in a society is, or what the structure of rights would be in the
absence of all rent-seeking. That is a bit like asking what the world would
look like in the absence of all friction. None of the structures or activities
which we know might be viable in the absence of all friction, and, similarly,
no institutions and rights might survive if all rent-seeking expenditures
really disappeared. On the other hand, it does make sense to ask whether
there are incremental effects when friction increases in particular areas.
Similarly, we can try to identify the incremental effects on net social bene-
fits if particular rents change as the outcome of specific rent-seeking
processes, and what the associated rent-seeking costs are.
80 MUSHTAQ H. KHAN

Some readers may find a diagrammatic representation of the two

effects in production functions useful, but others may want to skip the
rest of this section. Figure 2.4 looks at rent-seeking in the conventional
rent-seeking model where rent-seeking sustains a monopolistic rent, say
based on import controls which protect a domestic producer. The pro-
duction possibility frontier PP for cars and grain shows the combinations
of goods the country can produce domestically, using all available
resources entirely in production. The international prices for cars and
grain are shown by the slope of the straight price lines.
The value of the monopoly right (which is the rent-outcome in this
case) is measured as follows. According to standard economic theory, the
efficient position for the economy given world prices is the point A where
the price line is tangential to the production frontier. This mix of cars
and grain gives the country its highest value of final output. The import
restriction raises domestic prices for cars (not shown in the diagram) and
moves domestic production to a point such as B. More cars are produced
locally, but a lot less grain, and society is worse off. Since inputs are held
constant, the value of lost final output at world prices (which are
assumed to be optimal prices) is the lost net social benefit. To compare
the value of output at B with that at A, we run the world price line
through B and compare its level with the level of the price line through
A. In Figure 2.4, the lost output is valued at XY when measured in grain
at world prices. XY is exactly equivalent to the deadweight welfare loss
with monopoly restrictions measured by the small triangle CDE in Figure
1.3. This is the (negative) value of the monopoly right.
The early rent-seeking theorists argued that XY underestimates the
social cost of the monopoly. At B, car producers are earning rents because
of the high domestic price of cars. Producers who do not enjoy these rents
can be expected to attempt to capture similar rents by spending resources
trying to persuade state officials to create new restrictions. Similarly, those
who enjoy the restriction may be expected to spend resources to ensure
that their rents are preserved. These rent-seeking expenditures use up
resources which could otherwise have been used to produce cars and
grain. The loss of these inputs from production to rent-seeking results in
a shrinkage of the production possibility frontier from PP to P'P'. Once
this happens, with the same restrictions, the economy produces at a point
such as B'. The location of the new position has no necessary relationship
with B, except that it is on a lower production possibility frontier.
We can now put a notional input cost on the rent-seeking. Compar-
ing the value of output at B', which is the final output after inputs have
been lost to rent-seeking, with the value of final output at B without the
input withdrawal gives us the rent-seeking cost. Measured in grain at
international prices, the rent-seeking cost is ZY. The net effect of the
 RENT-SEEKING AS PROCESS 81

Cars
PP is the production possibility frontier
A is the efficient output-mix
B is the output-mix after an import restriction on cars
P'P' is the frontier after rent-seeking activities
XY is the (negative) social value of the restriction
ZY is the additional rent-seeking cost

P'
Grain Z Y X

Figure 2.4 The net effect of rent-seeking with value-reducing rents

rent-seeking process is thus XZ. Of this, XY is the value of the rent cre-
ated by the rent-seeking (the rent-outcome), which is typically ignored
in the standard rent-seeking analysis because it is relatively small and
because economists already know about it. The rent-seeking cost, ZY, is
subtracted from this (increasing the negative benefit for society) to give
XZ, the net effect of the rent-seeking process. Note that the sequence of
events in this exposition is a notional one. The input withdrawal due to
rent-seeking activities and the monopoly rent created through this rent-
seeking are typically simultaneous events.
The importance of distinguishing between the inputs and rent-out-
comes of rent-seeking can be seen by considering an example where
rent-seeking is associated with the creation of socially beneficial rents. In
the last example, the restriction induced greater car production but had
no effect on technology. Figure 2.5 shows a case where the restriction
induces 'learning' by the car producer. If the state is able to ensure that
the rent earned by the domestic producer is for a limited period and sub-
ject to learning taking place, the result may be a movement outward of
the domestic production function. This is equivalent to the successful
learning case discussed in Chapter 1. If the subsidy is successful in induc-
ing learning, the rent creation would result in a movement outward of
the production possibility curve in the first instance.
Our starting point is once again point A on the initial production pos-
sibility frontier PP. The effect of the learning induced by the rent is to move
82 MUSHTAQ H. KHAN

Cars PP is the initial production possibility frontier

A is the efficient output-mix
p» P"P" is the frontier after import restrictions induce learning
B is the output-mix after the restriction
P'P' is the frontier with rent-seeking
P1 B' is the output-mix after rent-seeking
XY is the potential social value of the restriction
ZY is the rent-seeking cost

p. p..
Grain

Figure 2.5 The net effect of rent-seeking with value-enhancing rents

the production possibility curve out to P"P". As a result, the economy could
potentially move to point B. This part of the story is based on the analysis
in Chapter 1 and ignores any rent-seeking which may be associated with
the management of this rent. Rent-seeking expenditures may have an
effect which is equivalent to a lowering of the production possibility fron-
tier such that it reaches only P'P' instead of P"P". Actual production is at a
point such as B' rather than B because of this rent-seeking cost.
The overall effect is therefore composed of a rent-seeking cost ZY,
which is negative as before, and a potential social benefit of XYdue to the
induced learning, which in this case is positive. In this case, the net effect
of the rent-seeking process is a net benefit of XZ given by XY - ZY. Split-
ting the move from A to B' into two parts is analytically convenient but in
fact, once again, the two moves happen simultaneously. In the general
case, where either value-enhancing or value-reducing rights may be cre-
ated, the evaluation of both components of the rent-seeking process is
clearly important.

Rent-seeking: the evidence

Table 2.1 shows gross domestic product (GDP) and industrial growth
rates for several Asian economies over their three decades of high growth
 RENT-SEEKING AS PROCESS 83

Table 2.1 Growth rates of GDP and industrial output, a with corruption
indicators

Bangladesh India Pakistan South Korea Malaysia Thailand

1970-80 2.3 3.4 4.9 9.6 7.9 7.1

(5.2) (4.5) (6.1) (15.2) — (9.5)
1980-90 4.3 5.8 6.3 9.5 5.2 7.6
(4.9) (7.1) (7.3) (12.1) (7.2) (9.9)
1990-97 4.5 5.9 4.4 7.2 8.7 7.5
(6.8) (7.1) (5.5) (7.5) (11.2) (10.3)
1998h — • 5.0 5.4 -5.0 -6.0 -7.0
1999< — 5.2 4.3 -1.0 -2.0 0.5

Subjective corruption indicesd

1980-83 4.0 5.3 4.0 5.7 6.0 1.5

1996 2.3 2.6 1.0 5.0 5.3 3.3
a
Industrial growth rates in brackets
b
Estimates
c
Predictions (Asian Development Bank)
d
10 indicates minimum corruption, 0 indicates maximum corruption
Sources: World Bank 1994, 1998-99; corruption indices from Mauro 1995 and
Bardhan 1997

culminating in the financial crisis of 1997-98. We are not suggesting that

all of the difference in performance can be explained in terms of any
single model. Nevertheless, it is useful to ask whether differences in
processes of rent-seeking could account for at least part of their differ-
ences in performance. To answer this question, we draw on the existing
literature to summarize some of the evidence on rent-seeking in the
industrial sectors in the Indian subcontinent, Malaysia, South Korea and
Thailand, and ask whether the input or rent-outcome dimensions of
rent-seeking can explain performance differentials.

Rent-seeking costs

In terms of final outputs, the relatively poor performance of the Indian

subcontinent compared with the East Asian countries is shown by the rel-
ative growth rates of GDP and industrial output in Table 2.1. To what
extent can this be explained by differences in the input cost of rent-
seeking across countries? In the past, following Krueger (1974), rent-seek-
ing theorists have attempted to calculate the input cost of rent-seeking
as a percentage of GDP. The input cost is difficult to compute direcdy
because rent-seeking expenditures can take a variety of forms, including
84 MUSHTAQ H. KHAN

expenditures on corruption, lobbying and political contributions. For

reasons which will become clear after the 'Input cost of rent-seeking' sec-
tion where we discuss the determinants of such costs, we do not believe
that these costs can be indirectly deduced by measuring the total rents in
the economy, the method followed by Krueger and her followers. Instead,
we will argue that a precise measure of the rent-seeking cost as a share of
GDP is not absolutely necessary. We will rely on statistical, journalistic and
academic evidence to give the reader a feel for the substantial amount of
rent-seeking expenditures in all these countries in order to argue that dif-
ferences in these expenditures are not likely to be of a sufficient magni-
tude to explain the substantial differences in performance.
The evidence on corruption in Table 2.1 refers largely to the indus-
trial sector where foreign business was mostly involved. It suggests that
these countries all suffered significantly from corruption in the key
period of the 1970s and 1980s. The Business International index for cor-
ruption in 1980-83 (on a scale from 0 for maximum corruption to 10 for
no corruption) was 5.25 for India, 5.7 for South Korea and 6 for Malaysia
(Mauro 1995). Given the crudity of these subjective indices, these differ-
ences are not very significant. Thailand, on the other hand, had a very
high corruption index of 1.5 for this period, suggesting a combination of
large and widespread bribes faced by prospective businesspeople, and yet
it was a high-growth economy prior to 1997.
According to this index, by the mid-1990s corruption had increased in
most of these countries. The only exception was Thailand, which was the
most corrupt country in the group in the 1980s but, by the 1990s, was less
corrupt than the South Asian countries. Yet, despite this improvement,
Thailand led the East Asian countries into the financial crisis of 1997. At
the same time, the most significant increase in corruption in the 1990s was
in the South Asian countries, but paradoxically they suffered hardly at all
from the financial crisis of 1997. To the extent that the corruption index
is trustworthy, it corroborates other evidence which suggests that the
1997 financial crisis had specific causes which should not be confused
with our long-run assessment of the implications of corruption and rent-
seeking in these countries.
The publication of subjective indices of corruption should not lead us
to ignore other types of rent-seeking expenditures, in particular expen-
ditures on lobbying and on political 'contributions'. In all these
countries, the role of the state was substantial even though the types of
intervention were different. Lobbying and 'shoe-leather' costs in over-
coming red-tape affected them all, although here, too, there were some
differences. The Indian subcontinent has long been recognized as
having some of the most oppressive red-tape in Asia (see Litde et al.
1970). But there were significant red-tape and lobbying costs in the other
 RENT-SEEKING AS PROCESS 85
countries as well, although they are difficult to rank. Finally, contribu-
tions to political factions were an important rent-seeking cost in all these
countries and will be further discussed in our next section.
Looking at each of our countries in turn, the Indian evidence suggests
that rent-seeking expenditures had a rising trend over the 1960s and
1970s, as the intensity of rent-seeking contests increased (Bardhan 1984;
Ahluwalia 1985). Expenditures on political factions were a significant
component which grew from the mid-1960s onwards. Liberalization,
which began in earnest in the late 1980s, does not seem to have resulted
in a reduction in the most blatant forms of rent-seeking expenditures in
India (Harriss-White 1996). Liberalization probably did result in a reduc-
tion in the burning of shoe-leather required to work around the
labyrinthine industrial licensing system. On the other hand, it had
ambiguous effects on corruption and on political contributions, which
may actually have increased. As far as subjective perceptions of corrup-
tion go, Table 2.1 suggests that there was a significant increase in cor-
ruption in the Indian subcontinent in the 1990s following liberalization.
While corruption probably did increase over this period, there was
also a much greater public perception of corruption, fuelled by legal pro-
ceedings against highly placed politicians. Rajiv Gandhi was accused in
the late 1980s of covering up kickbacks to his party from Bofors of Swe-
den which was granted a contract to supply arms to the Indian army. In
late 1995, thirty or so politicians, including several cabinet ministers of
the succeeding Rao government, were implicated in a corruption scan-
dal involving US$20 million over a period of two years. Although the sum
involved was small, the case became politically important as an indicator
of widespread kickbacks from business to political faction leaders. Fol-
lowing Prime Minister Rao's fall from office in 1996, he too was charged
with corruption and arrested. Soon afterwards, a number of lesser Indian
politicians were implicated in corruption scandals, including, most
notably, the Chief Minister of Bihar, Laloo Prasad Yadav, who was forced
to resign in mid-1997.
In South Korea, the evidence suggests that corruption was high
throughout the high-growth period following the Park Chung Hee coup
of 1961 (Kong 1996). Although there has been a tendency among some
rent-seeking analysts to portray the South Korean state as relatively clean,
observers of South Korean industrial policy have pointed out the coexis-
tence of efficiency with corruption (Amsden 1989: 15, 73). Hard evi-
dence of the scale of corruption in South Korea has begun to emerge
only recently, particularly with the admission in 1995 by ex-President Roh
Tae Woo of his personal accumulation of around US$650 million during
his five-year period in office (Khan 1996a, 1996b). Like Rao in India, Roh
was eventually arrested on charges of corruption, and almost all the large
86 MUSHTAQ H. KHAN

chaebol were publicly named as having been involved in kickbacks to the

regime. Again, the subjective perception of corruption in Table 2.1 sug-
gests a worsening of corruption in South Korea in the 1990s, when liber-
alization began in earnest. Nevertheless, the perception of international
business was that corruption had worsened much more significantly in
the Indian subcontinent. However, the difference in the degree of cor-
ruption in these countries was less significant in the 1980s when the per-
formance differential between them was most significant. Moreover, in
the 1990s, when India suffered a catastrophic increase in corruption,
South Korea and the East Asian newly industrializing countries suffered
most severely from the financial crisis.
The efficiency of the South Korean industrial policy regime meant
that little attention has been given in the literature to the costs of lobby-
ing in South Korea. But we do know that industry associations had to
spend a lot of time in consultations with government. This was clearly a
rent-seeking input, but, in contrast to India and many other developing
countries, the outcome of the lobbying in South Korea was, on the
whole, productive. Nevertheless, the lobbying must have involved real
and substantial input costs. In addition, there were also contributions to
political parties and factions, but they were incorporated in the payoffs
going to the top man as a result of the centralization of the political
establishment in this period. Thus, payoffs going to President Roh from
the chaebol were partly used to fund his own political campaign, partly to
fund the campaigns of his opponents (Kim Dae Jung, his arch-rival,
admitted that he received part of the money!) and even to provide per-
formance-related kickbacks to bureaucrats.
The Malaysian evidence suggests that corruption was substantial
throughout its period of high growth in the 1970s (Jomo 1986: 243-72).
However, compared with the other countries, Malaysia receives a rela-
tively clean report from international business in its subjective corrup-
tion index. We will suggest a possible explanation for this in our next
section. While journalistic evidence of cases of corruption involving top
politicians has not come to the fore as much as in India and South Korea,
scandals involving kickbacks from major construction projects such as
dams have attracted international attention because they involved West-
ern governments and companies. In the 1980s, evidence of political
contributions from business to political factions increased, as factions
within the ruling party developed contacts and kickback arrangements,
particularly with Chinese business (Jomo and Gomez, this volume).
Liberalization probably contributed to the worsening of corruption in
the 1990s, as indicated by the index in Table 2.1. Lobbying by business is
less widely discussed in Malaysia, perhaps because the state was, for a
time, less accessible to domestic capitalists than in India or South Korea.
 RENT-SEEKING AS PROCESS 87

Political contributions were also centralized during this period, as we will

see in our next section, which kept them more moderate than in the
Indian subcontinent.
In Thailand, the high degree of corruption of political leaders has
been well known for some time. In 1973, when Prime Minister Thanom
Kittikachorn fell, the subsequent government was actually able to seize
assets equivalent to US$140 million (Phongpaichit and Baker 1997: 287).
If anything, the magnitude of the bribes collected by the top leaders has
gone up over time despite a long history of new governments attacking
the corrupt politicians of the previous regime. In addition, corruption
has become more democratic over time, with a growing number of polit-
ical factions participating in 'money polities'. The distinctive feature of
Thailand from the 1970s onwards was that a large number of these fac-
tions were controlled by emerging capitalists, a feature which we will see
in the next section was of some significance (see also Sidel 1996). While
the corruption figures in Table 2.1 suggest some decline in the corrup-
tion faced by foreign business over time, the political evidence which we
will later discuss suggests that 'money politics' and expenditures on polit-
ical factions increased significantly from the mid-1970s.
While rent-seeking was widespread in all these countries, this does not
mean that the expenditures on rent-seeking in absolute terms or as a
share of GDP or industrial value-added were the same. A subjective
assessment of the balance of evidence suggests that over the 1970s and
1980s, relative rent-seeking expenditures were greatest in the Indian sub-
continent and Thailand, less so in Malaysia, and least in South Korea.
However, since even Malaysia and South Korea had very interventionist
states during this period, with substantial corruption and political con-
tributions, the differences in the share of rent-seeking expenditures in
GDP are likely to have been relatively small.
How large would differences in rent-seeking costs have to be to explain
a significant part of the differences in performance? In Table 2.1, we see
that, in the 1970s, the difference in industrial growth rates between India
and South Korea was around 10 per cent per year, falling to 5 per cent in
the 1980s. No-one suggests that this can be entirely due to differences in
rent-seeking costs, but it is instructive to ask how large these differences
would have to be to explain such performance differentials. The incre-
mental capital-output ratio in Indian industry was around 8 in the 1970s
and 14 in the 1980s (Chakravarty 1987: 105). Thus, for Indian industry to
have grown 10 per cent faster in the 1970s, it would have had to invest 80
per cent more of industrial value-added in the 1970s; and for it to have
grown 5 per cent faster in the 1980s, it would have had to invest 70 per
cent more of its industrial value-added. Thus, to explain the growth
differential in terms of rent-seeking costs, we would have to argue that
88 MUSHTAQ H. KHAN

rent-seeking in Indian industry absorbed 70-80 per cent of its industrial

value-added which would otherwise have been invested on top of the share
lost to rent-seeking in South Korea. From the qualitative evidence we have
looked at so far, this amount of additional rent-seeking in India is not
credible. This is another way of saying that the productivity of investment
matters. The productivity of investment is not entirely independent of the
rent-seeking process, since differences in the types of rents have important
implications for the productivity of investments.

Rent-outcomes
The outcomes of rent-seeking have varied much more significantly across
our countries. The industrial policy structure which emerged in South
Korea in the early 1960s is now well known (Amsden 1989; Chang 1994;
Kim and Ma 1997). Rents for learning were created using state subsidies.
But, in South Korea, effective performance monitoring ensured that sub-
sidy-recipients did in fact move up the technology ladder and the learn-
ing rents (see Chapter 1) were significantly value-enhancing. In contrast,
in the Indian subcontinent, industrial policy in the 1960s also aimed to
promote strategic sectors but the results were less impressive. Licensing of
production sought to use entry barriers to create rents for infant indus-
tries and to encourage the adoption of new technologies. However, per-
formance monitoring was much weaker, in fact virtually non-existent, and
the rights which created rents were not, or could not be, re-allocated
when performance lagged (Ahluwalia 1985). A significant part of Indian
rent creation was of value-reducing redistributive rents for competing fac-
tions based on caste, community, language and party, which are discussed
further in our next section. These differences in rent-outcomes can
potentially explain substantial differences in growth rates.
By the 1980s, important changes began to emerge in both countries.
Both India and South Korea embarked on liberalization strategies in the
mid-1980s, which marked an important shift in the types of rights and
rents which both economies had been supporting in the past. In India,
the immediate effects of liberalization were positive, given the poor per-
formance of previous statist policies. In contrast, in South Korea, liberal-
ization, particularly of the financial sector, marked a break with
previously successful industrial policy (Chang et al. 1998). It is arguable
that industrial policy of the old type was no longer feasible, given tech-
nological and social developments in South Korea. We will come back to
this debate later. What is clear is that South Korean industrial perfor-
mance declined in the liberalization phase as learning rents and the
industrial policy structure were progressively abandoned.
The Malaysian story in the 1970s and 1980s is different from both the
South Korean and Indian ones. The most distinctive feature here was the
 RENT-SEEKING AS PROCESS 89

creation of redistributive rents for ethnic Malays, based primarily on

transfers from the Chinese-Malaysian business sector. Transfers on this
scale should have had negative incentive effects, but in fact, despite some
dampening of confidence, Chinese-Malaysian capitalists continued to
drive the domestic industrial sector (Jomo and Gomez, this volume). In
addition, the public enterprises set up to create jobs for Malays were
often reasonably competent recipients of learning rents, although mon-
itoring of subsidies was substantially weaker than in South Korea. Finally,
an important component of Malaysian rent-seeking was the insulation of
multinationals from domestic redistribution. The confidence of multi-
nationals explains the large inflow of capital and technology in the
1970s, and again since the late 1980s, until the financial crisis of 1997
temporarily halted this process.
The Thai rent-outcomes were different again. Thai rent-seeking
resulted in redistributive transfers to capitalists, but, unlike in South
Korea, these transfers mainly supported primitive accumulation rather
than being learning rents. More significantly, the rent-seeking in Thai-
land was very competitive and repeatedly resulted in entry into rent-earn-
ing industrial sectors by excluded capitalists (Doner and Ramsay, and
Rock, this volume). Fortunately for Thailand, the relatively basic tech-
nology in most of its industrial sectors did not require learning and mon-
itoring rents for their adoption or efficient operation. As a result, rapid
entry and dissipation of monopoly rents turned out to be value-enhanc-
ing. On the other hand, the unplanned and almost anarchic nature of
Thai rent-seeking undoubtedly had a role to play in explaining the grad-
ual adoption of the unsustainable capital account policies which precip-
itated the 1997 financial crisis.
Based on our discussion so far, Figure 2.6 summarizes some aspects of
the inputs and rent-outcomes of rent-seeking in these countries,
focussing on the industrial sector in the high-growth period of the 1970s
and 1980s. Differences between countries in terms of rent-outcomes
were significant. We saw in Chapter 1 that these differences may be asso-
ciated with very large differences in growth rates and thus explain a
significant part of their differences in performance. In comparison, dif-
ferences in the scale of their rent-seeking expenditures appear to be less
significant. This does not mean that differences in rent-seeking costs
were not important, but it does mean that policy and analytical attention
has to be re-oriented.

Patron-client networks and the organization of rent-seeking

So far we have looked at the types of rents and the associated rent-seek-
ing costs in our countries. We now look at what we know about who was
engaged in rent-seeking and how this rent-seeking was organized. In
90 MUSHTAQ H. KHAN

SOUTH KOREA INDIAN SUBCONTINENT

RENT-SEEKING INPUTS RENT-SEEKING INPUTS

* Substantial centralized bribes • Moderate but dispersed bribes
»Lobbying • Lobbying
* Limited expenditures by political factions • Substantial expenditures by political factions

RENT-OUTCOMES
RENT-OUTCOMES
» Learning rents which became value-reducing
• Value-enhancing rents for learning sustained
monopoly rents
by effective performance monitoring
»Value-reducing ^distributive rents to political
factions

MALAYSIA THAILAND

RENT-SEEKING INPUTS RENT-SEEKING INPUTS

• Moderate centralized bribes »Substantial dispersed bribes
• Lobbying »Lobbying
• Moderate expenditures by political factions * Substantial expenditures by political factions

RENT-OUTCOMES RENT-OUTCOMES
• Redistribute rents with some value- » Redistributive rents for factions controlled
reducing effects by capitalists
• Rents for learning in public sector but with » Competitive destruction of monopoly rents
weak monitoring by new entrants
• Secure rents for multinationals

Figure 2.6 Rent-seeking in Asian industrial sectors in the 1970s and 1980s

developing countries, a significant part of the rent-seeking cost is spent

within patron-client networks and the rents produced as a result are also
often distributed within these networks. A study of the resource flows
within these networks is thus a very useful way of mapping differences in
the organization of rent-seeking across countries. On the one hand, a
large part of the total inputs used in rent-seeking are often spent within
these networks. Some of these expenditures are legal, such as election
expenditures or payments to party officials, but large parts are illegal or
quasi-legal, such as payoffs to mafia bosses, payoffs to members of fac-
tions to retain their allegiance, illegal election expenditures, and so on.
Collectively, these inputs maintain the organizational power of patrons,
which is often critical for winning rent-seeking contests. At the same
time, a large part of the rents which are the outcomes of rent-seeking are
likely to be created for key members or constituencies within these
 RENT-SEEKING AS PROCESS 91
networks. Thus, there is likely to be a 'circular flow' whereby part of the
income from rents created for patrons as rent-outcomes in one period
provides the resources for inputs of rent-seeking expenditures on clients
in the next period. This sustains their organizational power and allows
further rounds of rent-seeking. These flows of resources therefore give us
very useful information about differences in the organization of rent-
seeking across countries.
This section looks at patterns of resource flows in our target countries
based on a reading of their economic and political histories. We focus on
those features of patron-client relationships in each country which are
particularly relevant for our subsequent comparative analysis of rent-
seeking. From the perspective of our subsequent analysis, we will be par-
ticularly interested in the distribution of organizational power within
these countries. A comparative approach is very important because it
directs our attention at an abstract level to what is different between coun-
tries. Looking only at one country often prevents such an understanding
because, to some degree, all types of organizations and types of rent-seek-
ing can be found in every country. What is important is that the relative
importance of different processes can vary significantly and the compar-
ative approach allows us to focus on what is distinctive in each country.
We focus on the industrial sectors in our countries over the 1960s, 1970s
and 1980s. We also touch on the likely changes in flows within networks,
and in the underlying distribution of power in the 1990s, to see how the
organization of rent-seeking was changing over time.

The Indian subcontinent

Despite important differences between India, Pakistan and Bangladesh,
there are many similarities in the predominant ways in which rents are
sought in these countries. They each have a very large number of fac-
tional groups which compete for redistributive rents. And, in each case,
members of the 'intermediate' or 'middle' classes play a key organiza-
tional and leadership role within these factions. The intermediate classes
are, in the main, the educated sections of the population, both employed
and unemployed, and the richer peasants whose sons and daughters pro-
vide new entrants into the educated classes through the universities and
colleges. While capitalists and landlords may, as individuals, control sig-
nificant resources, they are too few in number to control the political
process by themselves. In contrast, the middle and lower middle classes
have the organizational power to dominate politics.
The composition of the group of classes providing political and orga-
nizational leadership varies across regions in the subcontinent. But, by
and large, the groups which dominate organizational politics are neither
92 MUSHTAQ H. KHAN

capitalists nor landlords in the conventional sense, nor are they from
working class or poor peasant backgrounds. While their social origins
vary, they typically occupy an intermediate position in society. Some
Indian political economists have singled out professionals (white-collar
workers) as playing a distinctive role in Indian rent-seeking. For instance,
Bardhan (1984) identifies professionals as one of the three classes form-
ing the coalition of dominant classes in India, together with capitalists
and landlords. Professionals are a subset of the intermediate classes; they
have high levels of education and therefore have more privileged posi-
tions in the job market. But professionals are not the only members of
the intermediate classes. Less well-educated lower middle class groups
such as unemployed college graduates, the urban petty-bourgeoisie and
richer peasants in the villages have substantial organizational power and
play a key role in the competition for redistributive rents. We include all
these groups in our category of the 'intermediate' classes.
The roots of the role played by the intermediate classes go back at
least to British colonial times, if not earlier. The British in India were so
few in number that they could only have ruled with the complicity of
Indian classes and groups which had the power to challenge them. These
groups included, in the first instance, landed elites and later members of
the emerging 'middle class', both of which became key players in the
colonial polity. The strategy of the colonial state was to exploit divisions
among these groups and indeed to create new divisions. The object of
this exercise was to ensure that claims and counterclaims over resources
were finely balanced so that the state had to deal with a small number of
malcontents at any one time. On the other hand, because redistributions
were based on organizational power, there were big potential gains for
factions with organizational power. Given the weakness of the productive
classes, organizational power involved the construction of cross-class
alliances led by political entrepreneurs from the intermediate classes. As
a result, linguistic, religious and caste organizations proliferated. The
lion's share of the redistributive rents was, of course, captured by the
political entrepreneurs but, to mobilize large numbers, at least some of
the rents had to be distributed down the factional networks.
Subsequent economic and political developments further strength-
ened the intermediate classes. The deepening of democratic aspirations
and demographic growth strengthened these groups both numerically
and politically. Most political scientists agree that factional politics inten-
sified in India after the mid-1960s (see, for instance, Rudolph and
Rudolph 1987). A similar intensification also happened in Pakistan and
later Bangladesh at about the same time, despite the presence of military
governments in the 1960s and again in the late 1970s and early 1980s
(Khan 1989). As the intermediate classes grew in strength, the numbers
 RENT-SEEKING AS PROCESS 93
of factions and competing ideological identities also increased. New eth-
nic, religious and caste groups entered the political arena. This pattern
of politics has not enriched the vast majority of the populations of these
countries, but it has enabled successive layers of emerging middle class
groups to get access to rents on the basis of their ability to organize the
much more numerous groups below them.
One of the distinctive features of rent-seeking in the Indian subconti-
nent is that the number of competing factions has always been large and,
moreover, has been rapidly growing since the 1960s. An important con-
sequence of this was that, for anyone with resources to spare, organiza-
tional power in the form of 'unemployed' factions could be cheaply
purchased. This explains why emerging industrial capitalists (and, in the
countryside, rich landlords) have found it so easy to contribute to fac-
tions which could provide them with additional political muscle. This in
turn has allowed capitalists and others to seek and protect redistributive
rents. The excess supply of organizational power and the fragmented
nature of factions help to explain the dense structure of interlinked eco-
nomic and political exchanges within patron-client networks in the
Indian subcontinent. This interlocking of economic and political
exchanges in Indian corruption was identified by (among others) Wade
(1984,1985,1989).
Figure 2.7 shows the complexity of theflowsof resources between the
state, capitalists and political organizers in the Indian subcontinent,
which we will later compare with our other countries. In these diagrams,
bureaucrats (B) and politicians (P) are shown as two parallel hierarchies
within the state. For simplicity, the figure only distinguishes between two
social groups, capitalists (C) and non-capitalists (N), the latter being led
in the main by the intermediate classes discussed earlier. However, suc-
cessful non-capitalist organizers can often become political leaders or
even capitalists over time.
The cross-cutting patron-client resource flows in the Indian subcon-
tinent can be described as 'fragmented clientelism'. There are a large
number of competing patrons supporting non-capitalist clients (the
arrows from P to N). These flows are, in the first instance, resources
which political entrepreneurs spend as rent-seeking inputs to buy orga-
nizational power. The quid pro quo for these patrons is a reverseflowof
political and organizational support from clients. Since this is not an eco-
nomic flow, it is not shown in Figure 2.7, but the organizational power
which patrons mobilize in this way plays a critical role in the rent-seeking
process in these countries. When this type of rent-seeking is successful,
redistributive transfer rents for factions are created as an outcome, shown
byflowsof resources typically funded by transfers from the state. These
rents can benefit different constituencies and are shown in the diagram
94 MUSHTAQ H. KHAN

Politicians

Capitalists Non-capitalist
clients

Figure 2.7 Resource flows in patron-client networks since the 1960s: Indian
subcontinent

as a number offlows:from B to N (when transfer rents are created for

non-capitalist constituencies), from B to C (when transfer rents are cre-
ated for capitalists), and from B to P (when political leaders directly gain
control over budgets which they can allocate to their constituencies).
This fragmented clientelism has important implications for rent-out-
comes in industry. Like capitalists in other countries, Indian capitalists
have engaged in straightforward rent-seeking. They have spent resources
on politicians and bureaucrats (the arrows from C to P and from C to B)
in the form of inputs going into lobbying and bribes. When this rent-
seeking has been successful, the rent-outcome for capitalists has taken
the form of transfers sustaining primitive accumulation, monopoly rents
protecting particular producers or ostensible learning rents (all shown
by the arrows from B to C).
But, apart from this standard type of rent-seeking, capitalists in the
Indian subcontinent have also engaged in 'political' rent-seeking. Given
the excess supply of organizational power, capitalists have spent rent-seek-
ing inputs purchasing political organizers (the arrows from C to N and
from C to P), and thus organizational power and 'protection'. These
inputs gave individual capitalists the political power to protect their rents.
The rent-outcome of this type of rent-seeking was the political protection
of rents, which had an important but subtle effect. The purchase of fac-
tional political power by capitalists made it difficult for the state to man-
age rents for learning efficiently. Subsidies had to be granted to capitalists
attached to powerful factions and could not be withdrawn once granted.
This ensured that rents which were ostensibly learning rents for infant
industries were effectively converted into monopoly rents for protected
capitalists. Subsidies for poorly performing industries and sectors per-
sisted despite common knowledge of their performance failures (Khan
 RENT-SEEKING AS PROCESS 95
1989). Although the Philippines has a very different social history, with
the oligarchs rather than the intermediate classes playing leadership
roles, Hutchcroft's analysis of patron-clientflowsin the Philippines (this
volume) has interesting parallels with India's fragmented clientelism.
The experiment with liberalization in the Indian subcontinent in the
1980s and 1990s has to be seen in this context. By reducing the amount
of subsidy up for grabs, the supporters of liberalization hoped to drive
out redistributive factions, and eventually the blocking effect these
played in processes of structural change. The likely outcome of this strat-
egy is still in the balance. There is no evidence yet that redistributive pol-
itics has been effectively curtailed. Much of the early success of
liberalization has been due to a boom in the demand for consumer
durables rather than a decline in redistributive politics. It is only if the
latter is achieved that liberalization would change the pattern of rent-
seeking in India in the long run (Harriss-White 1996; Khan 1996a). The
limited evidence on corruption suggests that redistributive demands may
actually have increased, driven by more intense conflicts over resources
(see the corruption indices in Table 2.1).

South Korea
South Korea during the 1960s and 1970s presents a very different config-
uration of patron-clientflows.In contrast to the complexity of the flows
we see in the Indian subcontinent, the predominant patron-client flows
in South Korea were more co-ordinated. The state enjoyed much greater
political power relative to its constituents and its executive leadership
could deal with political contestants in a much more centralized way. At
the same time, non-capitalist political organizers seem to have been much
weaker than in the Indian subcontinent. This allowed patrons located
within the South Korean state to enjoy a higher degree of autonomy from
competing demands in society (Jones and Sakong 1980; Mason et. al.
1980; Amsden 1989; Kim 1994: 59-70; Kong 1996; Kim and Ma 1997). In
Figure 2.8 we exclude non-capitalist political organizers entirely, not
because they were completely absent but because they did not play a deci-
sive role in the process of rent creation and allocation at this time.
Figure 2.8 shows the most important flows associated with rent-seek-
ing in South Korea during its industrial policy phase (Amsden 1989;
Khan 1989; Chang 1994; Kim and Ma 1997). The most important rent-
outcome during this period was the transfer of resources from the state's
bureaucratic apparatus (B) to emerging capitalists (C). Initially, these
transfers were simply transfer rents supporting primitive accumulation,
for instance, when abandoned Japanese assets were 'privatized'. Later,
these transfers took the form of learning rents for emerging capitalists.
96 MUSHTAQ H. KHAN

Bureaucracy
B

C
Capitalists

Figure 2.8 Resource flows in patron-client networks in the 1970s: South Korea

South Korea was one of the most successful countries attempting to catch
up using rents for learning in the 1960s and 1970s. At the same time, sub-
stantial rent-seeking costs on the input side were associated with these
transfers. We now know that there were substantial rent-seeking inputs in
the form of kickbacks from the favoured industrial groups (C) to the
political leadership (P) and through them to bureaucrats (B) as well
(Khan 1996a, 1996b; Kong 1996). These revelations emerged during the
corruption cases of the 1990s, but they referred to the sharing of bribes
between top politicians and bureaucrats in the 1970s and 1980s.
The key difference of the South Korean rent-seeking process from
that in the Indian subcontinent was the absence of decentralized centres
of organizational and political power which had the ability to effectively
demand or protect redistributive rents. This had important conse-
quences for rent-outcomes, in that transfers organized as learning rents
could generate growth because the central leadership of the state could
use a carrot-and-stick strategy to induce learning but not allow feather-
bedding. The distribution of organizational power in South Korea pre-
vented individuals unrelated to industrial policy from offering to protect
the rents of emerging capitalists independently of the interests and cal-
culations of the political leadership (Woo-Cumings 1997).
The absence of a large number of redistributive groups led by a pow-
erful intermediate class can in turn be traced to Korea's social history and
the nature of the Japanese colonial impact (Kohli 1994). The Japanese,
unlike the British, did not rule through the creation of supporters and
administrators within the local population. Instead, they relied to a much
greater extent on Japanese colonial administrators. This had much to do
with Japan's geographical proximity and its demographic dominance
over its colonies, as well as perhaps to differences in colonial ideology.
The British in India could not have fielded the same number of troops
and administrators relative to the domestic population. Consequently, its
 RENT-SEEKING AS PROCESS 97

colonial strategy was significantly different. In contrast, the Japanese colo-

nial state could carry out far-reaching social changes from above, often
with great harshness. Japanese land reforms and confiscations destroyed
the power base of the landed elite. It transferred between a quarter and a
third of arable land to Japanese entrepreneurs and corporations (Kohli
1994: 1277-9). But, at the same time, considerable investments in indus-
try and agriculture created employment opportunities in the productive
sector, rapidly changing the structure of the economy.
In contrast to the British in their far-flung colonies, the Japanese goal
in its neighbouring colonies seems not to have been to extract a few
resources and maintain a captive market at the lowest cost. Instead, they
aimed to convert Korea into a productive base for Japan and eventually
to absorb it totally (Kohli 1994: 1272-4). Accommodating landlords,
urban professionals and middle classes formed no part of this plan, and
the organizational power and legitimacy of intermediate groups never
developed to the same extent. To say that South Korean industrial policy
eventually benefited from this social history is not to deny the impor-
tance of the leadership role of Park Chung Hee, nor the importance of
the institutions under which rents for learning were administered during
the industrial policy phase. However, similar institutional attempts to dis-
cipline recipients of learning rents failed in other countries, such as Pak-
istan in the 1960s, which did not have this social history (see, for
instance, Khan 1999).
The pattern of South Korean rent flows shown in Figure 2.8 did
change over time. Rapid economic development eventually created a
large middle class which, by the mid-1980s, became increasingly unwill-
ing to accept the high-handed way in which resources were being allo-
cated by the state. Not surprisingly, by the early 1990s, revelations of
corruption increased dramatically, even though much of this referred to
the efficient rent creation period of the 1960s and 1970s. The evidence
suggests that the pattern of corruption was also changing by the 1990s.
Evidence of value-reducing interlocking between political factions and
capitalists along the Indian pattern begins to emerge. Thus, in 1997, the
steel company Hanbo went bankrupt amidst allegations that it had con-
tinued to receive state support long after its poor economic performance
had become well known. Factions within President Kim Young Sam's
party and one of his sons were implicated in supporting these subsidies.
In the same year, his finance minister seems to have supported a take-
over of the automobile operations of the Kia conglomerate by its com-
petitor Samsung, a strategy which many observers felt was motivated by
political rather than economic considerations. The minister was closely
associated with Samsung, and the company had also invested heavily in
President Kim's home town of Pusan. These and other revelations led to
98 MUSHTAQ H. KHAN

a decline of domestic and international confidence in industrial policy

well before the financial crisis of 1997.
Chang et al. (1998) argue that these examples of efficiency-reducing
corruption in South Korea were not typical of industrial policy in that
country. They subscribe to the view that the gradual abandonment of
industrial policy in the 1990s and the shift towards liberalization was a
policy decision which was not driven by any change in the viability of old-
style industrial policy. They may be right, but it may also be that, by the
1990s, real changes were taking place in the distribution of political
power which allowed rent-recipients to form political alliances to protect
their rents in ways which had not been possible earlier. The growing tech-
nical sophistication of South Korean industry was undoubtedly also mak-
ing the allocation of learning rents more difficult, since bureaucrats were
less and less competent to judge performance. The shift towards liberal-
ization may well have been driven, at least in part, by a recognition within
the state that efficient rents for learning could no longer be effectively
managed. This does not mean that liberalization of the type selected was
the only or the best response. Constructing the institutions and political
alignments to manage learning rents when political power is fragmented
is a challenge for all developing countries. For relatively advanced coun-
tries like South Korea, which are operating close to the technical frontier
on many (but by no means all) fronts and have exhausted easy learning
opportunities, the challenge is more daunting. Here, the challenge is
also to construct new institutions for managing Schumpeterian innova-
tion rents in addition to learning rents.

Malaysia
The Southeast Asian countries were located somewhere between South
Korea and the Indian subcontinent in terms of the relative organiza-
tional power of their intermediate classes. They did not experience the
draconian colonialism and social engineering which South Korea and
Taiwan suffered under the Japanese (Kohli 1994). On the other hand,
although their colonial experience was closer to that of the Indian sub-
continent, in most cases they had a shorter colonial history and the devel-
opment and accommodation of the intermediate classes was less
advanced. Indeed, in the case of Thailand, there had never been direct
colonial rule.
As in the Indian subcontinent, post-independence Malaysia faced
redistributive demands from its own intermediate classes. However, here,
a centralized pattern of resource flows emerged in response to these
demands which proved to be compatible with rapid growth. Paradoxi-
cally, the ethnic divide in Malaysia between its largely Chinese-Malaysian
 RENT-SEEKING AS PROCESS 99
capitalists and the predominantly Malay population allowed this central-
ized redistribution to emerge. The political isolation of the Chinese cap-
italists allowed them to be effectively 'taxed' in a centralized way for the
benefit of emerging intermediate groups. Moreover, since the bulk of
the transfer could be legal, the need for illegal exactions was far less. This
is probably an important reason why Malaysia was the least corrupt of the
countries in Table 2.1. If, instead of the ethnic argument, a purely wel-
farist argument for transfers had been used, it would probably not have
allowed the same pattern of centralized transfers. Welfarist transfers
would have gone to the poorest groups in Malaysia, and not to the polit-
ically powerful Malay middle class, and would not have served the politi-
cal purpose of accommodating the organizationally powerful. The
ethnic and religious diversity of intermediate groups in India is one rea-
son why it has been so difficult to construct a similar centralized transfer
for the Indian intermediate classes.
The centralized solution to the redistributive problem emerged as an
unintended consequence of the 1969 riots and the adoption of the New
Economic Policy. The political consolidation which took place after the
riots established UMNO (the United Malays National Organization), the
Malay party in the ruling coalition, as the dominant political power in the
country. The effect was to consolidate potentially competing Malay clien-
telist groups into a unified structure and, at the same time, to establish
their political dominance over the largely Chinese-Malaysian capitalists
who would have to pay for the redistributive rents. We could therefore
characterize Malay clientelism as 'centralized clientelism', compared with
the fragmented clientelism afflicting the Indian subcontinent (Khan
1989) or the decentralized, but capitalist-led, clientelism in Thailand, dis-
cussed below (Doner and Ramsay, Rock, this volume; Sidel 1996).
The resource flows within patron-client networks in post-1969
Malaysia are shown in Figure 2.9. The most important rent-outcome of this
rent-seeking system was the redistributive transfer rent going from the
mainly ethnic Chinese capitalists (C) to the central political leadership
(P) of UMNO. This included both legal taxes and illegal extractions.
Malaysia's rich natural resources also allowed the state to tap significant
natural resource rents. Collectively, these resources were used to create
further transfer rents for the intermediate classes in a number of forms,
including jobs in public sector enterprises and subsidized loans from the
banking system (see Chin andjomo, this volume), shown by arrows from
P to N. The organizational power of UMNO was, in turn, based on rent-
seeking inputs being expended by the party leadership in the form of
rent-sharing with lower-level clients. Thus, the arrows from P to N were
sometimes rent-seeking inputs which maintained the organizational
power of the ruling party.
100 MUSHTAQ H. KHAN

Bureaucracy Politicians

C C
Capitalists
N' 'N
Non-capitalist
clients

Figure 2.9 Resource flows in patron-client networks in the 1970s: Malaysia

A subsidiary type of rent-seeking in Malaysia involved, as its outcome,

the transfer of relatively small learning rents to domestic capitalists as
assistance for moving into high-technology industries and the capture of
natural resource rents by companies gaining rights to exploit Malaysia's
rich natural resources. These rent flows are shown by the arrows from B
to C. The implicit transfers which the state organized for Malaysia's cap-
italists were typically not the large, explicit rents for learning (as in South
Korea), but they were nevertheless of economic significance (Jomo 1986;
Jomo and Edwards 1993). To sustain these rights, capitalists also spent
further resources as rent-seeking inputs, in lobbying or bribing state offi-
cials at various levels (flows from C to P and from C to B).
Compared with the Indian subcontinent, the distinctiveness of the
Malaysian rent system was that the redistributive transfer from the Chi-
nese capitalists was centralized and, initially at least, direct links between
particular capitalists and political factions in the Indian manner did not
exist. By satisfying the demands of the organizationally powerful through
a centralized redistributive transfer, this strategy separated them, for a
time, from capitalists seeking rents. The demands of the latter could be
evaluated on the basis of economic calculations (such as who could offer
the highest bribes or the highest growth rates for future taxation and
bribes) without individual capitalists being able to deploy political power
to the same extent as in the Indian subcontinent.
Finally, the political stability which Malaysia achieved as a result
allowed it to attract high-technology investments. The centralized politi-
cal settlement, together with the fact that large natural resource rents
 RENT-SEEKING AS PROCESS 101
were also available for redistribution, meant that domestic redistributive
demands could be met internally. As a result, high-technology multina-
tionals were assured that their global Schumpeterian rents would be pro-
tected in Malaysia and would not be captured by local political processes.
This must have contributed to the willing relocation of many of these
firms to a cheap labour haven, bypassing countries like India which also
had plenty of skilled labour. Not surprisingly, prior to the financial crisis,
multinationals in Malaysia were driving exports and technology acquisi-
tion to a greater degree than in most other developing countries (Jomo
1986: 254-6; Jomo and Edwards 1993).
While Malaysia's centralized redistributive system was, for a time, com-
patible with rapid growth, it was nevertheless less dynamic than the
industrial policy system of South Korea in the 1960s and 1970s. Since the
bulk of the redistribution was to the intermediate classes, this limited the
resources which could be transferred to capitalists to accelerate primitive
accumulation or used as learning rents. Technical progress in Malaysia
was therefore based on directly attracting foreign investment rather than
inducing domestic learning. Nevertheless, given the domestic political
configuration, it is doubtful whether a South Korean industrial policy sys-
tem would have been feasible. The Malaysian state faced much greater
political demands for redistribution, and the centralized system of redis-
tributive rents was an efficient response.
The pattern sketched above has changed to some extent over time. As
the economy has grown, the political power of competing Malay factions
within UMNO has grown as well (Jomo and Gomez, this volume). As
decentralized factions developed through the late 1980s and 1990s, the
Malaysian rent-seeking system began to slowly approach the Indian pat-
tern, with factions increasingly able to play a role in protecting rents for
particular capitalists. The growing factionalization within UMNO was
exemplified in the conflict between Prime Minister Mahathir and his
erstwhile deputy Anwar Ibrahim. If the Malay intermediate class groups
are indeed becoming more fractured, the centralized rent distribution
system shown in Figure 2.9 may no longer be feasible. The challenge for
Malaysia will be to democratize its polity without allowing competing fac-
tions to block efficiency-enhancing changes in the South Asian fashion.

Thailand
In Thailand, as in Malaysia, the Chinese played an important role in busi-
ness and trade. But, in contrast to Malaysia, ethnic Chinese capitalists in
Thailand intermarried with the local population and were linguistically
integrated. Thailand was also different from all the countries discussed so
far in not having experienced direct colonial rule. Perhaps partly as a
102 MUSHTAQ H. KHAN

result, its middle class of professionals, salaried workers and the petty-bour-
geoisie were politically passive even as late as the 1980s (Phongpaichit and
Baker 1997: 363). Redistributive political factions were dominated to a
much greater extent than in the Indian subcontinent or Malaysia by
business interests, although there were powerful patrons in the country-
side who could mobilize large sections of the rural population. There
were ongoing tensions in the Thai polity between a military-bureaucratic
group which wanted authoritarian politics to clamp down on clientelism,
Bangkok-based capitalists who wanted to take over political factions to
achieve their own interests, and rural patrons who wanted to use their
organizational power for developing provincial business and trade inter-
ests of their own. Despite these tensions, the distinctive feature of Thai
clientelism from the 1970s onwards was that redistributive rents were, in
the main, demanded by groups which wanted to engage in primitive accu-
mulation to develop business interests. While the balance between the
Bangkok capitalists, the provincial capitalists and the military shifted over
time, by the mid-1970s a stable pattern began to emerge as provincial and
Bangkok capitalists began to collectively dominate political factions
(Phongpaichit and Baker 1997: 332-54).
Figure 2.10 shows the dominant patterns which emerged after the fall
of the military in 1973, although there were brief interruptions following
military coups in 1976 and 1991. The key arrows are the ones showing
rent-seeking inputs from capitalists (C) to political factions led by them-
selves (C), and thence to other politicians (P) and non-capitalist mem-
bers of factions (N) who provided the organizational power for winning
elections. By the 1970s, Thai capitalists were running their own political
factions to a much greater extent than in other developing countries in
Asia (Sidel 1996; Phongpaichit and Baker 1997: Tables 10.1-10.2). This
not only gave Thai capitalists places in parliament but also the political
power to bargain for subsidies, franchises and licences, which were the
rent-outcomes of their rent-seeking, shown by the arrows from B to C (see
also Doner and Ramsay, and Rock, this volume). These rents included
monopoly rents, transfer rents supporting primitive accumulation, and
learning rents for infant industries.
The distinctive features of the Thai rent-seeking system were, first, the
relatively low degree of redistributive rent transfers organized by non-
capitalist political entrepreneurs. Since the capitalist faction leaders did
not have the social legitimacy to demand redistributive rents on ethnic,
religious or other ideological grounds, Thai transfer rents supported
primitive accumulation to a greater degree than in Malaysia or in the
Indian subcontinent. When redistributive factions are led by non-capi-
talist intermediate classes, competitive clientelism can lead to the gener-
ation of a growing number of ideological or ethnic identities to create
 RENT-SEEKING AS PROCESS 103

Bureaucracy Politicians

A\ A
C C
Capitalists

N N N
Non-capitalists

Figure 2.10 Resource flows in patron-client networks in the 1970s: Thailand

redistributive rents, as we see in the Indian subcontinent. However, when

competitive factions are led by capitalists, competition between them is
more likely to lead to excluded factions trying to use transfer rents to
enter existing high-rent markets, since they cannot so easily create new
ideological justifications for redistribution to themselves.
A second feature of the Thai rent-seeking system was the intense com-
petition between these capitalist-controlled factions. The relatively large
numbers of capitalists going into the political fray reflected the develop-
ment of trade and commerce in Thailand. Not having suffered an inter-
ruption due to a colonial take-over, small traders, often Chinese, had
accumulated slowly over a century and, by the 1960s, many of them were
substantially wealthy. The vigorous political competition between fac-
tions controlled by Thai capitalists prevented the political system from
being monopolized for long by any particular faction. Thus, although
the rent-seeking input costs in the form of corruption and clientelism
were high, long-run economic performance was good because the rent-
outcomes were rapid primitive accumulation and a tendency for new
capitalists to enter sectors with high monopoly rents. Unlike in other
developing countries, there was a greater downward pressure on monop-
oly rents. On the other hand, the management of learning rents was
poor, as the allocation of subsidies depended more on political bargain-
ing power than on economic performance.
A key factor which ensured that this rent-seeking system was efficient
was the nature of the technology which Thai capitalists were adopting in
the 1970s and 1980s. In sectors such as textiles, logging, food processing,
and so on, Thailand was adopting technologies which had limited
economies of scale and which did not require long periods of learning.
In particular, they did not require learning rents for successful adoption.
104 MUSHTAQ H. KHAN

Rents, in this context, were only useful in accelerating primitive accu-

mulation and, as soon as that had happened, the competitive bidding-
down of rents in these sectors was socially desirable. This would not have
been the case if useful rents had had to be maintained and managed, for
instance if learning had been required or if sophisticated monitoring
and regulatory mechanisms had needed to be developed. In the long
run, as Thailand moves into higher-technology sectors, institutional
reformers will have to face these issues.

Summary
The snapshot pictures of resource flows within patron-client networks in
this section provide a starting point for our analysis of rent-seeking. It is
important to recognize that these patterns are changing over time and so
each pattern is specific to a particular phase of a country's development.
Nevertheless, once particular patterns are recognized, we can ask gen-
eral questions, the answers to which may be relevant for other contexts
as well. In the next two sections we will look at the variables which can
explain differences in the input costs of rent-seeking and the differential
rent-outcomes in different contexts.

The input cost of rent-seeking

Conventional rent-seeking models have concentrated almost exclusively
on the rent-seeking cost which is the input cost of rent-seeking. This is the
cost to society of resources being used up in rent-seeking activities. These
activities include lobbying, bribing, maintaining political factions, and so
on, which can potentially absorb a significant share of society's resources.
Calculation of the 'rent-seeking cost' involves two steps: first, estimating
the magnitude of the rent-seeking expenditure, and, second, estimating the
social cost of this expenditure. The early rent-seeking models used a num-
ber of simplifying assumptions to show that rent-seeking expenditure was
equal to the size of the rent being competed for. If this was true, then for
a total rent of $100, the total expenditure on rent-seeking would be
exactly $100. For the second step, these models simply asserted that this
entire expenditure was a social cost. We begin by looking at the early mod-
els. We then see how, with different political and institutional assump-
tions, the rent-seeking cost can be much larger or smaller.

The rent-seeking expenditure: early rent-seeking models

We know that individuals will only spend resources on rent-seeking

if their expenditures change the probability of their winning (or not
 RENT-SEEKING AS PROCESS 105
losing) the rent they are seeking (or which they already possess). How
much individuals spend in aggregate will depend on how they perceive
their probabilities of winning are likely to change as a result of these
expenditures. This is where our assumptions about institutions, bargain-
ing power and strategic perceptions become very important. The impor-
tance of these assumptions can be seen by considering how the early
rent-seeking models worked. Later, we will consider the effects of relax-
ing these assumptions.
The key, but often only implicit, assumption in the standard Krueger-
Posner type of rent-seeking model is that each individual's probability of
winning the rent depends on that individual's proportionate expenditure
on rent-seeking. In other words, IT, the probability of individual i win-
ning the rent (of any value R), is given by

where E. is the expenditure of the ith person on rent-seeking, and ZEj is

the rent-seeking expenditure summed over all persons. If the probability
of winning was determined in this way, this means that if person i spends
$10 on rent-seeking when the total expenditure on rent-seeking is $100,
^'s probability of winning the rent R is 0.1. If this is how the probability of
winning is determined, we can then determine how much would be
spent on rent-seeking in aggregate. The answer turns out to be exactly R.
This is an important result. It says that, in this case, if the total rent, R, is
$1000, the total expenditure on rent-seeking, EK, will be $1000 as well.
The reason for this can be seen by looking at the expected gain from
'investing' one more dollar in rent-seeking. The expected gain is the
probability of that dollar winning the prize (the rent) times the size of
the prize which is R. In symbols, is expected gain = I1R where EL is the
probability of i winning the rent with an expenditure, E}, of $1. For
instance, if for the last dollar, IT is 0.25 and the prize is a rent of $1000,
the expected gain is $250. Since the expected gain of $250 is achieved
with an outlay of $1, person us likely to invest the dollar in rent-seeking.
When is person i likely to stop investing further sums? As i (and others
like i) keep investing in rent-seeking, the value of EEj will keep growing
and, as a result, the value of IT will keep falling. Eventually, the value of IT
will fall to the point where ELR (is expected gain) is exacdy $1. Any invest-
ment of a further dollar in rent-seeking beyond that point will not be
attractive for i or anyone else. Clearly, when IE. = R, given that E = 1, II
will equal 1/R. The expected gain from an expenditure of $1 will then be
ILR = 1. Any further investment will result in IX declining further and the
expected gain from subsequent investments will be less than $1. Thus, if R
= 1000 and a total of 998 dollars has been spent on rent-seeking, a further
106 MUSHTAQ H. KHAN

dollar spent will have a 1/999 chance of winning the prize, giving an
expected gain ofjust more than $1 (1000 x 1/999) for an expenditure of
$1. The next dollar will have an expected gain of exacdy $1 as total expen-
diture, XEi? reaches $1000. Beyond that point, further dollars spent have
an expected gain of less than $1 and further rent-seeking expenditures
will no longer take place. But, by then, the total expenditure on rent-seek-
ing, SEj, will have reached exacdy the value of the rent, R.
This is why early rent-seeking theorists were happy to estimate the
rent-seeking cost by simply calculating the value of total rents in the
economy, usually by adding up all the monopoly rents and subsidies.
Thus, in Figure 2.4, the rent-seeking cost which was analytically identified
as YZ could be given a numerical value simply by estimating the monop-
oly rent or the subsidy in the protected sector (Krueger 1974). Alterna-
tively, if we go back to Figure 1.3 in Chapter 1, the social cost of
monopoly was identified as a deadweight welfare loss equal to the small
triangle CDE. Now rent-seeking theory was saying there was an addi-
tional rent-seeking cost which was equal to the size of the rent, in this
case equal to the much bigger rectangle BCDP2.

Rent-seeking expenditures versus rent-seeking costs

The theory discussed so far estimates the expenditure on rent-seeking, ZEj,

and assumes that this is an accurate measure of the rent-seeking cost. This
may not be the case. Not all of the expenditures on rent-seeking are
expenditures on inputs and are therefore not a cost for society. If some
of the expenditures on rent-seeking are transfers from one person to
another, as bribes can be, the transferred resources are potentially avail-
able for production and no social cost is involved. Thus, there is a dis-
tinction between rent-seeking expenditures on inputs which are used up
and expenditures which simply transfer resources across individuals
(Browning 1980; Tullock 1980b; Varian 1989).
An example of a rent-seeking expenditure which consumes inputs is
lobbying. When an industrialist employs a lobbyist, the lobbyist con-
sumes inputs while performing a specified activity. These inputs cannot
be used subsequently to employ an engineer. On the other hand, an
example of a rent-seeking expenditure which simply transfers resources
is a bribe from an industrialist to a government official in exchange for a
licence. Here, no activity has been performed by the government official
which uses up inputs (ignoring the cost of signing pieces of paper which
would perhaps have to be signed anyway). The bribe transferred is there-
fore potentially available for the same range of uses as before. The recip-
ient could use the money to organize production or go for a holiday, just
as the bribe-giver could have done. As far as society is concerned, inputs
 RENT-SEEKING AS PROCESS 107

have not yet been used up. If all rent-seeking expenditures were transfers
rather than expenditures on inputs, there would be no potential loss of
inputs for producing final outputs and, therefore, no rent-seeking cost.
However, the fact that inputs remain potentially available following a
transfer does not mean that the allocation of inputs in production is
unchanged. Individuals have different preferences, and the bureaucrat
may use a bribe differently from the industrialist. If the industrialist is
more likely to invest than the bureaucrat, a bribe may have a social cost
in a poor country with an investment constraint. Thus, even if rent-seek-
ing expenditures are transfers, they can still affect the allocation of
resources in production. An accurate measure of the rent-seeking cost
would have to break down any rent-seeking expenditure into three com-
ponents. First, part of the total expenditure may be a pure transfer which
leaves final output unchanged. This component of rent-seeking expen-
ditures will have zero social cost. Second, a part may be a transfer which
nevertheless changes allocative decisions in particular ways. Here, the
social cost is the difference in value of final output with and without the
transfer. This may be difficult to estimate in practice. Third, there may be
a component which is a true input withdrawal, and this part of the rent-
seeking expenditure is entirely a cost. The practical difficulty of estimat-
ing the true social cost of rent-seeking expenditures in this way explains
why we usually make the simpler assumption that the rent-seeking cost is
at least proportional to the rent-seeking expenditure. If this assumption
is justified, higher rent-seeking expenditures should at least imply higher
rent-seeking costs. For comparative purposes, such an assumption is jus-
tified as long as the composition of rent-seeking expenditures is roughly
the same in the situations being compared. This qualification should be
borne in mind, although we do not have any simple way of correcting our
estimates when this is not the case.

The rent-seeking expenditure: additional variables

The claim of the early Krueger-Posner rent-seeking models was that the
rent-seeking expenditure is equal to the size of the rent. This, as we have
seen, was based on some very special assumptions. We now see that, if we
take into account other institutional and political variables, the magnitude
of rent-seeking expenditures can be more or less than the size of the rent.

Institutional rules
A key assumption of the first-generation models was an implicit institu-
tional rule for allocating the rent-generating right. This institutional rule
said that, when individuals or groups spend resources on rent-seeking,
108 MUSHTAQ H. KHAN

their probability of getting the rent is equal to their share of the total
rent-seeking expenditure, EJ/ZEJ. But, if the rule for allocating the rent
is slightly altered, the final expenditure can be substantially more or less
than the size of the rent (Mueller 1989: 229-46).
For instance, if only a small number of individuals are allowed to enter
the rent-seeking game, and the rent-generating right is randomly allo-
cated to one of them, the total expenditure may be very small. This
would be the case if the expenditure each person has to make to enter
the game is small. Thus, if the rule is that the first five people in a queue
are allowed to bid $1 for a rent of $1000, which is then allocated to one
of them by the state either randomly or according to some autonomously
determined rule, the total rent-seeking expenditure will be limited to $5.
This is a simplified version of the argument that insulated, authoritarian
or 'invulnerable' states which can limit the competition over rents can
also limit rent-seeking expenditures (Chang 1994: 38-44; Kim and Ma
1997). This is also what Hutchcroft (this volume) calls 'purposive rent
allocation', which he contrasts with 'competitive rent-seeking'.
However, this institutional argument is incomplete. It is not clear why
secondary rent-seeking does not take place. Secondary rent-seeking in this
case refers to expenditures by excluded groups to change the rent-allo-
cation rule itself, since this rule excludes many potential rent-seekers
from the chance of winning and also excludes many state officials from
collecting bribes which they may otherwise have done. In fact, rules for
allocating rents which exclude many rent-seekers are often contested.
One important variable which determines the outcome is the distribu-
tion of political power between insiders and outsiders in the restricted
rent-seeking game. If the excluded have the power to contest, it is
unlikely that they will be effectively excluded in the long run, and we
should expect to see the exclusionary rules being changed. It follows that
institutional rules which seek to lower rent-seeking expenditures by lim-
iting access to rents can only work if those being excluded are not pow-
erful enough to contest their exclusion.
In contrast, we can also think of institutional rules allowing high
degrees of competition which may result in much larger rent-seeking
expenditures than the rent available. One example would be a rule
which says that any number of agents can compete and the right is allo-
cated to the biggest spender. Under this institutional rule, the rent-seek-
ing expenditure is indeterminate and may be much larger than the rent
being competed for. For instance, for a rent of $1000, it is quite possible
that, under these rules, each of ten contestants bids $990, resulting in
$9900 being spent in rent-seeking. However, this rule too is unlikely to be
sustained in a repeated game because too many contestants will go bank-
rupt. Contestants are likely to begin to collude when bidding for the
rent, but it is difficult to say much more a priori.
 RENT-SEEKING AS PROCESS 109
In the real world, an institutional rule which is often relevant for allo-
cating rents is the 'democratic' rule. This rule says rents are allocated to
coalitions of majorities in representative institutions. Analytical compar-
isons of rent-seeking expenditures under 'democracies' and 'dictator-
ships' have attracted great interest. However, it turns out that, at a purely
analytical level, political institutions have indeterminate effects on rent-
seeking. Democratic legislatures could be associated with high or low
rent-seeking expenditures depending on other conditions. As an exam-
ple, Congleton (1980) argued that in democracies, if there is competi-
tion in forming coalitions, this is likely to drive bribes down to the
minimum effective level for each legislator. The total bribe paid could
then be as low as the minimum bribe per legislator for half the legislators
plus one.
For instance, suppose the minimum bribe acceptable to each legisla-
tor is $1 and there are three legislators. Suppose also that we start from
a position where bribes are high and all three legislators are getting a
bribe of $5, represented by (5,5,5). Since only two votes out of three are
needed for a majority, rent-seekers can offer the first two legislators a
lower total bribe to form a new coalition which still has the majority
required to allocate rents. For instance, they could offer (6,5,0). This in
turn can be bettered (from the rent-seeker's point of view) by an offer of
(7,0,1), which costs even less but will be accepted by a new majority com-
bination of legislators. This in turn can be bettered by (0,1,1). In each
case, rent-seekers buy the required two votes, but for less and less, until
the minimum effective bribe is reached. A game-theoretic version of this
co-ordination problem facing corrupt legislators in a democracy is pro-
vided by Rasmusen and Ramseyer (1994). The problem with drawing
firm conclusions about the rent-seeking expenditure in a democratic leg-
islature is that the result depends on the minimum bribe which legisla-
tors will accept, and, moreover, the minimum-bribe coalition may not
necessarily be stable. Rent-seekers who have lost out have the incentive
to offer higher bids to new coalitions of legislators so that bribes can be
bid up again. Thus, if legislators are powerful enough to demand high
minimum bribes, or if winning coalitions can be repeatedly overthrown
by new combinations, it is possible for rent-seeking expenditures to be
very high in a democracy. Whether democracies actually result in high or
low rent-seeking expenditures clearly cannot be determined from such
abstract models.
Another approach to modelling the rent-seeking cost under democra-
cies comes from transaction cost economics. We have seen that the social
cost of rent-seeking is not necessarily proportional to the magnitude of
the bribes and transfers. Thus, even if democracy lowered the total bribe,
this does not necessarily mean that the rent-seeking cost is low. One of the
true costs of transfers is the 'transaction cost' of organizing them. These
110 MUSHTAQ H. KHAN

are the costs of negotiating the size and allocation of the transfer. Negoti-
ating uses up resources (in the simplest sense, because haggling uses up
time which could have been spent in production). If failed negotiation
results in conflict, there are additional costs in the form of strikes or even
riots. These are true social costs, which may or may not be directly pro-
portional to the size of the transfers taking place.
North (1990) calls these costs of organizing transfers the 'political
transaction cost'. He then puts forward a somewhat different argument
for democracy on the grounds that democracy reduces political transac-
tion costs to their lowest possible level. The intuition here is that the free
flow of information in a democracy would make the process of striking
deals easier and faster than in other systems. But, once again, one could
argue that whether a democracy ensures the lowest political transaction
cost for organizing transfers and bribes depends on the distribution of
power. If there are many groups which are evenly matched, they may
each hold out for very small gains, in which case the political transaction
cost under democracy may be very high. Nevertheless, if North is right,
rent-seeking costs will be minimized in democracies. Note that this result
directly contradicts the argument which suggests that an invulnerable or
autonomous state can ensure low rent-seeking costs. These competing
models show that it is possible to construct perfectly logical arguments
showing how quite different institutions may be better for reducing rent-
seeking costs. Equally, the same institution may be associated with high or
low rent-seeking costs depending on other conditions.
The theoretical indeterminacy of the rent-seeking expenditure asso-
ciated with specific institutional rules is confirmed when we look at our
countries and try to relate rent-seeking costs to the degree of democra-
tic competition. By this we mean how far their institutions allowed free
elections, a free press and freedom for groups to organize into factions
and parties. India was clearly the most democratic of our group of coun-
tries. Its constitutional arrangements ensured regular elections, a free
press and many competing parties. The only break in its democratic
record was the brief period during 1975-77 when Mrs Gandhi imposed
her Emergency.
The other countries are more difficult to rank. In each case, some
democratic rights were suspended for some part of the period we are look-
ing at. Rights were suspended for varying periods, and some rights but not
others were curtailed, making a clear ranking difficult. Keeping this in
mind, we would rank Malaysia next. On the one hand, although party
choice was limited, Malaysia had a civilian administration throughout the
period we are interested in. As we have already seen, the representative
structure which emerged after 1969 was responsive to redistributive
demands coming from its large intermediate classes. On the other hand,
 RENT-SEEKING AS PROCESS 111
many organizational rights, particularly of labour unions, were curtailed
during the Emergency of 1963-66 and some rights remained curtailed
thereafter (Jomo 1986: 236). The ethnic dominance of the Malays in the
representative structure which emerged after 1969 also made it more dif-
ficult for some excluded groups to compete for rents. This justifies rank-
ing Malaysia lower than India.
South Korea, Thailand, Pakistan and Bangladesh are at the other end
of the institutional spectrum as they each suspended civilian administra-
tions for varying periods in the 1960s, 1970s and 1980s, followed by con-
trolled transitions to democracy. In South Korea, Park Chung Hee's coup
of 1961 established the authoritarian state which governed South Korea
during its industrialization. The state made frequent use of the Korean
Central Intelligence Agency to control dissent and periodically used mar-
tial law in the early years. It also exploited the popular perception of
impending hostilities with North Korea to institutionalize limits to
democracy in theYushin Constitution of 1972. Genuine democratization
began only in the 1980s (Woo-Cumings 1997). Pakistan and Bangladesh
were similar to South Korea in having an authoritarian state in the 1960s
following Ayub Khan's military take-over in 1958. When the two coun-
tries split apart in 1971, gradual moves towards democracy began, but
with another military interlude in both countries covering roughly the
mid-1970s to the late 1980s.
The fall of the military government in Thailand in 1973 marked the
beginning of its slow progress towards greater democratization. How-
ever, the military remained suspicious of the 'corrupt politicians' who
dominated parliament and did all they could to restrict the power of the
legislature. Constitutional provisions allowed the Prime Minister and
some of his cabinet to be appointed from outside the legislature, and the
military was usually successful in ensuring that its candidates remained at
the apex. When it felt that parliament was stepping outside its bounds,
there were short-lived coups in 1976 and again in 1991. Despite this, par-
liament played a function in the rent-seeking game by allowing capitalist
factions to seek redistributive rents, in the way already described, and the
powers of the legislature gradually increased over time (Phongpaichit
and Baker 1997: 290-364).
A loose ranking in terms of the degree of democratic competition in
these countries would, therefore, place India first, followed by Malaysia,
and then the other four countries, which are difficult to rank further.
Fortunately, the precise ranking does not matter very much for what we
want to say. If North's (1990) proposition about democracy is true, India
should have had the lowest rent-seeking costs (relative to the size of its
GDP), followed by Malaysia, and with South Korea, Thailand, Pakistan
and Bangladesh having the highest. If, on the other hand, the argument
112 MUSHTAQH. KHAN

in favour of invulnerable states is true, then the ranking in terms of rent-

seeking costs should be reversed. On the basis of our earlier discussion,
admittedly based on subjective and qualitative data, the actual ranking in
terms of rent-seeking costs does not fit either institutional story.
If we look at the 1970s, authoritarian South Korea probably did have
lower relative rent-seeking expenditures than democratic India (but
probably not much lower). On the other hand, authoritarian Pakistan
and Bangladesh seem to have had higher rent-seeking expenditures than
democratic India. (In a similar vein, Hutchcroft in this volume suggests
that authoritarian rent allocation also failed to reduce rent-seeking costs
in the Philippines under Marcos.) Thailand's fairly authoritarian regime
over the same period probably led to one of the highest rent-seeking
expenditures, and probably higher than the relatively democratic
Malaysia. In the 1980s, some of these rankings change, but, once again,
there is no simple story. Depending on which countries and periods we
select, we can find support for either hypothesis.
Clearly, there are other variables which could explain the differences
in rent-seeking costs in these countries, but the interesting question is
whether the effects of particular institutional rules also depend on the
social context. Chang (1994: 45) points out that restricting political com-
petition under authoritarianism is not a simple issue, because the insti-
tutions which will successfully restrict competition depend on the
political economy of the country. We would go further and argue that the
rent-seeking cost is not always reduced by attempting to reduce political
competition institutionally. While an institutional restriction of political
competition seems to have worked for a time in South Korea, given the
weakness of its excluded rent-seekers, such a strategy has often resulted
in increased secondary rent-seeking costs in other developing countries.
The comparison of Pakistan and Bangladesh with India in the 1960s
and 1970s is instructive because these countries had very similar social
structures. However, their political institutions differed, as Pakistan and
Bangladesh repeatedly attempted to restrict access to political power
while giving a small number of players access to industrial sector rents.
These were precisely the institutional features which are often identified
as important in explaining low rent-seeking expenditures in South Korea
(Kim and Ma 1997). However, in both Pakistan and Bangladesh, excluded
groups led by the intermediate classes were always successful in vigorously
contesting their exclusion whenever it was attempted, and this eventually
resulted in much larger secondary rent-seeking expenditures over time
(Khan 1989, 1999). Such was the magnitude of this secondary rent-seek-
ing effort that authoritarian regimes in these countries either did not sur-
vive for long or did not remain authoritarian in practice.
These examples suggest that whether democracy or authoritarianism has
lower rent-seeking costs will also depend on the degree of fragmentation of
 RENT-SEEKING AS PROCESS 113
society and the strength of redistributive factions. Where social factions
are weak and power is centralized, as in South Korea in the 1960s and
1970s, the institutions of authoritarianism may produce low rent-seeking
costs. Where social factions are strong and the effective power of the state
to suppress them is weak, democratic institutions may be necessary to
achieve the lowest rent-seeking costs, not only for the information rea-
sons suggested by North but also because they are likely to result in lower
levels of conflict from excluded groups and, therefore, in lower sec-
ondary rent-seeking costs. The institutional rule for allocating rent is
therefore a useful starting point for analysing rent-seeking expenditures
as long as we remember that institutional rules do not exist in a social
and political vacuum.

Sunk costs and insider advantages

Given an institutional structure, rent-seeking expenditures can depend
on the costs and benefits of the different contestants. Insiders in a rent-
seeking game may have 'sunk costs', that is, investments which they have
already made which are now of little value in other uses. For instance,
investments already made in patron-client networks, in acquiring insider
information and even in R&D often have this character because they are
of little value in other sectors. If outsiders know this, rent-seeking is sim-
ilar to an entry deterrence game, where the incumbent paradoxically has
an advantage due to prior sunk costs. The advantage comes from the fact
that the incumbent can credibly threaten to spend resources fighting
potential entrants even if that implies big losses for a time, since part of
the incumbent's assets has no value elsewhere. Knowing this, potential
entrants may decide not to bother to spend resources and the rent-seek-
ing expenditure may be very low (Rogerson 1982).
We may then expect challenges from outsiders to be less frequent
when insiders have established themselves for some time in particular
sectors. However, this theoretical expectation is not supported by the evi-
dence. Although India's industrial sector was somewhat smaller relative
to the economy than that of South Korea's at independence, big capital-
ists in India were effectively already insiders. Big business houses, such as
the Tatas and Birlas, played a key part in the nationalist struggle against
British colonialism and subsequently enjoyed substantial influence
within the Congress Party. Their views were influential in the construc-
tion of the Bombay Plan of 1944 which established the capitalist class as
legitimate partners of the state in the construction of post-colonial India.
Yet the Indian evidence suggests that the insider status of established cap-
italists was not sufficient to limit the overall rent-seeking expenditures in
the industrial sector. In Malaysia, too, the existence of established capi-
talists did not deter rent-seekers. Here, the established capitalists were
114 MUSHTAQ H. KHAN

Chinese-Malaysians, but their insider status did not deter the most
important group of rent-seekers: the Malay political elite, whose activities
entailed inevitable rent-seeking costs (Jomo 1986).
On the other hand, the incumbent rent-recipients in South Korea in
the 1960s and early 1970s were paradoxically much less credible as estab-
lished insiders. The chaebolhad been tainted by their association with the
Japanese colonial power and their influence over Park's nationalist
regime was correspondingly limited. Consequently, in the early years
they did not enjoy the status of established insiders. Of the top ten chae-
bol in 1965, only three remained in the top ten in 1975. Since then,
greater stability has emerged in the longevity of the top chaebol (Fields
1995: 34-5). Nevertheless, rent-seeking expenditures were probably rel-
atively lower in South Korea in the 1960s and 1970s than in India and
Malaysia. Thus, the sunk-cost advantage of insiders does not seem to cor-
relate well with our perceptions of relative rent-seeking costs in these
three countries. This does not mean that the insider effect is not impor-
tant. But it does suggest that in our countries, countervailing factors,
such as the institutional variables discussed earlier and the power vari-
able to be discussed next, may have pulled relative rent-seeking costs in
other directions.

The distribution of power

The outcomes of rent-seeking games often depend on which of the com-
petitors can inflict the biggest costs on others and hold out the longest in
expensive contests. These attributes can be described in terms of the dis-
tribution of the power to contest, bargain and hold out. The simplest
model in which to see the importance of power is in a rent-seeking con-
test which takes the form of a game of co-ordination with conflict (the so-
called Chicken game). In this two-person game, both players gain as long
as co-ordination is achieved (in this case, through the creation of a
socially useful right), but the benefits are unequally shared since the
right and the associated rents go to one person alone (which is the
source of the conflict). The creation of exclusive property rights is an
example. A society which creates property rights over resources threat-
ened by free access overuse is collectively better off, but the particular
individuals getting the rights gain disproportionately. Each agent is
therefore likely to spend on rent-seeking to become the owner of the
proposed property right (and of the associated rents), but, if everyone
engages in rent-seeking, a clear winner may not emerge, which may pre-
vent the right from being created at all.
An example of the payoff structure in such a game for two agents, or
classes of agents, is shown in Figure 2.11. This shows the payoffs to each
 RENT-SEEKING AS PROCESS 115
agent under each combination of strategies, with A's payoffs being shown
first. Note that only the ranking of the payoffs matters and not the
absolute numbers. The payoffs reflect the net effect of rent-seeking, that
is, they take into account the social value of the rent created as well as the
rent-seeking cost. In this example, the social value of the rent associated
with the property right is 14 units. The rent-seeking cost is 1 unit for each
individual engaging in rent-seeking. The starting point, when the right
does not exist, is shown in the bottom right-hand corner of the box,
where both players avoid rent-seeking and get the fallback payoff of 1
unit each. The right is created if one of the players engages in rent-seek-
ing. For instance, if A engages in rent-seeking and B does not, the right
is created for A. As a result, A gets the lion's share of the added value in
the form of a rent. Even after A's rent-seeking expenditure of 1 unit, A
gets a final payoff of 10 units, while B gets 5. The total social payoff is thus
15 units, compared with the previous payoff of 2, the difference (13
units) being the social value of the new right (14 units) less the rent-seek-
ing cost (1 unit). The individual payoffs are reversed if B engages in rent-
seeking and A does not, but the total social payoff is unchanged. If A and
B both engage in rent-seeking, the social outcome is the worst, since both
incur the rent-seeking expenditure of 1 unit and the right is not created
in this round, since a winner cannot be decided. Their payoffs are now 0
each, giving a total social payoff of zero. Moreover, the rent-seeking is
likely to continue in subsequent periods as long as each player has the
resources to continue.
The equilibrium strategies in this game are indeterminate. If A
believes that B will engage in rent-seeking, A's best strategy is to avoid
rent-seeking. It is clearly in B's interest to make A believe this. Conversely,
if B believes that A will fight, B's best strategy is to avoid rent-seeking.
Each side therefore wants the other to believe that it will fight. If both
believe they have a chance and engage in rent-seeking, the rent-seeking
expenditure is greatest and the right is not created. This is the worst out-
come for society, with a payoff of (0,0). If neither believes they have a
chance, the rent-seeking expenditure is zero, but in this case society is
worse off, with a payoff of (1,1), because the useful right is not created.
The best outcome obtains if only one of them engages in rent-seeking.
The rent-seeking expenditure is then low and a useful rent-outcome is
produced. What actually happens in each round will depend on the rep-
utation of the agents. This is based on their mutual assessments of rela-
tive power, which makes the threat to fight more or less credible to their
opponents (Knight 1992). For instance, if A is very wealthy (and can
therefore hold out for many rounds of the game) or has acquired a rep-
utation in the past for fighting, A's threat to engage in rent-seeking is
likely to be credible. In this case, B may not bother to rent-seek and the
116 MUSHTAQ H. KHAN

Engage in Avoid
rent-seeking rent-seeking

Engage in
0,0 10,5
rent-seeking

Avoid
5,10 1,1
rent-seeking

Figure 2.11 Rent-seeking game involving co-ordination and conflict

right may be created for A after the first round. If both agents are evenly
matched, there may be many rounds of contestation until reputation or
the relative power of one is established, and the right is created for that
person. Thus, evenly matched contestants may spend much more on
rent-seeking than will contestants who are very unequal. Thus, paradox-
ically, an egalitarian society may suffer more from rent-seeking expendi-
tures when possibilities of new rents emerge.
This example shows why institutional rules may be insufficient for
determining the magnitude of rent-seeking expenditures. The same insti-
tution may lead to high or low rent-seeking expenditures depending on the expec-
tations of the contestants. In the example above, political institutions
implicitly allow both agents free access to the rent-seeking competition,
but their rent-seeking expenditure depends on how they believe the
other will act. This belief is likely to be based on the objective relative
power of the agents. If one is clearly much more powerful in the sense of
the ability to engage in contests, the other is more likely to give up. With
some amendments, a model similar to the one above may be used to
explain the extent of secondary rent-seeking expenditures in the context
of insulated state institutions. The rule followed by the insulated state is
that insiders get rights over rents while outsiders do not, regardless of
their expenditure. However, if outsiders can impose costs on both the
state and the insiders by engaging in rent-seeking, their strategy will
depend on their perception of how long their opponents can withstand
this contest. Only if the state and its insider clients are perceived by out-
siders as powerful enough to resist their rent-seeking challenge will the
rent-seeking expenditure be low.
 RENT-SEEKING AS PROCESS 117

Thus, low rent-seeking expenditures under insulated states require

that excluded social actors in these societies believe they will not be able
to change the exclusionary rules by secondary rent-seeking (Khan 1995).
In contrast, if excluded outsiders feel they can win, insulated institutions
can provoke bouts of massive rent-seeking expenditures. This is why a
political analysis is important for revealing the actual or perceived power
of the different groups engaged in the rent-seeking process. This is
clearly an area where the rent-seeking methodology can profitably draw
on the work of political scientists and others studying the relative power
of groups involved in rent-seeking activities in particular countries.

Summary
Our discussion in this section suggests that, by looking at a range of vari-
ables which may determine rent-seeking expenditures, we can go beyond
the early models which claimed that rent-seeking costs would be equal to
the size of the rent. These additional variables improve our understand-
ing of why rent-seeking expenditures varied across our countries, even
though these differences are unlikely to explain performance differ-
ences on their own. Thus, the observation that South Korea and Malaysia
suffered lower rent-seeking costs than India may not be wrong, even
though the differences were probably less dramatic than is often sug-
gested. In the first two countries, centralized rent allocation resulted in
relatively low rent-seeking expenditures not only because of centralized
institutions, but also because of a distribution of power in society which
allowed these institutions to work at low cost. In South Korea, this was
due to the relative weakness of the intermediate classes, in Malaysia
because an implicit social contract was constructed which allowed the
intermediate classes to be centrally accommodated. In India, democratic
rules and a fragmented distribution of social power resulted in higher
rent-seeking expenditures, but these were probably somewhat lower than
in Pakistan and Bangladesh, where centralized institutional allocation
was, for a time, attempted in societies with very dispersed distributions of
power. Thailand was an intermediate case. Despite the attempts of the
military and bureaucracy to maintain centralized allocative rules, the dis-
tribution of power between competing factions meant that rent-seeking
expenditures were very large and centralized allocation did not last very
long. On the other hand, the dispersion of contestation power was less
than in the Indian subcontinent due to the lesser role of the intermedi-
ate classes. Rent-seeking expenditures of all types were possibly as large
as in India but lower than in Pakistan and Bangladesh, as secondary rent-
seeking in the form of violent social contestation of state policies was less
marked. In each case, while the differences in rent-seeking expenditures
118 MUSHTAQ H. KHAN

contribute to part of an explanation of performance differentials, it

should be clear by now that the real differences lay in the rent-outcomes
of the rent-seeking process.

The rent-outcomes of rent-seeking

In Chapter 1, we saw that there were important differences between types
of rents, some of the important features of which were summarized in
Table 1.3. While each rent is a source of extra income for its recipients,
some rents can clearly be socially beneficial, while others are socially
impoverishing. We also saw earlier that there were substantial differences
in the rent-outcomes of rent-seeking in our countries in terms of the
types of rights which were created, maintained or transferred as a result
of their rent-seeking (Figure 2.6). Why should rent-seeking result in the
creation of value-reducing rents in some cases but value-enhancing rents
in others? This question has received relatively little attention in the rent-
seeking literature.
To some extent, this is because it is not easy to provide neat answers to
this question and economists typically dislike messy stories. Nevertheless,
the absence of elegant theory does not mean that the question can be
shelved. Indeed, we would argue that not addressing the rent-outcomes
of rent-seeking makes much of the rent-seeking analysis worse than use-
less, since conclusions based on the input side of the story alone may be
positively misleading. Fortunately, despite the absence of elegant mod-
els, we can draw on a broader literature in institutional economics and
political economy to discuss some of the conditions under which value-
enhancing rents are likely to emerge. Since rights and rents are evolving
over time, we only need to identify the factors which allow value-enhanc-
ing rights and rents to emerge. Figure 2.12 shows that the value of any
new right created by rent-seeking can be decomposed into net gains
(equal to x) for gainers, and net losses (equal to y) for losers. Since the
net social benefit associated with a specific rent or right is precisely the
net gain for the gainers after the losses of the losers have been accounted
for, the net social benefit attributable to a particular right is (x-y).
Figure 2.12 says that the net social benefit associated with any rent can
be decomposed into gains for gainers and losses for losers. This is simply
an arithmetic fact, but it may help some readers to see how this decom-
position works for the simplest case of the monopoly rents analysed in
Figure 1.2 in Chapter 1. When a monopoly rent is created, output falls
from Qx to Q2. The losers are consumers and (previous) producers, while
the gainer is the monopolist. The gain, x, for the monopolist is the
monopoly rent, so x = BCDP2. The loss for consumers is equal to the
shrinkage in the consumer surplus, which is equal to PjFE - P2FD =
P1P2DE. The loss for producers is equal to the shrinkage in the producer
 RENT-SEEKING AS PROCESS 119

Creation or transfer of
particular rights results in

Net gains for gainers = x Net losses for losers = y

V
The effect of the new rights on net social benefits = x-y

Figure 2.12 Decomposing the value of the rent-outcomes of rent-seeking

surplus, equal to PTAE - BAC = PjBCE. T h e total loss of the losers is y =

PjPgDE + PjBCE. T h e n e t gain, (x-y), is BCDP 2 - P ^ D E - P ^ C E =
- C D E , which is the deadweight welfare loss, the (negative) n e t social ben-
efit associated with the monopoly.
In the case of o t h e r rents, too, the n e t social benefit can b e decom-
posed into gains for gainers a n d losses for losers. In the case of complex
rents, such as S c h u m p e t e r i a n rents or learning rents, the eventual n e t
social benefit d e p e n d s o n the conditions which d e t e r m i n e these gains
a n d losses (see Figure 1.7). For instance, the gains from learning rents
d e p e n d o n how well the rents are policed a n d what the recipients have
to d o in r e t u r n , which can d e t e r m i n e w h e t h e r the eventual gains for soci-
ety outweigh its short-term losses. But, in every case, socially desirable
rights are created if, a n d only if, x-y>0 for any new rights a n d rents cre-
ated. Equally, socially desirable rights are maintained if value-reducing
changes (x-y<0) are not introduced. Thus, the creation a n d the mainte-
n a n c e of desirable rents are closely related.
We want to identify the conditions u n d e r which rent-seeking results in
the systematic creation of socially valuable rents a n d rights (where
x-y>0), as o p p o s e d to socially d a m a g i n g rights (where x-y<0). T h e com-
plication in trying to look for general conditions is that these conditions
can d e p e n d o n who is seeking the r e n t a n d how. At the very least, we have
to distinguish between t h r e e scenarios. In the first, individuals (or
groups) privately negotiate changes in rights without involving the state at all.
In the second scenario, individuals a n d groups again take the initiative
in seeking rents, b u t the state ultimately creates, maintains or transfers
rights. Here, individuals or groups attempt to influence the state hy spending
resources in bribing or lobbying, or by using political pressure. Success
now depends on relative influencing abilities, so we have to look at how
120 MUSHTAQ H. KHAN

private players manage to get the state to act in their interest, possibly
against the interests of others. In the third scenario, the state leads initia-
tives to create and change rights according to its own objectives. The state is
no longer passively responding to influence, but is the primary 'rent-
seeker'. Here, the agenda of the state leadership matters, but social
groups also matter because they can support or resist the state. In reality,
rent-seeking is likely to involve elements of more than one of these cases.
For instance, the state may simultaneously respond to pressures from
society while trying to follow its own agenda. Nevertheless, the simplified
scenarios make it easier to identify the conditions under which value-
enhancing rents are likely to emerge.
Table 2.2 summarizes a number of conditions for each of the three
scenarios (labelled A, B and C), which we discuss in turn. Some are nec-
essary conditions; others are necessary in some situations but not others.
It is best to see them as conditions which are conducive for the creation
and maintenance of value-enhancing rights and rents.

A: Rent-seeking through private negotiation

In our first scenario, rents are created through private and voluntary
negotiations between individuals and groups, with the state playing no
role at all. Only one condition is required to ensure that only value-
enhancing rights are created and this is condition (A-i) in Table 2.2.

(A-i) Gainers always compensate losers

Since this condition is usually met whenever we assume voluntary nego-
tiation, nothing more is required. If the gainer has to compensate the
loser by paying him y, the net value to the gainer of the proposed rights
(ignoring any additional rent-seeking cost) is (x-y). Therefore, gainers
will only propose these rights if x-y>0. The net value of these rights for
society (again ignoring the rent-seeking cost) is also (x-y). This is why,
in this case, rights which reduce value for society will never be intro-
duced. For instance, a monopoly would never be created if the monop-
olist had to compensate all potential losers before the monopoly could
be set up.
In practice, this type of rent-seeking is rare. However, an example
would be the creation of voluntary rules governing access to, and use of,
a natural resource such as a fishing lake. Such agreements create de
facto property rights and natural resource rents for the users. These
arrangements do in some cases evolve through voluntary negotiation,
although, in practice, some users are almost always excluded without com-
pensation and the arrangement is therefore never truly voluntarily nego-
tiated. Despite the limited historical evidence for voluntarily negotiated
 RENT-SEEKING AS PROCESS 121

Table 2.2 Conditions for the creation of value-enhancing rent-outcomes

Different rent-seeking scenarios Conditions conducive to the

A: Rent-seeking through private
negotiation, with no role for the state
B: Rent-seeking by attempting to
influence the state
C: Rent-seeking led by the state
creation of socially valuable rents
(A-i) Gainers always compensate losers
(B-i) The spending power of rent-
seekers is proportional to their gain or
loss
(B-ii) The political power of rent-
seekers is proportional to their gain or
loss
- if this does not hold, we require
at least -
(B-iii) Political demands for transfers
can be met with a stable set of
redistributions
(C-i) State officials are value-
maximizers who learn rapidly from
their mistakes
(C-ii) The costs of collecting bribes or
taxes do not differ across groups
(C-iii) The state's institutional structure
allows all costs and benefits to be
internalized
(C-iv) Losers do not have the power to
politically resist the state

changes through rent-seeking, some institutional economists have con-

structed long-run models of institutional change with the 'as if assump-
tion that losers are compensated (for instance, North 1990). A possible
justification for such an assumption might be that losers are unlikely to
give up without a fight, and the more they stand to lose, the more likely
they are to fight. If the conflict imposes costs on the gainers equal to the
loss of the losers, it may be convenient to assume that losers are always
compensated even if in reality they are not. The net gain to the gainers
will, once again, be (x-y). However, such models may be misleading pre-
cisely because the cost inflicted on gainers in the course of a conflict is
often not equal to the potential losses of the losers (see also Khan 1995).
There are some important reasons why in the real world important
institutional changes, such as the creation of property rights, typically do
not happen through processes of negotiation and compensation. First, all
losers typically do not have the institutional basis to demand or bargain
for compensation. In such cases, rent-seeking is by definition not volun-
tary. For instance, when a manufacturer seeks a monopoly right and con-
sumers do not have the institutional ability to demand compensation,
122 MUSHTAQ H. KHAN

the rent-seeking process is not driven by voluntary negotiation. Second,

when large differences in power exist between classes of agents, it makes
no sense for the strong to compensate the weak. Third, even if they were
so minded, their commitment to compensate losers may not be credible.
This is because when the gains and losses take place over time, the com-
pensation would also have to be paid over a period of time. But the insti-
tutional change, once it takes place, will ex post change the bargaining
power of the losers, usually making them weaker than they were ex ante.
The offer of compensation in the future is therefore often not credible.
As a result, compensation is frequently not offered and, if offered, is not
accepted as credible. This explains why relatively few institutional
changes (value-enhancing or otherwise) actually take place through
compensation, which in turn raises serious questions about the signifi-
cance given to this scenario by theorists.

B: Rent-seeking by influencing the state

In the second scenario, individuals or groups in society still take the ini-
tiative in rent-seeking, but now a state exists which enforces rights and
contracts. The creation or maintenance of rents now requires the partic-
ipation of the state. But here the state does not have its own agenda, it
simply responds to social pressures. Social actors seek rents by competing
to influence the state. Influencing the state can involve spending
resources in lobbying or bribing, but it can also include political pres-
sure. Influencing can also extend to groups taking over the state appara-
tus by winning elections or organizing coups. Thus, on the one hand,
rent-seeking through the state involves having the economic ability to
spend resources to influence the state; on the other, it also involves hav-
ing the political ability to organize effectively, as this is an alternative way
in which 'influence' can be exercised.
Ensuring value-enhancing outcomes (that is, those where x-y>0)
requires that influence is proportional to the absolute value of gains and
losses. For instance, if the creation of a new rent implies that gainers
stand to gain $100 and losers stand to lose $50, the creation of this value-
enhancing rent requires that the gainers should have greater (economic
and political) influencing power. This will ensure that the value-enhanc-
ing rent is created. Blocking value-reducing changes requires the same
conditions; in other words, losers should have more influencing power
when the value of their loss is higher than the value gained by gainers.
Thus, the creation and maintenance of value-enhancing rents is assured
if the economic and political power to influence is proportional to the
absolute value of the gain or loss. Since political power is usually not
proportional to potential gains and losses from rent-seeking in most
 RENT-SEEKING AS PROCESS 123
countries, we need at least a third condition to limit the damage from
value-reducing rent-seeking. This says that it should be possible to satisfy
political demands for transfers with a stable set of redistributive flows. If
this condition is not met, the outcome can be even worse. We discuss
each of these conditions in turn.

(B-i) The spending power of rent-seekers is proportional to their gain or loss

With a neutral state which can be influenced, those who can spend more
on lobbying and/or bribing will win, other things being the same. It
would seem at first sight that the amount individuals or groups are will-
ing to spend should bear a close relationship to the absolute value of
their potential gain or loss. This is, after all, the implicit assumption in
the simplest rent-seeking models where rent-seekers spend as long as a
cost-benefit calculation suggests positive net returns from such expen-
ditures. If groups can spend in proportion to their potential gains or
losses, any proposals for value-enhancing new rights will win because
gainers will spend more than losers, and value-reducing changes will be
blocked because losers will spend more than gainers.
Unfortunately, this is not always the case. Condition (B-i) may not
hold because groups are not necessarily always able to spend in propor-
tion to their gains and losses. Rent-seeking may then result in value-
reducing rents being created irrespective of the amount spent on
rent-seeking. In other words, a responsive state may not only suffer from
large rent-seeking costs (as we saw in our last section), but the rent-out-
come of the rent-seeking may now also be value-reducing if (B-i) does not
hold. The most commonly identified reason why condition (B-i) may fail
is the 'collective action' problem popularized by Olson (1965, 1982). A
group which has a larger absolute gain (or loss) may not be able to mobi-
lize more resources if it faces a free-rider problem in collecting contri-
butions from individual members. The severity of the free-rider problem
depends on many things, but the size of the affected group is one factor.
Even if a large group collectively faces a large gain (or loss), it may fail to
raise sufficient resources for lobbying or bribing if there are many free-
riders. Small cohesive groups may be able to raise more, even though the
absolute value of their gain (or loss) is smaller. A responsive state may
then create rents for small, well-organized groups simply because they
can spend more, even though these rights are value-reducing for society.
Condition (B-i) could also fail for a number of other reasons. For
instance, there may be an inter-temporal problem if gains and losses hap-
pen at different times. For instance, future gainers and losers may have a
lower ability to spend than current gainers and losers, because of market
failures which prevent the former from borrowing cheaply on the basis
124 MUSHTAQ H. KHAN

of their future gains or losses. This problem is exacerbated when unborn

future generations are affected by current decisions. Under these cir-
cumstances, value-reducing rights may be created because of these inter-
temporal effects.
The failure of condition (B-i) could explain the existence of ineffi-
cient rents in some cases. For instance, inefficient industries may keep
getting protection or subsidies because, although their gain is smaller
than society's collective loss, the small number of gainers in the ineffi-
cient industry may be able to spend more on lobbying than a diffuse and
large group of losers in the rest of society. Since industrial subsidy-recip-
ients are always a relatively small group compared with the rest of society,
this may seem like a promising route for explaining inefficient rents in
the industrial sector. However, it is not clear that it takes us very far in
explaining differences among our countries.
First, industrial subsidy-recipients in all our countries were a relatively
small group. If anything, South Korea's industrial sector was the most
concentrated, with a few firms dominating each industrial subsector
(Amsden 1989). Therefore, the numbers argument does not explain why
industrial subsidies were efficient in South Korea, since there was as great
a likelihood that firms in South Korea should be able to bribe the state
to have an easy life. Second, there are no obvious reasons why our coun-
tries should have differed substantially in terms of groups raising
resources for rent-seeking on the basis of future gains and losses. It is true
that the South Korean and Malaysian states did plan with a longer time
horizon than the Indian state, but it is difficult to attribute this to the
greater ease with which future gainers and losers in the first two coun-
tries could raise resources to influence the state. Thus, while the evi-
dence does show that learning rents had dramatically different net social
benefits in different countries, these differences are not adequately
explained by the degree to which condition (B-i) held.

(B-ii) The political power of rent-seekers is proportional to their gain or loss

Political power is not always proportional to economic power. Political

power may be exercised through mechanisms ranging from the ballot
box to political demonstrations, riots and civil war. As with raising
resources for spending, the exercise of political power can also involve a
collective action problem, but this is a different collective action problem
from that involved in mobilizing resources. A group which is not able to
raise much in the way of resources may be much more successful in mobi-
lizing themselves or other people to come out on the streets. In develop-
ing countries, in particular, economically superior groups are not always
organizationally more powerful. Indeed, organizational as opposed to
 RENT-SEEKING AS PROCESS 125
economic power is important for understanding the basis of clientelist
politics in many developing countries. Organizational power can allow
political organizers to create and capture rents even when their economic
power is relatively limited (Khan 1989).
Political power is often based on the costs a group can inflict on the
state through political processes, such as votes, strikes or, ultimately, civil
war, if its interests are not taken into account. The creation and mainte-
nance of value-enhancing rights is assured if political power is propor-
tional to the absolute value of the gains or losses of different groups. This
ensures that for any new rent where (x-y)>0, gainers who gain x will have
greater political power than the losers who lose y, and the rent will be cre-
ated. On the other hand, any rents where (x-y)<0 will be blocked. How-
ever, this condition is clearly much more demanding than (B-i). There is
no obvious reason why political power should be proportional to the
absolute value of the potential gain or loss unless political power is ulti-
mately based on the ability to mobilize economic resources. But this link
is precisely the one which is often broken in developing countries. The
political power of different classes and groups is based on such things as
legitimacy, literacy, political organization, and so on, which do not always
have a close correspondence with economic gains and losses.
If we compare our countries, it is not obvious why groups demanding
value-enhancing rights should have been politically stronger in South
Korea or Malaysia than in India. We have already seen that industrial
groups did not enjoy a great deal of legitimacy in the early 1960s in any of
these countries. On the other hand, there were differences in the political
power of unproductive groups demanding redistributive transfers. We
will return to this later. Only in Thailand do we find any evidence of value-
enhancing rent-seeking led by the bargaining power of productive groups
(see 'Patron-client networks' section; and also Doner and Ramsay, and
Rock, this volume). To a much greater extent than in the other countries,
Thai capitalists used their financial muscle to buy political factions which
then provided bargaining power within and outside parliament. The
rather exceptional role of capitalists in Thailand in controlling political
factions resulted in a much greater correspondence between political
power and calculations of gain and loss through changes in rights and
rents (condition B-ii). This in turn ensured that, for a time, rent-seeking
through the state produced value-enhancing outcomes in Thailand.
Capitalist-led rent-seeking in Thailand proved to be much more dam-
aging in a period of rapid globalization of financial flows in the early
1990s. When virtually limitless supplies of cheap funds became available
in global markets, the crude link between the economic productivity of
rent-seekers and their political power was fatally broken. If cheap capital
is available in large blocks for speculation, speculators in a decentralized
126 MUSHTAQ H. KHAN

and competitive clientelist system can acquire rent-seeking power on the

basis of borrowing, and they could drive the rent-seeking process even
though it was no longer value-enhancing. In the short run, the specula-
tor's bets can even be self-fulfilling, regardless of underlying productivity,
if other speculators are making similar bets on asset appreciation. The
financial and property speculation in Thailand in the mid-1990s certainly
suggests that something like this was happening. Paradoxically, therefore,
globalization may have contributed to the collapse of condition (B-ii) in
Thailand, opening up the possibility of value-reducing rights rapidly
emerging through capitalist-led rent-seeking. This possibility means that
Thai rent-seeking will have to be much more carefully regulated in the
future if its openness to global markets is to be maintained.
Unlike Thailand, there is little evidence that value-enhancing rent-
seeking in our other countries was driven by the greater political power
of productive groups. But this does not mean that the distribution of
political power was unimportant even in these countries. Political power
provided the basis for negotiating redistributive transfer rents. Redis-
tributive rents were least in evidence in South Korea, but, in India and
Malaysia, intermediate classes were driving value-reducing rent-seeking,
which was particularly damaging in India. When redistribution is taking
place through the exercise of political power, condition (B-iii) is
required for the emergence of value-enhancing rents.

(B-iii) Political demands for transfers can be met with a stable set
of redistributions
We saw in Chapter 1 that rents based on transfers can have negative effi-
ciency and growth implications. But are some transfer rents worse than
others? Since transfers can be the basis of primitive accumulation, they
can play an essential role in the transition to capitalism. Here, we will
only concentrate on transfers to non-productive groups, in particular to
groups led by intermediate classes, who play, as we saw earlier, an impor-
tant role in many of these countries. If transfers to these groups are being
continually renegotiated, the result is an unstable set of transfers. Such a
continuous renegotiation of transfers is most likely when there are more
potential groups demanding redistribution than can be satisfied given
the resources available. When this is the case, the negative effects of
transfers may be much greater.
One reason is that rent-seeking costs will be high if excluded groups
continue to contest, as already discussed. However, there are also likely
to be effects for rent-outcomes. First, the negative incentive effects on
other sectors are likely to be higher if the transfers grow over time to
accommodate further groups. A growing and shifting set of transfers will
 RENT-SEEKING AS PROCESS 127
be associated with negative incentive effects which can shrink value-
enhancing activities in the rest of the economy. Second, there is likely to
be a more subtle effect. Remember that unstable transfers most likely
reflect an excessive number of groups, all of whose demands cannot be
met. When this is the case, the unstable pattern of transfers is a reflection
of the large number of potential groups with political power. Under such
circumstances, it becomes increasingly likely that rent-recipients else-
where in the economy will develop alliances with dissatisfied groups with
political muscle which have not yet been accommodated. These political
alliances can then be used to protect value-reducing rents when they are
attacked by the state or by groups who suffer damage.
Monopoly rents are more likely to persist under these conditions
because their beneficiaries are likely to share these rents with political
factions in exchange for their support. Similarly, rents for learning are
more likely to become inefficient if their recipients share them with
political factions in exchange for their support in protecting these rents
when the state tries to withdraw them. We have seen that, while South
Korea suffered the least from redistributive transfers, the Indian sub-
continent suffered the most. Rent-seeking in the latter was dominated by
unstable patterns of redistributive rents which reflected the relative size
and organizational power of its intermediate classes. This can provide at
least part of an explanation for the persistence of monopoly rents and of
inefficient learning subsidies which effectively became monopoly rents
for many industrialists. The failure of condition (B-iii) can thus play a
potentially significant role in explaining poor industrial performance in
some countries (Khan 1989, 1999).
In contrast, in Malaysia, despite the presence of a large intermediate
class demanding redistribution, their demands could be met by a stable,
centralized set of transfers, and condition (B-iii) was met. The stability
and degree of centralization of the pattern of transfers reflected the
somewhat weaker position of Malaysia's intermediate classes relative to
the state, as well as the much greater availability of resources to redis-
tribute from both domestic natural resources and a relatively well-devel-
oped capitalist class. This allowed redistributive demands coming from
its intermediate classes to be met through a centrally negotiated social
contract. We have seen that this stable arrangement had desirable effects
for rent-outcomes. By accommodating most dissatisfied groups centrally,
their political power was not directed to protecting inefficient rents, at
least during the early years following the 1969 social contract.
Thailand is an exception since, although it was a good performer, its
redistributive transfers were neither stable nor uncontested, so that con-
dition (B-iii) did not hold. Thailand was similar to India in this respect.
Both countries had decentralized variants of clientelism. However, the
128 MUSHTAQ H. KHAN

difference was that, in Thailand, capitalists were in control of significant

chunks of these redistributive coalitions and used their political power to
compete for rents through the political process. Thus, Thailand fulfilled
condition (B-ii) to a greater extent than any of our countries, and cer-
tainly India, even though condition (B-iii) held only weakly if at all.

C: Rent-seeking led by the state

In our third scenario, the state acts as an agency in its own right in creat-
ing, maintaining or transferring rents. The magnitude of the rents which
the state can capture for its own purposes is an important consideration
in determining its decisions during the rent-seeking process. The impor-
tant variables determining the types of rents produced now include the
motives of decision-makers within the state, the transaction costs they face
in collecting payoffs, the organizational structure of the state which deter-
mines which costs and benefits are accounted for, and the power of indi-
viduals or groups in society to resist changes which hurt them. A different
set of conditions is now relevant for value-enhancing rights to emerge.

(C-i) State officials are value-maximizers who learn rapidly from their mistakes
The intentions of state leaders now clearly matter. This condition is
important because state leaders may sometimes have totally non-eco-
nomic objectives. As an extreme example, they may believe that the goal
of state policy should be the acquisition of cultural or racial purity, even
if it impoverishes eveiyone. However, even the most insulated societies
have not been so insulated that they are untouched by economics. Pow-
erful mechanisms operate, forcing leaders to give economic objectives
some importance, even if they did not do so initially. For instance, there
may be pressures from domestic groups who aspire to better lifestyles, or
military threats from economically advanced neighbours. Nevertheless,
the less important economic rationality is for state officials, the less likely
it is that value-maximizing rights and rents will be created by
autonomously acting states. If value-enhancing rents are to be created,
state officials have to be value-maximizers. It does not matter whether
they wish to maximize value to extract bribes for themselves or to maxi-
mize social welfare. Even if they are only selfish value-maximizers, as long
as the other conditions hold, there is a good chance that they will maxi-
mize social value simply to extract larger bribes.
However, it is not enough that state officials want to be value-maxi-
mizers. They must also have the ability to learn from their mistakes. If
they do, the long-run effects of mistaken beliefs may be minor. On the
other hand, if they suffer from long-term cognitive failures, this can
 RENT-SEEKING AS PROCESS 129
cause persistent performance failure. Some institutional economists
believe that cognitive failures must play an important part in explaining
long-run performance differences (North 1995; see Khan 1995 for a cri-
tique of this argument).
In comparing the leaderships in our countries, we have to be careful
not to fall into the trap of attributing the performance of the economy
to the ex post quality of its political and bureaucratic leaders. For instance,
it may seem plausible to compare the qualities of the bureaucracies in
our set of countries today and conclude that India suffers from an
obstructive and unimaginative leadership. Nevertheless, would we have
said this ex ante, say in 1950? The early leadership of the Congress Party
in India included modernizers like Nehru, who were strongly committed
to industrialization and modern technologies. The Indian Civil Service,
which the country inherited in 1947, was also a relatively competent
bureaucracy by developing country standards.
Although Indian policy-makers in the 1960s appeared less keen to cap-
ture world markets than their South Korean counterparts, once again, we
have to be careful about cause and effect. Chakravarty (1987: 16) argues
that, in India, state support for export-oriented textile industries was polit-
ically difficult since it would have meant supporting one regional group
of capitalists against others. Given the ability of powerful excluded groups
to organize opposition, this strategy may not have been politically viable
for the Indian state at that time, even if it had wanted to maximize the
growth rate. Indeed, agencies within the Indian state were aware of why
their industrial policy was going wrong very early on. For instance, an
internal committee of the Indian state, the Dutt Committee, reported as
early as 1969 that industrial policy was failing because the state could not
discipline poor performers and could not re-allocate resources rationally.
Since Indian state leaders were clearly aware of what was going wrong,
the creation of value-reducing rents and the adoption of welfarist ideolo-
gies which justified them may have reflected political constraints rather
than being independent variables which caused poor performance.
Equally, the economic take-off in South Korea and Malaysia was not pre-
ceded by wide-ranging changes in the ideologies and objectives of their
bureaucracies. Rather, it was associated with political changes which made
new policies and institutions possible, which in turn allowed new accu-
mulation strategies. Individuals did matter, but they only succeeded when
they could implement policies because they were consistent with the bal-
ance of forces in society. Thus, the apparently value-reducing objectives of
bureaucrats and politicians can often be a dependent rather than an inde-
pendent variable. To the extent that this is the case, we should be careful
not to explain differences between countries in terms of the cognitive fail-
ures of their leaders.
130 MUSHTAQ H. KHAN

(C-ii) The costs of collecting bribes or taxes do not differ across groups

A selfish value-maximizing state may create value-reducing rights which

enrich itself rather than society. This possibility is much reduced if the
state has a long time horizon (see condition C-iv below) and if it does not
face different costs of collecting bribes or taxes from different groups,
which we now discuss. Consider, for instance, a situation where this con-
dition does not hold, such that, for a value-reducing rent where x-y<0, it
is easier to extract bribes from the gainers (who gain a small amount x)
than from the losers (who lose a large sum y). If the state can extract a
bigger bribe from the gainers than from the losers, the value-reducing
right and the associated rent may be created. If, on the other hand, there
is no difference in the cost of collection, the losers would be able to block
the right by being willing to pay more than the gainers to veto the
change. Thus, differential transaction costs can lead to the creation of
inefficient rents by states (North 1981). Of course, if the state is altruistic
anyway, this condition is not necessary. But, even if state leaders are self-
ish, this ensures that value-reducing rents are blocked.
This condition is unlikely to hold in full measure anywhere since the
collection of bribes often requires costly investments in building contacts
and, paradoxically, in building trust. It is also cheaper to collect a large
bribe from a single person engaged in a large project (preferably involv-
ing the import of large capital equipment which can be over-invoiced)
than to collect many small bribes from a large number of people. This is
why corruption often results in the allocation of rights to a few cronies of
the regime, even when they are value-reducing for society. If officials
could auction all proposals, rights would be allocated to the highest
value-adders, and value-reducing proposals would be stopped by the
bribes of potential losers. Of course, the transfers involved would have
secondary implications for incentives and investment, and in any case a
state which publicly declared itself to be open to all offers would soon
lose all legitimacy. Nevertheless, if the costs of bribe and tax collection
vary significantly across groups, it is more likely that value-reducing
rights will be created and maintained.
There is no obvious reason why the transaction costs of collecting
bribes and taxes should have varied more significantly in some of our
countries than in others. Individual businesspeople in all our countries
had close relationships with state officials. In all countries, industrial poli-
cies favoured the creation of large capital-intensive plants. Collecting a
share of the rent from the relatively few businesses operating such plants
is cheaper in transaction costs. It may be that large plant technologies
were favoured precisely because of the transaction cost advantage of
extracting bribes from large capitalists. India had the most deliberate
 RENT-SEEKING AS PROCESS 131

strategy of promoting small-scale enterprises, partly because of Nehru's

political compromise with Gandhi's petty-bourgeois constituency. Large
numbers of smaller firms may have made efficient corruption more dif-
ficult in India, but the performance of India's large plants was as bad or
even worse than that of its medium and small plants (Little et al. 1987).

(C-iii) The state's institutional structure allows all costs and benefits
to be internalized
For the state to create rents which add to net social benefits, its calcula-
tion of the costs and benefits associated with the proposed change has to
coincide with the actual social costs and benefits. In the language of
economists, there should be no externalities: all costs and benefits have
to be internalized. There may be many reasons why this may not happen;
for instance, the differences in collection costs discussed earlier may lead
the state to ignore some costs or benefits. Here we will look at a specific
factor which can prevent internalization: the institutional structure of
the state itself.
If the state is fragmented into a number of agencies each trying to
maximize bribes for itself, the outcome may be worse than under a cen-
tralized state. This is because the fragmented agencies are not able to
look at the bigger picture and internalize all the effects of their separate
decisions. An influential model of the negative effects of state fragmen-
tation is Shleifer and Vishny's (1993) model of corruption. They assume
that the state only creates value-reducing rights, such as licences to
import restricted items. These restrictions create monopoly rents for
licence-holders and income for the state in the form of bribes, but they
reduce net social benefit. The only question for Shleifer and Vishny is
the bribe price which is charged for each right and the quantity of restric-
tive rights which are supplied under different institutional structures.
Nevertheless, since the quantity of restrictive rights produced is an aspect
of the rent-outcome, their analysis is a useful starting point, although
some of their conclusions can change when we look at states creating
value-enhancing rents.
Keeping in mind that they assume that the state only creates value-
reducing rights, they argue that a very fragmented state structure is the
best. A totally centralized state with a high degree of co-ordination is next
in terms of desirability. But, paradoxically, an intermediate situation with a
semi-fragmented state structure and limited co-ordination is the worst.
The optimality of the very fragmented structure follows from their assump-
tion that a no-rent economy without state intervention is the most efficient.
If many state agencies compete with each other to sell the output-reducing
restrictions (such as licences to import or produce particular items), the
132 MUSHTAQ H. KHAN

bribe 'price' of these permits falls, eventually to zero, and producers can
buy as many of them as they need. Restrictions effectively disappear, since
if anyone can buy at zero price the 'exclusive' right to import, effectively
anyone can import. An efficient market outcome then emerges. But we
have argued that states can also create value-enhancing rents. A totally frag-
mented state will not be able to create value-enhancing rents either, say
through property rights over scarce resources or targeted learning rents. A
very fragmented state may therefore not be optimal in a world where value-
enhancing rents exist.
An intermediate level of state fragmentation generates the worst out-
come in their model. Here, each state agency supplies one of a number
of restrictive rights to produce or import, but these are collectively
required to produce a final product. For instance, the rights to import
steel and glass are supplied by separate agencies, but factories need to
have both. A 'prisoner's dilemma' problem emerges because each
agency takes the quantity of rights supplied by the others as given, while
attempting to maximize its own take. Thus, the agency supplying permits
to import glass takes the existing import of steel as given and sets a price
for glass import permits to maximize its bribe. In the same way, the
agency supplying steel import permits takes the imports of glass as fixed.
They do not realize, particularly if they are playing this game just once,
that if each pushes up the price of ^permit, this will reduce the demand
for the other permit, which will eventually lower demand for its own per-
mit. The outcome is that the bribe (or price) demanded for each restric-
tive right is set too high. Compared with the previous case, many fewer
permits are sold and overall productive activity is correspondingly lower.
This problem is reduced if the state is totally centralized, and all agen-
cies come under a master agency which jointly sets the price of every per-
mit. The master agency can then maximize the total bribe by co-ordinating
the 'price' of each restrictive right. This will typically involve setting the
price for each permit at a somewhat lower level which takes into account
the effect on the demand for other complementary rights. While the mas-
ter agency is only concerned with maximizing the total bribe, its co-ordi-
nation nevertheless has the nice effect of increasing value for society. This
is because the level of each bribe is now lower, more permits are sold than
in the second case and, therefore, the level of productive activity in the
economy is higher, and closer to the perfectly competitive situation
(Shleifer and Vishny 1993). Effectively, each agency is now forced to 'inter-
nalize' the cost it imposes on other agencies by charging too high a bribe.
Thus this institutional structure internalizes more (but not all) of the costs
of bribe collection and the resulting outcome is somewhat closer to the
social optimum.
This model may seem to explain why South Korea, say, which appar-
ently had more centralized state agencies, also had less damaging forms
 RENT-SEEKING AS PROCESS 133
of corruption than countries in the Indian subcontinent. But, on closer
inspection, the model has a number of problems. Shleifer and Vishny are
talking about the institutional structure of agencies. The failure of state
agencies to co-ordinate is more often the result of the dispersed political
power of the rent-seekers affected by the state. For instance, it is possible
for states with formally centralized institutional structures to behave in a
fragmented way if, for instance, powerful but dispersed interest groups
can prevent co-ordination by state agencies. Thus, institutional central-
ization is not sufficient for co-ordination. The Pakistani state in the early
1960s, for example, was institutionally as centralized as the South Korean
state, but it was far less successful in co-ordinating agency actions.
Moreover, states whose formal institutional structures appear to be
fragmented can sometimes behave in a co-ordinated way, particularly in
repeated games. Shleifer and Vishny's analysis is of a one-shot game,
which is particularly inappropriate for modelling state-society interac-
tions. Institutionally fragmented agencies could begin to act in a co-ordi-
nated way in a repeated game provided the payoffs from co-ordination are
large compared with the payoffs from non-coordination, the time dis-
count of officials is sufficiently low so that they do not ignore the future
completely, and most importantly, the agencies are not involved in pro-
tracted political conflicts over how the spoils should be shared. Thus,
institutional centralization may not even be necessary for co-ordination to
emerge in repeated games. In fact, even in South Korea, the centraliza-
tion of the state was not absolute. There were different agencies, such as
the Economic Planning Board, the Ministry of Finance and the President,
making decisions, but, in a repeated game, their decisions were effectively
co-ordinated. The agency structure which concentrated key decisions in a
small number of agencies in South Korea offers, at best, a partial expla-
nation of its good co-ordination. More important was the distribution of
power between the key players in its rent-seeking game, which allowed co-
ordination to be effective and made South Korea significantly different
from other institutionally similar competitors.
Finally, the Shleifer and Vishny model takes as its benchmark the neo-
classical model of efficient competitive markets with no rents and no
intervention. In reality, states can and do create value-enhancing rents as
well. The optimal institutional structure of the state, when we allow for
this possibility, is more problematic. If sectors and projects are techno-
logically complementary, innovation and learning may be accelerated if
the structure of rents is centrally co-ordinated (Aoki et al. 1997: 6). This
is because, in this case, each project has large external benefits for com-
plementary projects, and net social benefits will be higher if investments
in these projects are co-ordinated. In this case, too, centralized states
have an advantage in creating value-enhancing rents compared with frag-
mented states (although very fragmented states are no longer desirable).
134 MUSHTAQ H. KHAN

In fact, South Korea in the 1960s followed this type of technology trajec-
tory. Its relatively centralized state structure would have helped state offi-
cials to internalize more of the external benefits of learning when they
were determining the allocation of rents for learning. This is a very dif-
ferent story from the one described by Shleifer and Vishny, even though
there is a superficial similarity in the conclusion that centralized states
produced more efficient rights by internalizing external effects. In either
case, South Korea's state structure satisfied condition (C-iii) and con-
tributed to the internalization of all relevant costs and benefits.
In contrast, if technologies are small-scale, or if projects are substitutes,
too much central co-ordination may be counter-productive. It may lead to
large and avoidable losses when 'co-ordinated mistakes' are made, for
instance, in the selection of an integrated set of investments which collec-
tively turn out to be wrong. In these cases, since each project has few exter-
nalities for other sectors, the economy may benefit from a more
fragmented set of institutions through which competing value-enhancing
rents are created. This allows greater competition among competing sets of
rent-generating projects, which may be more socially beneficial by maxi-
mizing entry and minimizing risk. This seems to have been the case in Thai-
land under its competitive clientelism (Doner and Ramsay, this volume).
Thus, given the different technology trajectory which Thailand followed,
although its state institutions were more fragmented than those in South
Korea, it did not necessarily contravene condition (C-iii) too seriously, since
its technologies were relatively small-scale, with few externalities.
A range of state structures may therefore be optimal for creating
value-enhancing rights and rents, depending on different technologies
and their associated externalities. Condition (C-iii) simply says that the
institutional structure should be such that all external costs and benefits
of decisions are accounted for. If complementary value-reducing rents are
being created (the Shleifer and Vishny case), a totally fragmented state
is best, but a centralized state will minimize the social damage more than
a partially fragmented one. However, when value-enhancing rents are
being created, a centralized state will be most conducive for value-
enhancing outcomes, but only if technologies are large-scale or comple-
mentary, with many externalities. In contrast, when technologies have
few externalities, there is little benefit in co-ordinating, but there could
be large costs if co-ordinated mistakes occur. In this case, more frag-
mented states with lesser agency co-ordination may be better for creating
value-enhancing rents.

(C-iv) Losers do not have the power to politically resist the state
Our final condition examines the minimal political requirement rele-
vant for this scenario. The state should not face strong political resistance
 RENT-SEEKING AS PROCESS 135
from losers. This condition is usually not identified in the literature, but
is necessary for the creation of value-enhancing rights when the state is
an autonomous actor. However, one consequence of this condition not
holding is widely recognized, and that is the effect on the time horizon
of state leaders. If this time horizon is very short, it is very likely that state
leaders will try to extract resources from the economy by increasing their
share of rents, even if that results in the size of the pie shrinking. If their
time horizon was longer, this would not make sense, since they would be
better off getting a constant share of a growing pie. While the time pref-
erence of state leaders can sometimes be an independent variable (some
leaders are just impatient), it is often actually a reflection of the vulnera-
bility of the leadership. When leaders face very strong opposition from
society, perhaps because they lack legitimacy, their response is often to
make money fast and get out. In such cases, the time preference of lead-
ers is not an independent variable but is determined by the political
instability of the state.
Here, we will examine a more important implication of political resis-
tance. When states face strong political resistance from those who stand
to lose from the creation of particular rents, these rents may obviously
not be created, even if they add value for society. Thus, even if x-y>0, if
losers can politically resist by imposing high costs on the state (described
as 'transition costs' in Khan 1995), the change is unlikely to go through.
Condition (C-iv) clearly has close parallels with condition (B-ii), which
was relevant when different groups were influencing the state. Even if
influence is not involved, powerful losers can still stop change. As with
condition (B-ii), the failure of this condition can either result in value-
enhancing rights not being created, or being created at very high rent-
seeking cost, which in this case is the transition cost which losers can
inflict on the state.
The extent to which condition (C-iv) is fulfilled often depends on the
relative power of the clients of the state. Where its clients are weak, the
state is able to dictate terms. We have elsewhere argued that such a rela-
tionship between a state and its clients is a feature of 'patrimonial'
patron-client networks (Khan 1996a, 1996b). In such a context, the state
may be able to override sectional interests to achieve value-maximiza-
tion. In contrast, where its clients are strong, the state cannot easily hurt
them. This, in contrast, is a feature of'clientelist' patron-client networks,
since now clients call the shots. Condition (C-iv) fails in clientelist net-
works and the state may fail to produce value-enhancing rent-outcomes
because powerful clients are able to resist changes.
Our discussion of patterns of redistributive rent flows, in the earlier sec-
tion on 'Patron-client networks', is once again useful because it helps us
to identify the underlying distributions of power in the countries consid-
ered here. The political isolation of capitalists receiving rents for learning
136 MUSHTAQ H. KHAN

in South Korea made it the country in our sample which most closely ful-
filled condition (C-iv). Value-reducing learning rents could be terminated
without the losers being able to resist these changes politically. The distri-
bution of political power within South Korea provides the best example of
patrimonial patron-client networks in action, certainly during the period
of high industrial policy in the 1960s, 1970s and the first half of the 1980s
(see Figure 2.8). In contrast, the flows between patrons and clients in India
(see Figure 2.7) were an example of clientelist patron-client networks,
where condition (C-iv) broke down most significantly. The state faced sig-
nificant political resistance whenever it attempted to change the allocation
of rights and rents according to any independently defined criteria. There-
fore, to the extent that states in these countries were trying to push their
own developmental agendas, condition (C-iv) suggests that the state would
be most likely to produce value-enhancing rents in South Korea and least
likely in India.
Malaysia was in an intermediate situation (see Figure 2.9). It did have
a powerful clientelist constituency, but it was centralized and did not pro-
vide, at least initially, the incentives for value-reducing alliances between
threatened capitalist interests and clientelist factions seeking payoffs for
their political support. As a result, the political resistance facing the
Malaysian state when it tried to change specific rents was higher than in
South Korea but lower than in India. Thailand (see Figure 2.10) is an
anomalous case because its large numbers of autonomous centres of
power could theoretically have resulted in serious political constraints
facing the state if it had tried to follow an autonomous agenda. But the
evidence suggests that the state in Thailand played a more responsive
role during its high-growth phase, and played a lesser role in taking the
lead in allocating sectoral and firm-level learning rents to accelerate
development. This does not mean that learning rents were not being
allocated in Thailand. Indeed they were, as Rock (this volume) argues.
However, because Thai rent-seeking was predominantly responsive, as in
our Scenario B, its failure to meet all the conditions required for state-
led rent-seeking was less damaging. In contrast, in our other countries,
the more significant leading role of the state and the weaker role of cap-
italist-led rent-seeking make their rent-seeking closer to our Scenario C.

Summary
Clearly, states played an autonomous role in all these countries, the dif-
ference being only in extent and significance. In all of them, the degree
to which conditions (C-i) to (C-iv) held was therefore important. Differ-
ences in ex ante leadership qualities (C-i) and in the transaction costs of
collecting bribes and taxes (C-ii) were less dramatically in evidence
 RENT-SEEKING AS PROCESS 137

across our countries. There were differences in the institutional and orga-
nizational structure of the state (C-iii), but, in most Asian countries,
states were relatively centralized. In some cases, as in the Indian subcon-
tinent and in Thailand, the state behaved in a more fragmented way. This
was only partly due to differences in the formal institutional structure,
and to a larger extent due to differences in the distribution of bargain-
ing power within these countries which allowed different parts of the
state to be captured by competing factions. This brings us to differences
in the political power of potential losers, (C-iv). The evidence suggests
that the potential resistance faced by states trying to impose particular
rent-outcomes varied greatly.
Table 2.3 summarizes the discussion in this section by listing the criti-
cal differences between our countries. While rent-seeking of the type
described in each of our three scenarios was going on in every country,
the balance did vary. The table records the preponderant forms in each
country based on our discussion. Rent-seeking in South Korea during its
high-growth phase in the 1960s and 1970s was very largely led by the
state, as in scenario C. Society-led rent-seeking in South Korea at that
time was not a significant part of its industrial performance story. Most of
the conditions required for value-enhancing rent-seeking held. But the
political condition (C-iv) is particularly important because it differenti-
ated South Korea most significantly from the others. However, by the
mid-1990s, this condition for the effective operation of state-led rent-
seeking may no longer have held, and, in any case, South Korea's indus-
trial policy regime began to be substantially dismantled at this time.
India and Malaysia had state-led and society-led rent-seeking. The
poor performance of India was attributed particularly to the failure of
conditions (B-iii) and (C-iv), which are closely related. The absence of a
stable set of transfer rents in India was a symptom of a distribution of
power which also resulted in strong political resistance to state-led rent
changes whenever this hurt powerful constituencies. The failure of these
conditions distinguished India from Malaysia. But changes in Malaysia's
social and political context meant that by the mid-1990s, the differences
with Indian rent-seeking were becoming less marked. It has to be remem-
bered, though, that by then Malaysia was a much richer country and the
severity of its developmental problems was no longer comparable.
Finally, Thailand had primarily society-led rent-seeking. This was
largely capitalist-led from the 1970s, and the fulfilment of conditions
(B-i) and (B-ii) contributed to value-enhancing rent-outcomes. The glob-
alization and unprecedented financial flows of the 1990s upset the inter-
nal balance which kept political power roughly proportionate to
economic productivity. Foreign capital inflows gave a rent-seeking advan-
tage to speculative capitalists who were primarily interested in short-term
138 MUSHTAQ H. KHAN

Table 2.3 Key conditions explaining differences in rent-outcomes

Country/ region Scenario (s) appropriate Conditions explaining

for modelling dominant difference in
rent-seeking processes rent-outcomes
Indian subcontinent BandC (B-i)-(B-iii) did not hold
(C-i)-(C-iii) partially held
(C-iv) did not hold
South Korea Primarily C (C-i)-(C-iii) partially held
(C-iv) held
Malaysia BandC (B-i)-(B-ii) did not hold
(B-iii) held
(C-i)-(C-iv) partially held
Thailand Primarily B (B-i)-(B-ii) held
(B-iii) did not hold
(G-i)-(G-iii) partially held
(C-iv) did not hold

returns from asset price inflation. The shift in policy-making in favour of

these groups resulted in a self-fulfilling asset inflation for a time but,
inevitably, the bubble finally burst in 1997.
We have drawn on institutional economics and political economy to
identify a number of conditions which could explain differences in rent-
outcomes in a specific group of countries. A look at other countries or
periods may throw up other conditions which are important. We have
also seen that the presence or absence of specific conditions is not
enough to ensure, or rule out, value-enhancing rent-outcomes. Rather, a
mix of institutional and political conditions seems to be required, and
some of these conditions can compensate for the absence of others. The
mix which does or does not work also depends on technologies and global
market conditions. These complexities prevent us from constructing
simple models of the determinants of rent-outcomes. However, we can
identify some conditions which appear to have been important.
This analysis can help to assess the prospects of particular reforms. For
instance, the experiences within the Indian subcontinent suggest that, if
the political settlement cannot be changed, democracy or authoritarian-
ism makes little difference for rent-outcomes. In these countries, con-
structing a social contract which reduces the blocking effect of clientelist
factions must clearly be an important priority. Malaysia suggests one solu-
tion to the problem of constructing a social contract which sustained, for
awhile, value-enhancing rent-outcomes. The South Korean model of the
1970s is unlikely to be useful for countries suffering from clientelist polit-
ical constraints, as the unique political settlement underlying its success
 RENT-SEEKING AS PROCESS 139
is not likely to be reproducible. On the other hand, South Korea may
have more to learn from other developing countries as its political set-
tlement begins to approximate the more typical pattern and political
resistance to state-led rent creation increases. Thailand appears to be a
tantalizing model for many developing countries. Its internal political
balance was also unique, but it was one which a number of developing
countries may eventually move towards. But the success of the Thai rent
system was itself dependent on particular technology and global market
conditions. The challenge for the future is to devise institutional struc-
tures which can manage rents in the typical developing country polity
dominated by strong intermediate classes, where the adoption of some
technologies requires the management of learning rents, and where the
gradual opening up of capital markets introduces new challenges.

Conclusion
Our analysis of rent-seeking as a process distinguished between the input
costs of rent-seeking and the rent-outcomes. While substantial rent-seek-
ing costs were observed in all the countries we looked at, they differed
greatly in terms of the rent-generating rights created as a result of these
expenditures. Conventional rent-seeking models misrepresent the rent-
seeking problem by presenting only one side of the process, the input
side, which eats up resources in rent-seeking costs. We also need to
understand why the rent-seeking process created very different rent-out-
comes in different countries, as these differences explained much of the
differences in the net effects of rent-seeking.
There were differences in rent-seeking costs across countries, but the
institutions which reduced rent-seeking costs varied, depending on polit-
ical conditions. Thus, authoritarian regimes succeeded in reducing rent-
seeking costs in some countries, but, in others, they resulted in higher
rent-seeking costs than in similar countries with democratic institutions.
Similarly, attempts to reduce the competition for rents by reducing the
number of players in the rent-seeking game worked in some countries
and not others. The success of exclusionary strategies depended on the
relative contestation power of the groups included in, or excluded from,
the rent-seeking.
To explain differences in rent-outcomes across countries, we drew on
political economy and institutional economics. We found that differences
in institutional structures often provided an initial explanation for some
of these differences. In addition, differences in the political power of com-
peting groups, and in their ability to resist change, also had considerable
explanatory power. This is particularly important, as political variables
have typically been given little attention in the rent-seeking literature.
140 MUSHTAQ H. KHAN

Furthermore, the rent-seeking process is itself evolving, and there are

important differences in the net effects of rent-seeking over time.
Some of these results have obvious implications for policy. First, the
stress which is usually put on the magnitudes of rent-seeking expendi-
tures is, at best, emphasizing half of the problem. The qualitative data
suggest that the variance in rent-seeking costs is less significant than the
variance in the social value of the rents created by the rent-seeking. Thus,
even if rent-seeking costs could be cut back very substantially in poorly
performing countries, as long as the rent-outcomes continue to be value-
reducing, the impact on performance may be limited. Second, improv-
ing rent-outcomes appears to be not just a problem of getting the
institutions and policies right. The value of the rent-outcomes also
depends on the interdependent effects of technologies, institutional
strategies and the distribution of bargaining power in society. In some
cases, policy can focus on adjusting institutions and technologies to polit-
ical realities. In other cases, responses which seek to directly change the
political reality may be a precondition for achieving better results.
An important conclusion which we draw is that a number of rents, and
the rent-seeking which sustained them, played a critical role in the rapid
development of capitalism in the East Asian countries. Not only was the
creation of rents critical for primitive accumulation and learning, trans-
fer rents were critical for maintaining political stability even though the
economic implications of these transfers varied significantly. The role of
rents in economic development is worth stressing in the aftermath of the
financial crisis of the late 1990s. The depth of this crisis led many econo-
mists to link the immediate economic woes of the region to the systems
of rents and rent-seeking popularly described as 'crony capitalism'. The
implicit counterfactual to 'crony' capitalism is a 'genuine and impartial'
capitalism of free markets, zero rents, fair market-determined returns for
everyone, and a minimal state which only maintains a level playing field.
However appealing such a mythical capitalism may be, our discussion has
been concerned to establish that such a model is not relevant for devel-
oping economies, and perhaps not for any economy. The relevant dis-
tinction is between rent-seeking systems which are developmental and
those which are crippling. The relevant policy question is to understand
how one may transform into the other.
The financial crisis was related to the nature of rent-seeking in East
Asia and some of the interconnections were explored in our analysis.
The immediate cause of the crisis was the role played by speculative cap-
ital flows which were inadequately regulated. The regulatory failure
could have been due to the overconfidence of policy-makers in high-
growth economies, but it could also have been exacerbated by rent-seek-
ing pressures from the beneficiaries of rents in financial markets. We
 RENT-SEEKING AS PROCESS 141
have argued that there were good reasons why such pressures could have
emerged. The possible role of rent-seeking in bringing about the finan-
cial crisis should not, however, take attention away from the many other
types of rents and rent-seeking determining the long-run economic per-
formance of these countries.
The long-run relationship between rent-seeking and growth is of much
greater interest. If growth requires the management of growth-enhancing
rents rather than the abolition of all rents, high-growth countries will
always have rents and will therefore inevitably have to live with rent-seek-
ing. Globalization and liberalization will not change this fundamental
economic problem, nor is globalization or liberalization likely to succeed
if policy-makers attempt to proceed on the basis of inappropriate no-rent
market models. The no-rent model remains compelling not because the
evidence supports it, but because its policy implications are much simpler
to understand. Our analysis suggests that identifying the conditions which
have in the past been conducive for growth is a much more challenging
task. The conditions which allow value-enhancing rents to emerge and
which limit rent-seeking costs vary from country to country because coun-
tries do not have the same political conditions and do not follow the same
technology trajectory. This is where a deeper examination of the histori-
cal evidence is important to warn us against falling for seductively simple
theories. There is no evidence in Asia, possibly no evidence anywhere, of
long-run development taking place on a no-rent basis. Instead, the policy
challenge is to construct and reconstruct institutions and politics in devel-
oping countries to sustain developmental rents and rent-seeking while
attacking value-reducing rents and rent-seeking.

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 CHAPTER 3

Rent-seeking and Economic

Development in Thailand

Richard F. Doner and Ansil Ramsay

The Asian economic crisis of the late 1990s has intensified debates over
the consequences of corruption and rent-seeking for economic growth.
The events that began in Thailand in 1997 and spread rapidly to the rest
of the region have allowed critics to say, 'We told you so'. These critics
were able to draw upon a substantial body of economic theory linking
corruption and rent-seeking with poor economic performance. Neo-clas-
sical economic theorists have long assumed that 'clientelism and the
rent-seeking behaviour associated with it are fundamentally inimical to
national economic growth' (Maclntyre 1995: 4). Practitioners of the
public choice school of economics have devoted considerable attention
to the undesirable consequences of rent-seeking. Gordon Tullock, one of
the pioneers of the public choice school of economics, went so far as to
suggest that rent-seeking 'is one of the basic reasons for Asia's backward-
ness. Asian countries have been doing this for a very long time' (Tullock
1980: 25). State-centred explanations of economic growth also assume
that clientelism and rent-seeking are harmful to growth. Much of the lit-
erature on the role of the state in promoting rapid growth in the East
Asian newly industrializing countries stresses the importance of insulat-
ing state officials from rent-seeking.
There are two major problems with explaining Thailand's problems by
focussing mainly on clientelism, corruption and rent-seeking. The first is
that it experienced several decades of sustained, rapid economic growth
prior to 1997. If clientelism, corruption and rent-seeking are so damag-
ing, how did Thailand grow so fast for so long? Second, explanations of
the crisis that focus upon cronyism and rent-seeking do not account for
the suddenness of the Thai economic crisis. They cannot explain why
rapid growth changed to negative growth so suddenly. We do not suggest
that clientelism, corruption and rent-seeking had no role in Thailand's

145
146 RICHARD F. DONER AND ANSIL RAMSAY

economic difficulties. To understand their role, however, it is necessary to

understand the changing context of political power in Thailand in recent
decades as well as changes in the global economy. We shall return to these
matters after we have examined the shortcomings of using clientelism,
corruption and rent-seeking to explain Thailand's economic difficulties.
Proponents of neo-classical, public choice and state-centred app-
roaches believe that rent-seeking leads to waste of resources, discourages
innovation and the emergence of new firms, reduces competition, and cre-
ates conflicts between upstream and downstream producers. It leads to
wasted resources as businesses spend money cultivating favours from gov-
ernment officials. Such activity diverts resources which could be used for
more productive purposes and is therefore termed directly unproductive
profit-seeking behaviour (Bhagwati 1982). Rent-seeking discourages inno-
vation and start-ups of new firms by creating numerous barriers in the form
of permits, licences and tax documents which weigh more heavily upon
new firms than already established firms (de Soto 1989; Murphy et al. 1993:
412-13). Officials reduce competition by bestowing on favoured rent-
seekers monopolistic controls over sectors of the economy and/or various
forms of protection from competition, such as quotas and tariffs. When
officials provide such protection for upstream producers, downstream
firms lose access to low-price, high-quality inputs.
Yet several Southeast Asian countries with reputations for pervasive
rent-seeking experienced rapid economic growth in recent decades.
One possible explanation for their success is that clientelism and rent-
seeking are less pervasive in rapidly growing Southeast Asian countries
than is commonly assumed. This explanation can be ruled out in the
Thai case. There is little question that clientelism and rent-seeking have
been pervasive in Thailand. Analyses in the 1960s of postwar Thai poli-
tics by Wilson (1962) and Riggs (1966) highlighted the pervasiveness of
particularistic, affective relationships between high-status, politically
powerful ethnic Thai political elites and lower-status, politically vulnera-
ble ethnic Chinese business interests, emblematic of clientelism. Chinese
entrepreneurs used clientelist ties to get licences, permits, quotas and
tariff protection. In more recent decades, the political power of Sino-
Thai businesspeople has grown dramatically and clientelism has become
less important to business success, but corruption and rent-seeking
remain prevalent (Laothamatas 1992: 105-8; Laothamatas 1994: 209).
Recent empirical studies find corruption and rent-seeking to be
extremely widespread in Thailand (Mauro 1995).
The presence of rapid economic growth in Thailand, despite exten-
sive clientelism, corruption and rent-seeking, suggests that these phe-
nomena can have different effects upon growth in different settings. In
some countries, they can have strongly negative effects, while, in others,
they do not. In sum, if corruption and rent-seeking can be damaging to
 RENT-SEEKING IN THAILAND 147
growth in some countries, but not others, we need a clearer understand-
ing of what kinds of corruption and rent-seeking affect economic per-
formance in what kinds of circumstances. The first question this chapter
addresses is why they did not have more damaging effects in Thailand.
The chapter begins by examining how Thailand avoided the suppression
of new firms and reduction of competition that are some of the most
destructive consequences of rent-seeking. In many less developed coun-
tries, established, politically influential firms that win competitions for
rents can use requirements for permits, licences and quotas to obstruct
the entry of new firms and suppress competition. This behaviour can
have a considerable, cumulative effect upon a country's economic flexi-
bility and capacity for economic growth (de Soto 1989; Murphy et al.
1993: 412-13; Chang 1994: 30; Zhou 1995: 228).
Our initial emphasis is on the ways in which clientelism in Thailand
helped to facilitate competition from the 1950s through the mid-1970s by
allowing new entrants into economic sectors. As a consequence, rent-
seeking did not have as destructive an effect upon new firms and compe-
tition as it has had in many other less developed countries. Rather than a
blanket endorsement of Thai clientelism as a source of economic growth,
however, our argument specifies a certain state structure and context of
political power which limits the negative consequences of clientelism for
competition and acknowledges the importance of institutions for resolv-
ing collective action problems growing out of competition. Thai clien-
telism facilitated new entrants because of the relative insecurity of its
patrons, on the one hand, and the stable macroeconomic context in
which Sino-Thai businesses operated and prospered, on the other. Vari-
ous public, private and mixed public-private institutional arrangements
enabled Thailand to overcome collective action problems that hampered
sustained economic growth in many other less developed countries.
This chapter explores the impact of clientelism and institutions on
rent-seeking in a particular sector - textiles - that typified and helped lead
Thailand's economic development. We first identify the key features of
the country's national and textile-related growth. We then review the logic
behind our key independent variables and conclude with a note on the
utility of a sectoral focus. Next, we explore the impact of clientelism and
institutions on the evolution of the textile sector. Our concluding remarks
examine the causes of the Thai economic crisis that began in 1997.

Institutions and politics in economic growth

Economic growth in Thailand

In broad terms, economic growth is a series of change outcomes falling
on a continuum of increasingly difficult adjustment challenges. At one
148 RICHARD F. DONER AND ANSIL RAMSAY

end is a country's capacity to maintain profitability in existing sectors

despite cyclical changes such as global or domestic market gluts. A sec-
ond stage is the capacity for structural change or diversification through
the transfer of resources to new sectors, industries or products. Such
diversification includes a wide range of potential shifts - for example,
from a monocultural economy, to one based on the cultivation and
export of several commodities; from cultivation and export of raw mate-
rials, to their processing and export; from agriculture and mining, to
manufacturing; from simple assembly of finished consumer goods, to
manufacture of upstream capital and intermediate inputs; from one
industrial sector, to several; from manufacture for domestic consumers,
to production for export; from export to one market, to export to a
greater number of more demanding export markets.
In principle, such changes involve resource shifts from sectors in
which a country is less competitive, to those in which it has a comparative
advantage or wants to gain one. Regardless of whether such shifts are in
fact consistent with neo-classical notions of comparative advantage, they
do reflect the belief that a higher level of development 'reduces a coun-
try's vulnerability to the risks' associated with its current leading sec-
tor (s), while increasing its abilities to seize greater or safer opportunities
in other sectors and products (Shafer 1994: 11). At the most difficult end
of the growth continuum is the capacity to develop global competitive-
ness in new and higher value-added activities. Here the objective is not
simply to shift into and expand exports in new sectors but also to increase
local capacity for product development.
At the national level, Thailand has progressed rapidly and far up this
hierarchy of economic growth:
• Overall gross domestic product (GDP) growth averaged 7.2 per cent
between 1965 and 1980, 6 per cent between 1980 and 1988, and 9.8
per cent between 1988 and 1991 (Doner and Hawes 1995, Table 6.1:
146).
• Despite severe productivity weaknesses, agriculture (the country's
core sector after the war) grew at an average rate of nearly 4 per cent
from 1960 to 1980, and slowed only moderately during a period of
falling world commodity prices to 3.4 per cent in the 1980s. Through-
out the postwar period, Thailand has remained the world's top rice
exporter and ranks among the leading exporters of tapioca, sugar and
processed fish. This export performance in turn reflects the diversifi-
cation of agriculture since the 1950s.
• The economy as a whole has shifted from agriculture to industry and
services as agriculture's share of GDP declined and national exports
fell sharply since 1960 (Doner and Hawes 1995, Tables 6.2 and 6.3:
147-8). This process accelerated during the 1980s: between 1980 and
 RENT-SEEKING IN THAILAND 149
1995, agriculture declined from 23 per cent to 11 per cent of value-
added in GDP, while industry rose from 29 per cent to 40 per cent
(World Bank 1997: 237).
• The service sector has continued to be prominent, its share of output
rising slightly from 48 per cent to 49 per cent over the 1980-95 period
(World Bank 1997: 237).
• Manufacturing activities have become more diversified. Growth rates
were quite high across different manufacturing subsectors during the
1970s and the late 1980s. And, by the second half of the 1980s, the
shares of manufacturing value were relatively even across manufac-
turing subsectors, with only textiles and food exceeding 10 per cent.
In 1990, food, textiles and garments accounted for 36 per cent of man-
ufacturing value-added (Doner and Hawes 1995: 9-10).
• Exports account for a relatively large share of the economy - just
under 42 per cent of total GDP - and manufacturing has led the coun-
try's export growth. Manufactured goods constituted 6 per cent of
exports in 1965. This figure rose to 28 per cent in 1980 and to 73 per
cent in 1993, while primary exports (fuels, minerals and metals) fell
from 97 per cent to 36 per cent between 1965 and 1990 (Doner and
Hawes 1995: 11; World Bank 1997: 243).
• Textiles have played an important role in this growth. We shall review
other aspects of this industry's performance below. Here, we simply
note two facts. First, the industry accounted for over 20 per cent of
manufacturing GDP from 1987 to 1993. Second, textiles made up
almost 32 per cent of the country's export earnings in 1986 and
roughly 15 per cent from 1987 to 1993 (Textile Industry Division 1995:
9). In fact, domestic over-capacity in textiles fuelled a sharp growth in
textile exports in the mid-1980s. This over-capacity, not the explosion
of foreign investment, seems to have been the key stimulus to the
country's export boom of the late 1980s (Akrasanee et al. 1991).
The Thai economy also exhibits some significant weaknesses. One of
the most significant is that much of its recent export growth has relied
upon labour-intensive industries. Many firms have been slow to upgrade
and move into exporting higher value-added products. The export boom
of the late 1980s was led by only three sectors: machinery and electrical
products, cloth and leather products, and canned foods accounted for
three-quarters of the total increase in exports, with machinery and electri-
cal products making up over 36 per cent of export growth (Brummitt and
Flatters 1992: 3,13-15). Second, as many have noted, the country's growth
is outstripping its capacity to provide critical collective goods, such as edu-
cation and public transportation, while contributing to growing income
inequalities, land shortages, environmental degradation and urban con-
gestion. Finally, because of weaknesses in the supply chain, especially in
150 RICHARD F. DONER AND ANSIL RAMSAY

upstream industries, Thai exports are highly import-dependent. There are

thus questions as to the net contribution of exports to Thailand's income.
The average import content of exports grew 27 per cent during the 1980s
- from 16.9 per cent in 1981 to 23.7 per cent in 1992 (Brummitt and Flat-
ters 1992: 21). Such import-dependence has been a continuing problem
for textiles, since upstream producers have been unable to supply garment
firms with inputs at sufficient quality and price.
We shall return to the problems of collective goods and gaps in the sup-
ply chain later in the chapter. At this point, we turn to the factors account-
ing for the country's successful economic performance, beginning with a
general discussion of the ways in which successful markets operate.

Conditions for effective markets

At a minimum, economic growth requires markets in which agents oper-
ate in a relatively stable macroeconomic environment and face a combi-
nation of potential rewards and punishments. The importance of stable
macroeconomic environments is now uncontested. We shall address this
issue later; for now, our concern is with rewards and punishments. As the
institution that makes and enforces rules, the state is key in establishing
such incentives. First, the state must credibly assure firms that they can
keep what they earn. Firms must be convinced that state officials will not
confiscate private wealth for their own benefit, whether through expro-
priation, heavy taxation or inflationary financing. Lacking such commit-
ments, firms will fail to invest ex ante because of their knowledge that the
insecure environment reduces the benefits they accrue from investments
ex post. States typically make such commitments by establishing clear prop-
erty rights. On the other hand, the state must also convince private agents
that it will not save those that fail to plan well and operate efficiently.
States typically establish the threat of such sanctions through some com-
bination of hard budget constraints and competitive pressure. The for-
mer may take the form of limits on government fiscal transfers to firms
and/or constraints on firms' access to central bank loans - in sum, any-
thing that precludes bailouts and subsidies. Competitive pressure, on the
other hand, can be imposed by lowering entry barriers to new entrants,
whether domestic or foreign. The lack of a credible commitment to
imposing such sanctions encourages firms to engage in behaviour such as
lobbying, bribery and direct political action. Such activities expend
resources, not to increase productive efficiency but to garner rents.
The preceding account is useful in identifying key functions of suc-
cessful markets. What it fails to do is to allow for variation in the institu-
tional means through which such functions emerge. In the neo-classical
version, the state guarantees freedom from arbitrary confiscation by
 RENT-SEEKING IN THAILAND 151
establishing formal property rights. The threat of punishment for ineffi-
ciency emerges from the state not being involved in product markets and
thus allowing a constant stream of new entrants, and imposing hard bud-
get constraints through a central bank independent of societal influ-
ences. The statist literature, drawing on the experiences of South Korea,
Taiwan and Singapore, provides a somewhat different view of market
functions. Rather than establishing clear property rights, the state (to
varying degrees) uses the threat of confiscation to induce performance
and compliance with state guidelines. Competitive pressure results not
from ease of entry by domestic actors, but by state-imposed contests in
which a domestic firm is pitted against foreign competitors by tying its
access to capital, inputs and opportunities to its capacity to produce glob-
ally competitive goods (World Bank 1993: 86). As a result, rather than
hard budget constraints imposed by independent central banks, the sta-
tist package involves an insulated planning agency providing funds to
strong firms in targeted sectors.
The neo-classical and statist models portray successful markets in
which efficient states are either deliberately hands-off or deliberately
hands-on. This leaves out a large number of developing countries which
have experienced significant growth, but whose states are neither all that
efficient nor able to avoid mucking around in the market. These 'soft'
state countries thus compel us to recognize the potential for successful
markets based on a different set of institutions and politics than those
assumed by neo-classical and statist models. Montinola et al. (1995), for
example, point to what they call 'federalism, Chinese style', to account
for the PRC's rapid economic growth since economic reform. In this
arrangement, a law of property and contracts does not exist, but political
reform 'has placed considerable limits on the discretion of the central
government' (Montinola et al. 1995: 51). In addition, competition for
revenues among local governments constrains them from imposing con-
ditions that could scare away revenue-generating firms. This competition
thus acts to encourage new entrants. Finally, declining tax revenues and
limits to intergovernmental transfers impose some hard budget con-
straints. The differences between these competing models of the market
are summarized in Table 3.1.

Thai clientelism under hard budget constraints

The Chinese model opens up conceptual possibilities for other effective
markets under novel institutional and political arrangements. In our
view, the Thai case is such a case. Sino-Thai entrepreneurs experienced
brief, but intimidating, periods of ethnic populism. However, economic
growth began to accelerate after 1960, in part because of protection from
152 RICHARD F. DONER AND ANSIL RAMSAY

Table 3.1 Market types and functions

Market function

Market Impose hard

type Avoid confiscation Allow new entrants budget constraints

Neo-classical Formal property Free entry, state Imposed by central

rights through legal keeps out independent bank
system
Statist Confiscates property Restricts domestic Imposed for some;
of firms failing to entrants; imposes others highly subsidized;
perform pressure through planning agency
'contests' and export provides funds to those
requirements who meet performance
requirements
Federalism, Property rights not Relatively free due Revenue-sharing among
Chinese-style formalized; central to interprovincial provinces limited; local
government competition; fuelled revenue tied to local
constrained by by foreign/Overseas prosperity
political reform, Chinese investment
and provinces by
interprovincial
competition
Thai 'hard Formal property Relatively free due to Imposed by central bank
budget' rights weak; intra-elite fragmentation that is autonomous from
clientelism confiscation rare and ability of new clients state political elite and
due to protection to find patrons; fuelled closely tied to
by patrons by foreign investment commercial banks

confiscation provided to Sino-Thai business clients by political-military

patrons, whether directly or indirectly through patrons' linkages to com-
mercial banks. Such protection also reflected political-military officials'
belief that they were better served by economic growth than by other
means common in developing countries (McVey 1992: 30; Murphy et al.
1993: 413).! Thailand lacked a landed aristocracy, which is a typical
source of largesse for political elites. Its agricultural economy was based
on a rice sector composed of small farmers linked to foreign markets
through ethnic Chinese millers, merchants and bankers, rather than on
a plantation-based agriculture dominated by large landowners. Nor was
the state itself available for exploitation. Partly for historical reasons,
Thailand's central bank and finance ministry developed preferences for
fiscal caution and macroeconomic stability. These preferences were
backed up by two important sources of leverage. Thai macroeconomic
officials presided over a budget process insulated from the influence of
particular business interests and, more importantly, political-military
 RENT-SEEKING IN THAILAND 153

elites and sectoral agencies such as the Ministry of Industry. This auton-
omy was in turn bolstered by close consultation and overlapping interests
between the central bank and finance ministry, on the one hand, and
Thailand's growing commercial banks, on the other. Heavily involved in
agricultural exports (even as they moved into urban manufacturing),
Sino-Thai commercial bankers shared the central bank's preference for
realistic, stable exchange rates and low inflation.2
Our argument thus far is that the Thai political economy provided for
de facto property rights, maintained macroeconomic stability and
imposed hard budget constraints. But this arrangement was, after all, a
clientelist one in which officials had authority over entrepreneurs' abil-
ity to enter product markets. As noted earlier, such arrangements typi-
cally result in inefficient rent-seeking a n d / o r monopolies (Kurer 1993).
Our argument is that, in Thailand, clientelism helped to facilitate com-
petitive market structures because intra-elite rivalries helped to ensure
that aspiring entrepreneurs could find patrons.
To see how this occurred, it is useful to note that clientelism is an
exchange relationship, albeit a particularistic, affective one, between
individuals or groups with clear status differentials. In clientelism,

the client 'buys', as it were, protection against the exigencies of the markets
or of nature or of the arbitrariness or weakness of the centre, or against the
demands of other powerful groups or individuals. The price he pays for it is
not just a specific service but the acceptance of the patron's control of the
(client's) access to markets and public goods, as well as his ability to convert
fully some of his resources. (Eisenstadt and Roniger 1980: 71)

In the Thai case, ethnic Thai political officials had the power and status
to 'sell' access to the means of production and markets to Sino-Thai busi-
nesses who themselves could not operate in the public, political sphere
prior to the 1970s. However, the concept of clientelism as an exchange
relationship also highlights the patron's reliance on the client for various
goods or services. As Eisenstadt and Roniger (1980: 70) note, patrons are
often in precarious positions, especially in 'situations of modernisation or
development, where the relatively high degree of flow of free resources
makes the competition for any specific position intense'. In Thailand,
patrons relied on clients not only for the reasons noted earlier (i.e. lack of
landed aristocracy and hard budget constraints), but also because of frag-
mentation and rivalry within the political elite itself. Such rivalry persisted
even from 1958 through the 1960s, the period during which Field Marshal
Sarit ostensibly centralized the state and ended inter-factional competi-
tion. For one thing, it became clear that state-owned enterprises were
much less lucrative than support for Sino-Thai clients. In addition, spoils
154 RICHARD F. DONER AND ANSIL RAMSAY

sharing, which began as a mechanism for political stability, soon turned

into a channel for competition. The victorious Sarit group allowed various
members of the elite access to lucrative posts in the bureaucracy and mili-
tary. As a result, agencies and ministries competed to extend their influ-
ence by linking up with the private sector. And finally, intra-elite rivalry
intensified after Sarit's death. The spoils of corruption now had to be even
more equally divided among competing factions, 'each of which already
had a good start while Sarit was alive' (Morell 1974: 846).
We suggest that this rivalry among patrons had two beneficial conse-
quences. One, which we do not discuss here, was the discouragement of
capital flight. Intra-elite rivalries meant that networks of supporters were
critical. This encouraged patrons to reinvest money gained through
patronage. As Morell (1974: 635) notes, 'Without money, no network;
without network, no power; and without the power, no money'. More
critically for our purposes, fragmented political patrons eager to obtain
extra-bureaucratic funds helped to facilitate a constant flow of new pri-
vate sector claimants' access to markets. Put simply, an aspiring entre-
preneur could nearly always find a patron.
This argument is not that clientelism or corruption is efficient in gen-
eral. It is rather that the particular type of clientelism in Thailand tended
to expand, rather than restrict, new opportunities. Essential government
goods, such as permits to open factories, could 'be supplied by at least two
government agencies' (Shleifer and Vishny 1993: 606). In short, the
inability of patrons to provide exclusive rights to clients gave rise to the
proliferation of rights. This pattern was, by the way, not limited to upper
echelons of the political-military elite. It was also evident in the Board of
Investment whose allocation of promotion certificates was described as
'extremely promiscuous' (Siamwalla 1975: 38). And broader bureaucratic
fragmentation as well as flows of new foreign investors encouraged it.
Thailand's particular type of clientelism also protected Sino-Thai
entrepreneurs from the most economically destructive form of corrup-
tion. This is one in which 'numerous bureaucrats need to be bribed to
get a government permit, and bribing does not guarantee that some
other bureaucrat, or even the first one does not demand another bribe'
(Shleifer and Vishny 1993: 600). High-ranking military and civilian offi-
cials had strong vested interests in seeing their business clients succeed
economically and could protect them from harassment.
The dynamics of Thai clientelism led to competitive market structures
in several important sectors, ranging from rice to autos, and finally, as dis-
cussed below, to textiles.3 In some countries, a proliferation of new
entrants can lead to excessive entry into protected industries and even
collapse (Khan 1996: 19). This happened to a lesser degree in Thailand
 RENT-SEEKING IN THAILAND 155
because of institutional arrangements that facilitated effective solutions
to collective action problems.

Institutions and collective action

Competitive market structures are necessary, but insufficient, for eco-
nomic growth. Moving to higher levels of growth involves increasing flex-
ibility, in which organizations and individuals adapt their resources and
objectives to changing opportunities and constraints. Flexibility, in turn,
requires addressing a series of adjustment costs. Correcting macroeco-
nomic imbalances by reducing inflationary demand pressures (through
cuts in consumption and/or investment) involves absorption costs. Fric-
tional (or transaction) costs occur when economic agents attempt to shift
resources deployed in and developed for one (declining) sector to a dif-
ferent (growing) sector. As markets are often imperfect, prices are often
sticky and resources frequently heterogeneous and immobile. Thus, a
farmer cannot be converted easily into a hotel worker. Nor can a low-wage
worker be converted instantly into a skilled technician. This last case high-
lights the impact of market failures as well. Shifting low-wage, unskilled
labour to more-demanding, higher-skilled occupations requires costly
training. Because it is difficult for individual firms to capture the benefits
of investments in such training (as newly trained workers leave for better-
payingjobs elsewhere), markets often fail to provide such services. Finally,
flexibility involves distributional costs: adapting to new opportunities
often changes the relative size of productive sectors, thus giving rise to
conflicting groups of winners and losers (Killick 1994: 16-17).
Such adjustment costs typically pit the short-term interests of individ-
ual actors against the broader interests of the group, whether defined as
the industry, the sector or the nation. Put differently, they often constitute
collective action problems. And collective action problems commonly
require institutions for their resolution. In this chapter, institutions refer
to formal 'arrangements for aggregating individuals and regulating their
behaviour through explicit rules and decision processes' (Levi 1990: 405).
Until recently, observers tended to downplay the contribution of institu-
tions in Thai economic growth. The traditional social science view of
Thailand was as a 'bureaucratic polity', in which Sino-Thai business-
people were 'pariah entrepreneurs' dealing with insulated military offi-
cials who, in turn, governed a 'loosely structured social system' (e.g. Riggs
1966). These characterizations captured only part of the Thai political
economy. And, while Skinner's (1958) pioneering work captured the
institutional richness of the Chinese community, scholars generally failed
to link ethnic-based institutions to the country's economic performance.
156 RICHARD F. DONER AND ANSIL RAMSAY

Building on the work of Skinner, as well as of Laothamatas (1992),

Christensen (1993), Hewison (1989), and Rock's chapter (this volume),
our argument is that Thailand is, in fact, rich in institutions which have
been critical to its economic growth. These range from state organiza-
tions (e.g. Bank of Thailand, Ministry of Commerce, Crown Property
Bureau), to private arrangements (e.g. secret societies, clan associations,
family networks, commercial banks, business associations), to more for-
mal public-private arrangements (e.g. commerce ministry participation
in the Board of Trade, finance ministry participation in the Thai
Bankers' Association, National Economic and Social Development
Board participation in the Thai Tourism Authority, joint public-private
consultative committees, etc.). Elsewhere, we have noted the importance
of formal institutions in such key areas as rice exports, financial stability,
tourism development, rural-urban resource shifts, and export promo-
tion (Doner and Ramsay 1997). In this chapter, we wish to highlight the
role of institutions in the resolution of problems in the textile industry.
Two qualifications are in order prior to examining the textile industry
itself. We do not mean to exaggerate the presence and contribution of
institutions to resolving collective action problems in Thailand.
Although we feel that explaining Thai growth requires much greater
emphasis on institutions than most have given them, we also draw atten-
tion to the country's institutional weaknesses and the corresponding lim-
its on its future economic prospects. In addition, our sectoral focus
imposes certain limitations on the generalizability of our findings. It is
plausible, for example, to assume that the institutional requirements for
promoting integration between garment firms and dyers are more
demanding than those for linking rice farmers, millers and exporters.
Nevertheless, our belief is that a sectoral focus will allow a deeper sense
of Thailand's institutional endowment by highlighting the trans-sectoral
presence of some institutions and the narrower impact of others.

The textile and garment sector: a case study

Economic growth in the sector

The Thai textile and garment sector has progressed far up the hierarchy
of economic growth discussed above. Since its beginnings in the early
1950s, it has been transformed from a minor industry capable of pro-
ducing some of the textiles needed for the domestic market into a major
industrial sector producing a range of textile and garment exports for
export markets (see Table 3.2). It has not yet made the transition to the
most demanding stage in the growth hierarchy - the development of
original brand-name manufacturing - and it faces several structural
 RENT-SEEKING IN THAILAND 157

Table 3.2 Thailand: clothing and textile production, 1975-93

Year Clothing (million pieces) Fabrics (million square yards)

1975 488 1,128
1980 722 1,821
1985 946 2,494
1986 1,035 2,633
1987 1,135 2,912
1988 1,227 3,074
1989 1,389 3,469
1990 1,653 3,987
1991 2,005 5,746
1992 2,142 6,312
1993 2,256 6,248
Sources: Suphachalasai 1992 for 1975-90 figures; Textile Industry Division 1995
for 1991-93 figures

problems, but, compared with the textile and garment sectors in many
less developed countries, it has had remarkable success. In 1994, the sec-
tor accounted for 14.5 per cent of Thailand's total export earnings and
23.5 per cent of industrial GDP, and employed over a million workers
(Bangkok Post, 30 December 1994).

Constructing markets in the sector

In the last section, we suggested that formal property rights were some-
what weak in Thailand but that entrepreneurs could protect their prop-
erty rights by finding high-ranking civilian or military officials as their
patrons. They could also do this by securing financial backing from lead-
ers of commercial banks who had their own ties to official patrons. Nei-
ther approach established strong property rights, but both gave a
measure of security from arbitrary confiscation.
One of the best examples of the use of patronage is Sukree Photi-
ratanangkun, who started in the textile business in the late 1940s as the
owner of a small fabric store in Bangkok and eventually became the
owner of the largest textile conglomerate in Thailand in the late 1970s.
Sukree openly acknowledges that he had close ties with military officials
and that their help contributed to the growth of his business (Chanson-
nimi 1987: 38). During the 1950s, he maintained links to both of Thai-
land's major postwar military factions - the Plaek Phibunsongkram and
Sarit Thanarat groups. One of Sukree's patrons was Chamnan Panchat,
the son-in-law of one of the most powerful members of the Sarit faction
and a major figure in the Union Bank. Through contacts in the military,
158 RICHARD F. DONER AND ANSIL RAMSAY

Sukree was able to take control of a spinning and weaving mill formerly
owned by the government and to become the sole supplier of blankets to
the army in 1959. He used these assets to establish joint ventures with
Japanese and European textile firms in the 1960s and rapidly created an
integrated textile group with upstream, midstream and downstream
capabilities (Saengthongkam 1987: 72; Doner and Ramsay 1993: 694).
Throughout this period, Sukree's firms had links with powerful military
men. His Thailand Textile Industry Co. Ltd, for example, included
General Krit Sivara and Air Chief Marshal Boonchu Chantarubeksa as
members of the board (Morell 1974: 1021).
Other textile firms were established in the 1950s by commercial
bankers who had links to military patrons through their banks. Bangkok
Weaving Mills was established in 1950 by the Assakul family which owned
Ocean Insurance. Thailand Knitting Factory Ltd was established in 1955
with the backing of U Chu Liang of the Bangkok Metropolitan Bank.
Both Luckytex Ltd (1960) and Thai Durable Textile Co. Ltd (1960) were
started with the backing of Chin Sophonpanich, founder of the Bangkok
Bank (Suehiro 1985: 3-46).4By 1960, there were twenty textile compa-
nies in Thailand founded by sixteen different groups of investors
(Suehiro 1985; Muscat 1994: 117-18).5
Property rights were strengthened in the 1960s when the new Sarit
Thanarat government adopted policies to promote import-substitution
industrialization. To encourage investment, the government passed the
Investment Promotion Act of 1960 that guaranteed that the state would
not nationalize promoted firms or create state firms which would com-
pete with private firms.6 Thai textile firms strengthened their property
rights further by forming joint ventures with major Japanese textile com-
panies that began investing in Thailand in the 1960s. The Thai firms that
formed these joint ventures had grown large enough to be attractive
partners to the Japanese because of property rights assured through
clientelism. As noted above, Sukree Photiratanangkun began produc-
tion with links to powerful military patrons, as did Praman Adireksan.
Both went on to build major textile groups through joint ventures with
Japanese firms (Suehiro 1985: 3-47, 48; Suehiro 1989: 149-50, 236-9).
Several families who established leading textile firms between 1946
and 1960 were still among the major textile groups in the late 1970s.
Their early political connections gave them advantages which they par-
layed into joint ventures with Japanese companies (e.g. the Adireksan,
Bhotiranankun, Sinpatanasakul and Assakul families).7
In addition to protecting property rights, clientelism contributed to
competition by lowering entry barriers for new entrants into the textile
industry. Competition among factions in the political elite gave textile
entrepreneurs choices of patrons. Instead of 'monopoly clientelism',
 RENT-SEEKING IN THAILAND 159
which forces entrepreneurs to establish links with a single dominant
patron and often leads to the suppression of competition, Thailand's
'competitive clientelism' allowed a number of competing firms to
emerge.8 Thus, Sukree was able to build a textile empire, even though he
got a later start in the industry than Praman Adireksan. Praman was a
lieutenant general and the son-in-law of the most powerful military
leader in Thailand when he invested in Thai Textile Co. Ltd in 1954. This
company became the core of his textile conglomerate, and 'almost all of
the existing larger and medium-sized weaving factories jointly invested in
this firm' (Suehiro 1989: 150). Yet Sukree was able to begin building his
own textile group in 1957 by making connections with leaders of the
Sarit Thanarat faction and by choosing market niches which did not lead
to direct competition with Praman (Bangkok interview, July 1996) .9
Competitive clientelism also helped lower entry barriers by contribut-
ing to the fragmentation of decision-making in the Thai state. Fred Riggs
was one of the first to take note of the dispersal of overlapping govern-
mental functions among several agencies. While this weakened coherent
policy-making and implementation, it provided 'more employment
opportunities for public officials. If dispersal of functions leads to staff
duplication, well and good, thereby the number of positions is increased!'
(Riggs 1966: 349).
The result was that many agencies were unable to make policies
coherently or implement them effectively. At least four agencies - the
Board of Investment, and the commerce, industry and finance ministries
- controlled trade policy. Five departments in three ministries influ-
enced access to permits and licences. Politically, this pattern of policy-
making allowed patrons in a range of agencies to satisfy particular groups
of supporters (Christensen et al. 1993: 20). Economically, it meant that
the Thai state was strikingly incapable of imposing capacity controls.
Larger, established textile firms have, on several occasions, prevailed
upon the Ministry of Industry to restrict expansion of textile capacity in
the name of preventing overproduction. These periodic bans on expan-
sion of capacity are clear cases of rent-seeking aimed at protecting the
interests of established firms.10 But these efforts have been consistently
defeated by firms who start up production without registering with the
Ministry of Industry in order to free-ride on the rents. In 1974, for exam-
ple, the overnment banned new plants and the expansion of capacity
in spinning, but the number of spindles climbed from 1,094,000 in 1975
to approximately 1,600,000 by the end of 1982 (Srisilpavongse 1983a:
26, 1985: 27;JICA 1989: 1-3). In the mid-1980s, these unregistered mills
accounted for an estimated 30 per cent of production. Starting firms in
this way allowed entrepreneurs '(with adequate information and con-
nections with government officials) to start a business with minimal tax
160 RICHARD F. DONER AND ANSIL RAMSAY

burdens and administrative procedures' (Simon 1994: 234). They were

not burdened with having to acquire the numerous permits and licences
which suppress new firms and innovation elsewhere (Murphy et al. 1993:
412).
Once the firms were in operation, there was a strong revenue incen-
tive for the government to register them as legal firms. Firms that opened
during bans on expansion operated illegally without paying taxes. It was
in the finance ministry's interest to allow them to register as legal firms
because then they would begin paying taxes and contributing to govern-
ment revenues. In 1981 and 1987, the government offered such firms the
chance to register without any penalties for having operated illegally.
Divided responsibilities among and within agencies also helped firms
to expand their capacity. Until 1984, the Ministry of Commerce con-
trolled machinery imports, while the Ministry of Industry was in charge of
capacity. The two ministries did not co-operate, which made it easy for
firms to sneak machinery into the country and expand capacity (interview
with Suphat Suphachalasai, 27 May 1994).11 One of the most spectacular
cases of lack of co-operation among state officials occurred in 1983, when
Sukree Photiratanangkun's Thai Melon Textiles received permission
from the Ministry of Industry to install 125,440 spindles and 1000 looms,
but actually installed an extra 44,800 spindles and 358 looms above the
allowed numbers. The Department of Textiles in the Ministry of Industry
discovered the violation, ordered him to disassemble the additional
machines and threatened him with a jail sentence (Prachachat Thurakit, 21
May 1984: 1, 4). Sukree approached Prime Minister Prem Tinsulanond
for help, met with army commander General Arthit Kamlang-ek, and peti-
tioned the Board of Investment to allow him to keep the extra machines.
The case was finally settled in the Ministry of Industry's Textile Policy
Committee. The committee allowed him to continue operating the spin-
dles and looms, with the stipulation that he had to establish a bonded
warehouse which would use the production of the additional equipment
only for exports (Prachachat Thurakit, 19 December 1984).
Increased capacity, and greater competition, drove prices down, mak-
ing Thai textiles more competitive in world markets. This nullified gov-
ernment efforts to limit capacity to protect the profits of established
textile firms. The Ministry of Industry was unable to enforce policies
which attempted to override market forces by limiting production capac-
ity (Suphachalasai 1989a: 20). The consequence has been high levels of
competition in most sectors of the textile industry.
The exception has been in the upstream, capital-intensive sectors of the
industry, and, even in these sectors, competition has increased over time.
In 1989, the Japan International Cooperation Agency (JICA) expressed
concern that only two firms were making polyester staple. It suggested that
 RENT-SEEKING IN THAILAND 161
the protectionism provided to these firms contributed to high prices for
domestic yarn (JICA 1989: C-27).12 But, as early as 1980, Akrasanee (1980:
25-6) found that the 'concentration of ownership does not seem to have
much effect on prices'. To the extent that oligopoly had been a problem,
it was alleviated in 1992 with the addition of two more producers of poly-
ester staple (Bangkok interview, 22 July 1992). By the summer of 1992, syn-
thetic fibre producers were concerned about too much competition
(Bangkok Post, 30 June 1992: 57). In midstream and downstream parts of
the textile and garment sector, there has been considerable competition,
not only between big, integrated domestic and foreign firms but also
among large, integrated firms and smaller, more specialized firms. It was
this competition in the domestic market that pushed a number of firms
into exports in the early 1970s (Suehiro 1983: 34).
While the state's inability to impose controls led to extensive over-
capacity, it kept entry barriers low, and it helps to explain an important
puzzle in the Thai case: the emergence of dynamic export performance
in textiles and garments despite a protectionist trade regime. As some
Thai economists note, there has been 'water in the tariffs' (Bangkok
interviews, 11 July 1989, 22 January 1993). That is, domestic prices are
often close to cost, insurance and freight prices because of high levels of
competition from domestic rivals, from smuggling, from administrative
irregularities, from market slumps, from temporary lifting of protection-
ist measures and from the threat of such changes (Brimble 1993; Muscat
1994: 149).
Part of the growth of the textile industry can be explained by the ways
in which competitive clientelism contributed to competitive pressures.
Hard budget constraints also helped to convince entrepreneurs that the
state would not save firms which ran into difficulties because of poor
planning and inefficient operation. This was made clear in the early years
of the textile industry when the government allowed G.S. Cotton Mills,
one of the largest industrial firms in the country, to collapse in 1956 with
a loss of 1200 jobs. The company appealed to the government for help
prior to the collapse but was turned down (Hewison 1989: 169). The gov-
ernment has consistently refused to bail out individual failing textile and
garment firms, even though it has helped the sector as a whole through
tariffs, promotional privileges and credit subsidies for exporting firms.
When individual firms have faced difficulties, they have had to turn to
commercial banks for assistance.
In addition to hard budget constraints, Thai textile and garment
exporters have benefited from a very stable macroeconomic environment.
'The exchange rate of Thai currency has been kept close to its equilibrium
rate for the last twenty-five years and inflation has been remarkably low'
(Suphachalasai 1989a: 19). These macroeconomic conditions have given
162 RICHARD F. DONER AND ANSIL RAMSAY

Thai textile and garment exporters a considerable advantage over exp-

orters in other countries that have experienced sharp changes in currency
exchange rates and high rates of inflation. One example is the Swiss textile
industry, which was badly hurt in the late 1970s when the Swiss franc appre-
ciated sharply in value. More recendy, South Korean and Taiwanese pro-
ducers suffered from currency appreciation in 1985. Thai textile and
garment producers benefited, both through more competitive prices for
their products and through accelerated South Korean and Taiwanese
investment in Thailand.

Resolving collective action problems

Low entry barriers contributed to a competitive textile industry, but com-
petition among individual firms, as well as among upstream and down-
stream sectors, has led to major collective action problems. Finding
solutions to these problems has been extremely important for sustained
growth. The industry is 'really five or six industries wrapped up in a single
package', but 'no individual sector can exist without the assistance and
co-operation of the other sectors. And yet due to the unique characteris-
tics and requirements of each sector, they often find themselves at con-
flict ...' (Business in Thailand 1978: 31).13 Rational behaviour from the
point of view of individual producers, or from particular sectors, can be
very damaging for the sector as a whole. Part of the industry's success has
come from its ability to overcome collective action problems that would
have severely hampered its growth if left unresolved. We will examine
three cases where the industry's participants have been relatively suc-
cessful in resolving such problems, and briefly mention two areas where
they have had less success.
The first case of successful collective action was resolving an overpro-
duction crisis in 1970-71.14 A decade of buoyant national economic
growth in the 1960s had fuelled domestic demand for textiles, and
import-substitution industrialization had led to the rapid development
of domestic and Japanese-owned textile capacity. By 1970, Thailand was
self-sufficient in a wide range of textile goods and the domestic market
was saturated. Producers found themselves with excessive stocks and
faced destructive price-cutting as firms competed to sell their products.
The problems were compounded by a flood of cheap textile imports.
The Thai Textile Manufacturers' Association (TTMA) provided the
institutional leadership for a solution to the crisis. Its solution was to help
firms to begin exporting. The main obstacle was that Thai textile costs
were, on average, 30 per cent higher than world prices. It was necessary to
reduce this price differential before exports could become a solution to
glutted domestic markets. The TTMA imposed a five-baht levy on each
 RENT-SEEKING IN THAILAND 163
spindle and used the money to subsidize 'exporters as a "reward" for not
dumping their products in the domestic market' (Yoshihara 1994: 112).
This step still left Thai prices 20 per cent higher than world prices, and
narrowing the gap required government help. The TTMA persuaded the
Bank of Thailand to cut electricity rates and to lower interest discounts on
trade bills of firms that had exported textiles from the commercial rate of
12 per cent to 7 per cent. In addition, it persuaded the government to give
rebates of business taxes and import duties on goods that were used in
exported textiles (Assakul 1990: 14-15; Yoshihara 1994: 112). Finally, the
TTMA established a 'pledge of co-operative implementation of produc-
tion and sales of textile products for export' (Assakul 1990: 19-20).15
The TTMA did not have a well worked-out strategy for leading the tex-
tile industry into export-led industrialization prior to the crisis. The poli-
cies it developed to encourage exports were ad hoc solutions to an
overproduction crisis. However, it was the private sector that actually ini-
tiated the export thrust, got firms organized and pushed the government
to follow suit (interview in Bangkok, 1996). Furthermore, the TTMA
directly linked government support for firms to increased exports. This
market-conforming strategy that emerged from the crisis encouraged
firms to continue exporting. The policies the TTMA had persuaded the
government to adopt, along with Thailand's low wages, made Thailand
highly competitive in international textile markets. They left Thailand
well positioned to take advantage of strong world demand for textiles in
the early 1970s.
This demand was dramatically reduced at the end of 1973 by the
effects of the OPEC oil embargo and war in the Middle East. The indus-
try was also hurt once again by a flood of cheap imports dumped on the
Thai market. By 1975, capacity in the textile industry exceeded demand
by 35 per cent. Once again, the TTMA took the lead in responding to the
crisis, and once again help for firms was directly linked to their perfor-
mance as exporters. The proposed solution was to continue export
efforts but also to reduce capacity to cut supplies in the domestic market.
Since successful exporting required firms to sell below costs, the TTMA
helped by asking the government for central bank export credits, export
rebates and interest rate cuts on letters of credit. The TTMA also co-ordi-
nated a very effective program of getting member firms to cut produc-
tion capacity by 25 per cent of their spindles above 5000 spindles. The
cuts in capacity were monitored by a subcommittee that checked firms'
production without advance warning (Assakul 1990: 44—53). The main
emphasis, however, was on increasing exports rather than on cutting pro-
duction. To encourage firms to export, any firm that exported products
in a given month was allowed to expand capacity by the same amount in
the following month (Assakul 1990: 46).
164 RICHARD F. DONER AND ANSIL RAMSAY

The TTMA took the lead again as the world economy entered a reces-
sion at the beginning of the 1980s and as, closer to home, the border
trade with Cambodia was closed. By the summer of 1981, many members
had stopped weekend operations, stocks were accumulating, and many
firms were losing substantial amounts of money. The TTMA got its mem-
ber firms to agree to reduce capacity from 1.5 million spindles to 1.0 mil-
lion spindles and to cut production by 25 per cent.16 The agreement was
enforced by a committee composed mainly of younger members, whose
smaller, newer firms were particularly vulnerable. This committee went
around to factories to make sure that producers had actually shut down
machines (Bangkok interview, 2 August 1989). TTMA goals were not
fully achieved, but the firms did reduce overall stocks. At the time the
agreement was reached in October 1982, firms had 300 million square
yards of stocks on hand. By January 1983, stocks had been reduced to 280
million square yards and, by the end of the first quarter, had been further
reduced to 260 million square yards (Business Review 1984).17
The other institution that played an important role in alleviating this
crisis was the Bangkok Bank. Chin Sophonpanich, its founder, believed
that the textile industry would be the leader of Thai industrialization,
and his son and successor, Chatri, seemed to share that view (Bangkok
interview, 10 July 1991). The Bangkok Bank was the largest provider of
credit to the industry and had a very strong vested interest in seeing the
firms to which it had loaned money survive. At the end of 1982, Chatri
Sophonpanich called a meeting of major textile producers to end the
ruinous competition which had left many firms facing bankruptcy
(Srisilpavongse 1983b: 30).18 This intervention, along with the actions of
the TTMA, contributed to the reduction in stocks, ended a potentially
ruinous situation for many companies and left them poised for the next
upturn in world demand for textiles.19
Several factors account for the relative success of the TTMA and the
Bangkok Bank in getting firms to limit production. One was the 'encom-
passingness' of both institutions. Encompassing, or multisectoral, insti-
tutions are likely to have greater success in curbing firms' pursuit of
particularistic benefits than single-sector institutions. TTMA member-
ship included both upstream and midstream parts of the textile industry,
and the Bangkok Bank had made loans to different parts of the industry.
It had an interest in helping to preserve and strengthen an entire sector
rather than particular firms within the sector (Olson 1965; Maxfield and
Schneider 1997: 29-30). Second, co-operation was facilitated by a rela-
tively small number of participants. Seventy firms belonged to the TTMA
in 1983, but the four largest groups of firms controlled 49 per cent of the
spinning machines, and their annual sales represented nearly half of
total value-added in textiles (Akrasanee 1980: 24; Suehiro 1983: 33).
 RENT-SEEKING IN THAILAND 165
Third, the TTMA was able to deliver selective benefits to firms that co-
operated with it. In the early 1970s, it had its own funds to help export-
ing firms, and it also gained leverage over firms by providing its stamp of
approval for commercial bank lending. In a number of cases, the
Bangkok Bank went to the TTMA to ask about the financial status of
firms applying for loans (Bangkok interview, 27 July 1989). For its part,
the bank had the advantage of 'a fairly substantial amount of cross-fertil-
isation between the textile industry, the banking and finance sector and
the government' (Tambunlertchai and Yamazawa 1981: 87). This cross-
fertilization contributed to information exchange, reciprocity, credibility
and trust, which facilitated resolution of collective action problems
(Maxfield and Schneider 1997: 7).20
Overproduction became less of a problem in the late 1980s and the
1990s as firms became more familiar with the cyclical nature of demand
and became more cautious about investing heavily in new plant and
equipment (Bangkok interviews, 26 and 28 June 1991). Firms began to
use subcontracting to respond to surges in demand rather than investing
in new plant and equipment (Bangkok interview, 23 July 1992). Over-
production also became less of a problem as firms became more suc-
cessful in finding export markets for their products (Bangkok interview,
8July 1991).
Success in finding export markets depended, however, upon resolving
another collective action problem. Much of the world trade in textiles
and garments is carried out through the Multi-fibre Arrangement (MFA)
rather than through free markets. Through its participation in bilateral
agreements under the MFA, Thailand obtains quotas from importing
countries.21 These export quotas are then allocated to specific firms.22
The collective action problem for Thai exporters was finding some way
of co-ordinating the allocation of quotas. Conflicting interests often hin-
der the resolution of such dilemmas because the choice of any system of
co-ordination will benefit some firms more than others. If firms' owners
persist in pursuing their individual interests, co-ordination may not be
possible at all (Snidal 1985: 932). Even if co-ordination problems are
solved, the solution may prevent start-ups of new firms and limit compe-
tition. Thailand avoided these problems.
The decision was made to allocate quotas to firms based upon their
past export records. This decision clearly benefited established larger
firms that had already become active exporters.23 One example is Saha
Union, which made a concerted effort to build up its exports in the early
1970s. When the quota allocation system was worked out between
exporters and the Ministry of Commerce's Department of Foreign
Trade, firms such as Saha Union were the clear winners. The main fea-
tures of the system are summarized by Siamwalla et al. (1989: 42-3):
166 RICHARD F. DONER AND ANSIL RAMSAY

The system is based primarily on past export performance of the grantees. Just
as the international agreements that Thailand has entered into guarantee her
right to export at least the same amount as it did the preceding year, this right
is transferred to the individual exporting firms. This right is embodied in the
notion of a principal quota. A firm that acquires the principal quota in a given
year and that utilises all of it is then assured the same amount the following
year. The growth rates permitted by the international agreements are then put
into a central pool called the 'residual quota', as are those quotas which, for
one reason or another, cannot be utilised by the principal-quota holder. New-
comers may sup from this trough, but the system that is devised still permits
existing firms a more than fair chance at it.

Larger exporters, who had established a strong record of exports,

received the largest principal quotas when the system went into effect.
They have been further advantaged by the four criteria for allocating the
residual quota - '(1) utilisation of domestically produced inputs; (2)
price per unit; (3) domestic value-added in the exported products; and
(4) duration of time between the order and delivery dates' (Siamwalla et
al. 1989: 42-3). Large exporting firms with integrated fibre, spinning
and weaving plants use more domestically produced inputs and have
higher domestic value-added than small firms (Suphachalasai 1990: 61).
The Thai quota system confirms the expectations of public choice the-
orists that established firms with political clout will be the main winners in
a quota system and that new, smaller firms will be penalized (Murphy et
al. 1993: 412-13; Zhou 1995: 226). To make matters worse, the quota sys-
tem has been tinkered with frequentiy since its inception, partly as a result
of lobbying by firms disadvantaged by the system and partly as a result of
rent-seeking by ministers of commerce. Yet the quota system has not had
the effects which many public choice theorists might have expected. Saha
Union, the firm that received the largest quotas when the system was
established, is one of the most efficient and well-managed textile firms in
Thailand. While the quota system has disadvantaged newer firms, it has
also encouraged them to find markets in non-quota countries. Driven by
intense competition in the domestic market and opportunities for sales
abroad, new small and medium-sized firms which have difficulty getting
access to quotas are forced to seek export markets in non-quota countries.
These firms have been joined by larger exporters who are constrained by
quotas imposed by the United States and the European Community
(Siriwatpatara 1989: 146-53, 191). Consequently, the share of garments
exported to quota markets dropped from 86 per cent in 1976 to 56 per
cent in 1987. Since 1987, the share has dropped even further (Table 3.3).
Finally, success in expanding into new markets has also been the
result of close co-operation between firms and representatives of the
 RENT-SEEKING IN THAILAND 167

Table 3.3 Thailand: clothing exports by type of agreement, 1987 and 1993

Type of agreement Value (million baht) Share (%)

1987 1993 1987 1993
Quota 20,485.7 44,434.0 56.3 48.5
Non-quota 15,887.8 47,113.9 43.7 51.5
Total 36,373.5 91,547.9 100.0 100.0

Source: Textile Industry Division 1995: 26

Department of Export Promotion. Unlike the state officials portrayed in

much of the public choice literature, officials in this department have
helped Thai manufacturers to find new markets and to move into
higher value-added production (de Silva 1994: 31 ).24
Not all of the collective action problems in the industry have been
overcome so satisfactorily. Some have taken a very long time to resolve,
and others have yet to be resolved. An example of the former was a con-
flict between dyestuff producers and downstream manufacturers of tex-
tiles and garments. A 1989 report noted that the textile industry's
'largest bottleneck' was in the lack of dyeing and finishing capacity
(JICA 1989: 1-39). For several years, there were only two dyestuff pro-
ducers in Thailand. Both had received promotional privileges from the
Board of Investment, which had established a surcharge of 20 per cent
on imported dyes. Both also seem to have had very strong political con-
nections.25 Local dyers complained that the dyestuffs manufactured by
the two companies were of inferior quality, and that to get high-quality
dyes they had to import them from abroad and pay the 20 per cent duty.
After years of struggle between the dyestuff makers and downstream
producers, the problem was finally alleviated in 1994 when tariffs on
dyestuffs were lowered.26
One serious collective action problem that has yet to be resolved is the
provision of adequate training for technicians and skilled workers and
other types of technological support. As wage rates have risen, the Thai tex-
tile industry has found it necessary to move into higher value-added prod-
ucts, requiring more advanced machines and workers with greater
technical skills. Firms traditionally dealt with the problem of skill shortages
by recruiting technicians through overseas Chinese networks. But, as the
industry grew, this strategy became less feasible. Some firms initiated in-
house training programs, but these were plagued with a classic free-rider
problem: newly trained workers were quickly hired away by competitors,
thus discouraging firms from training workers. The industry has yet to find
a satisfactory solution to this particular collective action problem.27
168 RICHARD F. DONER AND ANSIL RAMSAY

The financial crisis

Given this success, how did Thailand get into such serious economic dif-
ficulties at the end of the 1990s?28 The broad answer is that state and pri-
vate sector institutional arrangements which had supported growth in
recent decades proved inadequate in dealing with two major changes
occurring in the global economy. The first has been the emergence of
increasing competition for Thai industries from lower-wage economies.
The second has been a massive increase in flows of capital into and out of
countries. Thailand's inability to respond effectively to these two changes
is the major cause of the economic crisis that developed in the late 1990s.
The two changes also raised the costs of corruption and rent-seeking for
the Thai economy. One of the reasons Thailand was not better positioned
to compete economically was its inadequate human and physical infra-
structure. This inadequacy was caused, in part, by corruption and rent-
seeking that slowed efforts to improve education and to respond to the
need for better public transportation. The second was the weakening of
the oversight capacities of the central bank at the same time as Thailand
was liberalizing its finances in an effort to attract flows of global capital.
While Thai institutional arrangements were successful in promoting
rapid industrialization, labour-intensive products such as garments,
shoes, gems and jewellery dominated manufactured exports from 1985
to 1993. The growth rates of these products began to slow during the first
part of the 1990s, and, in 1996, the export growth rate dropped to zero.
Part of this slowdown was caused by cyclical factors, including slower
growth in overall world trade, appreciation of the baht, high domestic
inflation, and devaluations in China in 1990 and 1994. More ominously,
however, there were structural reasons for the slowdown. On the one
hand, Thailand had lost its comparative advantage in labour-intensive
goods after only a decade. Wage rates in such key sectors as textiles were
much higher than in several other Asian countries. On the other hand,
Thailand's lack of ability to manufacture, as opposed to assemble,
medium- to high-technology products was becoming obvious. A 1998
study concluded that, despite its intensive growth during the 1980s, Thai-
land's export structure was closer to that of the Philippines than Taiwan,
Singapore, South Korea or even Malaysia. Thailand had remained an
assembly base whose cost advantage would prove as temporary as its suc-
cess in lower-technology exports. The underlying problem was that its
ability to absorb new technologies and to raise the capacities of indige-
nous firms was 'far more limited than it was in the newly industrialised
countries at a similar stage in their development' (Westphal et al. 1990).
Thailand's more sophisticated manufactured exports came from for-
eign, not domestic, firms; the latter have been heavily oriented to the
 RENT-SEEKING IN THAILAND 169

domestic market and have much lower technical capabilities. While

some firms in various sectors have continued to upgrade technology and
training and to maintain their competitiveness in world markets, too
many companies have not solved the problem of growth in 'volume
rather than in kind'. This problem is epitomized by the closure of Sukree
Photiratanangkun's Thai Melon Textile Co. Ltd and Thai American Tex-
tile Co. Ltd in July 1998. They were closed because they had failed to
upgrade manufacturing equipment, which left them behind competitors
(TheNation, 22July 1998).
The vulnerability of the manufacturing sector was exacerbated by the
financial crisis that hit Thailand in 1997. Ironically, the crisis had its ori-
gins in changes in global capital markets that were expected to benefit
Thailand. These changes made large amounts of investment funds avail-
able that could have been used to upgrade firms' export capacities,
improve infrastructure, and improve the training and education of the
workforce. Instead, they led to disaster. One reason was the way in which
the Bank of Thailand proceeded with financial liberalization in efforts to
attract investment funds from global capital markets. At the same time
that the bank made it easier to borrow funds from abroad, it kept the baht
pegged to the dollar. This led borrowers to assume that the government
'would never leave them holding the bag under devaluation pressure',
thus encouraging large amounts of unhedged borrowing (Passell 1997:
D2). Much of the money borrowed from abroad was not used produc-
tively. A good deal of it went into real estate and industrial sectors where
there was considerable oversupply. Banks were willing to lend money
short-term for speculative long-term investments, in part because money
was so easily available but also because the government had, for all pur-
poses, guaranteed that commercial banks would not be allowed to fail.
The consequences were a bubble economy and a rapidly growing cur-
rent account deficit that reached 8 per cent of GDP in 1995 and 1996.
Currency speculators sensed weakness and began attacking the baht in
late 1996 and, again, during the spring of 1997. The Bank of Thailand
used up nearly all of the country's foreign reserves defending the cur-
rency, and, on 2 July 1997, it was forced to free the baht from its peg to
the dollar. This 'managed float' led to a rapid fall in the baht's value, and,
in August, Thailand was forced to go to the International Monetary Fund
for help. The IMF organized a US$17.2 billion dollar package that
included standby credits of US$4 billion, US$14.5 billion in contribu-
tions from other Asian countries, and US$2.7 billion in structural adjust-
ment loans from the World Bank and the Asian Development Bank
(Ingsrisawang and Yuthamanop 1997). The ensuing year was a disaster
for the Thai economy. The currency crisis spread to other countries in
Asia, and their difficulties, coupled with continuing economic stagnation
170 RICHARD F. DONER AND ANSIL RAMSAY

in Japan, made it much more difficult than initially anticipated for Thai-
land to recover. Large numbers of companies began to go bankrupt,
Thai banks accumulated increasing numbers of non-performing loans,
and the economy experienced negative growth.
Corruption and rent-seeking were not the main causes of the eco-
nomic crisis, but they contributed to it in two ways. The first was by
hampering Thailand's efforts to improve educational and physical infra-
structure to respond to growing competition from abroad. One of the
major impediments to industrial upgrading has been the shortage of
well-educated workers. In 1997, nearly 80 per cent of Thai workers had
only a primary education or less (Terdudomtham 1997). Only 37 per
cent of females and 38 per cent of males in the appropriate age group
were in secondary school in 1993, which ranked Thailand well behind
not only South Korea and Singapore, but also Malaysia, Indonesia, Sri
Lanka and China (World Bank 1997: 226-7). This lag was not caused
solely by corruption and rent-seeking, but it clearly played a role in ham-
pering efforts to improve educational standards. Many politicians see the
ministry as a source of patronage, rather than as an institution for raising
the educational standards of Thai children. Its purchases of books,
school supplies and equipment such as computers provide numerous
opportunities for rent-seeking and corruption, and several past ministers
have taken full advantage of these opportunities. In past decades,
this failure was not especially damaging, because economic growth
depended largely upon exports of agricultural commodities and low-
skilled, labour-intensive industrial products. The ease with which Thai-
land was able to grow on the basis of these kinds of exports undermined
incentives to improve education and perpetuated patronage politics in
the ministry. In the present circumstances, the lack of a more educated
and skilled labour force is a major impediment to upgrading Thailand's
industrial competitiveness.
Corruption and rent-seeking also slowed efforts to provide solutions to
Bangkok's strained transport and telecommunications infrastructure.
Traffic congestion in the Bangkok region made travel very slow, reducing
the number of trips trucks could make between factories, and between
factories and the port. One leading garment exporter noted that, in 1991,
his quality control people spent two hours daily travelling and six more
inspecting garment makers. By 1994, it was the other way round because
of the traffic (interview in Bangkok, 1994). In 1995, at the beginning of a
four-day holiday, traffic backed up bumper to bumper for 60 miles as
vacationers tried to leave Bangkok (Friedman 1996). In an effort to
relieve strains upon telephones and roads, the government began to pri-
vatize infrastructure provision by letting state enterprises give 'conces-
sions' to private companies. The procedures for making bids were open
 RENT-SEEKING IN THAILAND 171
to considerable political manipulation (Siamwalla 1997b: 16). Large infra-
structure projects in the late 1980s included an elevated railway project,
the addition of three million telephones, and other large telecommunica-
tions projects. The way in which the Chatchai Choonhawan government
awarded the contracts for these projects caused considerable criticism and
charges of corruption. The contracts for both the railway project and
the telephone project, awarded during Chatchai's government, were
changed by the military-backed government of Anand Panyarachun in an
effort to create a more transparent bidding process (Phongpaichit and
Piriyarangsan 1994: 44). However, provision of adequate transportation
infrastructure continued to be a problem into the late 1990s, in part
because 'the large potential for corruption revenue has resulted in heavy
political in-fighting' (Phongpaichit 1996: 379). In the past, clientelism did
not involve such large projects and opportunities for big-ticket corruption
because of hard budget constraints imposed by the central bank and the
country's lack of attention to the need for major upgrading. Through the
mid-1980s, technocrats were careful to avoid big-ticket items. Thailand's
need for a major expansion of infrastructure in the late 1980s was a result
of its past virtues and an unexpectedly large increase in demand for infra-
structure as a result of the economic boom.
The second way in which corruption and rent-seeking have con-
tributed to the economic crisis has been by undermining the autonomy
and oversight capacity of the central bank. As noted earlier in the chap-
ter, one of the main reasons for Thai economic success has been the
ability of the Bank of Thailand to maintain hard budget constraints. It
was able to do so for many years under military rule because military lead-
ers gave it a good deal of political autonomy as part of an implicit agree-
ment between high-ranking military officials and the technocrats who
managed the bank. 'The technocrats would not encroach on the sectoral
and microeconomic mismanagement which benefits the political
masters, while the latter would allow the technocrats to keep control over
the macro economy' (Christensen and Siamwalla 1993: 7). The central
bank's autonomy also derived in part from its reputation. Dr Puey
Ungphakorn, the governor of the bank in the late 1950s and in the
1960s, imbued it 'with a spirit of fierce integrity'. Its 'reputation of incor-
ruptibility gave it considerable moral authority and prestige and allowed
it de facto autonomy, overriding its dejure subservience to the Ministry of
Finance' (Siamwalla 1997a: 70). The transition to more democratic pol-
itics that began in the 1980s undermined both the political autonomy
and the integrity of the bank.
Political autonomy was undermined because governors of the Bank of
Thailand became increasingly open to pressure from political leaders
and businesspersons affected by its decisions. This is particularly the case
172 RICHARD F. DONER AND ANSIL RAMSAY

in exchange rate policy. The bank could, and did, push through unpop-
ular devaluations in earlier years, most notably in 1984. By the mid-1990s,
it was extremely difficult for a governor of the bank to do this. There was
enormous opposition to devaluation from the many politically influen-
tial businesses that had borrowed capital denominated in dollars, and
who would be badly hurt by devaluation. In addition, bank governors
were well aware that it had become more common for finance ministers
to dismiss governors than in earlier decades. Thus, when it would have
been very helpful to the economy to devalue the baht at the beginning
of 1997, 'it appears that the Bank of Thailand was reluctant to do so for
fear of political repercussions' (Siamwalla 1997a: 71).
The integrity of the central bank was undermined in 1996 by a series
of problems. The year began with the finance minister firing the deputy
governor for allegedly leaking confidential banking information to
members of the public. A little later in the year, the governor of the bank,
Vijit Supinit, admitted accepting 4000 shares at par value from a finance
company before the shares were listed on the stock exchange. The most
damaging news for the bank's reputation, however, was the way it had
handled problems at the Bangkok Bank of Commerce. This bank had
been in difficulties since 1992, but the central bank had failed to take
steps to address the problems effectively. To make matters worse, it
appeared that the Bank of Commerce had received favourable treatment
from the central bank. Among other violations, it had made large unse-
cured loans to politicians, including members of the cabinet, for a land
purchase scheme. The loans were not repaid, and an accumulation of
bad loans had left it nearly bankrupt. Despite its record of violations, the
Bank of Thailand Fund injected 16 billion baht into the Bank of Com-
merce to save it (Yuthamanop 1996: 18-19; Vatikiotis 1998). These reve-
lations severely undermined the central bank's credibility just as the
country was entering a major financial crisis.
Corruption and rent-seeking in electoral politics will also make it more
difficult for Thailand to emerge from its economic crisis. The first
decades of growth after 1960 were accomplished by simply shifting
resources from agriculture to manufacturing and by using Thailand's
comparative advantage in low-cost manufacturing. To accomplish this,
Thailand had to do three things: assure entrepreneurs that it would not
confiscate their property, allow new entrants into emerging industrial sec-
tors to encourage competition, and impose hard budget constraints.
Thailand's competitive clientelism helped to protect property rights and
to allow new entrants, while a politically insulated central bank main-
tained hard budget constraints. The main collective action problems were
overproduction and resolution of upstream-downstream conflicts.
Now, the challenges are more demanding. In the immediate future,
Thailand faces the daunting prospect of rebuilding a badly damaged
 RENT-SEEKING IN THAILAND 173

banking system, restoring autonomy and integrity to the central bank, and
helping firms to find financing and markets in the midst of an Asia-wide
recession. In the longer term, it faces the difficult task of developing global
competitiveness in new and higher value-added activities. The political and
collective action problems that will have to be overcome are formidable,
and the way in which Thailand has democratized makes the problems even
more formidable. Thailand has moved towards democratic politics with
fragmented, patronage-based political parties heavily dependent upon
rural votes to win office. Provincial constituencies supply over 80 per cent
of seats in the lower house of parliament. To win votes in these con-
stituencies, politicians depend heavily upon the support of networks of
local businesspeople, or chaopho, who are involved in an array of legal and
illegal activities. Some of the chao phohave entered politics themselves and
won election to parliament. The transition to more democratic politics has
increased the power of these provincial leaders and has made them for-
midable competitors with the military, national officials and Bangkok busi-
nesspeople for rents and a share in corruption (Phongpaichit and
Piriyarangsan 1994: 57-98). One of the main prizes in this competition is
control of cabinet seats and the power to allocate quotas, licences, con-
tracts and ministerial funds that comes with the seats. Thai political parties
are, for the most part, groupings of loosely allied leaders and their fac-
tional followers whose main goal is to obtain enough parliamentary seats
to become part of a government and gain control of a ministry.
One of the consequences of this kind of politics is a lack of cohesive
governance. Cabinets are always coalitions of political parties. They are
prone to collapse, not only because of conflicts among the parties com-
posing the government but also because one of the main goals of oppo-
sition parties is to unseat the cabinet and cause a reshuffle of ministerial
positions. This makes it very difficult for governments to put together
coherent, sustainable policies.
Another consequence has been the politicization of the bureaucracy,
including bureaucrats in the formerly autonomous and incorruptible
Bank of Thailand. Ministers are much more likely to retaliate against civil
servants who do not agree with them by reshuffling positions in the min-
istry (interview in Bangkok, 1989), and technocrats in appointed posi-
tions are much more likely to be ignored or dismissed. One of the best
examples of this politicization is the Bank of Thailand. The Minister of
Finance appoints, and has the power to dismiss, the governor of the
bank, but this power was rarely used before the 1980s. After two gover-
nors were dismissed in the 1980s, subsequent governors were much more
likely to try to anticipate finance ministers' wishes and 'followed the cur-
rent political line' (Siamwalla 1997a: 70-1).
A third consequence is strong disincentives to address many of the
major problems Thailand now faces. Electoral politics has made the task
174 RICHARD F. DONER AND ANSIL RAMSAY
of resolving banks' bad loans more difficult because many rural voters,
and politicians representing rural constituencies, argue that they should
not have to pay for the mistakes of wealthy businesspeople in Bangkok.
Electoral politics has also made industrial upgrading more difficult.
Many rural-based politicians are unwilling to support initiatives to
upgrade industries that are based in and around Bangkok. Several rural
legislators refused to support the creation of a textile institute to help
improve competitiveness in the textile industry because they saw no rea-
son to help rich Bangkok capitalists when more money was needed in the
provinces (interview in Bangkok).

Conclusion
Thailand experienced remarkable economic growth for several years
before plunging into economic crisis in 1997. This chapter has sought to
explain how this growth was accomplished despite the presence of exten-
sive clientelism, corruption and rent-seeking. Our explanation is that the
mutual vulnerability of clients and patrons during the formative stages of
Thai economic growth facilitated the entry of new firms and the creation
of a competitive market structure in a variety of economic sectors. The
greater openness and competitiveness of Thai politics since the mid-
1970s furthered this process. Established firms with strong political con-
nections were not able to suppress rivals effectively, and the resulting
competition contributed to the rapid growth of import-substituting
industries and to export-oriented growth. As noted earlier, this explana-
tion is not a blanket endorsement of clientelism as a source of economic
growth nor a dismissal of the waste caused by rent-seeking. Thailand had
considerable success because a particular form of clientelism facilitated
market entry in the context of hard budget constraints and great macro-
economic stability. We have also argued that sustained economic growth
required resolution of collective action problems emerging from com-
petitive markets. Competition alone does not ensure sustained economic
growth. Various institutions have helped to address, if not always resolve,
collective action problems. The Thai Textile Manufacturers' Association
stands out in this regard for the ways in which it used market-conforming
strategies to resolve over-capacity problems in the 1970s and 1980s.
These strategies linked assistance from the association and the govern-
ment to strong export performance by Thai textile firms.
It was not corruption and rent-seeking that caused the economic cri-
sis. Nor was Thailand's increasing lack of industrial competitiveness the
main cause of the sudden collapse. The lack of competitiveness would
have gradually taken a toll on growth rates, but it did not cause the crisis
that began in 1997. The main causes were increases in global capital
 RENT-SEEKING IN THAILAND 175

flows, and the weakness of domestic financial institutions and oversight

as Thailand liberalized its finances to try to take advantage of these
changes. Asjomo (1998) points out, 'the subversion of effective financial
governance at both international and national levels created conditions
that led to the crisis'. In the new global and domestic political environ-
ment, corruption and rent-seeking have, however, made it harder to
improve human resources, technological capacity and physical infra-
structure. All are necessary to improve productivity in the manufacturing
sector. Through their impact on the electoral process and parliamentary
politics, corruption and rent-seeking have also made it more difficult for
Thai governments to extricate Thailand from the economic crisis that
engulfed it in 1997.

Notes

1 Thai military-bureaucratic officials did not reach this conclusion because

they were particularly enlightened in comparison with officials in other less
developed countries, or because they had well-thought-out beliefs on the
importance of well-defined property rights at the micro level. The conclusion
grew out of struggles among political elites. Some of the most perceptive of
military officers began to see in the 1950s that links with state-owned enter-
prises were much less lucrative than links with private firms owned by Sino-
Thai clients. Field Marshal Sarit Thanarat, who became the dominant figure
in Thai politics in the late 1950s and early 1960s, had strong links to the pri-
vate sector. He realized that, by supporting a shift in state policy away from
emphasis on the public sector and towards the private sector, he could under-
mine major political opponents whose political base was in the state sector.
Such a shift in emphasis also won him international backing from the United
States and the World Bank. Once Sarit demonstrated the efficacy of this
approach, other officers and officials followed.
2 Mushtaq Khan points out that the absence of a large, politically powerful
landlord class in Thailand capable of protecting inefficient rights 'is an exam-
ple of differential group abilities to organise collective action being such that
groups demanding inefficient rights do not have an advantage, in this case
because a large potentially regressive group does not exist' (Khan, personal
communication). It is important to note that commercial banks, which did
want efficient rights, were capable of gaining these rights because their inter-
ests overlapped with those of the central bank and military leaders.
3 It is important not to overstate the degree of competition. Numbers of firms
in sectors can be a misleading indicator of competition, because a single con-
glomerate dominated by one family can own several firms. Suehiro found
that 50 of the largest 70 Sino-Thai firms in 1981-83 belonged to only sixteen
conglomerates (Suehiro 1992: 37). There was, nevertheless, intense compe-
tition in several sectors, including textiles and garments.
4 A more complete list of companies and their patrons is needed to substanti-
ate the argument in this section.
176 RICHARD F. DONER AND ANSIL RAMSAY

5 A list of the twenty firms, their year of registration, type of business, and pro-
moters and shareholders can be found in Suehiro (1985: 3-47, 48).
6 The Act was amended in 1962 to encourage more investment.
7 For a complete list of the families involved in the initial twenty firms, see
Suehiro (1985). For a chart showing the dominant firms and families in 1978,
see Business in Thailand (1978).
8 In contrast to Thailand, see the case study of Filipino Synthetic Fiber's ability
to maintain a monopoly position in synthetic fibres in the Philippines in the
1970s and 1980s (Kuo 1995: 114-15).
9 Fragmentation of power among industries also played a role here. Praman
worked through the Ministry of Industry to try to dominate the industry.
When Sukree could not get help from the ministry, he turned to the Board
of Investment (interview with Arthit, Textile Industry Division, 1 June
1994).
10 Praman Adireksan was Minister of Industry on some of these occasions and,
as minister, had considerable influence over granting licences for textile
firms to begin operations, and imposing capacity controls on the textile
industry.
11 A January 1985 Bangkok Bank Monthly Review article by Kanitha Srisilpavongse
says that, in 1984, the Textile Policy Committee changed this policy so that
the importation of machinery was subject to both Ministry of Industry and
Ministry of Commerce approval.
12 See Krirkkiat Phiphatseritham (1981) for an influential study suggesting that
there is considerable monopoly and oligopoly in Thai industries, including
textiles. Information on concentration levels in spinning and weaving in
1979 can be found on pages 159-61. Major groups of firms in 1979 are listed
on pages 163-4.
13 At the upstream end of the sector are synthetic fibre production and spin-
ning. Weaving, dyeing and printing form the midstream parts of the sector,
and garment-making is the activity furthest downstream (JICA 1989: C-27,
1-12).
14 Overproduction is a classic collective action problem. When too many goods
are being produced, driving prices down, a rational individual choice is to
produce more goods to make up for lost revenues. If all producers make the
same choice, then even more goods are produced, and prices are driven even
further down, with resultant bankruptcies and loss ofjobs.
15 For the details of this pledge, see Assakul (1990: 19-20).
16 Some sources say 20 per cent.
17 Kanitha Srisilpavongse (1985: 28) suggests that the effort was less successful:
'Not everyone stuck to the promise and those who idled some of their
machinery were the ones to lose out'.
18 Among the firms present were some of the largest textile producers in Thai-
land, including Thai Melon Polyester, Luckytex, Thai Durable and Union
Textiles.
19 Not all producers joined in the agreements to limit production. Sukree
Photiratanangkun took advantage of the situation to free-ride and dramati-
cally expand spinning and weaving capacities.
20 Joseph Kling (1993) points out that there is a good deal more collective
action than Mancur Olson's theorizing would lead us to believe. One reason
is that existing networks based upon ethnic and cultural ties help to reduce
the transaction costs of taking effective collective action.
 RENT-SEEKING IN THAILAND 177

21 There were close consultations between representatives of the commerce

ministry and business associations during these negotiations (interview at
Ministry of Commerce, 28 June 1989).
22 The MFA was created in 1974 to regulate trade in textiles and garments
between developed and less developed countries. The goal was to allow less
developed countries to continue to expand their exports of textiles and gar-
ments to the developed countries who were participants in the MFA, but it
also protected producers in the developed countries from market disrup-
tions resulting from these exports. Under MFA terms, participating countries
can conclude bilateral agreements on a mutually agreed basis (Siriwatpatara
1989; Kiatchaipipat 1994: 23-4).
23 The quota system in Taiwan also benefited large exporters in the 1970s and
1980s, causing 'heated debates about quota allocation' (Kuo 1995: 102).
24 This assertion is questioned by two interviews conducted in Bangkok during
July 1996.
25 Some interviewees suggested that the two plants had links to Banharn
Silparcha, an influential politician who has held a number of ministerial posi-
tions in Thai cabinets and who was selected as prime minister after the July
1995 election.
26 For an account of how this collective action problem was resolved, see Doner
and Ramsay (1996: 31-3). One of the main factors leading to a solution was
the role of broker played by officials in the Textile Industry Division of the
Ministry of Industry. This is another example of officials behaving very dif-
ferently from how they are portrayed in most of the rent-seeking literature.
The Philippines' textile industry has had great difficulties in resolving
upstream-downstream conflicts between textile producers and garment
manufacturers (Kuo 1995: 113).
27 See Doner and Ramsay (1996) for a more complete account of this problem
and why it has been so intractable. See Kuo (1995: 98-102) for a discussion of
Taiwan's textile association's resolution of a range of collective action problems,
including the establishment of a textile technology college to train technicians.
28 What follows is a summary of a much longer analysis under the title 'Thai-
land: From Economic Miracle to Economic Crisis' (Doner and Ramsay 1999).

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1990. Export Growth of Thai Clothing and Textiles, World Economy 13(1),
March: 51-73.
 RENT-SEEKING IN THAILAND 181

1992. The Structure of the Textile Industry and Government Policy in Thailand.
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Tambunlertchai, Somsak and Ippei Yamazawa 1981. Manufactured Exports and For-
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Faculty of Economics, Thammasat University.
Terdudomtham, Thammavit 1997. The Economy: The Bubble Finally Burst,
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Textile Industry Division 1995. The Textiles Industry in Thailand. Bangkok: Depart-
ment of Industrial Promotion, Ministry of Industry.
Tullock, Gordon. 1980. Rent Seeking as a Negative-sum Game, in James M.
Buchanan, Robert D. Tollison and Gordon Tullock (eds) Toward a Theory
of the Rent-seeking Society. College Station: Texas A&M University Press.
Vatikiotis, Michael. 1998. Anatomy of a Crisis, Far Eastern Economic Review, 21 May.
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Yongyuth Yuthavong 1990. The Development of Technological Capability
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225-41.
 CHAPTER 4

Thailand's Old Bureaucratic Polity

and Its New Semi-democracy

Michael T. Rock

Scholarship on Thailand suffers from an enduring paradox. While polit-

ical scientists (e.g. Girling 1981; Morell and Chai-Anan 1981) decry a
rent-seeking feudalization of administration in both the old bureaucratic
polity and the new semi-democracy, economists (e.g. World Bank 1993;
Muscat 1994) herald pragmatism and conservatism in economic policy.
Where one saw patron-client ties, lack of interest in developmental out-
comes, incessant struggles for control over the machinery for extraction
of rents, and a congenital inability to make hard decisions, the other saw
sound macroeconomic management, limited intervention in markets,
an ability to avoid making major mistakes and impressive successes in
family planning, public health and education.
Prior to the financial and currency crises of 1997, it was difficult to dis-
agree with the economists.1 Between 1955 and 1988, per capita eco-
nomic growth in Thailand averaged 3.9 per cent per year (Christensen
et al. 1993: 2). Only four countries - Brazil, Malaysia, Taiwan and South
Korea - grew faster. High economic growth was accompanied by a rapid
decline in the incidence of poverty and substantial exports of manufac-
tures.2 An export and foreign investment boom after 1988 contributed to
an even faster rate of growth (6.4 per cent per capita per year between
1989 and 1992).3 This long-term development performance has made
Thailand one of the development success stories since 1960. Not sur-
prisingly, the World Bank (1993) included it among the high-performing
Asian economies in its East Asian Miracle study.
But, clearly, all is not well. Rapid growth came at great expense to the
environment (TDRI 1990), the quality of urban life, particularly in
Bangkok, and with a substantial increase in income inequality (Medhi et
al. 1990). More to the point, the current financial and currency crisis sug-
gests that the rent-seeking of the old bureaucratic polity may have been

182
 THAILAND: OLD AND NEW 183
eclipsed by a new, and perhaps more virulent, breed in the more pros-
perous and democratic Thailand. It is now widely recognised as both seri-
ous and endemic.4 It was so serious that it provided legitimate cover for
a military coup in 1991. More recently, in a substantial departure from
the past, it has tarnished the image of two previously 'squeaky clean' cen-
tral economic institutions - the central bank and the finance ministry.
This has been extended to Thailand's nascent stock exchange.5
How does one resolve this enduring paradox of such unusually good
long-run development performance in the face of apparently wide-
spread corruption? Or put another way, if rent-seeking is so pervasive,
why is development performance so good? These questions are answered
by examining the changing role of rents and rent-seeking in Thailand's
evolving political economy.

A short history of rent-seeking in Thailand

Throughout the nineteenth century, Thailand was a relatively self-suffi-
cient, semi-feudal economy (Bell 1970). With the imposition of the
Bowring Treaty in 1855, the country began a century-long process of inte-
gration with the West. The political crisis that accompanied the forced
opening of the economy led the monarchy to turn to administrative
reform and political change to preserve Thai independence. For the
most part, reforms reinforced traditional institutions - the monarchy
and Buddhism - and fostered the development of a centralised state,
weak interest groups and non-democratic politics (Rock 1994).
By 1927, the outlines of the modern Thai political economy were set.
The centre (Bangkok) had moulded a loosely integrated collection of
semi-autonomous provinces into a nation-state by a triad of forces, con-
sisting of a highly centralized bureaucracy that invested in national
defence and transport infrastructure, a freed peasantry that expanded
the area under cultivation, and Chinese traders and European exporters
who facilitated the rice trade.6 Political legitimacy for this particular
political economy rested on an aura of sacredness surrounding the
monarchy, an elitist, hierarchical social structure in which superiors and
subordinates were interlinked in a set of reciprocal, but unequal, rela-
tions, and the pervasive influence of Buddhism.7
Subsequent political developments - the formal establishment of par-
liamentary democracy in 1932, accommodation with Chinese 'pariah'
entrepreneurs in the 1950s, and ceding of substantial control over eco-
nomic policy to Western-trained technocrats from the 1960s - reinforced
the traditional pillars of political legitimacy and the tendency towards a
centralised state, a weak political party system and unstable democratic
political institutions.8
184 MICHAEL T. ROCK

Political scientists dubbed this particular political formation a

'bureaucratic polity' - a political system where power and prestige were
located within the bureaucracy, rather than in extra-bureaucratic forces
or political parties under parliamentary rule (Riggs 1966). Dynamism in
the bureaucratic polity was provided by an incessant rivalry among 'big
men' within the political elite over the division of spoils extracted from
Thailand's pariah entrepreneurs.9 When one big man met another, con-
flict ensued. After one rival defeated another, a cycle of dominance fol-
lowed, only to be repeated when the latest 'big man' fell. This repetitive
cycle of rivalry meant that the bureaucratic state was weak, fragmented
and not oriented towards developmental outcomes. It was also rife with
factionalism, personalism, favouritism and nepotism. Decision-making
was opaque, cumbersome, subject to substantial delay, and fraught with
pecuniary abuse of office. The bureaucracy operated by avoiding the task
of making hard decisions, keeping the tension between the bureaucracy
and the public low, and taxing those least able to make trouble (Girling
1981: 138). These norms made it possible for those in the centralized
state, especially cabinet ministers, to engage in a (largely hidden from
public view) rent-seeking feudalization of administration.
But how precisely did rent-seeking take place in the bureaucratic
polity? And how has this changed as Thailand's political economy
evolved from a bureaucratic polity to a semi-democracy? While no defin-
itive answers to these questions can be given, Christensen et al. (1993:
21-4) suggest how rent-seeking has worked. Concurrent with Field Mar-
shal Sarit's decision in the mid-1950s to rely on the private sector as the
engine of growth, the government created the institutions for modern
macroeconomic management - a planning agency (the National Eco-
nomic and Social Development Board), an Office of Fiscal Policy in the
Ministry of Finance, and the Bureau of the Budget - and vested them
with authority for maintaining macroeconomic stability (Muscat 1994:
92). Both legal rules and informal norms for budget preparation insu-
lated the budget from bureaucratic politics (Christensen et al. 1993:
26-8). Although the size of the budget has been significant, the proba-
bility of changing fiscal allocations through rent-seeking activity at the
macroeconomic level has generally remained small.
Because of this, macroeconomic management was surprisingly good
and there were few opportunities for rent-seeking in budget policy and
practices. Prior to the financial and currency crisis of 1997, inflation aver-
aged less than 7.5 per cent per year and rarely exceeded 10 per cent. Fis-
cal deficits averaged 2.2 per cent per year and rarely exceeded 5 per cent
of gross domestic product (GDP) (IMF 1991:166-7). Debt service peaked
at 31.9 per cent of exports in 1985 and declined thereafter, falling to 15.5
per cent of exports by 1989 (World Bank 1990b: 362). In addition,
 THAILAND: OLD AND NEW 185

because the country's political leaders and business community recog-

nized the importance of trade and were committed to an open economy,
price distortions, particularly those surrounding the exchange rate and
foreign trade regime, never turned too far against exports (Pasuk 1980:
439-57; Muscat 1994: 163-9).10
There were two important consequences of this particular political
economy. It severely constrained overall rent-seeking and, by itself, this
may explain why development performance has been so good in the face
of countervailing rent-seeking. It also forced rent-seekers into the inter-
stices of microeconomic or sectoral policies. As the macroeconomic agen-
cies were divorced from real involvement with line ministries, this meant
that, beyond the imposition of macroeconomic budgetary constraints,
they lacked the ability to influence policy-making in the sectoral agencies,
such as the Ministry of Industry, the Ministry of Commerce, or the Board
of Investment. To make matters worse, industrial policy-making was spread
across a wide array of sectoral agencies with limited technical capacity. The
Board of Investment (BOI) offered lucrative fiscal incentives to promote
investment. The Ministry of Commerce controlled the import and export
of certain goods, including the ability to ban imports and exports of those
goods. The Ministry of Industry issued licences to build factories, regulated
business conduct and enforced zoning laws. The Industrial Finance Cor-
poration of Thailand, a private development bank, lent long-term to
medium and large-scale enterprises (Christensen et al. 1993: 24).
Inadequate co-ordination between these agencies and overlapping
jurisdiction may have increased opportunities for rent-seeking, but it
probably also limited rent-seeking expenditures in view of the ambigu-
ous rights available and the limited probability of securing attractive
rights through rent-seeking efforts. At least four agencies - the Board of
Investment, the Ministry of Finance, the Ministry of Commerce and the
Ministry of Industry - controlled trade policy. No less than five depart-
ments in three ministries controlled access to numerous permits and
licences. Sometimes, multiple offices were involved in obtaining a single
permit. Efforts by the BOI to facilitate the permit acquisition process
through its Investment Services Centre were routinely blocked by depart-
ments or ministries who refused to relinquish control over their prerog-
atives. Overlapping jurisdiction meant that industries banned from
expansion due to concerns of excess capacity by the Ministry of Industry
had either been aggressively promoted by the BOI or had grown due to
the high tariffs under the control of the Ministry of Finance (World Bank
1980: 48). And firms provided privileges by the BOI often found those
privileges undermined by the actions of other ministries.11
This fragmentation of industrial policy and its separation from macro-
economic policy-making appear to have served an important political
186 MICHAEL T. ROCK

function. They provided rich opportunities for the 'big men' in the
bureaucratic polity to use sectoral policies to satisfy the demands of their
supporters. Students of Thai politics described how politicization of sec-
toral policy worked in both the old bureaucratic polity and the newer
semi-democracy. Following elections, winning party coalitions and their
'big men' were routinely allocated ministries along party lines. Chart
Thai, one of Thailand's oldest and largest business parties, was regularly
allocated a dominant role in the Ministry of Industry. Commerce was
dominated by another old-line party, the Social Action Party, and the
Ministry of Agriculture was evenly split among the top three. Technocrats
were rarely appointed to important positions in the sectoral ministries.
Cabinet ministers used these portfolios to reward supporters. In agricul-
ture, government procurement of rice at above-market prices favoured
some, rather than all, farmers. The Ministry of Industry used its control
over import and export bans to protect those who received its licences.
Requiring factory permits was used to restrict entry into an industry, to
tightly manage industry expansion and to impose domestic content
requirements on those receiving licences (Christensen et al. 1993: 20-4).

An alternative explanation
This interpretation of Thai-style rent-seeking seems to offer an internally
consistent and powerful explanation for what I have called one of the
enduring paradoxes of Thai political economy. In this view, the answer to
the question - 'If rent-seeking is so pervasive, why is development perfor-
mance so good?' - is straightforward. Because macroeconomic and trade
policy were managed by politically insulated technocrats, rent-seekers were
forced into the interstices of sectoral ministries if they wanted to extract
rents. By itself, this combination placed natural limits on rent-seeking and
probably ensured that it did not derail development performance. But,
because sectoral policies were divorced from macroeconomic manage-
ment, there was sufficient sway within the political economy for lucrative
rent-seeking.
While compelling, this interpretation comes at high cost. The focus
on micro (sectoral) rent-seeking feudalization of administration requires
overlooking important contrary evidence, which suggests that micro
(industrial) policy intervention was selective, extensive and effective. As
I have argued elsewhere, without it, there is some reason to doubt
whether Thailand would be where it is today - a next-tier newly industri-
alizing country (Rock 1995). This suggests that, rather than abrogating
responsibility for sectoral policy, Thai policy-makers may have been able
to use selective industrial policy and rents to positive developmental
advantage. The emphasis on rent-creating micro policies also misses
 THAILAND: OLD AND NEW 187

what may be even more important - the increased politicization of cen-

tral economic agencies and macroeconomic policy following the consol-
idation of Thai democracy.
The focus on rent-seeking in microeconomic policy analysis leads to
overlooking longstanding and significant selective distortions in agricul-
tural markets. Furthermore, it leads to a discounting of equally impor-
tant examples of successful selective interventions during first-stage
import-substitution industrialization in the 1960s as well as in second-
stage import-substitution industrialization in the 1970s. It also con-
tributes to a critical oversight of the systematic turning of the entire
industrial policy machinery to promote non-traditional manufacturing
exports during the 1980s.
In agriculture, particularly rice agriculture, distortions in prices, includ-
ing the price of labour, were systematic, sustained over time, and signifi-
cant.12 What was the purpose of the government's rice price policy and how
did it intervene in rice markets?13 Except for occasional rent-seeking, gov-
ernment intervention in rice markets was aimed at stabilizing rice prices at
a low level.14 This was achieved through a variety of taxes, including a vari-
able export tax, onrice.This policy enabled the government to take advan-
tage of a large land frontier to manipulate an industrious, but politically
docile, peasantry by giving peasants access to land while taxing them heav-
ily.15 As a result of the government's systematic use of a variable export tax
on rice for over thirty years, it was possible to extract resources from agri-
culture without impoverishing the peasantry and to build an indigenously
owned commercial banking system and an import-substitution industrial
base in Bangkok behind protective barriers.16
But precisely how did the government go about supporting the devel-
opment of indigenously owned commercial banks and industrial enter-
prises? In both instances, government policies were selectively applied to
favour a relatively small number of private entrepreneurs. With promul-
gation of the Commercial Banking Act of 1962, the government began
prudential regulation of banks. But government intervention in the bank-
ing sector quickly moved beyond prudential regulation as the govern-
ment banned new bank entry, severely limited foreign bank expansion
and undermined the operations of informal credit markets (Hewison
1985: 283; Suehiro 1992). The major consequences of these policies were
rapid growth in bank deposits, an equally rapid development of a small
number of family-owned commercial banks, a decline in importance of
foreign-controlled banks, and significant concentration in the banking
industry.17 Taken together, these outcomes virtually guaranteed the easy
availability of credit to a small number of Thai entrepreneurs.
Systematic government policy bias favouring large firms and a few
entrepreneurs is also evident in industrial policy. Between 1959 and
188 MICHAEL T. ROCK

1980, government requirements for promotional privileges - such as

BOI business tax exemptions on imported capital goods and raw materi-
als, tariff protection on local production, tax holidays and the Industrial
Finance Corporation's subsidized credit - favoured large firms.18 Prefer-
ential access of large firms to promotional privileges and subsidized
credit was frequently combined with bans on new entry into promoted
industries and removal of banned industries from eligibility for promo-
tional privileges.19 This highly effective bias in favour of large firms and
a few entrepreneurs stands in marked contrast to the well-known inef-
fectiveness of government programs designed to help small and medium
enterprises.20 Both have been of recurring concern to the World Bank
(1980: 62-3). As in the banking sector, the effect of this bias has been the
domination of Thai industry by large firms combined into a small num-
ber of family-centred conglomerates. By the early 1980s, large firms con-
stituted a mere 1.6 per cent of all industrial establishments, but owned 54
per cent of all industrial assets and accounted for 41 per cent of indus-
trial employment. These large firms were overwhelmingly controlled by
a small number of family-owned conglomerates. Of Thailand's 100
largest manufacturing firms, 50 belonged to one of sixteen conglomer-
ates, which together controlled 90 per cent of the total assets of Thai
firms (Suehiro 1992: 37).
How has the government policy bias favouring a small number of
large commercial banks and large import-substitution industrialization
firms bound together in family-owned conglomerates affected the inter-
national competitiveness of Thai manufacturers? As experience else-
where shows, large business groups can help developing countries
acquire industrial competence, internalize external economies and over-
come shortages of entrepreneurial talent, but they can also lead to sub-
stantial economic inefficiency.21 What happened in Thailand? Have any
of these infant industries graduated into export production?
While research in this area is sketchy, the experiences of two of Thai-
land's most influential entrepreneurs, their business groups and their
textile firms appear to be typical.22 Sukree Photiratanangkun, founder of
the Sukree Group and the Thai Blanket Industry (TBI), and Damri
Darakananda, founder of the Saha Union Group and the Union Textiles
(UT) company, began as merchants and importers of manufactured con-
sumer goods. When the government began promoting import-substitu-
tion industry, both found that they lacked the technical and managerial
know-how to begin local production. Both responded by contracting
with foreign capital - Sukree in 1959 and Damri in 1961 - for technical
and managerial assistance at the same time as they sought and received
government promotional privileges (Suehiro 1992: 56-7; Doner and
Ramsay 1993: 695-7). The large size of the Thai domestic market and the
 THAILAND: OLD AND NEW 189
extension of promotional privileges to foreign firms engaged in joint
ventures with Thai firms apparently made contracting with foreign capi-
tal relatively easy.23
Sukree and Damri used their easy access to governmental promo-
tional privileges and to newly amassed private deposits in a small number
of commercial banks and joint venture agreements with Japanese capital,
to acquire industrial competence in technology, management and mar-
keting. By 1965, Sukree's TBI Group showed signs of becoming a mod-
ern textile group. It learned to use its joint venture partners to move
upstream by producing new synthetics, spinning them into cloth, and
finishing and dyeing the cloth. By 1983, TBI dominated the country's
spinning industry.24 The TBI Group also learned how to export.
Damri's Saha Union Group experienced similar growth and develop-
ment. During the early 1970s, while Thailand was still promoting import
substitution in textiles, Saha Union started ten firms producing yarn and
sewing threads.25 At the request of the Bangkok Bank, the group also
took over the country's largest spinning and weaving operation - Thai
Durable Textile. By the mid-1980s, Saha Union's Union Textiles was the
second-largest spinning operation in the country.26 Like TBI, Saha
Union used foreign technical assistance to move production upstream,
but it went farther than TBI by moving into petrochemical production so
it could gain access to raw materials for synthetic fibres production. Saha
Union's UT company was also more successful than TBI in moving into
exports. It aggressively sought the Multi-fibre Arrangement (MFA)
export quotas of Thai firms that let their quotas lapse, and just as aggres-
sively entered non-MFA markets. By 1988, 45 per cent of UT's sales were
in exports (Doner and Ramsay 1993: 698). By 1993, it held 25 per cent of
the Thai fabric export quota and some 40-50 per cent of the quota to the
US market.
Once technical, managerial and marketing competence was acquired,
both entrepreneurs successfully wrested control of their joint ventures
from foreign partners. When Japanese joint venture partners refused to
remove restrictions on Saha Union's entry into textile export markets in
the late 1970s, the company used personal ties to the Bangkok Bank to
gain access to a soft loan to buy out its Japanese partners.27 Sukree used
a variety of tactics to get a French firm, Rhone Poulenc Textiles, to sell its
shares in Thai Melon Polyester rather than submit to the French firm's
demands regarding management practices and pricing policy (Doner
and Ramsay 1993: 695).
But these are not the only examples of effective selective intervention in
markets. Thailand deepened import-substitution industrialization during
the 1970s and early 1980s by extending protection to capital goods indus-
tries. As a result of that effort, heavy industry's share in manufacturing
190 MICHAEL T. ROCK

value-added increased from 31.9 per cent in 1970 to 42.6 per cent in 1979,
while the share of agricultural processing industries declined from 39.3
per cent in 1970 to 26.2 per cent in 1979 (Christensen et al. 1993: 8-10).
An examination of the protection offered one subsector, diesel engines
with less than 20 horsepower, reveals that protection was industry- and
firm-specific, and conditioned on firm performance.
Starting in 1980, the BOI extended privileges to three joint venture
firms to produce diesel engines for agricultural machinery. Import
duties of 20 per cent and a 20 per cent import surcharge provided some
protection against competing imports. Protected firms received a 90 per
cent reduction in import duties on raw materials and business taxes. The
BOI banned the entry of other firms into the industry. In exchange, it
expected promoted firms to shift from assembly to pressing and forging
parts within three years and to increase local content from 20 per cent to
80 per cent within four years. When promoted firms were unable to meet
the local content requirements, the BOI proposed increasing the tariff
but reducing the import surcharge. The promoted firms countered with
a proposal to sustain the import surcharge. In the end, the BOI
responded by rewarding only those firms that met the local content
requirement with additional tariff protection (Paitoon 1987: 18-20).
Starting in 1985, the government intervened heavily to promote two
export industries - international tourism and electronics. The tourist
sector had been neglected by the donor community, but the govern-
ment, particularly the Secretary-General of the National Economic and
Social Development Board (NESDB), believed that tourism could gen-
erate significant amounts of foreign exchange. To facilitate this, the gov-
ernment organized public and private sector agencies - such as the
Tourism Authority, the Airport Authority, and the hotel industries and
tourist companies - to oversee development of a comprehensive promo-
tion and investment program for the tourist sector. Between 1985 and
1988, tourist revenues tripled from about US$1 billion to US$3 billion,
accounting for nearly 15 per cent of export earnings. Although there has
been no systematic study of the government's selective intervention
in this industry, it is hard not to agree with Muscat, who argues that
the Prem government's promotion of international tourism may well
have been the single most important export policy success of the 1980s
(Muscat 1994: 197-8).
Government support to the electronics industry was similarly success-
ful. Prior to 1986, the BOI had worked off and on with the Electrical,
Electronics and Allied Industry Club (EEAIC) of the Federation of Thai
Industries. Ultimately, this led to formation of a joint public-private Sub-
committee for the Development of the Electronics Industry for Export.
The purpose of this industry-specific export promotion program was to
 THAILAND: OLD AND NEW 191
deepen the capacity of Thai electronics firms to produce component
parts, particularly cathode ray tubes (CRTs) for colour televisions. A
small number of firms had acquired the capacity to design and assemble
black-and-white televisions, but local electronics firms and the BOI were
frustrated by the unwillingness of foreign investors to help Thai firms
develop the capacity to produce CRTs.28 Because of this, the BOI agreed
to work with the EEAIC on a CRT localization project. The BOI
exempted the project from income taxes, prohibited competing invest-
ments in CRT production, and imposed a 30 per cent import surcharge
on top of a 30 per cent tariff. The BOI also had the capacity to impose an
import ban, if necessary. Most importandy, BOI support for this project
was limited to five years. After that, local firms were expected to be able
to successfully compete with foreign firms in CRT production.
The BOI turned to a prominent Sino-Thai conglomerate, the Siam
Cement Group, to lead the project and it sought bids from foreign com-
panies to participate in it. Subsequently, the project was awarded to Mit-
subishi because of its willingness to transfer technology and strengthen
Thai CRT in-house engineering capabilities. Thai firms affiliated with
the project used their monopoly position to move rapidly up the learn-
ing curve as they went from simple assembly to production of phosphor
screen coating, vacuuming the picture tube, and assembly of the elec-
tronic gun and deflection yoke. Over time, this evolved into a greater
role for Thai engineers in the design of product specifications. This ulti-
mately grew into a formal R&D (research and development) design unit.
Eventually, the R&D unit designed metal and plastic components,
engaged in materials and product testing, and co-ordinated total quality
control. In the first year of the project (1990), virtually the entire output
was sold locally. By 1994, Thai CRT firms were selling 50 per cent of their
output to export-oriented multinational firms (Felker 1998: 395-402).
In addition to overlooking important examples of effective micro
(selective) intervention in agricultural and industry-specific markets, the
rent-seeking explanation of micro policy rests much too heavily on an
outdated, static and narrow conception of the Thai state and its rela-
tionship to Thai society. Because of significant changes in society, the
state and state-society relationships, politics and microeconomic policy-
making evolved over time. It is not that patron-client politics did not or
do not exist; they clearly did and do. It is not that industrial (micro) pol-
icy was not and is not fragmented; it clearly was and is. But the balance of
Thai politics has shifted away from rivalry between 'big men' and their
clients and towards 'liberal corporatism',29 in which competing business
interests have voluntarily come together in business associations to
advance their collective interests, especially by lobbying the state and
otherwise co-operating, often under state co-ordination through limited
192 MICHAEL T. ROCK

regulation. As this happened, the particularistic outcomes that charac-

terized the industrial policy of the bureaucratic polity gave way to more
rational outcomes. This would have been impossible without significant
strengthening in the technical capacity of the Thai state, including closer
integration between the core macro agencies and sectoral ministries
responsible for micro (industrial) policy. This also happened.
While space does not permit a full elaboration of the changes in
state-society relationships and within the Thai state, it is possible to pro-
vide a broad outline of key developments. Rapid economic growth over
thirty-five years facilitated the emergence of a substantial urban middle
class, a stronger and more dynamic civil society and an independent
bourgeoisie (Girling 1984; Anek 1988; Dalpino 1991: 64). The growing
financial independence of the Sino-Thai business community, especially
the large conglomerates, increasingly insulated business from the
reaches of government (Suthy 1982: 2-27). Over time, government con-
trol of trade associations declined and representatives of these associa-
tions penetrated the public sector.30 The business community also began
to play a more prominent role in Thai cabinets, as it learned how to col-
laborate with the public sector and how to use its resources to influence
and control political parties (Bangkok Post, 31 December 1982: 31-2;
Dalpino 1991: 64-5).31 In short, the business community learned how to
use political parties and electoral politics to protect its interests.
Although full democracy has not emerged, these changes facilitated the
emergence of stable semi-democratic rule in 1978 (Chai-Anan 1990:
281-2). As a result, the old bureaucratic polity was transformed into a
semi-democratic 'broker polity' in which 'the key figure [became] the
prime minister who [had] the main responsibility for brokering a free
for all between a growing number of organized [particularly business]
constituencies' (Ramsay 1985: 8). By adjudicating among the rival claims
of competing factions, the state increasingly determined access to busi-
ness opportunities, thus limiting entry and avoiding wasteful excessive
competition. While this increasingly involved rent-seeking by electoral
means, the constantly shifting power-sharing arrangements of successive
coalition governments since the late 1980s have limited the waste attrib-
utable to the protracted fractional competition supposedly characteristic
of contemporary Thai politics. With governance capacity enhanced by
electoral legitimacy and increased competence, the Thai state became
better able to create conditions and implement policies favouring prof-
itable business investments.
Breakdown of the bureaucratic polity occurred alongside significant
technical strengthening of the infrastructure of the Thai state. By 1986,
nearly 40 per cent of the top 400 civil servants in the country had Masters
or PhD degrees from Western universities. This included significant
 THAILAND: OLD AND NEW 193

numbers of senior officials in the so-called sectoral agencies.32 While this

was no guarantee of more developmentally oriented decision-making, it
provided an opportunity to rationalize industrial policy-making and to
launch an export campaign.33 Prime Minister Prem Tinsulanond, who
governed from 1980 to 1988, seized this opportunity by relying on an
economic crisis to significantly restructure the relationship between the
core macro agencies and the sectoral ministries.34 A Council of Eco-
nomic Ministers, a subcommittee of the cabinet, stood at the apex of this
new relationship, with the NESDB acting as the secretariat. The Secre-
tary-General of the NESDB was, for the first time in history, invited to
weekly cabinet meetings, and it was Prem's practice to regularly turn to
the NESDB for advice during these meetings (Muscat 1994: 178).
In 1981, Prime Minister Prem created, at the request of the business
community and the behest of the NESDB Secretary-General, a peak pub-
lic-private sector forum: the Joint Public and Private Sector Consultative
Committee (JPPCC) .35 The purpose of the committee was to provide reg-
ular opportunities for dialogue between leadership of the business com-
munity and senior government officials in core macro agencies and
sectoral ministries. Prem chaired the monthly committee meetings.
Because the government feared that the committee would be used by
business to press individual demands, it made it clear that the JPPCC
would focus on general problems facing business. In 1983, Prem estab-
lished a subcommittee of the JPPCC, chaired by the NESDB, that
included senior government officials from sectoral agencies and business
community leaders. The subcommittee set the agenda for the monthly
meetings and tracked implementation of JPPCC actions. This was fol-
lowed by the creation of government-business industry-specific councils
and government-business sectoral ministry councils.
These institutional changes within the government, and between the
government and the private sector, provided a unique opportunity to
reform industrial policy along neo-liberal lines.36 But efforts to do so were
blocked by old patron-client ties between industrialists in the private sec-
tor and cabinet ministers in sectoral (line) ministries.37 In fact, the trade
regime became more protectionist.38 Following this failure, the govern-
ment turned its new-found power to neo-statist micro (selective) interven-
tions. BOI promotional privileges - including exemptions and/or
reductions in import duties and business taxes on imported inputs,
machinery and equipment, and exemptions from corporate income taxes
- were extended to export projects, including those of direct foreign
investors.39 This shift required changing the criteria for offering promo-
tional privileges to foreign firms. The new criteria permitted majority for-
eign ownership for export-oriented firms and 100 per cent foreign
ownership for plants that exported all of their output. Foreign firms
194 MICHAEL T. ROCK

responded well to the BOI-sponsored 'contest', as the average export

propensity of foreign firms increased from 33 per cent in 1984 to 50 per
cent by 1988 (World Bank 1993: 142). This was followed in 1985 by Japan-
ese financing of a long-term export industry modernization program
through the International Finance Corporation of Thailand at highly sub-
sidized interest rates.40 Starting in 1986, the Bank of Thailand's longstand-
ing program of subsidies for the working capital needs of agricultural
exporters was re-oriented to meet the needs of exporters of manufactures.
By 1988, these exporters were receiving more than one-half (53 per cent)
of the bank's subsidized loans.41 The combination of rising effective rates
of protection and countervailing export subsidies suggests that Thai trade
policy during this period was closer to Korea's during its early export
expansion (1965-68) than it was to neo-liberal prescriptions.
Thai industrial policy mirrored that in Korea in several other ways.
Korea's export-oriented macroeconomic and trade policies were comple-
mented by the creation of a high-level Export Development Committee
to deal with production and marketing problems facing exporters and by
large, selective investments in education.42 The government assumed that
Korea's potential for industrial and export growth was severely con-
strained by market failures in information and labour markets. The first
led to creation of several public sector organizations, including one, the
Korea Trade Promotion Agency, to deal with marketing problems. It also
led to visits by high-ranking government and business leaders to foreign
markets and to the use of overseas embassies to promote exports. The sec-
ond led to specific government interventions in education and labour
markets, particularly the training of scientists and engineers.
The Thai government reached similar conclusions and responded in
similar ways. Market failures in export information markets led the Prime
Minister and business leaders to make several overseas trips to promote
Thai exports. Embassies were charged with responsibility for promoting
Thai exports. The government also created a highly effective Depart-
ment of Export Promotion in the Ministry of Commerce (McKean et al.
1994: 21-4). The department identified buyers, ran trade fairs and
matched buyers with local producers. While public sector export mar-
keting agencies traditionally exert little influence on large domestic
firms with good foreign buyer contacts, this department played a critical
role in matching buyers with smaller wholly owned Thai firms with no
prior export experience (McKean et al. 1994: 21). During the post-1985
export boom, the department was also an important source of informa-
tion on new suppliers for foreign buyers.
Once the government became aware that shortfalls in the stock of
well-trained engineers and technicians were a bottleneck to industrial
expansion, it took several steps to remedy the problem. A major govern-
 THAILAND: OLD AND NEW 195
ment scholarship scheme for overseas training was announced. Both the
government and the private sector launched a program to entice Thai
science and technology manpower working abroad to return home. The
BOI relaxed immigration requirements, which enabled firms to bring in
engineers and other skilled technicians, and the government also
encouraged the private sector to invest in the production of engineers
(World Bank 1990c: 35-8). The BOI is considering extending promo-
tional privileges to a Thai equivalent of the Korean Advanced Institute of
Science and Technology.
How have all of these selective and highly targeted microeconomic
interventions affected manufactured export growth and Thailand's
industrial structure? As yet, there are no definitive answers to these ques-
tions, but several pieces of evidence suggest that they probably played a
significant role. For one, econometric evidence reveals that movements
in the real exchange rate cannot account for export success (Muscat
1994: 196). Because the trade regime became more protective during
this period, success cannot be attributed to neo-liberal trade reform.
This leaves room for industrial policy explanations of success. If indus-
trial policy was effective, or if excessive entry into certain industries
occurred due to uneven state control and regulation, Thailand's indus-
trial structure should differ significantly from expected international
norms. One crude measure of this is the ratio of actual value-added as a
percentage of GDP of a sector to the predicted value-added of that sec-
tor (World Bank 1993: 304-6, 327). If the ratio of actual value-added to
predicted value-added equals one, industrial structure mirrors interna-
tional norms. If it is greater or less than one, a sector deviates from inter-
national norms. By inference, deviations from international norms
reflect, among other things, differences in factor endowments, the influ-
ence of industrial policy and/or uneven sectoral regulation.
Given Thailand's rich natural resource base and overwhelming com-
parative advantage in agriculture, one would expect the share of value-
added in agricultural processing industries to be significantly greater
than one and to deviate most from international norms. Yet the actual
share of value-added in food, beverages and tobacco in Thailand in 1986
was only 34 per cent of its expected share (World Bank 1993: 306). More-
over, the overall manufacturing share of value-added in GDP exhibits far
greater deviation from international norms than that for any other high-
performing Asian economy, including Korea.43 In three of nine subsec-
tors - textiles (3.33), wood and wood products (1.85), and metal
products and machinery (1.82) - actual value-added was between two
and three times that predicted by international norms. Taken together,
these outcomes suggest that Thai industrial policy or uneven sectoral
regulation almost certainly exerted significant influence on industrial
196 MICHAEL T. ROCK

structure. However, the superior and continued growth of government-

prioritized sectors, as well as the impressive overall performance of the
economy, suggests that strategic industrial policy, rather than uneven
governance, was primarily responsible for such uneven growth and struc-
tural change.

Productive and unproductive rents

Sustained selective interventions in agricultural markets, successful indus-
try- and firm-specific interventions during first- and second-stage import-
substitution industrialization, and the systematic use of the industrial
policy machinery to promote non-traditional manufacturing exports
during the 1980s, suggest that micro, sectoral and industrial policies in
Thailand have been more coherent and development oriented than rent-
seeking interpretations admit. When combined with an ability to avoid
serious economic policy mistakes and the adoption of a statist transition
to export-led industrialization following the failure to liberalize the trade
regime along neo-liberal lines, it is difficult not to conclude that the Thai
government appears to have found ways to use the rents created by selec-
tive interventions to promote industrial, and then export-led industrial,
growth. This parallels developments in Northeast Asia.
But this interpretation leaves several important questions unan-
swered. If micro policies were used more or less rationally to hasten
industrial development, how does one explain the widespread percep-
tion of rent-seeking alongside strong development performance, partic-
ularly in the old bureaucratic polity? Second, what about the growing
public perception of rent-seeking in the new semi-democracy? In what
ways, if any, does it differ from old-style rent-seeking? And, more impor-
tantly, what role has this new Thai-style rent-seeking played in the finan-
cial and currency crises of 1997?
There are three tentative answers to the first question. First, some part
of the concern over rampant rent-seeking in the old bureaucratic polity
is undoubtedly correct, but it is misplaced. To the extent that rents and
the seeking of them promoted the development of industry, including
large-scale export-oriented conglomerates, they quickened the pace of
Thai development. But even though they served a positive development
purpose, because they conferred large privileges and benefits on rela-
tively few well-connected individuals in the bureaucracy and the Sino-
Thai private sector, it is not surprising that they attracted substantial
public and academic attention, particularly among political scientists.
(They may have also contributed to the growth in income inequality.)
Because economists focussed on neo-liberal interpretations of Thai
development, they also missed the productive use of rents in selective
 THAILAND: OLD AND NEW 197

micro policies. This is not unlike what happened with neo-liberal inter-
pretations of development in Korea and Taiwan. All of this was exacer-
bated by opaque, cumbersome, subject to delay, time-consuming and
consensus-building policy-making processes. Thus, it is not surprising
that many confused this with a rent-seeking feudalization of administra-
tion. Second, there is no doubt that some of this rent-seeking served no
useful purpose. Unfortunately, it is not so easy to distinguish productive
rent-seeking from unproductive rent-seeking. Finally, as the Thai state
became increasingly capable of managing micro (sectoral) policies for
development, as happened during the latter Prem period, the ratio of
unproductive to productive rent-seeking probably declined.
But what about rent-seeking in the more democratic period following
the Prem governments? Several developments are particularly worri-
some. For one, Thailand's transition to democracy was elite-based. While
this worked to severely restrict popular sector demands on the govern-
ment, the transition was accompanied by a carrying-over of a tradition of
clientelism around directly unproductive activities (see Sidel 1996:
56-63). This, at least partially, explains why successive Prem governments
had difficulty liberalizing the trade regime along neo-liberal lines and
why they ultimately resorted to a neo-statist alternative. Moreover, as long
as increasingly competent and politically insulated technocrats con-
trolled economic policy, including sectoral policies, unproductive rent-
seeking was held in check. The Prem government's liberal corporatism
was an important part of this.
Unfortunately, the liberal corporatism of the Prem period was not sus-
tained by subsequent democratic governments. In fact, those govern-
ments were manifest by a return to micro (sectoral) rent-seeking policies
and, for the first time in modern Thai history, by politicization of macro-
economic policy-making. This began in 1988, when the Chatchai gov-
ernment bypassed the NESDB and funded a number of pork-barrel
projects that allocated lucrative public sector contracts and trade quotas
to loyal political supporters (Christensen et al. 1993: 100). One result of
this was that corruption in the Chatchai government was widely seen as
endemic. This provided the pretext for the military coup in 1991.
Although the well-respected and short-lived Anand government and
the largely ineffective Chuan government restored technocratic influ-
ence over the major economic ministries and brought rent-seeking by
politicians under control, this did not last. Following the election success
of the Chart Thai Party in 1995, a quintessential rural-machine patron
politician was named prime minister (King 1996: 136). Banharn had
been a member of Chatchai's 'buffet cabinet' that had mounted an
elected MPs' frontal assault on the state and technocratic control over
economic policy-making. His cabinet appointments and those for major
198 MICHAEL T. ROCK

economic ministries, particularly the finance ministry, signalled further

politicization of macroeconomic policy (Murray 1996: 372).44 This was
worsened by a corruption scandal that subsequently plagued the central
bank, the finance ministry and the stock exchange.45 This provided an
opening for Banharn to fire the heads of the Bank of Thailand, the Min-
istry of Finance, and the Securities and Exchange Commission. In fact,
during his tenure, Thailand saw the coming and going of three separate
finance ministers. This was previously unheard of. After Banharn was
forced to resign under a cloud of scandal, retired armed forces chief,
Chavalit, succeeded him. To secure crucial support from Chatchai to
form the new government, he reneged on his pre-election pledge to
appoint a 'dream team' of technocrats to the finance ministry - under-
lining how difficult it is to reverse the greater rent-seeking consequences
of democratization in the last decade.
These developments revealed that the tradition of respect for the hon-
esty, integrity and technical competence of central economic agencies -
the NESDB, the finance ministry and the central bank - was succumbing
to attempts by elected politicians to capture the economic core of the
Thai state. This was made easier by the backlog of pressing infrastructure
investments and the budget surpluses that followed introduction of a
value-added tax.46 But potentially dangerous precedents were set, as the
rhythm of electoral politics has come to depend on MPs aligning them-
selves with business elites in Bangkok and in the provinces (see Ockey
1993: 48-77; World Bank 1993: 304-6, 327: Callahan and McCargo 1996:
376-91). Because of this, money for vote-buying is critical to electoral
success, especially since neither parties nor candidates run on identifi-
able platforms. Once elected, officials expect to use their positions to
recoup election expenses, establish war chests for the next election and
distribute favours (Callahan and McCargo 1996: 378-9). Because this
tendency has been unchecked in Thailand's semi-democracy, rent-seek-
ing by new political elites has seriously undermined economic policy-
making and development performance.
This can be most clearly seen in the financial and currency crisis of
1997. The roots of the crisis lie in financial liberalization policies enacted
by the technocratic Anand government during 1991-92. This was unwit-
tingly abetted by an established tendency of the Bank of Thailand to res-
cue ailing financial institutions (see Ammar 1997: 6; Lauridsen 1998: 4).
With liberalization, the government removed interest rate ceilings, lib-
eralized foreign exchange transactions on the current and capital
accounts, increased the scope of business open to commercial banks and
finance companies, and established the BIBF, the Bangkok International
Banking Facility (Lauridsen 1998: 5). The technocrats who proposed
these measures hoped they would increase competition in the domestic
 THAILAND: OLD AND NEW 199
banking sector and establish Thailand as a regional financial centre
(Ammar 1997: 2). Unfortunately, liberalization occurred without ade-
quate prudential regulation by the central bank. To make matters worse,
the BIBF became little more than a vehicle for attracting foreign capital
which was loaned out by commercial banks and the newly created
finance companies.47 Because both believed that the Bank of Thailand
would not devalue the baht, neither sought to hedge their foreign
exchange risks. This combination - financial liberalization without ade-
quate prudential regulation, a tendency of the Bank of Thailand to res-
cue ailing financial institutions, opening of the capital account, and
maintenance of a fixed exchange rate - created severe moral hazard
problems.48 The result was a predictable boom-bust cycle in asset prices
that undermined the financial system, the currency and the economy.49
Because the financial and currency crisis was so predictable, it is nec-
essary to ask why Thailand's much-heralded technocrats did not foresee
it and act to avert it. While there is not yet a fully adequate explanation
for this failure, Ammar (1997) attributes it to outdated management
practices at the Bank of Thailand and infighting within it, and to a
decline in the technical capacity of Thailand's core macro agencies. To
this might be added the need to deal with a new development problem:
financial liberalization. But surely this combination is not sufficient.
Some, perhaps most, of the difficulty should surely be attributed to the
politicization of these same core agencies by successive democratically
elected governments. Signs of this politicization are not difficult to find.
They are manifest in a decline in the quality of appointments to head
key macro agencies; the adoption of a political strategy of 'implicit inter-
vention' by governors of the central bank; by political infighting among
political parties for 'spoils' associated with control over the macro agen-
cies; by demoralization among technocrats in key macro agencies; and
by the rapid turnover of leadership in these agencies.50 Unless this par-
ticular combination can be turned around, it signals a new development
in rents and rent-seeking in Thai political economy. If it continues, it
might even make the rent-seeking in the old bureaucratic polity look
small by comparison.

Notes

1 For discussion of the financial-cum-currency crisis, see Ammar (1997).

2 The incidence of poverty declined by 56 per cent between 1962 and 1986
(World Bank 1990a: 41).
3 Between 1986 and 1989, annual foreign direct investment flows and exports
more than doubled (IMF 1991: 715).
200 MICHAEL T. ROCK

4 Public opinion surveys conducted by Chulalongkorn University in 1992-93

confirmed that corruption is a normal fact of life in Thailand ('Corruption is
Rife in Public Life, Says Panel Body', Bangkok Post, 5 March 1996).
5 For discussion of corruption in central economic ministries, see 'BBC Crisis
Rocks Authority', 'Vijit under Mounting Pressure', and 'The Bull That Never
Charged', Bangkok Post: Economic Review, mid-year 1996: 33-7.
6 According to Chai-Anan (1971: 78), expenditures for defence and the Min-
istry of Interior increased from 4 per cent of the budget in 1892 to 48 per cent
by 1930. The government also invested heavily in rail development (Feeny
1982:80-1).
7 During this time, the king was the formal head of state, a revered symbol of
national unity, and defender of the Buddhist religion. For a discussion of tra-
ditional Thai political culture, including the central role of the king, and the
extension of that political culture into the modern period, see Girling (1981:
18-45).
8 Between 1932 and 1982, Thailand had 13 constitutions, 14 elections, 14
coups and 42 cabinets. The fundamental weakness of legislatures, political
parties and modern political institutions ultimately developed into a vicious
cycle in Thai politics. Successful coups have been predictably followed by new
constitutions, the emergence of new political parties, elections, a honey-
moon period, and the return of 'crisis' which precipitated yet another coup
(see Chai-Anan 1982: 1-2). The vicious cycle re-emerged in the military coup
of 24 February 1991 - the seventeenth coup attempt in fifty-nine years.
Despite the formal establishment of parliamentary democracy in 1932, real
political power rested with the bureaucracy and the armed forces. Modern
political institutions remained weak and unstable. Legislatures rarely acted as
real brakes on executive actions. Political parties were impermanent and sub-
ject to constant fragmentation; all too frequently, they were little more than
loose alliances of businesspeople, bankers, retired military men and former
civil servants who clustered around a 'big man'. Few parties operated nation-
wide, had grass-roots bases or represented consistent philosophical ideas.
More often than not, they were part and parcel of Thailand's traditional
patron-client system. For a discussion of patron-client politics in Thailand,
see Girling (1981: 119-23).
9 The classic statement of the relationship between Thai bureaucrats and the
Sino-Thai business community is Skinner (1958).
10 In a World Bank (1983a: 60) study of price distortions in 31 developing coun-
tries in the 1980s, Thailand's distortions were less than in 29 of the countries.
With respect to the exchange rate, the government was not afraid to devalue;
it devalued the baht by 9 per cent between 1972 and 1980 and by another 25
per cent between 1980 and 1989 (IMF 1991: 710-11).
11 In the early 1980s, the BOI provided a 'no competition' guarantee to one
firm to make compressors for refrigeration units. Despite this guarantee, one
of the rejected firms persuaded the Ministry of Industry to give it a licence to
operate (Brown 1983: 63-4).
12 Because rice has been the primary wage good, government rice price policies
have exerted substantial influence on the price of labour (Bertrand 1980: 45,
79).
13 For discussion of Thai rice price policy, see Ammar (1975: 233-49).
14 Between 1962 and 1980, the wholesale price of non-glutinous rice in
Bangkok averaged about 75 per cent of the export price (World Bank 1983b:
97). But this varied considerably from year to year depending on the harvest
 THAILAND: OLD AND NEW 201

and world markets. When world rice prices rose, signalling greater profits in
exports, the Thai government intervened with a variable export tax to keep
the price of rice in Bangkok stable. When export prices fell, the export tax
on rice was lowered.
15 On the industriousness of the peasantry, see Keyes (1983: 851-68). Piker
(1976: 7-26) discusses the role of the land frontier on rural social organiza-
tion. Wong (1987: 72) estimated that approximately 7.8 per cent of national
income was transferred out of agriculture annually by export taxes on rice
through the 1960s. Bertrand (1980: 45, 79) concluded that, between 1955
and 1966, taxes on rice were about 40-45 per cent of the export price and
80-85 per cent of farm gate prices.
16 On the development of the banking system, see Suehiro (1992: 42-50). On the
development of industry, see Suehiro (1992: 50-7) and Narongchai (1973).
17 Commercial bank deposits increased by 760 per cent between 1956 and 1967,
but, because of the government moratorium on the establishment of new
banks, the top four banking families increased their control of bank assets
from 32 per cent in 1962 to 62 per cent in 1981 (Suehiro 1992: 48-9).
18 Large minimum investment requirements and equally large minimum pro-
duction capacity requirements effectively discouraged small and medium
enterprise entrepreneurs from applying for government promotional privi-
leges (World Bank 1980: 53-7; Hewison 1985: 280, 282-3; Suehiro 1992: 56).
19 As late as 1980, four industries - raw sugar, ice, new models of automobile
assembly, and textiles - were subject to bans on new entry and thirty others
were subject to conditions which limited new entry (World Bank 1980: 63).
20 For a discussion of the ineffectiveness of Thai government policy towards
small- and medium-scale industry, see Rock (1984).
21 On the role of business groups in overcoming shortages in entrepreneurial
talent and market imperfections, see Leff (1979: 46-64). On how business
groups can be used to acquire and disseminate industrial competence, see
Mardon (1990: 111-38).
22 The discussion focusses on these two groups because they exert a large influ-
ence on the Thai textile industry, an industry that played a critical role in
post-1985 manufactured export expansion. What follows is drawn from
Doner and Ramsay (1993: 691-703).
23 The government extended promotional benefits to foreign companies work-
ing with Thai firms because they recognized that domestic capital was short
of technical know-how and managerial ability (Hewison 1985: 281).
24 TBI controlled the largest number (336,434) of spindles in the country
(Doner and Ramsay 1993: 696).
25 Effective rates of protection for textiles increased from 44.1 per cent in 1971
to 78.2 per cent in 1978 (World Bank 1980: 72).
26 Union Textiles controlled 271,320 spindles (World Bank 1980: 72).
27 Amnuay Virawan, a director of both the BOI and the Bangkok Bank, was
recruited to Saha Union. Once there, he negotiated the loan with the bank
that enabled Saha Union to buy out its Japanese partners (Doner and Ramsay
1993:697).
28 This was because CRT imports accounted for 40 per cent of the value of
imports for colour televisions (Felker 1998: 396).
29 For a discussion of this transition, see Anek (1992: 149-71).
30 Prior to 1932, the government rigidly controlled and eliminated associa-
tional groups as they formed. After 1932, such groups were controlled by the
government's power to attend and close association meetings, to investigate
202 MICHAEL T. ROCK

the origins of group leaders, and to punish and fine groups. By the late 1970s,
trade association leaders were interacting regularly with central government
authorities and serving on government committees (Suthy 1982: 53-67).
31 Business representation in Thai cabinets increased from a minuscule num-
ber in the late Sarit-Thanom era and in the Thanin administration to
between a third and a half in each of the five Prem cabinets (Anek 1988: 453).
32 More than one-third (16 out of 43) of the top officials in the Ministry of Agri-
culture, a quarter (7 out of 25) of those in the Ministry of Commerce, a third
(6 out of 17) of those in the Ministry of Industry, and a third (7 out of 17) of
those in the Ministry of Science, Technology and Education had graduate
degrees from the United States (Muscat 1994: 56).
33 Muscat (1994: 195) uses this term to describe the government's approach to
promoting exports during this period: 'The architects of structural adjustment
concluded that the economic policy measures aimed at industrial cost-com-
petitiveness would have to be complemented by the introduction of an export
"campaign" mentality in the relevant agencies of government, in place of the
lip service that had characterized past efforts to promote industrial exports'.
34 Although Thailand's macroeconomic crisis was mild by developing country
standards, it worried government and business leaders. Following the first oil
price shock, foreign debt grew by 34.6 per cent per year between 1975 and
1980. After the second oil price shock, the current account deficit increased
to more than 7 per cent of GDP in 1980. For a discussion of this, see Muscat
(1994: 176-89) and Anek (1992: 36-8, 78-82).
35 Both business and government leaders saw the JPPCC as an opportunity to
create Japanese-like co-operation between business and government. Busi-
ness wanted this to facilitate reduction in red-tape and taxes. Senior govern-
ment leadership, particularly the Secretary-General of the NESDB, saw this as
an opportunity to promote manufactured exports, increase control over sec-
toral ministries, and reduce opportunities for corruption. As he said,
any country which competes successfully . . . in the international economic
arena is also a country with a workable system of government-business col-
laboration . . . Historically two kinds of capitalism [have] existed: the deca-
dent and the mature ones. Both kinds had a close government-business
relationship. However, the decadent capitalism was characterized by corrupt
dealing between officials and businessmen. The mature capitalism . . . had
open consultation between legitimate government and business representa-
tives. The decadent capitalism usually ended up in revolution, such as the
cases of China and Russia. (Anek 1992: 81-2)
36 The JPPCC did simplify export administration (Anek 1992: 127).
37 The Minister of Industry blocked neo-liberal reform of the trade regime
(Muscat 1994: 178).
38 By 1985, the effective rate of protection of Thai manufacturing reached
52 per cent, nearly twice that of Korea, Malaysia and the Philippines
(Christensen et al. 1993: 10).
39 By the mid-1980s, over 60 per cent of the BOI's promoted projects were
export-oriented (Paitoon et al. 1989: 56).
40 Interest rates for export loans were 3.5 per cent below market rates (Paitoon
etal. 1989:51).
41 Interest subsidies on export loans ranged from 2.5 per cent to 3 per cent. The
volume of subsidized export loans rose from 10.2 billion bant in 1975 to
128.6 billion baht in 1988 (Paitoon et al. 1989: 52).
 THAILAND: OLD AND NEW 203

42 For discussion of government intervention in production and marketing, see

Rock (1992: 339-57). For discussion of selective intervention in education,
especially in the training of scientists and engineers, see Westphal et al.
(1985: 187-92).
43 The actual share of manufacturing in value-added in 1986 was 1.68 times the
international norm. This compares with 1.26 for Korea and Hong Kong, and
1.38 for Singapore (World Bank 1993: 327).
44 As Murray (1996: 372) states, when the Banharn cabinet was announced, it
was greeted with horror. It has also been referred to as the 'Mafia Cabinet'.
45 See Note 4.
46 Throughout the 1970s and 1980s, the central government ran fiscal deficits.
Through the last half of the 1980s, these deficits threatened macroeconomic
stability. (For discussion of this, see Rock 1994: 18-37.) With the enactment
of a value-added tax, revenues rose relative to expenditures, and modest
deficits became surpluses averaging between 4 per cent and 5 per cent of
GDP (IMF 1996: 586).
47 It was popular with borrowers because interest rates on dollar loans were 4-6
per cent less than on baht loans. Because of this, BIBF finance accounted for
nearly one-half (US$31 billion) of all foreign debt by the end of 1996
(Ammar 1997: 5).
48 Moral hazard occurs when deposits in financial institutions are guaranteed
by government and when no-one polices lending practices. When this hap-
pens, lenders are prone to engage in excessively risky lending practices
because they know that depositors will be protected. As Krugman (1998: 3-4)
states, this kind of incentive structure encourages lenders to engage in 'heads
I win, tails the taxpayer loses' lending practices.
49 I call this crisis 'predictable' because it has been experienced elsewhere in
the developing world (Chile in 1982 and Mexico in 1995). Cortes-Douglas
(1992), McKinnon and Pill (1994), Kaminsky and Reinhart (1995), and
Krugman (1998) have modelled various aspects of it.
50 On the decline in quality of political appointees, see Murray (1996: 372-3).
On the adoption of 'implicit intervention', see Ammar (1997: 10). On polit-
ical infighting, see Lauridsen (1998: 8). On demoralization, see Ammar
(1997: 10). Finally, on rapid turnover, see Doner and Ramsay (1998: 35-6),
and Lauridsen (1998:8).

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 CHAPTER 5

Obstructive Corruption: The Politics of

Privilege in the Philippines

Paul D. Hutchcroft

Throughout the late 1980s and early to mid-1990s, an enduring puzzle

for many analysts of Thailand, Malaysia and Indonesia was the seemingly
compatible coexistence of rampant corruption and rapid economic
growth. Now, amid the crisis of the late 1990s, much debate centres
around the degree to which corruption is actually to blame for the steep
plunge of these same economies. As a country with longstanding experi-
ence combining corruption with generally less-than-stellar economic
performance, the Philippines offers valuable insights into the patterns of
behaviour now commonly associated with its neighbours' malaise.
At the outset, it is important to note that the Philippines has often been
out of step with regional economic trends. Between 1980 and 1992, while
its Southeast Asian neighbours were moving towards new strategies and
subsequendy reaping unprecedented economic gains, the Philippines'
real per capita income declined by 7.2 per cent. Even when Philippine
aggregate annual growth rates climbed to 5-7 per cent in the mid-1990s,
the country's overall economic performance remained comparatively
modest and the gains short-lived. At decade's end, the Philippines
has enjoyed a relative buoyancy amid the crises that surround it: while
many neighbours suffered severe economic downturns, the Philippines
registered a barely positive annual growth rate (of 0.1 per cent) for
1998. The country's earlier adversity has in many ways offered a certain
short-term advantage, as the very lack of extended periods of high growth
inhibited the dramatic surges in foreign indebtedness - and property
and stock market values - that were found elsewhere in the region
(Hutchcroft 1999a).
Through the repeated boom-and-bust cycles of the postwar Philip-
pines, analysts (whether economists, political scientists, businesspeople
or political leaders) have commonly and quite consistently suggested

207
208 PAUL D. HUTCHCROFT
that high levels of corruption, clientelism and rent-seeking are a major
reason for the economy not having done better. The devastating
impact of Marcos-era cronyism makes this case most clearly, but also in
the pre- and post-Marcos years one finds political economic patterns that
are widely viewed as detrimental to the economy as a whole. When
Ferdinand Marcos initiated his New Society in 1972, it is worth recalling,
many would have agreed with his condemnation of an 'oligarchy that
appropriated for itself all power and bounty' (Marcos 1979: 6). Marcos
did, indeed, tame selected oligarchs most threatening to his regime, but
both his own plunderous activities and those of his relatives and associ-
ates brought forth the term 'crony capitalism', now used throughout the
world (de Dios 1984; Hutchcroft 1991; Manapat 1992). When economic
reforms were attempted (with limited success) late in the administration
of Corazon Aquino, they were launched - quite significantly- amid ready
acknowledgement that 'the base for crony capitalism' survived the down-
fall of Marcos in 1986 (Manila Chronicle, 2 June 1990, quoting Finance
Secretary Jesus Estanislao; see also Montes 1988 and de Dios 1990).
One of the most forceful official attacks on these practices came from
President Fidel V. Ramos, at his 1992 inauguration, when he declared
that the Philippine economic system 'rewards people who do not pro-
duce at the expense of those who do ... [and] enables [those] with polit-
ical influence to extract wealth without effort from the economy'. Once
in office, Ramos declared the country's many 'cartels and monopolies' a
major impediment to economic growth and mounted a major effort to
promote greater competition in several key sectors of the economy.
Administration reformers commonly emphasized their determination to
'level the playing field' and undercut the oligarchic privilege that has
long nurtured uncompetitive structures. Their ambitious program of
economic reform encouraged the growth spurt of the mid-1990s and
raised hopes that the political economic system might become less
obstructive to the goals of national development. While corruption
remained a prevalent phenomenon throughout the Ramos years,1 the
surprising success of many reform measures led some to proclaim a new
'market consensus' able to challenge entrenched patterns of the past
(Magno 1995: 31). Indeed, prominent businesspeople who initially
resented Ramos' efforts to reform them eventually came to fear the
decline in reform momentum that might come after his departure (for
further analysis of the reforms, see Hutchcroft 1998: 241-55).
When President Joseph Estrada assumed office in mid-1998, however,
the rapid re-emergence of many former Marcos cronies raised concerns
that the Ramos reforms are a thing of the past (see Far Eastern Economic
Review, 16 July 1998: 28, and 13 August 1998: 20-1). While there is some
comfort that the former 'sick man of Asia' has been relatively insulated
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 209
from the regional economic crisis, the new political leadership provides
little hope that the reform momentum of the previous administration
can be sustained or expanded (indeed, many are concerned that ele-
ments of the reforms may be undermined) (Hutchcroft 1999b).
Given its often distinctive developmental trajectory and considerable
experience with what is popularly termed 'crony capitalism', the Philip-
pines offers many insights for comparative analysis. The prevalence of
corruption and rent-seeking can be quite compatible with rapid eco-
nomic growth, as the postwar experience of Japan clearly demonstrates
(post-1990 difficulties notwithstanding). In other settings, however, cor-
ruption and rent-seeking are commonly treated as major obstacles to the
nurturing of more advanced forms of capitalism. While some element of
particularistic privilege is found in all political systems and no 'playing
field' is entirely level, it is equally obvious that landscapes of special
advantage vary enormously in shape from one political economy to
another: some varieties of unevenness may actually promote economic
growth, whereas other types of rough terrain seem to pose enormous bar-
riers to sustained development. Unfortunately, scholarship has a long
way to go not only in understanding the complex variations in the 'poli-
tics of privilege' found from one setting to another, but also in specifying
their highly diverging impacts.
Drawing on the Philippine experience, this chapter takes initial steps
towards building a framework able to explain why particular forms of the
politics of privilege may be relatively more compatible with, or relatively
more obstructive to, the process of economic development. In the
process of making this inquiry and surveying contrasting landscapes, I
will utilize a framework that draws insights from three literatures, with
distinct lineages, that overlap but all too rarely interact: those relating to
rents, corruption and clientelism. While this chapter by no means
attempts to resolve the causal complexities of current crises elsewhere in
the region, it is hoped that the initial framework developed here can be
useful in examining changing dynamics in a range of settings in which
rent-seeking, corruption and clientelism have long been a major feature
of the political economic terrain. The particular configuration of politi-
cal power in the Philippines, I will conclude, has quite consistently nur-
tured a 'politics of privilege' generally obstructive to sustained economic
development.
The first section of this chapter analyses the insights to be derived
from the three paradigms, and the second proceeds both to develop a
framework based on these insights and to apply it to an analysis of the
Philippine political economy. In the conclusion, I examine the prospects
for altering the country's politics of privilege in ways that may prove less
obstructive to national developmental goals.
210 PAUL D. HUTCHCROFT

Surveying the paradigms

The quest for and allocation of particularistic advantage has long been
the subject of academic investigation, but the language and concepts
employed in this process of inquiry have varied across time and across
disciplines. Each of the major paradigms - rents, corruption and clien-
telism - offers important insights to political economists, yet all would be
enhanced by a more concerted effort at cross-fertilization. The following
is a preliminary attempt to encourage useful hybrids.2
The most recent addition to the theoretical repertoire is, of course,
the literature on rents that has emerged from economics. The strength
of this body of thought is its attention to market processes, and it is not
surprising that rent theorists have achieved prominence in an era in
which markets are widely praised and governments routinely reviled.
Rents are, by definition, created when the state restricts the operations
of the market. The processes of rationing foreign exchange, curbing free
trade and licensing some aspect of economic activity - to give just a few
examples - serve to create 'rent havens' that can be captured by some
combination of well-placed businesspeople and bureaucrats. The fight
for privilege, known as rent-seeking, encourages 'directly unproductive
profit-seeking' activities - sometimes legal (e.g. lobbying) and sometimes
not (e.g. bribery). Overall, the focus is on 'the rent-seeking society1', analy-
sis of the specific types of state structures in which this behaviour most
thrives is commonly thwarted by distrust of states in general. Because
conventional rent-seeking believed that the rent-seeking cost was
'directly related to the scope and range of governmental activity in the
economy, and to the relative size of the public sector' (Buchanan 1980:
9), the solution was self-evident: 'the state's sphere should be reduced to
the minimum, and bureaucratic control should be replaced by market
mechanisms wherever possible' (Evans 1995: 24).
Indeed, a major problem with the rent-seeking literature is its often
strong ideological bias. The majority of theorists

are obsessed with demonstrating the negative impact of government on the

economy. They view competitive markets as the most socially efficient means
to produce goods and services ... [and] do not treat the effects of government
intervention as variable, sometimes reducing and sometimes stimulating
social waste. (Levi 1988: 24)

This bias is best refuted by Peter Evans, who points out that many bureau-
cracies do indeed possess the capacity to restrain rent-seeking tendencies
and promote collective effort among individual officeholders; 'strict adher-
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 211

ence to a neo-utilitarian logic', he asserts, 'makes the existence of a collec-

tive actor difficult to explain and the nightwatchman state [favoured by
neo-utilitarians] a theoretical impossibility'. His analysis of the role of states
in economic transformation, moreover, highlights major problems with the
assumption that competitive markets 'are sufficient to the kind of structural
transformation that lies at the heart of development' (Evans 1995: 25).3
Ideological bias aside, there are at least four other major deficiencies
with much of the rent-seeking literature. First, even if a bureaucracy is
pared down to a minimalist role, it is likely to retain ultimate responsibil-
ity for such basic tasks as building infrastructure and providing law and
order. As long as bureaucrats continue to be tasked with supplying these
goods, there remain arenas in which rent-seeking behaviour may be able
to thrive. In settings where (to quote Weber 1978: 987) individual bureau-
crats can easily 'squirm out of the state apparatus', the provision of public
goods may bring significant opportunities for private profit. Even in a
minimalist state, for example, motor vehicle licensing authorities will
potentially be able to extract an extra unofficial sum for a scarce resource,
and police may be able to transform their public power into lucrative kid-
nap-for-ransom schemes. Privatization by no means resolves the dilemma:
the process of bidding and negotiating with private companies seeking to
build and maintain a road, for example, can provide enormous rent
havens easily tapped by those with the most favourable political connec-
tions. Because rent theorists have little to say about such post-market-
shrinking problems, the solution necessarily shifts away from market
remedies and towards the realm of politics and public administration.
Second, the literature on rents generally neglects vitally important
political elements of government-business relations. As Jomo and
Gomez (1995: 3) explain, there are major problems with the presump-
tion that rents will be allocated solely according to market processes -
and a 'certain irony' that

the very people who assume that markets have been distorted with the cre-
ation of rents also seem to assume the existence of perfectly competitive mar-
kets for rent capture involving a fully competitive process. Rent-seeking may,
in fact, not be very competitive - due to the clandestine, illegal, closed, exclu-
sive or protected nature of rent capture processes - thus limiting rent-seeking
activity and keeping down rent-seeking costs.

The allocation will, in all probability, be based not only on the market but
also on a range of non-market considerations, including ethnic,
regional, party and old-school ties. Politics, not the market, provides the
best clues to these processes.
212 PAUL D. HUTCHCROFT

Third, and closely related, is the problem of determining the degree

to which rents will be primarily captured by those in the state or those
outside the state. This brings in even larger structural considerations,
based on analysis of the historical development of state-society relations.
Within Southeast Asia, I argue elsewhere, the category of rent capitalism
(popularly known as 'crony capitalism') needs to be broken down fur-
ther: the ' "bureaucratic capitalism" ' associated with the former 'bureau-
cratic polity' of Thailand, for example, should be differentiated from the
'booty capitalism' spawned by the oligarchic patrimonial state found in
the Philippines. In the first type of rent capitalism, the major beneficia-
ries of patrimonial largesse are found within the state; in the latter, major
beneficiaries have an independent economic base outside the state
(Hutchcroft 1998: 18-21, 46-55).
Fourth, rent theorists rarely make a clear distinction between whether
those who compete for advantage are seeking generalizable policy bene-
fits (as when an exporters' association lobbies for reduced tariffs) or par-
ticularistic privileges (as when a family conglomerate bribes customs
officials for lower duties on a specific importation or lobbies con-
gresspersons for the construction of a particular road). Taken together -
whether lobbying or bribery, general or particularistic - all are seen as
examples of unproductive rent-seeking activities (see, for example,
Krueger 1974). From a purely market-based standpoint, it is no problem
to aggregate such activities into one category; from the standpoint of
political economy, however, there are certain disadvantages. Because
such distinctions are largely reflective of the degree of institutionaliza-
tion and differentiation of business interests, they are indeed important
to those investigating larger questions of political power and future pos-
sibilities of political economic transformation. Moreover, because the
relative incidence of bribery versus lobbying has an impact on the char-
acter of bureaucratic agencies, such distinctions are important to those
analysing state capacity to promote developmental goals.
As useful as rent theory can be to understanding the allocation of par-
ticularistic advantage, its limitations suggest the need to search elsewhere
for additional insights. Studies of corruption may have had their heyday
in the era of modernization theory, but it is a mistake to suggest that cor-
ruption is merely a 'primitive' way of conceptualizing rent-seeking
(Evans 1995: 24). It is a distinct paradigm that, over the course of many
years, has yielded many important lessons for contemporary analysis.
Indeed, it is worthwhile inquiring into why the concept of corruption is
often given only cursory scholarly attention - and sometimes eschewed
in favour of other conceptual approaches. Because corruption is nearly
omnipresent, some analysts seem inclined to treat it as an invariable
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 213
element of the political economic woodwork; in other words, they are
content to note that it exists almost everywhere without inquiring into
how it varies in character and impact from one setting to another. Oth-
ers, quite likely, have shunned the concept because it is more difficult to
compile reliable empirical data on the often-shadowy world of corrup-
tion, based quite inconveniently on 'what is', than it is to construct
abstract models of how rent havens are created in the absence of perfect
markets, based on the far less troublesome investigation of 'what is not'.4
'Primitive' (i.e. early postwar) language, conceptual complexity, and
dilemmas of data-gathering, however, are no excuses for throwing the
baby out with the bathwater.
Corruption focusses attention on the public sector and on the distinc-
tion between official and private activity. Nye's (1989: 966) oft-cited defin-
ition is a useful starting point: 'Corruption is behaviour which deviates
from the formal duties of a public role because of private-regarding (per-
sonal, close family, private clique) pecuniary or status gains; or violates
rules against the exercise of certain types of private-regarding influence'.
Starting with Nye's definition, one is able to go beyond the central concern
of conventional rent theorists (how states may distort markets) and move
into other important terrain as well (e.g. how markets may distort states).
Theorists of corruption, as a group, cannot be accused of any strong
ideological bias; on the contrary, one finds enormous variance in how to
approach the issue. In the early days of modernization theory, corrup-
tion was commonly condemned on moralistic grounds but rarely accom-
panied by much careful analysis of its precise consequences, not to
mention its causes, mechanics or remedies (Leys 1989: 52-3). Later 'revi-
sionist' approaches of the late 1960s found that corruption could, at least
occasionally and sometimes systematically, have a beneficial impact on a
range of important goals: 'nation-building', economic development,
administrative capacity, and democratization (Huntington 1968; Scott
1972a; Leff 1989; Nye 1989). Subsequent literature continues the ongo-
ing evaluation of costs and benefits (Carino 1986; Theobald 1990).
Such attention to larger context is at once both a strength and a weak-
ness of this body of literature. On the one hand, it is essential to view
corruption as an element of broader political interactions and to under-
stand that the prevalence of bribery may have both benefits as well as
costs. On the other hand, in the course of achieving breadth there is
sometimes a lack of specificity as to which goals are being included in the
cost-benefit analysis. Modernization theory's tendency to conflate
distinct goals and presume that 'all good things go together' spills over
into the Great Corruption Debate, as rival camps are at times over-eager
to declare corrupt behaviour either an overall good or an overall bad.
214 PAUL D. HUTCHCROFT

Many scholars who have contributed to this literature, however, are

quite explicit as to how costs and benefits need to be evaluated in terms
of specific goals (see, for example, Waterbury 1973; Nye 1989; and
Theobald 1990).
At the risk of simplifying what is indeed a very large body of work span-
ning a wide time period - from the earliest distinctions between private
and public domains until the present - there are at least four other
advantages to building on previous studies of corruption. First, as noted
above, the very definition of corruption focusses attention on the char-
acter of state agencies, specifically the degree to which any given system
reflects a clear distinction between a public and a private sphere. The
work of Max Weber not only highlights how polities vary enormously in
the degree to which such a distinction is recognized, but also how cor-
ruption can have a different impact from one setting to another. Unfor-
tunately, the potential for carrying forth Weber's nuanced comparative
analysis of the interaction of politics, bureaucratic structures and
economies has been hampered in recent decades by disciplinary over-
specialization: economists tend to treat all states as the same, political sci-
entists rarely devote much attention to bureaucratic structures, and
public administration specialists all too often ignore the larger political
and structural contexts in which their subject agencies are situated (see
Riggs 1987: 429).
Second, the corruption literature almost universally recognizes that
corruption can be expressed according to both non-market and market
factors. Scott (1972a: 88-9) explains that

as ideal types, 'parochial' (nonmarket) corruption is a situation where only

ties of kinship, affection, caste and so forth determine access to the favors of
power-holders, whereas 'market' corruption signifies an impersonal process
in which influence is accorded those who can 'pay' the most, regardless of
who they are. The real world, of course, rarely ever contains such pure cases.
The proportion of market to parochial corruption, and hence the pattern of
beneficiaries, varies widely among underdeveloped nations.

Modes of payment, he further explains, can be in cash or in kind; in elec-

toral settings, they may of course include delivery of a bloc of votes.
Third, the best of the literature on corruption insists that the concept
can only be properly analysed 'within a broader analysis of a regime's
political dynamics' (Scott 1972a: 6). Scott's own analysis leads him to sug-
gest that its impact may at times be expected to have a counter-hege-
monic influence by promoting the entry of new forces, but its more
'normal effect... is to cement together a conservative coalition and hold
back or cancel out the effects of growing collective demands' (1972a:
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 215
viii-ix). Waterbury concludes that 'endemic and planned corruption' in
Morocco 'serves only one "positive" function - that of the survival of
the regime. Resources are absorbed in patronage and are drained away
from rational productive investment' (1973: 555). Whether or not other
theorists agree with such conclusions, the very tendency to focus
on how issues of politics and political power are played out among major
social forces can be seen as welcome relief in an era in which the realm
of macro politics is often no longer the premier consideration of politi-
cal economy.
A final advantage of employing the term 'corruption' is that it recon-
nects academics with real politics and real political discourse. There has
probably never been a major political demonstration against rent-seek-
ing, but popular disgust over corruption - the violation of norms based
on a distinction between what is public and what is private - has in count-
less cases nurtured reform movements, provoked riots and contributed
to the downfall of regimes. As long as corruption scandals dominate the
headlines of many national newspapers, it seems a worthy objective for
academics to continue to investigate such phenomena.
Further political nuance comes from a third major paradigm, clien-
telism, which is above all a study of relationships of power. Persons of
higher social status (patrons) are linked to those of lower social status
(clients) in personal ties of reciprocity that can vary in content and pur-
pose across time (Scott 1972b). Patron-client ties may or may not be cor-
rupt but, 'when a patron occupies a public position or extracts favors
from those in public positions, patronage and corruption overlap'
(Waterbury 1973: 537). Conversely, purely market corruption has no ele-
ment of clientelism: it is a one-time transaction lacking in affective ties.
Although concrete empirical evidence may be elusive, it is probable that
- contrary to the expectations of many economists - purely market cor-
ruption is far less common than other variants of corruption. Power and
social relationships regularly interact with everyday market relations; in
all likelihood, markets of a corrupt nature - involving the complex inter-
play of private and public spheres - are even more heavily infused with
such ties. Integration of the clientelist paradigm into an analysis of the
search for particularistic advantage encourages analysts to go beyond
both the excessive attention to market transactions often found in eco-
nomics and the legalistic-formalistic approaches commonly found in the
field of public administration.
Along with the other two paradigms, however, clientelist literature
generally gives insufficient attention to the role of coercion in the search
for particularistic advantage (see Sidel 1995: 11-12). Since coercion
plays a major role in certain forms of corrupt behaviour (especially
in extortion and in the delivery of a bloc of votes), it is important to
216 PAUL D. HUTCHCROFT
supplement all three paradigms with careful consideration of the often
prominent role of violence. Scott (1972a: 34-5) tends to treat corruption
and violence as alternative expressions of political influence (the former
'a more peaceful route to influence' than the latter), but in practice the
two often reinforce each other in quite effective ways. A New York
mafioso, for example, may threaten an unco-operative city official with
the proverbial 'swim with concrete overshoes' in the East River, or a
Philippine influential may utilize state resources (the local police, or
temporarily released and heavily armed prison convicts) to strike out at
his or her political enemies.
Together, the three paradigms encourage careful analysis of the
search for and dispensing of particularistic privilege. Rent literature
focusses attention on what happens when state actions distort markets,
corruption literature examines how public roles and private influences
conflict within state agencies, and clientelism encourages clearer analy-
sis of the relationships of power that permeate states, societies and mar-
kets. The next task is to draw on these eclectic sources and begin to build
a larger framework in which to analyse more effectively the very diverse
impacts of the allocation of particularistic advantage.

Surveying the landscape of privilege in the Philippines

In varying settings, it was asserted at the outset, the range of related phe-
nomena variously described as rent-seeking, corruption and clientelism
may be relatively more compatible or relatively more obstructive to the
process of development. This chapter does not aim to provide a gener-
alizable framework able to explain when, where, why and how the impact
may be more or less positive, nor does it seek to provide a comprehen-
sive new typology of the range of phenomena encompassed by these
complementary paradigms. Rather, the purpose is to propose a series of
initial questions that may build on previous insights, from eclectic
sources, and contribute towards the longer-term goal of building such a
framework and such a typology. In other words, it is a preliminary treat-
ment intended to promote discussion and further refinement of ideas.
There are seven questions, I shall propose, that are useful in beginning
to assess the differential impact of rents, corruption and clientelism.
Together, they examine the variability of the 'take' among comparable acts
of corruption, the processes by which advantages are allocated, the way in
which the gains obtained are invested, the manner in which corruption
affects the operation of markets, the impact of corruption on a state's
capacity to execute a range of essential developmental tasks, the role that
corruption may play in promoting or impeding the institutionalization of
both state agencies and political parties, and the relative presence of
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 217

factors able to mitigate or counterbalance the prevalence of corruption. It

is important to emphasize that the focus here is the impact of corruption on
economic development, separate assessments of the impact of corruption
would be necessary if other goals (e.g. harmonious inter-ethnic relations,
democracy, or political stability) are to be considered. Distinct analysis
would also be required if one were investigating the causes or mechanics
of corruption, or optimal strategies to curb the phenomenon.

Is corruption relatively more variable or calculable?

A key factor in understanding the diverging impact of corruption and
bribery on capitalist growth, Weber suggests, is the variability of the phe-
nomena: they have the 'least serious effect' when calculable, and become
most onerous when fees are 'highly variable' and 'settled from case to
case with every individual official'. Indeed, if bribery is a calculable ele-
ment of a business firm's environment, its impact is no different from a
tax; to the extent that a firm must devote major effort to negotiating each
bribe, on the other hand, there is a high degree of unpredictability in the
amount of time and resources to be expended. Overall, Weber (1978:
240, 1095) expected that advanced forms of capitalism relied upon 'the
rational, predictable functioning of the legal and administrative agen-
cies'. If correct, a major obstacle to the development of more sophisti-
cated forms of capitalist accumulation is not corruption per se, but
highly variable corruption.
What sort of polities are most likely to spawn highly variable types of
corruption? Analysis of this question begins with Rudolph and Rudolph's
(1979: 198) important distinction between authority (the formal roles
conferred upon individuals in their official capacities) and power (when
incumbents pursue 'values, interests and goals of their own choosing that
conflict with those of the administrative structure'). Few would disagree
with Scott's (1972b: 92) observation, over two decades ago, that 'nomi-
nally modern institutions such as bureaucracies and political parties in
Southeast Asia are often thoroughly penetrated by informal patron-client
networks that undermine the formal structure of authority'. For present
purposes, it is worthwhile building on previous scholarship and examin-
ing further two key aspects of the interaction of power and authority
within bureaucracies and parties.
First, what are the relative strengths of informal and formal power?
Clearly, the formal structures of authority are stronger in some national
settings than others; within any national administrative apparatus, as
well, some agencies exhibit clearer lines of formal authority than others.
By definition, the stronger the formal authority relative to informal net-
works, the less prevalent will be the incidence of corruption.
218 PAUL D. HUTCHCROFT
Second, it is important to examine the process by which the power
and authority interact: do patron-client networks tend to coincide with
formal lines of authority, or do they constitute a competing source of
orders and inducements? Higher degrees of coincidence, I propose, will
in all probability yield more predictable forms of corruption; conversely,
the greater the degree of divergence between power and authority, the
more variable the form of corruption that is likely to emerge.5
Overall, structures of formal authority in the oligarchy-dominated
Philippine state are much more weakly defined than in certain other
Southeast Asian settings, in particular the former bureaucratic polity of
Thailand where bureaucratic elites have dominated weak societies.
Moreover, precisely because a greater degree of power exists outside of
the bureaucracy, one finds far less overlap between authority and power
in the Philippines than in pre-1980s Thailand. It is important to analyse
each of these points in greater detail.
The dominance of extra-bureaucratic power in the Philippines has
strong historical roots. Unlike in Thailand or Indonesia, where 'bureau-
cratic-aristocratic' elites (descended from precolonial kingdoms) were
strengthened by the nineteenth century commercialization of agricul-
ture, the same process in the Philippines 'gave rise to a new class of...
landowners who were quite separate from the bureaucracy' (Crouch
1985: 10). Their economic base was firmly outside the state. With the
arrival of the Americans, economic clout and national-level political
power were combined: anxious to win over the elite and pacify the arch-
ipelago, the United States quite quickly began to turn the reins of gov-
ernment over to this mestizo elite that had already developed a strong
economic base in the latter decades of the Spanish era. By concentrating
far less on the creation of a central bureaucracy than on the introduction
of representative institutions, American colonial rule actually reinforced
the decentralized nature of power in the Philippines. The representative
institutions enabled local caciques to consolidate their hold on the
national state and fostered the creation of 'a solid, visible "national oli-
garchy" '. The oligarchy took advantage of its independent base of power
and came to exercise powerful - yet particularistic - control over ele-
ments of the state apparatus through a spoils system that had become
well entrenched at the national level early in the century. 'Civil servants
frequently owed their employment to legislator patrons, and up to the
end of the American period the civilian machinery of state remained
weak and divided' (Anderson 1988: 11-12).
These colonial patterns seem to have become even stronger in the
post-independence years. Wurfel (1988: 80-5) reports that members of
congress actually felt that they were spending 'most of their time . . .
running an employment agency'. The bureaucracy expanded rapidly,
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 219
especially at election time. One episode is illustrative of the degree to
which the loyalties of individual bureaucrats were tied to extra-bureau-
cratic forces. In 1959, the Palace and Congress worked out the so-called
'50-50 agreement', in which responsibility for filling new bureaucratic
posts would be divided equally between the President and the House of
Representatives. One congressman insisted that the pact 'cannot be
interpreted as a spoils system or be considered an instrument of patron-
age because it is a necessary consequence of democracy'; the Civil
Service Commissioner, however, observed that 'this is no longer a gov-
ernment of laws but of men'. While bureau directors complained of the
need to bring unqualified personnel into their units, they lacked the
power to stand up to external pressures. As one bureau director
remarked, 'I have no real control over a man who owes his loyalty to a
Congressman . . . discipline breaks down now. The man who gets his first
job through a Congressman will also try to get a promotion the same way.
Most of those we have to accommodate aren't even eligible.' Another
bureau director explained that the budget of his agency 'cannot exist if
we don't cooperate with congressmen. If you tell them "NO" outright, by
golly, they will tear you to shreds in the next budget hearing' (Francisco
and de Guzman 1963: 109, 112, 116).
Similar patterns endure in post-1986 Philippine-style democracy, as
congresspersons continue to exercise enormous influence over who is
recruited and promoted within the bureaucracy, and how projects are
formulated and implemented by the bureaucracy. Formal authority
remains poorly developed and is often overwhelmed by informal net-
works of power controlled by social forces with a strong independent
base outside the state. Even in the military, the official chain of command
is often disrupted by outside networks of power. In the mid-1980s, for
example, when Armed Forces Chief of Staff Fidel Ramos was battling var-
ious coup attempts against the government of Corazon Aquino, he was
forced at one point to fly to Mindanao to negotiate with a major who
headed up a military brotherhood - that is, lowly in terms of authority,
powerful in terms of informal networks (Nemenzo 1986: 19).
In Thailand, by contrast, formal bureaucratic authority is historically
far more developed and has overlapped to a much greater extent with
informal networks of power. This is especially true if one examines the
relationship between power and authority in the period prior to the 1980s
- that is, before an increasingly assertive business sector and electoral
competition began to alter many dynamics of Thai politics. 'Throughout
Thai history', Girling (1981: 37) explains, one can discern a 'continuing
dialectic between bureaucratized, formal hierarchy and personalized,
informal clientship'. The military-bureaucratic elite consolidated its
strength during the reign of Chulalongkorn (the modernizing Thai
220 PAUL D. HUTCHCROFT
monarch who undercut local familial power and strengthened central
authority in the late nineteenth and early twentieth centuries) and actu-
ally seized the reins of power in 1932.
Clientelistic ties were of enormous importance in pre-1980s Thailand,
but these informal networks overlap to a far greater extent with formal
lines of authority than is the case in the Philippines; indeed, clientelistic
bureaucratic 'cliques' have been called 'the foundation of political life in
Thailand' (Scott 1972a: 59, quoting Wilson 1962: 116). Basic patterns of
recruitment and promotion are controlled by patrons located within the
bureaucratic structure, as the 'clientele of an upwardly mobile official is
likely to expand at a rate commensurate with his growing capacity to dis-
tribute rewards' (Scott 1972a: 61). This overlap of power and authority is
further highlighted by Girling (1981: 37-8, 42), who notes that 'Thai
society is very much a status society', with status differentiation embod-
ied in the bureaucracy. 'Yet power effectively underlies status: "Those
with most power are likely to have the highest status".'6
In summary, lines of formal authority are weaker and the disjuncture
between authority and power is far more pronounced in the Philippines
than in the more bureaucratized Thai political system prior to the 1980s.
In this loosely structured system, where patrons are as often found out-
side formal structures of authority as within them, there is likely less reg-
ularization of patterns of corruption from one case to another. The
primary loyalty of government employees often remains with the patrons
who got them the job in the first place, and agency heads have little abil-
ity to command the obedience of their subordinates. The formal lines of
demarcation among agencies are greatly undercut by the informal, yet
powerful, ties of loyalty between political patrons and their clients in the
bureaucracy. As a result, the bureaucracy is highly splintered and even
coherent agency-based factions are often difficult to discern. In short,
the Philippine bureaucracy not only lacks coherence among its various
parts (a common malady of the clique-ridden bureaucratic polity), but,
more fundamentally, it also lacks coherence within its various parts.
Anecdotal evidence does suggest that those seeking special favours
from the Philippine bureaucracy often face a highly unpredictable envi-
ronment: considerable negotiation is often necessary with a wide array of
officials (at various levels of the state apparatus), and it is often difficult
to determine which official will best be able to produce any given desired
result. It is indeed plausible that Philippine businesspeople's particularly
low regard for their country's bureaucracy comes not from a larger mag-
nitude of corruption per se, but rather from greater difficulties in getting
bureaucrats to 'deliver the goods' after they have been paid off. The
Philippines seems to fall somewhere within Rose-Ackerman's (1989: 805,
816) category of 'disorganized' bureaucracy, in which
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 221

the official chain of command is unclear and constantly shifting and the deci-
sion-making criteria are similarly arbitrary and unknown . . . While corrupt
bureaucrats may be willing to accept bribes, applicants cannot be sure that
officials have the power to perform their side of the bargain. Chaotic legal
procedures increase the demand for more certain illegal ones, but if the dis-
organization of government is far advanced, no bureaucrats may be able to
supply the requisite certainty even when offered a monetary incentive.7

To the extent that this description resembles aspects of Philippine

reality, businesspeople (especially those without favourable access to the
political machinery) will often find it very difficult to predict the cost, fre-
quency or results of their bribery of state officials. The basic 'rules of the
game' will often be far more arbitrary, and corruption will have a more
obstructive impact on the process of capitalist growth. Further research
is necessary to confirm these highly tentative comparisons of variability
and its roots; unfortunately, empirical obstacles to such comparisons are
likely to be unusually formidable.

How competitive and efficient is rent allocation f

To what extent are rents 'dissipated' - in other words, resources wasted -
in the course of rent allocation? Analysis of corruption and rents has
focussed considerable attention on the process by which particularistic
privileges are allocated but has unfortunately achieved little consensus as
to the impact of these processes on development. Key elements of
inquiry, as we shall see, involve the extent to which allocation is compet-
itive and the degree to which it generates efficiency.
Many economists - ever faithful to market processes - begin with the
presumption that bureaucrats will allocate scarce resources such as
licences and other favours via 'competitive bidding among entrepre-
neurs'. Leff (1989: 393, 396-7) argues that, within such a system, 'favors
will go to the most efficient producers, for they will be able to make the
highest bids which are compatible with remaining in the industry'. A
decade earlier, Krueger (1974: 195, 292) developed a model which also
tends to presume that bidding will be competitive - but came to the
opposite conclusion about efficiency: competition for rents diverts
resources towards such unproductive activities as lobbying and bribery,
and in the end generates welfare costs for society as a whole.
Quite problematic, however, is the idea that the allocation of privilege
will be decided according to market processes. With a few exceptions, it
seems, theorists of corruption have long recognized that corruption can
be expressed according to a combination of market and non-market fac-
tors. Scott's assertion of this important point has been noted above, as
222 PAUL D. HUTCHCROFT
has Jomo and Gomez's more recent argument about the often non-com-
petitive character of rent allocation. While all market transactions are
embedded within a particular social, cultural and political context,
exploration of the often-covert world of rent allocation, corruption and
clientelism requires one to pay special heed to the larger context within
which market forces operate.
The recognition that rents can be allocated according to both market
and non-market processes has led some neo-classical economists to pro-
pose - with further irony - that limits on competition might actually yield
higher levels of efficiency. As paraphrased by Amado Mendoza (1995),
these economists have argued that, since less competition over the allo-
cation of rents is considered less wasteful, 'the least wasteful situation is
one where an absolute dictator who will brook no complaint will dis-
pense rents as he sees fit'. Campos (1992: 15) argues that the costs of
directly unproductive profit-seeking activities will 'likely be smaller in an
environment in which only a limited elite can acquire rents' (see also
Krueger 1974: 301; de Dios 1993: 154) .8
Jomo and Gomez (1995: 3-4) suggest, similarly, that 'the existence of
rents, in itself, does not necessarily result in rent-seeking behaviour'.
Because 'certain political groups, individuals, or institutions usually have
much more influence on or even hegemony over the state', some will
probably do better than others in the process of securing advantage.
Knowing that there is indeed 'uneven access to opportunities for rent
capture', many parties will not even bother to enter the market. It is thus
useful to make an analytical distinction between two broad forms of allo-
cation: 'competitive rent-seeking' and 'purposive rent allocation'. Rents
are sometimes obtained by persons or groups that actively seek out the
advantage; in other cases, they are deliberately allocated from above to
persons or groups who exert relatively little effort. To the extent that
rents are purposively allocated rather than sought after, there may in fact
be far fewer wasted resources in the process of rent allocation than is
commonly presumed.
Just as Scott suggests that there are probably few cases of pure 'mar-
ket' or pure 'non-market' corruption, so also are there likely few cases of
purely 'competitive rent-seeking' or purely 'purposive rent allocation'. A
given claimant, for example, might have close affective ties to those who
allocate privileges and still have to expend considerable effort and
resources to ensure that (a) the allocator does not forget to take care of
what that claimant thinks is his/her due; and (b) this claimant's needs
are taken care of before other claimants whose affective ties with the allo-
cator are equally close. In short, both market versus non-market corrup-
tion as well as competitive rent-seeking versus deliberate rent allocation
are best conceived of as continua, across which one finds varying combi-
nations of the two 'pure' types.
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 223
Overall, we can expect that the centralization of authority and/or
power within a political economy will encourage a greater degree of pur-
posive rent allocation and a lesser degree of competitive rent-seeking.
Deliberate rent allocation, in turn, seems likely to promote relatively less
dissipation than competitive rent-seeking and thus has a more positive
(or less detrimental) outcome from the standpoint of development.
Evidence from the Philippine case, however, highlights the fact that vari-
able forms of rent allocation can exist within the same regime. Moreover,
as will be discussed further in the subsequent section, the Philippines
does not seem to provide a strong correlation between a relative increase
in the importance of purposive rent allocation and positive develop-
mental outcomes.
Both points become clearer through examination of the Marcos
regime. First, rent-seeking endured despite the relative centralization of
political power under authoritarian rule. If one looks only at those busi-
nesspersons who were 'in the game' (i.e. not victims of regime harass-
ment), there were four major categories of beneficiaries (Figure 5.1).
The vertical axis is a continuum spanning those who were already well
established when Marcos came to power and those who used ties to
the regime to emerge from more humble origins (i.e. 'arise out of
nowhere'); the horizontal axis is a continuum indicating whether favours
were obtained through 'market' or 'non-market' forms of corruption. As
emphasized above, however, one cannot say that those on the left were
without affective ties and those on the right never paid for favours. There
is more competitive rent-seeking on the left side of the continuum and
more purposive rent allocation 'from above' towards the right, but 'pure'
cases are probably rare.
The upper left is by far the largest category: established families that
were neither favoured nor shunned but that were nonetheless able to
work out favourable arrangements with the regime - in large part, it is
likely, through competitive rent-seeking. Although affective ties were by
no means absent among these established forces, they did not enjoy the
ready favours of those on the right side of the continuum - where those
listed include fraternity brothers, close allies and relatives of the First
Family. Rents from the coconut industry were purposively allocated to
Eduardo Cojuangco, a long-time political ally; the classic new man is
Herminio Disini, a virtual unknown prior to being given a near-mono-
poly of the tobacco filter market (through presidential decrees that pro-
vided specific favours to his firms). It is unlikely that either Cojuangco or
Disini (who married a cousin of First Lady Imelda Marcos, and was a golf-
ing partner of the President's) had much serious competition when they
obtained this or later advantages, although quite likely some not-insub-
stantial portion of the 'rent' was shared with one faction or other of the
First Family.
224 PAUL D. HUTCHCROFT

Relatively greater Relatively greater

reliance on reliance on
market linkages non-market ties

Relatively
more Most of the
established 'old oligarchy' Eduardo Cojuangco
entrepreneurs (neither favoured Roberto Benedicto
nor shunned)

Relatively less Chinese-Filipino Herminio Disini

established 'parvenus' Ricardo Silverio
entrepreneurs

Figure 5.1 Four major categories of beneficiaries of Marcos regime

Most Chinese-Filipinos are found on the left, forced - in large part

due to their greater vulnerability - to pay for favours extended by the
regime. One of the most successful was parvenu Lucio Tan, who would
likely fit best in the bottom centre of the matrix because he seemingly
combined close ties to Marcos with a need to pay heavily for the many
benefits he received.9 A number of other Chinese-Filipinos were forced
to make payments to Marcos through his designated 'bag-man', but
few were as successful in establishing such prominent stature within the
business community (i.e. move, as did Tan eventually, to the upper half
of the matrix) (Hutchcroft 1993: 148-54, 321, 330; see also Rivera and
Koike 1995).
In sum, even under the authoritarian rule of the Marcos administra-
tion there seemed to continue to be a large degree of competitive rent-
seeking among two major segments of the business community:
established families, and newcomers (many Chinese-Filipino) seeking to
move up the ladder of success but lacking strong personal ties to the
regime. Purposive rent allocation and competitive rent-seeking coex-
isted quite well, and varied according to the relationship of the claimants
to the regime: some were able to obtain rents with little effort, while oth-
ers needed to expend a great deal of resources to get what they wanted.
Other authoritarian regimes will in all likelihood maintain their own mix
of both purposive rent allocation and competitive rent-seeking, depend-
ing on the relationship of the ruler to various types of claimants.
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 225
Second, as will be discussed further below, the Marcos regime suggests
that an increase in the level of deliberate rent allocation relative to com-
petitive rent-seeking does not necessarily correlate with developmental
success: there are other variables that are seemingly far more determina-
tive of developmental outcomes. The entire process of allocation, as dis-
cussed above, is almost sure to be inherently political. As such, it is
necessary to probe the actual politics involved in the dispensing of privi-
lege, and to note that they probably vary enormously from one setting to
another depending on the overall terrain of the playing field (purposive
rent allocation by Regime A may be very different from purposive rent allo-
cation by Regime B) as well as the placement of key players on the field
(purposive rent allocation to Claimant A may be very different from pur-
posive rent allocation to Claimant B). One must go beyond the basic ques-
tion of 'purposive rent allocation versus competitive rent-seeking' and seek
to understand more clearly the motivations behind a given allocation of
rent and the political context within which it takes place. While purposive
rent allocation is, overall, likely to produce less wastage than competitive
rent-seeking, additional analysis is necessary in order to assess more accu-
rately the impact of specific rent allocations on developmental outcomes.

How are gains from corruption and rents invested1?

Whereas the previous question considered the processes by which rents
are allocated, this question focusses attention on how rents, once
obtained, are employed (Jomo and Gomez 1995: 5). It has long been rec-
ognized not only that one of the 'benefits' of corruption may be to pro-
mote rapid capital accumulation, but also that one must inquire as to
whether the capital itself is invested in productive ways (Nye 1989: 967).
At one end of the continuum, an entrepreneur invests his or her gains in
a high-value-added industry that creates a great many positive externali-
ties to the rest of the economy; at the other end of the continuum, advan-
tages are hustled out of the country and into Swiss banks and Manhattan
real estate.
There is no reason to expect that rents sought after in competitive
environments will necessarily result in more productive investment than
those that have been purposively allocated. On the other hand, in the
event that rents are purposively allocated there is no reason to expect
that either purposive rent allocators - or those who obtain rents via pur-
posive allocation - are necessarily going to be interested in promoting
productive investment. As asserted above, one must look at the larger
context in which rents are allocated. I propose that there are at least
three key variables to examine in assessing the productivity of privileges
obtained:
226 PAUL D. HUTCHCROFT
• What are the motivations of those who allocate and obtain privileges?
• Presuming that rents are allocated in order to promote developmen-
tal goals, what is the capacity of the state to enforce or promote pro-
ductivity criteria?
• How secure is the environment in which a given entrepreneur is
operating?

The motivations of those who obtain privileges through competitive

rent-seeking are probably impossible to evaluate with any precision:
some will be inclined to productive investment and some will not. In the
case of purposive rent allocation, however, one is by definition evaluating
a systematic effort towards a clear objective. The nature of the objective,
however, may have little to do with the promotion of explicit develop-
mental outcomes - and may just as likely be oriented towards clearly
political objectives. Such political goals may in fact be relatively harmless
- or actually promote - developmental objectives, as when privilege is
extended to a particular region or ethnic group. In other cases, political
goals may have a very harmful impact on the process of economic devel-
opment, as when a highly unproductive businessperson is given a trading
monopoly and extraordinary access to state credit in exchange for build-
ing local political support for the regime in an important bailiwick. If the
purposive rent allocator is highly dependent on such local powerbrokers
for political survival, it is particularly improbable that developmental
goals will figure prominently in the bargain.
Second, when rents are in fact allocated with clear developmental
goals, what is the capacity of the state to enforce or promote such goals?
In an optimal 'rent-seeking' scenario, those who obtain privileges
through competitive bidding must invest them in productive enterprise.
In an optimal scenario of purposive allocation, those who give out the
rents are not only very skilled in choosing the right entrepreneurs but
also quite capable of enforcing strict performance guidelines from those
they have provided with a particular benefit. Entrepreneurs favoured by
South Korea's Park Chung Hee, for example, were granted enormous
privilege but at the same time were forced to meet performance criteria
(commonly in the form of export targets). In many cases, however, those
who obtain advantages will be able to pursue their own goals - which may
or may not be oriented towards productive investment.
The clearest analysis, here again, requires careful examination of the
broader configuration of authority and power within which rent alloca-
tion takes place. Privilege may be extended to collective interests (a par-
ticular region, ethnic group, political party, or military faction) or to far
more particular interests (family members, fraternity brothers, golfing
partners, and so on). It is necessary to examine the relationship of rent
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 227
allocators to each of these types of interests. Moreover, one must note
that, while in some settings major beneficiaries will be found within the
state (commonly, top bureaucrats and military officers), elsewhere major
beneficiaries have an independent economic base outside the state
(Hutchcroft 1998: 46-55). Overall, analysis of the ability of allocators to
enforce and promote performance criteria requires that one examine
such basic issues as the distribution of political power, the character of
bureaucratic agencies, and the institutionalization and differentiation of
business interests. Questions of enforcement cannot be understood with-
out careful attention to the larger realms of power and authority.
Examination of the Philippine case highlights how developmental
goals may diverge significantly from the politics of privilege; beneficia-
ries of rents - whether those rents have been sought after or purposively
allocated - seem rarely to face any strong pressure to meet performance
criteria. In the 1950s, for example, entrepreneurs competed vigorously
to obtain import and foreign exchange licences, the receipt of which
provided windfall profits.10 Those who received the licences, whether
through competitive rent-seeking or purposive rent allocation, faced few
requirements as to how to employ them. The system of controls did
spawn the growth of a new group of Filipino manufacturing entrepre-
neurs in import-substitution industrialization ventures. But intra-agency
squabbles and inadequate central bank capacity to audit firms prevented
serious industrial planning. In some cases, in fact, entrepreneurs
requested licences to assist manufacturing ventures and then diverted
the proceeds to import finished goods (Golay 1961: 141, 152, 239; see
also Rivera 1994).
Even under Marcos' authoritarian regime, there was little enforce-
ment of larger performance criteria. There was, seemingly, a relatively
greater degree of purposive rent allocation in this period, as discussed
above; the regime's chief ideologue, in fact, later reported that Marcos
wanted to follow the Japanese example and create zaibatsu - but unfor-
tunately 'chose the wrong samurai' (Adrian Cristobal, former Special
Assistant for Special Studies, interview, 19 June 1989). The 'samurai'/
crony who created one of the healthiest business empires, by the end of
the regime in 1986, was Eduardo 'Danding' Cojuangco (a first
cousin - and bitter family rival - of Corazon Cojuangco Aquino). He was
among the most secure of all cronies, since he not only came from a well-
established family that had built up its fortune in previous generations
but also enjoyed strong personal ties with the President. These assets,
combined with strong business acumen, enabled Cojuangco to develop
a strong and diversified conglomerate nurtured by access to the enor-
mous coconut levy instituted by Marcos in the early 1970s. Centred
around coconut milling and trading, it also included banking and (by
228 PAUL D. HUTCHCROFT
the early 1980s) a large chunk of the country's largest firm, San Miguel
Corporation (see Hawes 1987).
While profits flowed freely from his diversified conglomerate, however,
there is little to indicate any strong pressures to advance the productivity
of the larger economy. In fact, Cojuangco proved to be far more inter-
ested in skimming wealth off the top than actually producing wealth by
enhancing the productivity of the coconut industry. Marcos, one might
expect, would see strong political advantages in demanding greater atten-
tion to the productivity of this industry since it involves a significant part
of the rural population - and the communist-led New People's Army reg-
istered some of its most important gains in regions where the industry is
dominant. Despite such political incentives, however, the levy drained
income from producers without any significant promotion of productiv-
ity gains (Ruivivar 1992). Without the enforcement of performance crite-
ria, Cojuangco could treat the industry as a source of plunder. Meanwhile,
the empires of other cronies (such as Disini and Silverio) went belly-up in
the midst of the general political and economic insecurity of the early
1980s and were rescued at great expense to the public treasury (Hutch-
croft 1998: 152-6). All the more, one can conclude, did they fail to regis-
ter productivity gains for the larger economy (on investment productivity,
see de Dios 1984: 15).
Third, rent-recipients operating in a very insecure environment may
have little incentive to adopt a long-run strategy in the country where
their advantage was obtained: capital flight, rather than productive invest-
ment of capital, will probably predominate.11 Unfortunately, the periodic
balance-of-payments crises that have plagued the postwar Philippine
economy have frequently created a very insecure environment for the
productive investment of gains from rents, corruption and clientelism. A
number of channels have expedited the export of capital in the past (see
Boyce 1993: 282-5); no doubt the close ties of Filipinos to relatives in
North America, Australia, Xiamen and Taiwan facilitated the process.

What is the impact on the market?

This question moves analysis from issues of investor productivity to those
of market performance: do rent allocation, corruption and clientelism
tend to promote or discourage competition among firms? Doner and
Ramsay (1995: 3-4) contrast 'competitive clientelism' (in which compe-
tition among political elites keeps barriers to entry low and thus fosters
business competition) with 'monopoly cronyism' or 'monopoly clien-
telism' (in which entrepreneurs can use their access to the state machin-
ery to enforce higher entry barriers and reduce competition) (see also
Scott 1972a: 91). Quite clearly, the former can be expected to promote
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 229

more favourable conditions for capitalist development, particularly

where the state lacks the regulatory capacity to ensure efficient perfor-
mance from cartelized and monopolized sectors.
Second, and closely related, is the need to examine whether corrupt
acts provide an escape from policies that obstruct markets, or whether
the acts themselves obstruct the efficient functioning of competitive mar-
kets. The first case is perhaps best illustrated by West African cocoa farm-
ers evading laws that require them to sell their produce to state
marketing boards and smuggling their produce to markets in neigh-
bouring countries (Bates 1981). The second occurs when an anti-trust
lawsuit is squelched through the bribery of key officials.
In early postwar Thailand, argue Doner and Ramsay (1995: 3-4), the
intensity of competition among the political elites promoted business
competition as well. Within a system they call 'competitive clientelism',
entry barriers to new firms remained low and

already established firms have had difficulty using political connections with
official patrons to block the emergence of new rivals . . . The constant and
intense interfactional rivalries that characterized Thai political elites opened
up opportunities for Chinese entrepreneurs anxious to gain entrance into new
markets because they were able to find patrons to protect and promote them.

The Philippines, they argue, might alternatively be labelled 'monop-

oly cronyism' or 'monopoly clientelism' (see also Doner and Ramsay
1997). In comparing competitive and monopoly clientelism, one might
note that in each setting those in positions of greatest power got what
they wanted: bureaucrats in Thailand were able to promote their own
economic security by forging ties with new business clients, while groups
of oligarchic families in the Philippines were able to promote the con-
solidation of their economic position by ensuring that new competition
would not emerge.
Indeed, 'rents' in the Philippines have been explicitly defined so as to
include 'protection from competition through quotas, tariffs and mea-
sured capacities' (in addition to 'subsidized credit, access to foreign
reparations, loans and grants'). Those who gain such 'property' need not
develop it; rather, 'they only need to maintain their influence over peo-
ple in the government machinery to maintain and expand their owner-
ship of economic advantages' (Montes 1988: 64—6). The reforms of the
Ramos administration, discussed above, were intended to alter these
longstanding patterns.
Although the Philippines has long suffered from monopoly clientelism,
there are at the same time ways in which corruption has promoted
the functioning of markets. This is particularly true of those forms of
230 PAUL D. HUTCHCROFT

corruption that circumvent import and export regulations: smuggling, vio-

lation of foreign exchange restrictions, and so on. Overall, however, it
seems that clientelism and corruption have been most influential in
restricting market competition and promoting the growth of 'cartels and
monopolies' that still plague important elements of the political economy.

What is the impact on state capacity ?

States have important tasks to achieve in promoting development. Even
advocates of a relatively minimalist role for the state, such as the World
Bank, assert that

governments need to do more in those areas where markets alone cannot be

relied upon. Above all, this means investing in education, health, nutrition,
family planning and poverty alleviation; building social, physical, administra-
tive, regulatory, and legal infrastructure of better quality; mobilizing resources
to finance public expenditures; and providing a stable macroeconomic foun-
dation, without which little can be achieved. (World Bank 1991: 9)

To the extent that corruption inhibits the achievement of these vital

foundations of laissez-faire capitalism, opportunities for sustained
growth will be impaired. If one expects that promotion of late industri-
alization requires an even more extensive role for the state, quite clearly
it will be necessary to build up an even greater degree of capacity
throughout the bureaucratic apparatus. For present purposes, however,
it is possible to confine our attention to the impact of corruption on the
basic political foundations of capitalist growth.
Some argue that corruption promotes development by promoting
administrative responsiveness. 'Many economic activities would be paral-
ysed', wrote Myron Weiner of Indian politics in 1962, 'were it not for the
flexibility which bakshish contributes to the complex, rigid, administra-
tive system'. Huntington (1968: 69) concurs: 'In terms of economic
growth, the only thing worse than a society with a rigid, overcentralized,
dishonest bureaucracy is one with a rigid, overcentralized, honest
bureaucracy'. Others introduce the distinction between 'speed pay-
ments' (involving 'bribes that expedite a decision without changing it')
and 'distortive payments' (which 'change the decision and contravene
formal government policy') (Scott 1972a: 67; see also Fegan 1994: 4-5).
From the standpoint of an individual businessperson or citizen, cor-
ruption does indeed grease the wheels of a bureaucracy; to be sure, 'hon-
est bureaucracies' can be infuriatingly inflexible to those with a
justifiable need to bend the rules, and 'dishonest bureaucracies' highly
responsive to those who have the means a n d / o r connections to do so.
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 231
From a macro perspective, however, it is important to consider the
impact of even seemingly innocuous 'speed' payments on the likelihood
of a bureaucratic agency delivering the services it was set up to deliver.
Such payments can encourage systematic delays, precisely because slow-
ing things down brings such handsome financial rewards to those in a
strategic position within the bureaucracy. Corruption may in some cases
be a valuable 'lubricant' to individual claimants, but one must not
neglect the degree to which such incentives build more bureaucratic 'toll
posts' and, in the end, exacerbate delays in the system as a whole (see
Alatas 1968: 31-5).
Moreover, one must assess the longer-term impact of corruption on
administrative capacity to perform essential developmental tasks.
Theobald (1990: 128) asserts that

widespread venality, far from drawing together the different departments and
areas of the public service, provokes fragmentation, dissension, inter- and
intra-departmentalrivalry. . . the low levels of morale and paranoia which are
typically associated with an acutely unstable work situation . . . will have very
marked consequences for job performance . . . [A prevalence of] nepotism,
political patronage and bribery . . . [means] there is little incentive for func-
tionaries to work efficiently or honestly.

While not denying that corruption may have some 'positive conse-
quences', Theobald (1990: 131) asserts that 'it is virtually impossible to
confine corruption to those areas where its effects are deemed to be ben-
eficial'. Even Huntington (1968: 69), who sees many positive benefits to
corruption, acknowledges that it 'naturally tends to weaken or to per-
petuate the weakness of the government bureaucracy'.
Aside from questions of flexibility and capacity, one must consider the
impact of corruption on government budgets. How much of an expen-
diture intended to promote certain developmental goals actually ends
up being utilized for such objectives, and how much gets leaked to pro-
mote private gain? On the revenue side, as well, corruption may reduce
the proportion of a given tax that actually ends up in public coffers; tax-
payers can bribe the right officials to informally bargain down their tax
burden or obtain a formal exemption. Either way, funds are diverted
from public to private ends. Leff (1989: 399) argues that 'there is no rea-
son to assume that the government has a high marginal propensity to
spend for developmental purposes'; moreover, 'when the entrepreneurs'
propensity to invest is higher than the government's, the money saved
from the tax collector may be a gain rather than a loss for development'.
This begs the question, however, of whether the private hands that dip in
the till will be investing their resources in the provision of public goods
232 PAUL D. HUTCHCROFT
essential to the promotion of development. In many cases, even the most
basic political foundations of economic development are severely dis-
rupted by corruption: such tasks, for example, as law enforcement, fire
protection, and the construction and maintenance of infrastructure.
While entrepreneurs may invest some resources in provisioning them-
selves with these goods (private security guards, fire brigades, roads), it
will be rare for private investors to charitably provide public goods when
governments fail to do so. As the World Bank explains, governments
must do what markets alone fail to do.
A key question, then, is how much corruption actually reduces public
expenditure on developmental goals (whether it be an irrigation project,
a road, or a rural health clinic). Wade (1982: 287-8) has provided an
exceptionally detailed empirical portrait of how corruption in a South
Indian system of canal irrigation impeded developmental goals. Irriga-
tion engineers were able to raise 'vast amounts of illicit revenue' in the
construction of irrigation works and in deciding how water was allocated;
in the process, the 'economic well-being of local communities' was often
poorly served. Overall, one can expect that 5 per cent diversion of
resources from public purpose to private hands is relatively harmless
compared with 10 per cent, and 10 per cent far less damaging than 25
per cent and above.
Within any given country, some elements of the political machinery
are likely to divert more resources than others: the actual incidence of
corruption may vary, for example, depending on whether one is exam-
ining the upper level or the lower levels of a bureaucracy, Agency A or
Agency B. Huntington asserts that 'most political systems' exhibit a high
incidence of corruption 'at the lower levels of bureaucratic and political
authority', and that as one moves to higher levels the frequency of cor-
ruption may - depending on the country - remain constant, increase or
decrease. In all cases, however, 'the scale of corruption (i.e. the average
value of the private goods and services involved in a corrupt exchange)
increases as one goes up the bureaucratic hierarchy or political ladder'
(Huntington 1968: 67, emphasis in original). Broad judgements as to
whether upper- or lower-level corruption will tend to be more damaging
to developmental prospects are difficult to make: bribes at the lower level
involve less money per transaction but may well prove more disruptive to
the functioning of the overall legal and administrative order. One can
presume, however, that corruption will have the most debilitating impact
when it is pervasive throughout a system, not only obstructing the provi-
sion of basic services through petty corruption at the lower levels but also
resulting in large-scale graft at the top.
From one agency to another, as well, there are commonly great
variations in the prevalence of corruption and rent-seeking. 'Unable to
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 233

transform the bureaucracy as a whole', Evans (1995: 61) explains of

Brazil, 'political leaders [tried] to create "pockets of efficiency"' in which
universalistic norms governed recruitment and an 'ethic of public service'
nurtured a 'clear esprit de corps'. Doner and Ramsay (1995: 2-3), simi-
larly, call Thailand a 'bifurcated state . . . divided between politically well
insulated macroeconomic agencies [including the Ministry of Finance
and the Bank of Thailand] and highly politicized line agencies'. 12
Moreover, the character - and hence impact - of corruption can vary
according to whether or not democratic institutions are present. While
some systems exhibit a clearer demarcation of administrative agencies
and parliamentary bodies than others, in general one can say that the
presence of representative institutions and electoral competition opens
up the system to the influence of a wider array of actors: party leaders,
politicians, and at least some element of a broader public. Moreover,
electoral systems offer

noncorrupt channels for influence that simply do not exist in autocratic sys-
tems. For a businessman to give money to a civil servant is generally illegal,
whereas the same amount given to a politician's campaign fund may 'buy'just
as much influence over government decisions but is quite proper... The over-
all level of corruption (legally defined) is not necessarily lower in party sys-
tems, but the party system generally does legitimize certain patterns of
influence that could only occur corruptly in a military/bureaucratic system.
(Scott 1972a: 94)

Finally, democratic institutions can, in some cases, provide new incen-

tives for corruption. In his study of India, Wade (1982: 318-19) concludes
that 'it is likely that elective institutions have amplified the pressures
towards corruption and made it more systematic . . . because of the spi-
ralling cost of fighting elections and nursing a constituency between elec-
tions'. The relationship between democratic institutions and corruption,
however, depends on a broad range of political dynamics: at the same
time that it enables more persons to seek a place at the trough, it can also
provide greater influence to those trying to topple the trough.
Despite the analytical utility of locating where resources may be
diverted from developmental goals, it is important to recognize how the
various parts seem to fit together as one single system of corruption.
Wade criticizes those who 'treat "administrative" and "political", "high"
and "low" level corruption as distinct and unconnected forms', demon-
strating that they are often 'systematically interconnected'. Theobald
(1990: 18), similarly, treats 'administrative and political corruption as
dimensions of the same phenomenon, as different sides of the same
coin' (see also Riggs 1987).
234 PAUL D. HUTCHCROFT
Corruption is extensive throughout the Philippine state apparatus,
from the lowest to the highest levels. As in many other settings, it is diffi-
cult to understand many aspects of politics without examining such
underlying (and usually, but not always, behind-the-scenes) realities.
While the terms 'anomalies' and 'irregularities' are commonly used in
discussions of Philippine corruption, such phenomena as bribes and
extortion are seemingly a regular element of the complex interlinkages
among bureaucrats, politicians, business, the press, and the public. A
1968 study found that a businessperson dealing with customs had to go
through fifty-four procedural steps to get an importation released, forty-
two involving payments requiring bribery. Failure to pay the proper
amount might encourage a forklift operator to 'accidentally' drop one's
cargo. The 'via dolorosa' of corruption may continue when the busi-
nessperson moves the goods from port to market, as further payment will
likely be required to police along the way (Kiunisala 1968: 2, 74). The
conduct of business requires considerable 'speed money'; in larger per-
spective, however, the marketization of the governmental machinery
through the construction of so many toll-gates does little but clog up the
works of the larger economy. Just as importantly, corruption obstructs
the provision of the most basic public services. Law enforcement officers
reportedly engage in kidnapping-for-ransom schemes, and fire protec-
tion officials reportedly overlook violations of safety codes in exchange
for the purchase (from the officials themselves) of low-quality fire extin-
guishers (Philippine Daily Inquirer, 21 March 1996).
Corruption in the Philippines includes not only lower-level customs
officials and police, it also stretches into those agencies that one might
expect to be somewhat insulated from its effects. The Central Bank of the
Philippines, for example, died an ignominious death in 1993, bleeding
red ink from a host of excessively generous programs of earlier years.
Corrupt practices in the disbursement of special benefits, in some cases,
allegedly reached all the way to the governor's office (Hutchcroft 1998).
Unlike in Thailand, where the Bank of Thailand enjoys a longstanding
reputation for probity and competence, it is difficult to speak of a 'bifur-
cated state' in the Philippines. This is not to say that there are no pock-
ets of efficiency, but to the extent they exist it tends to be because of
often-isolated efforts of highly talented and committed individuals to
produce results. All too commonly, agencies 'turned around' through
largely individual efforts - often based on personalistic ties - revert to
earlier patterns once the miracle worker has moved on to other pursuits.
State-building initiatives are all too rarely sustained.
The impact of such extensive corruption on capacity and morale is
indeed difficult to calculate. More quantifiable measures, such as deter-
mining percentages of developmental budgets diverted to private hands,
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 235
lack reliable data. But it is possible to note the phenomenon of roads that
exist on the map but not on the ground (called 'pocket roads' because
of where the money ends up), and new roads that immediately sport
huge potholes because of the use of shoddy materials and the weakness
of quality control procedures. To the extent that corruption contributed
to the 8-10 hours per day of electrical outages suffered by business and
residential consumers in the early 1990s, it quite clearly had little positive
developmental impact.
Following Wade's observations of India, Philippine corruption needs
to be treated as a highly interconnected system, spanning administrative
and electoral structures and stretching from top to bottom. The
demands of nurturing a political base and winning electoral competition
not only encourages corruption but also promotes entirely legal pork-
barrel diversions of resources into politicians' hands. Each congressper-
son and senator is able to disburse a large quantity of funds as he or she
sees fit: the peso equivalents of US$50,000 per senator in 1946 (Mojares
1992: 156), some US$125,000 per senator and US$75,000 per represen-
tative in the early 1960s (Wurfel 1988: 86), and almost US$700,000 per
senator and US$500,000 per representative in the Countrywide Devel-
opment Fund of the mid-1990s.13 It is difficult to say how much actually
gets spent on projects with a positive impact on development, but clearly
technical criteria have little impact on the choice of projects. The qual-
ity of the infrastructure suffers accordingly.

What is the impact on state and party institutionalization f

In addition to examining the impact of corruption on the capacity of
states to perform important developmental tasks, it is also valuable to con-
sider whether certain types of corruption may promote the institutional-
ization of bureaucracies and militaries. Returning to the discussion above
of the relationship between formal lines of authority and informal net-
works of power, I propose that a higher degree of convergence between
power and authority may occasionally promote state institutionalization.
Because of the divergence of power and authority in the Philippines,
there is little potential for corruption to further such institutionalization.
When Philippine military officers engage in corruption, for example, the
beneficiaries of their patronage may or may not include their underlings
within the state apparatus; patron-client networks are quite likely to spill
out to beneficiaries outside the system of formal authority. If a naval offi-
cer uses official supplies of fuel to promote sideline smuggling, there is
no great likelihood that he will share the loot with his rank-and-file. His
activities will probably do more to obstruct than to enhance the institu-
tionalization of the military.
236 PAUL D. HUTCHCROFT

Historic patterns of corruption in Indonesia and Thailand, by con-

trast, seem to be quite different. Crouch (1988: 38, 40) reports that, in
the late 1950s, (then) Colonel Soeharto was transferred from his post as
regional commander for Central Java because of involvement in a 'smug-
gling scheme ostensibly to raise funds for the "welfare" of his troops'.
While personal gain was clearly a major factor, Indonesian generals
engaging in such economic activities were also motivated to 'maintain
the functioning of their units and the loyalty of their troops'. State appro-
priations were insufficient to provision adequately the rank-and-file sol-
diers, and it was wise for patron-generals to share part of the gains from
corrupt activities with a clientele located within the state apparatus. One
cannot say that Indonesian generals are more generous than their Philip-
pine counterparts; rather, they are merely working within a system that
promotes the distribution of rewards within the state apparatus rather
than without. Systems of authority are complemented to a greater degree
by systems of power, and corruption may at times actually promote the
institutionalization of state agencies.14
The second consideration is the impact of corruption on the institu-
tionalization of political parties. Huntington (1968: 70-1) connects the
achievement of more institutionalized parties with the demise of cor-
ruption itself:

For an official to award a public office in return for payment to the official is
clearly to place private interest over public interest. For an official to award a
public office in return for a contribution of work or money to a party organi-
zation is to subordinate one public interest to another, more needy, public
interest. . . Corruption thrives on disorganization, the absence of stable rela-
tionships among groups and of recognized patterns of authority... [It] varies
inversely with political organization, and to the extent that corruption builds par-
ties, it undermines the conditions of its own existence . . . the incidence of corrup-
tion in those countries where governmental resources have been diverted or
'corrupted' for party-building is on the whole less than it is where parties have
remained weak, (emphasis added)

Historically, he continues, political parties of the West which were ini-

tially 'leeches on the bureaucracy in the end become the bark protecting
it from more destructive locusts of clique and family'.
As Huntington suggests, however, one should not presume that the
mere contribution of money to a political party will necessarily
strengthen the party itself. Just like bureaucracies, political parties com-
bine formal lines of authority with informal networks of power. In some
cases, grants of money obtained via corruption will promote the institu-
tionalization of the party, but, in other cases, parties themselves are so
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 237
riven along the lines of cliques, factions and personalities that new
resources will probably not have that result. Corruption can indeed con-
tribute to the important goal of party-building, but weak parties may
endure even when they are major beneficiaries of corruption. It is impor-
tant to take Huntington's observations a step further and ask why 'cor-
ruption builds parties' in some settings but not others.
Despite the prevalence of corruption in Philippine electoral processes,
there has been little institutionalization of political parties. Resources are
more likely to be controlled by individual politicians than by the party to
which he or she belongs, and the parties themselves generally remain
tools of convenience both for their leadership as well as for their mem-
bers. One can speculate that only a more fundamental shift in Philippine
politics - perhaps the development of clear ideological divisions within
the elite -will promote greater institutionalization of party machineries.

Are there counterbalances or limits to corruption f

To what extent is corruption's impact on economic development coun-

terbalanced by other 'growth-promoting economic and political factors'?
Does a political system generate an internal 'sense of limits' able to miti-
gate the extent of corruption? In assessing the impact of corruption on
economic performance, it is commonly argued that other factors may
insulate economies, at least temporarily, from its possibly detrimental
effects. In some settings, as Maclntyre (1995: 10-16) summarizes the
argument, it seems that 'clientelism . . . has been sufficiently counterbal-
anced by other growth-promoting economic and political factors that
have enabled strong economic growth to continue in the face of rampant
rent-seeking, or served to rectify the situation when the cumulative effect
of rent-seeking activities threatened to endanger the economy'. Among
these factors may be large endowments of natural resources, sizeable
quantities of foreign aid, strong investor confidence, and the presence of
nascent 'market-oriented reform coalitions'. The basic notion of consid-
ering countervailing factors is valid but, as Maclntyre demonstrates, this
line of inquiry tends to raise as many questions as it answers. Indeed, a
simple comparison of how Indonesia and Nigeria managed the windfall
of the oil boom and developed investor confidence returns analysis quite
quickly to the question of how some political economies are better
equipped than others in insulating themselves from the impact of 'ram-
pant rent-seeking'.
The Philippines has had ample supplies of both natural resources and
foreign aid and debt, and at various points they have played major roles
in enabling the country to register respectable levels of economic
growth: the decade of the 1970s, for example, is characterized as a time
238 PAUL D. HUTCHCROFT
of'debt-driven growth' (Montes 1989: 90). The key question, however, is
whether these resources may have been able to better promote economic
growth had the political environment been more conducive to larger
developmental objectives. In the mid-1990s, the Philippine economy was
buoyed by major infusions of foreign investment; once again, the ques-
tion arises as to whether the country might have been able to attract even
more foreign investment had such problems as kidnappings not scared
off many international investors since the late 1980s.
A far more fundamental 'mitigating factor' is the extent to which a
political system may be compelled to provide its own internal limits, how-
ever modest, to the prevalence of corruption. The presence of external
threat is often a key factor in encouraging 'a sense of limits', and 'an elite
which enjoys a measure of cohesion and security can develop a sense of
its collective, long-run interest'; in many cases, however, 'limits are virtu-
ally absent' (Scott 1972a: 79-80). To the extent that corrupt practices
become culturally embedded over the course of decades or even gener-
ations, it will likely be all the more difficult to promote a stronger sense
that 'enough is enough'.
To what degree does the Philippines generate its own internal sense of
limits able to curb the excesses of corruption? The presence of an exter-
nal threat, it was suggested, may encourage a stronger sense of limits.
Until recently, cliental relations with the United States seem to have insu-
lated Philippine elites from any real sense of interstate competition; with
the withdrawal of American military bases in 1992, however, Manila's rela-
tions with the rest of the world are no longer mediated through its special
ties with the United States. The Ramos administration displayed new per-
ceptions of the country's security position, and it was indeed military fig-
ures who played a leading role in deftly pushing for the economic reform
agenda that arose in large part out of this new world view (Hutchcroft
1998: 243-6). But changed perceptions do not automatically encourage a
reduction in the prevalence of corruption. Amid the Ramos reformers'
concerted efforts at economic reform, as discussed below, there was littie
attention to reform of key political, bureaucratic and judicial structures -
and high levels of corruption persisted. Even if inducement for change
may be great, obstacles to change remain formidable.
If a strong sense of limits does not necessarily emerge rapidly from
external threat, how might we judge the Philippines in relation to Scott's
(1972a: 79) suggestion that elite cohesion and security may promote 'a
collective sense of enlightened self-interest'? Authoritarian rule, Marcos-
style, did not bring a great deal of cohesion and, in the end, it only
promoted enormous insecurity. To be sure, the period is not remem-
bered for its sense of limits. Under democratic regimes, the scramble for
spoils within the oligarchy is at least equally unfavourable for building
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 239

cohesion, and a sense of elite security may or may not emerge depend-
ing on diverse factors. In general, the Philippine elite has not displayed
a strong, internally generated sense of limits during either authoritarian
or democratic periods.
To the extent that corruption becomes embedded within the culture
of politicians, bureaucrats, businesspeople, the press, and the public, the
harder it will be to establish a clear sense of limits.15 The more that net-
works of bribes and extortions become an integral part of larger political
dynamics, the more difficult it will be to root them out. Those most vic-
timized by corruption, meanwhile, may at times become inured to all but
its worst excesses. Large segments of the public are outraged, for exam-
ple, when corruption weakens basic aspects of safety regulation and con-
tributes to the high incidence of maritime disasters, but others seem to
have lost much expectation that the bureaucracy is ever going to enforce
such regulations effectively. Corrupt regulators, like approaching
typhoons, may leave enormous destruction and grief in their wake - but
they nonetheless come to be accepted (by at least some element of the
public) as one more of life's many risks.

Towards new terrain?

Utilizing insights from the literature on rents, corruption and clientelism,
this chapter highlights how the politics of privilege may vary in both char-
acter and impact from one setting to another. Building on an analysis of
seven sets of questions, it has provided a preliminary assessment of the
impact of these phenomena on Philippine development. First, the weak-
ness of formal lines of authority, and the divergence of authority with net-
works of informal power, seem to contribute to more variable, less
calculable forms of corruption in the Philippines. Second, competitive
rent-seeking continued to be an important part of the process of allocat-
ing particularistic privilege, even during periods (as under the Marcos
regime) when purposive rent allocation became somewhat more promi-
nent. While competitive rent-seeking likely leads to greater 'dissipation'
of resources than purposive rent allocation, the Philippine experience
suggests that this distinction does not necessarily have a great deal to say
about developmental outcomes; other variables seem to have greater
explanatory value. Third, motives for purposive allocation of rents often
have litde relation to developmental objectives and there are, in any case,
few performance criteria imposed on beneficiaries of rents, whether
under democratic or authoritarian regimes. Moreover, such beneficiaries
have often faced a very insecure environment for productive domestic
investment of their gains. Fourth, the character of corruption and clien-
telism in the Philippines does more to inhibit than promote competitive
240 PAUL D. HUTCHCROFT
markets. Fifth, corruption is extensive throughout the state apparatus
(and beyond) and has a debilitating impact on the capacity of the state to
conduct important tasks that promote development: it generates consid-
erable delays, depletes public resources and contributes to major infra-
structural deficiencies. Especially when democratic institutions are in
place, the diversion of funds intended for developmental goals occurs not
only through illegal acts but also through a highly elaborated pork-barrel
system. Sixth, corruption in the Philippines does little to promote the
institutionalization of either state agencies or political parties. Seventh, a
basic 'sense of limits' has been remarkably weak during both democratic
and authoritarian periods of postwar Philippine history. In summary, the
Philippine political economic system quite consistently nurtures types of
rent allocation, corruption and clientelism that prove generally obstruc-
tive to sustained economic growth. Drawing on this framework, one could
proceed to examine the impact of distinct 'politics of privilege' on eco-
nomic performance elsewhere in the region.
The economic reform initiatives of the Ramos administration in the
mid-1990s aimed to 'level the playing field' of the Philippine political
economy, and thus raised hopes that many past patterns of the politics of
privilege might be altered in ways that proved less obstructive to the coun-
try's developmental goals. By promoting market processes and opening
up sectors of the economy to greater competition, the reforms sought to
reduce the number of rent havens and thus curb the scramble for partic-
ularistic advantage. In an ideal scenario, entrepreneurs would be forced
to spend more of their time improving the productivity of their enter-
prises and less of their time negotiating for advantage with politicians and
bureaucrats. The telecommunications sector was the most dramatic suc-
cess story in the administration's concerted efforts to dismantle 'cartels
and monopolies': the former monopoly bitterly opposed liberalization
but, when forced to change in the face of competition, it has not only
greatly improved the quality of its service but also enjoyed an enormous
increase in its own profitability. Other sectors, including the shipping and
airline industries, also displayed impressive levels of transformation.
In the process, the reforms seem - at first glance - to confirm rent the-
orists' common assumptions that operations of the market are superior
to the interventions of the state. Even those who argue that an extensive
role for the state is necessary to promote late industrialization would be
hard-pressed to defend the capacity of the Philippine state to offer effec-
tive interventions towards developmental ends. Elsewhere, the relative
virtues of markets versus administrative guidance may be debated; in the
Philippines, however, markets seem to win hands down.
On closer examination, there are aspects of the Philippine experience
that offer a certain challenge to the usual assumptions of rent theorists.
Even if the Philippine state intervenes less in certain arenas of economic
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 241
policy-making, it at the same time retains responsibility for such basic
tasks as providing law and order, 'prudential' regulation of the financial
sector, and infrastructure. As long as the state remains ultimately account-
able for supplying these public goods, there necessarily remain rents ripe
for capture by both public officials and the private sector. In a minimalist
state, for example, judges and regulators will continue to be able to
extract payments for favourable decisions, and police may be able to
transform their public power into lucrative kidnap-for-ransom schemes.16
Privatization by no means resolves the dilemma: the process of bidding
and negotiating with private companies seeking to build and maintain a
road, for example, can provide enormous rent havens easily tapped by
those with the most favourable political connections (de Dios 1998: 80).
Because rent theorists have little to say about such post-market-shrink-
ing problems, the solution necessarily shifts away from market remedies
and towards the realm of politics and public administration. When indi-
vidual bureaucrats are able to pursue their own goals at the expense of
official goals, the provision of public goods may bring significant oppor-
tunities for private profit. Quite significantly, the prevalence of corrup-
tion may make it very difficult for some states to provide even the most
basic public goods necessary for development.
Leading reformers of the Ramos administration realized that the most
important tasks ahead are not so much in the economic realm as in
the political. The achievements of the Ramos administration to date,
observed Presidential Security Adviser Jose Almonte in early 1996, were
the 'easy' reforms. As 'hard' reforms requiring greater administrative
capacity are being attempted, he continued, 'the weaknesses of the
Philippine State are starting to show'. Unless it 'becomes stronger and
more efficient [the state] will not be able to deal with our long-standing
problems' (Almonte 1996: 1-2). A reduction in the scope of state activity
is actually the first step in strengthening the overall efficacy of the Philip-
pine state, but concerted attention to political, bureaucratic and judicial
reform will be necessary in order to ensure that whatever politics of priv-
ilege emerges in the future will have a far less detrimental impact on
Philippine development than that of the past.
Unfortunately, the Ramos administration devoted little attention to
these types of reforms (Rocamora 1995; Hutchcroft 1998: 251-4). The
major question for the future is whether subsequent leaders will show
commitment to such sweeping long-term agendas of reform, or whether
short-term goals of aggrandizement will instead dominate. While it
seems overambitious to expect an actual levelling of the playing field,
one can nonetheless hope that more favourable terrain might someday
be crafted. The Estrada administration has the opportunity to build on
recent reform momentum; sadly, however, its early actions suggest a
stronger inclination to revert to the more familiar patterns of the past.
242 PAUL D. HUTCHCROFT

Notes

1 In mid-1996, Philippine executives revealed a lower opinion of their bureau-

cracy than did their counterparts anywhere else in the region: nearly 45 per
cent considered the Philippine bureaucracy 'very corrupt', compared with 32
per cent in Indonesia, 13 per cent in Thailand, and 9 per cent region-wide.
The Philippine bureaucracy also received the worst ratings in terms of effi-
ciency {Far Eastern Economic Review, 30 May 1996: 27). Transparency Interna-
tional, polling businesspeople throughout the world, rated the Philippines
among the ten most corrupt countries of the fifty-four surveyed, but five
other Asian countries (Indonesia, India, China, Bangladesh and Pakistan)
were ranked as at least marginally more corrupt {Far Eastern Economic Review,
20 June 1996).
2 The following section, as well as elements of the subsequent framework, is
taken from Hutchcroft (1997). Thanks to Political Studies and Blackwell Pub-
lishers for permission to use material from this earlier work.
3 Fortunately, as Evans demonstrates, use of a rents framework does not
require that one adopt an anti-statist perspective, but this is the conventional
rent-seeking consensus (see also Chapter 2, this volume).
4 As one scholar noted thirty years ago, 'estimates of the extent of corruption
practices in underdeveloped countries are, expectedly, very imprecise.
Rumour abounds, facts are scarce' (Bayley 1989 [1966]: 939).
5 Scott (1972a: 90-1) concurs that more predictable corruption is 'less likely to
seriously retard economic growth'. Not only is the price more certain but
there is also greater 'probability of receiving the paid-for "decision"'. This
type of corruption is more likely when (a) 'the political and bureaucratic
elites are strong and cohesive', and (b) 'corruption has become "regularized"
- even institutionalized after a fashion - by long practice'. These insights, I
will seek to demonstrate, are strengthened by analysis of the relationship
between power and authority.
6 In pointing out these historical patterns of authority and power in Thailand,
it is important to emphasize the sweeping changes that have taken place in
recent decades. As the business sector has become much more assertive and
democratic institutions have been put into place, there is general agreement
that the bureaucratic polity is no more. Sidel (1996) provides an insightful
analysis of the shift 'from bureaucratic polity to bossism', as bureaucratic inter-
ests have lost strength and powerful business interests (many with solid provin-
cial bases of economic and political strength) have emerged to assume greater
control over the state apparatus. Over time, he argues, the bossism of 'Siam'
has come to resemble the far more longstanding bossism of its 'twin', the
Philippines. Put differently, one can observe a disjuncture between authority
and power in post-bureaucratic polity Thailand that broadly resembles pat-
terns long found in the Philippines. (See also Hutchcroft 1999b)
7 Legal procedures, in fact, may be intentionally obscured in order to heighten
the demand for illegal services. In such a system, moreover, those with spe-
cialised powers to interpret often opaque rules (i.e. lawyers) will likely play a
prominent role.
8 Other neo-classical economists, notes Mendoza (1995:13) in his review of the
literature, acknowledge that rent-seeking is not always competitive, yet
nonetheless 'assert that a more competitive situation will reduce wastes asso-
ciated with rent-seeking'.
 POLITICS OF PRIVILEGE IN THE PHILIPPINES 243

9 Indeed, Tan later complained (as he nurtured key allies inside the Aquino
administration and retained control over his companies) that he had been
the victim, rather than the beneficiary, of the regime because Marcos
demanded such large stakes in his firms. From his perspective, perhaps, he
paid handsomely for the right to be a crony; what others saw as bribes, he
claimed to be extortion.
10 The process by which rents were allocated in this period needs further
research, but it likely included both competitive rent-seeking and purposive
rent allocation, and diverse mixtures of market corruption and non-market
ties. While many of these advantages went to those with connections, cash
payments also played an important role: 'With the aid of... influential offi-
cials', reports one observer, 'import licenses were easily procured at 10%
commission' (Coquia 1955: 102-3). Manufacturers 'considered effort at the
Central Bank as important as at their plants' (Stifel 1963: 104) and employed
prominent intermediaries and possibly even coercion to assist their quest. In
one (perhaps apocryphal) incident in the late 1950s, Congressman Ferdi-
nand Marcos 'burst into [the] office' of a central bank official who had
refused to license the imports of 'a well-heeled Chinese businessman' and
pointed a revolver at the head of the official until 'the documents were
signed and turned over to him' (Seagrave 1988: 162).
11 Indeed, one could argue that an entrepreneur who benefits from a purpo-
sively allocated rent (and is thus probably close to the regime in power) is
likely to be more secure than one who has won out in a process of competi-
tive rent-seeking. To the extent that the regime as a whole is in danger of col-
lapsing, however, neither category of entrepreneur is likely to have much
sense of security.
12 The relatively more efficient agencies may be more insulated from clientelis-
tic pressures, but one should not presume that formal authority completely
displaces informal networks of power. As Rudolph and Rudolph (1979: 196)
argue in their 'revisionist interpretation' of Weber's work on bureaucracy,
effective administration depends not only on rational-legal authority but
also on the persistence of patrimonial features able to '[mitigate] conflict
and [promote] organizational loyalty, discipline, and efficiency'. Evans
(1995: 59) argues that informal networks within developmental states 'rein-
force the binding character of participation in the formal organizational
structure rather than undercutting it in the way that informal networks based
on kinship or parochial geographic loyalties would'.
13 There are now 24 senators and roughly 200 members of the House of Rep-
resentatives. In recent years, another element of the pork-barrel system grew
to consume nearly US$1 billion of the annual national budget. So-called
'congressional initiative allocations' enabled legislators to divert regular bud-
get allocations to patronage projects 'in aid of reelection'. Moreover, accord-
ing to some reports, legislators commonly enjoyed 30-40 per cent kickbacks
on the projects themselves. Media reports in 1996 stirred up major contro-
versy over the disposition of these funds and the corruption connected with
them. (See Philippine Daily Inquirer, 27 July, 4 and 18 August 1996.)
14 Overall, this period is, of course, known as one in which corruption in
Indonesia lacked any real limits (Scott 1972a: 80-4). To the extent that insti-
tutionalization was taking place, it was seemingly almost entirely within a mil-
itary that, after 1965, came to 'backbone' the rest of the bureaucracy
(Emmerson 1978; see also Anderson 1983, and Crouch 1988).
244 PAUL D. HUTCHCROFT

15 In this argument, cultural factors are viewed primarily as a dependent vari-

able, shaped by larger historical patterns of state-society relations. In no way
am I subscribing to the views of those who treat cultural deficiencies as a
major cause of Philippine national woes (as does, for example, Fallows 1987,
in his assertion that the country has a 'damaged culture'). In my view, cor-
ruption may become embedded in certain subcultures, but it is problematic
to blame corruption on broad (often ill-defined) national cultural attributes.
Such attributes are as much effect as cause of larger historical processes, and
'all cultures are rich in conflicting political potentialities' (Friedman 1994:
27-9). This said, it is nonetheless important to examine how cultural prac-
tices, once embedded, may encourage the persistence of corrupt behaviour.
16 Indeed, one can say that markets have intruded into realms in which they do
not belong. It is for this reason that some observers claim that the Philippines
'has the best judicial system that money can buy'.

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 CHAPTER 6

Funny Money: Fiscal Policy, Rent-seeking

and Economic Performance in Indonesia

Andrew Maclntyre

As Asia's economic crisis continues to unfold, commentators have been

scrambling to review earlier ideas about the political economy of the
region's rapid economic rise. One theme which has been widely touted
in this context is that rent-seeking and corruption lie at the heart of the
current problems. Although having considerable popular and intuitive
appeal, this line of argument faces an immediate problem: if rent-seek-
ing and corruption are so economically destructive, how is it that the
region did so well for so long? This is a knotty theoretical problem, with
important policy implications.
I will explore this problem by focussing on Indonesia and a set of ideas
about the political and institutional underpinnings of rent-seeking. My
aim is to develop an argument that will help to explain why Indonesia
(and perhaps some other countries) succeeded in achieving sustained
rapid economic growth in the midst of what was widely regarded as a sea
of rent-seeking activity. Inevitably, my focus will be on the Soeharto era -
the roughly three decades of rapid growth that came to an abrupt halt
with the current region-wide economic crisis.
Long before the onset of the Asian economic crisis, a large academic
literature on the political economy of industrial success in Asia focussed
on the so-called strong states of South Korea, Taiwan, Hong Kong, Sin-
gapore and, earlier, Japan. One of the most well-known propositions
from this literature was that relatively strong and capable states were insu-
lated from the diversionary political pressures of rent-seekers, and were
thus able to push rapidly ahead with policy measures which underpinned
high-speed export-led industrial growth. Curiously, though, there was lit-
tle direct attention in this voluminous literature to the dynamics of rent-
seeking in these countries.1 By implication, it was often simply assumed
that rent-seeking was either moderate in these countries, or it was limited

248
 FUNNY MONEY IN INDONESIA 249
and managed by the existence of technocratic and impervious institu-
tional arrangements.
Political economists working on the industrial newcomers of South-
east Asia (Thailand, Malaysia, Indonesia, and the Philippines) have been
much more troubled by the question of rent-seeking, believing it to be
neither moderate nor limited in these countries. These concerns pre-
dated the Asian economic crisis. Unsatisfied with the assumptions of so
much of the literature on Japan and the first wave of newly industrializ-
ing countries, a number of writers working on Southeast Asia have been
casting around for ways to explain the coexistence of pervasive rent-seek-
ing and sustained good economic growth (Laothamatas 1994; Maclntyre
1994, 1995; Doner and Ramsay 1995; Jomo and Gomez 1995), or, in the
case of the Philippines, explaining how rent-seeking has inhibited eco-
nomic growth (Hawes 1992; Hutchcroft 1994, 1996).
In this chapter, I am continuing in this vein. I draw on some recent
microeconomically rooted institutionalist literature to argue that rent-
seeking activity in Indonesia, although pervasive, produced less economic
inefficiency than it might have because of the incentive structure arising
from the prevailing political framework. Simply put, because power was so
centralized (under the political framework which evolved during the
1970s), the leadership was able to sustain something approximating
monopolistic control of rent management and thus had direct economic
and political interests in preventing unrestrained plundering and ineffi-
ciency. A recent body of literature on fiscal federalism has suggested that,
under certain conditions, a strongly decentralized federal framework can
generate policy competition among sub-national units of government,
leading to an increasingly market-oriented policy environment - which
would tend to reduce the scope for rent-seeking activity (McKinnon 1994;
Montinola et al. 1995; Weingast 1995). This is a fascinating thesis which,
in the Asian context, has so far been applied only to China. The argument
I develop here, although sharing an analytical emphasis on the economic
consequences of political institutions, in fact pulls in the opposite direc-
tion. It suggests that, under certain conditions, a highly centralized polit-
ical framework may produce more satisfactory economic outcomes
(which is not to say ideal economic outcomes) than some more decen-
tralized alternatives. In principle, these two approaches are not necessar-
ily mutually exclusive. Paralleling the diverse political economies of Asia,
it is possible that different approaches will explain different types of cases.
In addition to this underlying theoretical objective, in this chapter, I
try to widen the empirical focus of discussion about rent-seeking and
development in general by presenting new material concerning off-bud-
get fiscal activity in Indonesia. Debate about the economic significance
of rents and rent-seeking in Asia is almost always cast in terms of familiar
250 ANDREW MACINTYRE
empirical material relating to trade and industrial policy and, to a lesser
extent, the regulation of financial markets. Thus, we typically hear a
great deal about tariffs, preferential credit, monopolies and other
restricted market arrangements. But this by no means exhausts the sites
of significant rents and rent-seeking. Indeed, some of the largest rents
are located in other policy sectors altogether. Fiscal policy - particularly
the expenditure side of the ledger - is one important but largely over-
looked site for rent-seeking. Government spending is all about handing
out money and is thus a natural venue for rent-seeking. To the extent
that government spending provides subsidies, it is in effect creating a
rent for the recipient of the subsidy. Often such benefits are small or dif-
fuse and thus, for our purposes at least, unremarkable. Other times, how-
ever, they can create very large rents indeed which are transferred to
private or public actors.
Political leaders sometimes find the official state budget to be an awk-
ward vehicle for the transfer of such rents because it may be exposed to
the glare of scrutiny from a range of groups which may oppose the trans-
fer or even seek to prevent it from happening. Depending on the precise
political and economic circumstances in any given country, any of the fol-
lowing might be constraints on the use of the budget for large-scale rent
transfers: inflexible and unco-operative technocratic officials in finance
ministries and kindred agencies, the legislature, the press (and the wider
community of economic policy commentators), foreign donors (both
foreign governments and international financial institutions), and, pos-
sibly, foreign investors more generally. The desire to avoid scrutiny and
minimize constraints can lead political leaders to seek out more covert
and flexible ways to dispense money. One important option is off-budget
spending. Precisely because such activity is typically subject to little
scrutiny or restriction, it is an optimal venue for rent-seeking. As we shall
see, in Indonesia under Soeharto, there was large-scale off-budget fiscal
activity, which has gone largely unstudied but which is, in fact, analytically
interesting both for discussions about the political economy of rent-seek-
ing in general, and Indonesia's development in particular. It is not a coin-
cidence that one of the stringent conditions that the International
Monetary Fund (IMF) demanded of Indonesia as part of its 'rescue pack-
ages' in 1997 and 1998 was that all off-budget sources of revenue be
brought into the open and included in normal budgetary calculations.
Already embedded in the opening paragraphs of this chapter is the
implicit assumption that rent-seeking is a matter of economic concern.
Although the primary theoretical concerns of this chapter centre on the
organizational or institutional underpinnings of rent-seeking rather
than the more explicitly economic question of the efficiency implica-
tions of rent-seeking, some discussion of the latter is necessary. The
 FUNNY MONEY IN INDONESIA 251
chapters by Khan in this volume present detailed and cogent critiques of
the prevailing neo-classical economic orthodoxy concerning the effi-
ciency implications of economic rents in general, and rent-seeking in
particular. In different ways, each argues forcefully that it is unwarranted
to dismiss summarily the possibility that government intervention in
resource allocation can produce net national economic gains, and then
goes on to make the case that, in principle, there is no necessary reason
why the creation and deployment of economic rents by governments will
result only in the dissipation of resources and overall inefficiency.
In principle, I find such arguments persuasive. However, as Khan is
careful to emphasize in his detailed and systematic analysis of rent-seek-
ing, there is indeed much potential for inefficiency and loss. One of the
most impressive features of Khan's input-output framework for assessing
the creation and transfer of rents (or, rights, as he conceptualizes them)
is that he is able to specify, on an a priori basis, the conditions under
which efficiency-enhancing rents might be created. On the one hand,
this does serve to undermine the blanket dismissal of interventionist gov-
ernment policies in the orthodox rent-seeking literature stemming from
the work of Krueger (1974), Bhagwati (1982) and others. On the other
hand, however, it also underscores the point that very specific and strin-
gent conditions are required for efficiency-enhancing rents to be created
and deployed on a sustained basis.
One of the core assumptions I am working with in this chapter is that,
although rents and rent-seeking need not be injurious to economic
growth - and, indeed, may be essential for the development of some
industries - on balance, much of it is damaging. Certainly, this is the pre-
vailing assumption of most disinterested commentators on economic
affairs in Indonesia. Although cognizant of the policy achievements of
nearby Singapore, few analysts believe that the political economy of
Indonesia is hospitable to efficiency-enhancing interventionist measures.
The chapter begins with a discussion of Indonesia's economic perfor-
mance during the Soeharto era, focussing first on the official fiscal
record and then on the problematic issue of off-budget fiscal activity. For
the most part, attention will be directed to the expenditure side of the
ledger and the ways in which government was able to spend money
beyond that which it had in its official budgetary accounts. Next, I intro-
duce some theoretical argument relating to the institutional foundations
of rent-seeking. Finally, these ideas are tied back to Indonesia in an
attempt to explain how it is that apparently pervasive rent-seeking is
deeply destructive to economic activity in some circumstances, and much
less so in others.
Before getting underway, a quick word on terminology is needed.
Although the terms 'rent-seeking' and 'corruption' are analytically
252 ANDREW MACINTYRE

distinct, for convenience I will treat the latter as a subset of the former.
Accordingly, in using the term 'rent-seeking', some (but not all) of the
phenomena I am covering could also be classified as 'corrupt'. Further,
I conceive of rent-seeking as something undertaken by both private
individuals and public officials. I should also make clear that my focus
is almost entirely on the political economy dimensions of rent-seeking.
There are, of course, deeply important legal, social and moral dimen-
sions to this phenomenon, but I do not attempt to address them here.

Government spending: the official story

Although the Indonesian economy has suffered a very sudden and
devastating reversal, for roughly thirty years prior to the current crisis,
its performance was indeed very impressive. The economic achieve-
ments of the Soeharto era have been widely documented (Booth 1992;
Battacharya and Pangestu 1993; Little et al. 1993; World Bank 1993; Woo
et al. 1994; Hill 1996). Accordingly, it is unnecessary here to do more
than restate the core empirical point: from having been one of the worst-
performing economies in the region - and one seemingly beyond
redemption - Indonesia notched up remarkably good rates of sustained
economic growth and did so on a reasonably equitable basis compared
with many other developing countries.
Among the panoply of national economic policy settings, our focus is
on fiscal policy and the expenditure side in particular. While Indonesia's
fiscal record under Soeharto was far from unblemished, it is generally
viewed as having been remarkably creditable. In macroeconomic terms,
the picture was very positive. By comparison with its own past as well as
the experiences of many Latin American and African countries, govern-
ment spending was quite restrained in Indonesia since the late 1960s.
Much has been made of Indonesia's 'Balanced Budget rule', whereby
Soeharto's New Order regime forswore the fiscal debauchery of the
Sukarno years and resolved not to spend more than it earned from taxa-
tion combined with foreign aid (including foreign loans).2 While the
government's published budgetary data gave the impression that expen-
diture had been carefully regulated to ensure that it always exactly
matched government revenue, the reality was that this was only achieved
by an accounting trick whereby aid and foreign borrowings were treated
as revenue. In conventional terms, Indonesia ran a moderate deficit
more or less continuously since the inception of the New Order.3 The
important point here is not convenient accounting fictions, but the fact
that the government in effect disavowed the use of central bank borrow-
ing - or, more crudely, the use of the printing presses - to fund public
spending. In short, for the first time, Indonesia acquired a serious (if
padded) measure of fiscal discipline.
 FUNNY MONEY IN INDONESIA 253
Fiscal discipline by macroeconomic authorities was remarkably effec-
tive in stabilizing the economy and eliminating hyperinflation in the late
1960s, and again in reasserting control following the oil-driven inflation-
ary surges of the 1970s and early 1980s. Equally, when faced with a sharp
fall in domestic revenue following the collapse in oil prices, the govern-
ment was prepared to abandon expensive heavy industry projects, to cut
subsidies on fuels, and to introduce more effective domestic taxation
measures.4 Notwithstanding the fact that there was a moderate deficit for
much of the last thirty years, the commitment to fiscal discipline was cru-
cial. As Hill (1996) concludes: 'It is one of the basic tenets of the [New
Order] regime, and helps to explain why macroeconomic stability has
been broadly maintained since the late 1960s'. Little et al. (1993), in
their massive comparative study, argue that Indonesia's macroeconomic
management (including, specifically, fiscal management) was among the
most 'responsible' of the nineteen developing countries they surveyed
and was of fundamental importance to its economic achievements. If the
comparator set is narrowed from developing countries in general, to
countries 'blessed' with a resources boom, and particularly an oil boom,
Indonesia's record of fiscal restraint looks even better. As is increasingly
recognized, for a variety of reasons ranging from 'Dutch disease' and
macroeconomic imbalances through to fiscal indiscipline and rampant
corruption, resource booms in developing countries usually end up
being associated with distortion, waste and even economic chaos, rather
than sustained welfare gains (Sachs and Warner 1995). In a study of six
oil exporting countries, Gelb and Associates (1988) concluded: 'Indone-
sia was, in fact, the only country in the sample to implement a deter-
mined policy of expenditure reduction and exchange rate realignment
before the fading of the second oil boom. In this sense, its macroeco-
nomic management in 1973-81 could be considered as the most prudent
in the sample.'
But perhaps the most telling indicator of the macroeconomic dimen-
sions of Indonesia's fiscal record is not with other sets of developing
countries, but instead with its own immediate past. The contrast could
not be more striking. From the late 1950s until the mid-1960s, the econ-
omy was in continuous decline, with fiscal policy settings playing a lead-
ing role in the decay. The tax base was thin, budgetary auditing was very
weak, expenditure always exceeded revenue and, from the late 1950s, fis-
cal conditions degenerated from indiscipline into near-debauchery.
From 1963, the deficit was almost double the size of revenue as funds
haemorrhaged in the name of a quasi-socialist industrialization drive,
expensive military campaigns and unrestrained rent-seeking. The extra-
ordinarily lax fiscal framework played a critical role in fuelling the erup-
tion of hyperinflation (reaching an estimated 600 per cent), economic
meltdown and then political upheaval (Mackie 1967; Hill 1996).
254 ANDREW MACINTYRE
If we shift from the macroeconomic level to focus on the details of
expenditure patterns, the picture becomes rather more complex but
remains generally quite positive. Analysis of expenditure patterns is com-
plicated by the disaggregated and disjointed presentation of official sta-
tistics. Spending is separated into a Routine Budget (largely current
expenditure) and a Development Budget (largely capital expenditure).
The former is relatively straightforward, being primarily a formula-
driven funding of civil service and military salaries, together with foreign
debt repayment. During the 1980s, debt repayment came strongly to the
fore, becoming the dominant component of the Routine Budget. This
reflected not just Indonesia's high level of indebtedness, but also the gov-
ernment's unwavering commitment to meet all of its international finan-
cial obligations. (Unlike the big debtor economies of Latin America and
Africa, since the stabilization of its economy in the late 1960s under
Soeharto, Indonesia neither defaulted nor had a loan rescheduled - opt-
ing instead to accept cuts in domestic spending.)
The Development Budget was somewhat more discretionary and thus
somewhat more politicized than the Routine Budget in that ministries
and regional authorities were, to some extent, able to compete for allo-
cations. However, there was still a strong (if inconstant) formulaic dimen-
sion to this spending and the Development Budget was not subject to
systemic plunder or capture by societal or bureaucratic interests.
Although by no means immune from rent-seeking, pork-barrelling,
bureaucratic capture and outright theft, the striking point about the
Development Budget is that it was as well used as it was. There was con-
sistently strong support for education (particularly at the primary and
lower secondary levels), health services, agriculture, and transport and
communications infrastructure. Also, there were no stark spending
biases corresponding to standard developing country stereotypes: there
was not a heavy urban bias, there was not a major bias towards Java (by
far, the most populated island), there was not a heavy bias towards the
industrial sector, there was not a heavy bias towards military spending
(indeed, Indonesia had one of the lowest defence spending ratios in the
region, and was one of the few countries in which defence spending actu-
ally fell in recent years), and there was no discernible strong bias towards
the electoral cycle (indeed, civil service salaries were cut in three succes-
sive election years - 1982, 1987 and 1992). More generally, expenditure
was reasonably positive in terms of equity and was modestly, but appre-
ciably, positive in its distributional consequences (Booth 1992; World
Bank 1993; Hill 1996). In short, while there were indeed real problems
of leakage, distortion, corruption, and incompetence with public spend-
ing, the striking point is that, on balance, the pattern of expenditure
looked surprisingly good.
 FUNNY MONEY IN INDONESIA 255

Off-budget fiscal activity

Notwithstanding these many favourable points of comparison for

Indonesia's fiscal record, there is reason for pause. For there is more to
this story than meets the eye. Too often, discussion of Indonesia's fiscal
record (particularly in the comparative literature) takes the budgetary
record at face value. This, however, is problematic. Simply put, there was
a great deal offiscalactivity that took place off the budget. This is a large
and shadowy issue which is only now beginning to attract scrutiny. Sev-
eral overview studies of the Indonesian economy have suggested in pass-
ing that off-budget fiscal activity has become more prominent in recent
years (World Bank 1994; Nasution 1995b; Hill 1996).

Origins
Off-budget fiscal activity is not a new phenomenon in Indonesia. Nasu-
tion (1995b) points out that a system of informal financing became
established back in the 1940s during the armed struggle for indepen-
dence, when both the civilian and military arms of the fledgling republic
had to scramble to find resources as best they could in the midst of
upheaval and battle. Even though formal revenue streams were devel-
oped after the fighting stopped and the Dutch were ejected, the pattern
of informal fiscal activity continued. Senior military and civilian officials
cultivated covert relationships with businesspeople, with the resulting
revenue being hidden and managed through various so-called social or
charitable foundations (yayasan) and commercial joint ventures.5
Following the chaotic collapse of Sukarno's Guided Democracy, the
fiscal framework was overhauled. As part of the emergency economic sta-
bilization program of the late 1960s, the Balanced Budget rule was estab-
lished, important reforms were introduced to the state enterprise sector
(particularly the state banks), and there were gradual moves to
strengthen the level of economic co-ordination among key economic
policy agencies. Notwithstanding these important changes, off-budget
fiscal activity continued and appears to have expanded very rapidly with
the oil boom. As oil prices shot up, revenue was slopping around in such
abundance that the scope for off-budget activity was very great. The most
spectacular example of this was the state oil company, Pertamina. Under
the leadership of former General Ibnu Sutowo, Pertamina became a law
unto itself and siphoned off an apparently large share of oil revenue.
Sutowo used the off-budget revenue to fund grandiose and stunningly
unsuccessful industrial development plans. In addition to the funds
spent in this way, Pertamina accumulated a staggering level of interna-
tional debt which the central bank was forced to indemnify following the
256 ANDREW MACINTYRE
near-default of the oil company to its international creditors. The debt
was paid off over a number of years, and represented a massive off-bud-
get transfer from the central bank to foreign creditors. But the Pertam-
ina debacle was only the most crude and glaring example of off-budget
fiscal activity. As the New Order institutionalized itself, a range of sophis-
ticated systems was developed.

Types

In simple terms, off-budget fiscal activity refers to the use of money by the
government that was not covered in the official budget document
approved by the parliament each year. In Indonesia, off-budget fiscal
activity operated in many different ways under Soeharto. Some were
mundane while others were shadowy and politically sensitive. Much of it
was highly susceptible to rent-seeking. In broad terms, most of this activ-
ity can be classified under one of three basic types:
1. Command Lending The government could direct the managers of
one or more of the many state enterprises and official economic
entities to make resources under their control available to support
a government initiative. Although in principle most of these enter-
prises and entities had official reporting requirements and were
subject to oversight from a government ministry, in practice such
constraints could be readily circumvented. The institutions most
susceptible to being tapped for this purpose were the central bank,
the state commercial banks, the state pension funds, and other enti-
ties such as the grain stockpile authority (Bulog). The central bank
was a special case because, unlike other state enterprises or eco-
nomic entities, when it was directed to fund a given project it also
expanded the money supply in the process. Command lending via
the central bank can thus be thought of as an unfunded form of off-
budget fiscal activity which may also have had significant inflation-
ary consequences.
2. Private Contributions The government could also informally induce
the private sector to provide financing for a project about which the
government cared but was unwilling or unable to finance through
the budget. In this case, the government persuaded selected busi-
nesspeople that it was in their best interests to contribute to a press-
ing but unfunded policy priority. Although these monies were used
for public purposes, because their source was private they were
highly discretionary and easy to conceal.
3. Hidden Government Funds A third possibility was that the government
could draw upon funds it had hidden away in bank accounts other
than its official treasury accounts. In other words, the government
 FUNNY MONEY IN INDONESIA 257

could use off-budget revenue to fund off-budget expenditure. Again,

such expenditure was entirely discretionary, since officially these
accounts did not exist. That is to say, they did not show up in the offi-
cial statement of the government's financial position (the budget)
and were not subject to the scrutiny of either taxation authorities or
the parliament.
Of the three possibilities, the first is the one we know most about. It is
well known, for instance, that, although state enterprises received sup-
port through the budget, they also received very large-scale assistance
from the state banks. Similarly, the state banks themselves received off-
budget assistance from the central bank. Additionally, many private firms
benefited enormously from command lending. Examples of this type of
off-budget fiscal activity ranged from the issuance of financial guarantees
to public and private firms to underwrite their activities (as in the 1991
case of the head of a state bank being directed to provide a non-collater-
alized US$550 million letter of credit for the politically well-connected
Prajogo Pangestu's Barito Pacific Company); the writing-off or rolling-
over of repayments on loans that firms were unable or unwilling to make
(as in the 1994 decision of the central bank to extend a loan for some
US$350 million when the Clove Marketing Board, controlled by presi-
dential son Tommy' Hutomo Mandala Putra, indicated it would not be
able to repay as scheduled); the provision of heavily subsidized credit (as
in the 1995 take-over of an ailing textile firm, PT Kanditotex, by a group
including another presidential son, Bambang Trihatmodjo, and a son of
a former chief of the National Intelligence Agency, Bambang Yoga
Sugama); through to massive bailout operations (as in the almost
US$600 million rescue in 1994 of Bapindo, a state bank) (Maclntyre
1993; Schwarz 1994; World Bank 1994; Nasution 1995a).
Somewhat less well understood is the second type of off-budget fiscal
activity described above. Why would private businesspeople contribute
very large sums of money (beyond their official taxes) to fund govern-
ment policy objectives? The explanation was bound up with the intensely
clientelistic relationships between leading business groups, on the one
hand, and senior government officials - principally, the President - on
the other. Three examples will illustrate the dynamics of the phenome-
non. In 1983, when oil revenues began to fall, the government decided
to cut back drastically on planned investments in a number of large heavy
industrial developments in order to keep a 'balanced' budget. But this
did not mean that all such shelved planned investments were entirely
abandoned. In one case, Indonesia's wealthiest businessman, Liem Sioe
Liong, was persuaded by the government to invest in a massive new
US$875 million steel plant. Liem injected about US$100 million into the
operation and helped arrange supplementary funding from a number of
258 ANDREW MACINTYRE
international banks. In another case, in 1990 Liem and a newly ascen-
dant business magnate Prajogo Pangestu (mentioned earlier) agreed to
inject US$420 million between them to make good losses on foreign
exchange trading by Bank Duta, a large bank controlled by three social
foundations headed by President Soeharto. In other words, the two busi-
nessmen agreed to compensate the President's bank for the losses it had
incurred through its own mismanagement. In neither case is it likely that
they were compelled to take this action. Rather, it can be understood as
part of the ongoing political and economic exchange that characterizes
clientelistic relationships. The businessmen helped the politician and
the politician helped the businessmen. A month after the Bank Duta
bailout, despite howls of protest, Liem and Prajogo were designated the
local partners in two massive and keenly contested joint venture projects.
And earlier, when in 1989 Liem found the ongoing losses in the steel mill
plant he had subsidized (back in 1983) to be too great, the government
agreed to buy back his share on extremely generous terms (Schwarz
1994). A recent example of this phenomenon, which attracted consider-
able attention, involved private contributions to fund the development
of a new jet aircraft (the N-2130) by the state aerospace corporation,
IPTN. Controlled by (then) Technology Minister Habibie, IPTN's air-
craft projects have long been controversial because of their great cost
and uncertain return. In a bid to circumvent fiscal constraints imposed
on his operations by the Ministry of Finance, Habibie turned to the pri-
vate sector and, with the official backing of Soeharto, set about persuad-
ing private individuals to contribute a massive US$2 billion {International
Herald Tribune, 13-14 July 1996). It is difficult to believe that the busi-
nesspeople who injected money into this fund were doing so purely on
the basis of any commercial enthusiasm for the project itself. Instead, as
in the other cases described here, they were more likely driven by wider
clientelistic calculations and an expectation of being granted a substan-
tial rent elsewhere.
Most shadowy of the three types of off-budget fiscal activity outlined
above was the use of hidden off-budget revenue to fund an array of gov-
ernment priorities. As is normal, the Indonesian government main-
tained official treasury accounts with the central bank in which public
revenue is held. Beyond this, however, it also maintained a range of other
accounts with the central bank and some state commercial banks. The
funds stored in these accounts did not appear anywhere in budgetary
reporting. Very little is known about them and even less has been written
about the origins and purposes of the funds held in them. On the rev-
enue side, it would seem that three particular sources were very impor-
tant. For most of the New Order period, the outstanding source was of
course the oil and gas industry. Overwhelmingly, revenue from oil and
 FUNNY MONEY IN INDONESIA 259

gas extraction came in the form of royalties or taxes collected from for-
eign oil companies. Once these were collected, it was a simple matter for
the government to hold back a portion of the oil and gas receipts from
the taxation authorities and store the residue in an off-budget account.
As mentioned earlier, during the early 1970s control of such funds lay
with Pertamina's head, Ibnu Sutowo. In more recent times, as Pertamina
was reined in, management responsibility for these off-budget funds
passed to the Ministry of Finance.
Another similar source was the informal taxes collected from the
country's vast timber industry. The timber industry has been notorious
for rampant cronyism and corruption and for being largely beyond the
law. But, while the state had difficulty imposing its official writ on the
industry, unofficially firms within it contributed directly to a large fund
controlled by the President and managed in the forestry ministry. While
official tax receipts from the timber industry were problematic, from
about the early 1990s very large pools of unofficial revenue were accu-
mulated off-budget.
A third and little-known source of off-budget revenue which also
became important in recent years was the covert recycling of foreign aid
funds. This was an intriguing operation and can be briefly described as
follows. Official aid flows received by the Indonesian government were
distributed via the Development Budget as capital expenditure on par-
ticular projects. Often, the funds the government distributed took the
form of a loan. Thus, suppose international donors extended funds to
support the expansion of electricity production, the Indonesian govern-
ment then lent these monies to the state power company which, in due
course, repaid the loan to the government, and the government repaid
the donors. The key was in the way the resources were shuffled. While the
government repaid the international creditors from the (Routine) Bud-
get, the loan repayment from the state power company did not return to
the government's budgetary accounts but, instead, went into an off-bud-
get account known as the Investment Fund Account (Dana Rekening
Investasi) managed by the Ministry of Finance. From the government's
point of view, the beauty of this operation was that, while international
debt obligations were fully satisfied, the revenue coming back from the
domestic recipient of the funds was stored off-budget, out of sight, and
thus available for inconspicuous and discretionary deployment. This was
another example of the government keeping a portion of revenue away
from the taxation authorities and the glare of public scrutiny. As with the
off-budget forestry accounts, beginning in the early 1990s this account
swelled to become very large.
Beyond oil, timber, and aid recycling, other sources of revenue for
secret government accounts include unreported funds accumulated by
260 ANDREW MACINTYRE
the giant state grain and staple stockpile (Bulog) and a variety of shad-
owy foundations to which businesspeople made contributions in order to
maintain good political standing with the government.6 Funds of this
sort could be used for almost any purpose, ranging from the provision of
covert financing of political operations, through to industrial subsidies
(as in the case of the transfer of US$200 million from a reforestation
fund to support the development of another of Habibie's projects, the
N-250 turbo-prop aircraft, through to support of periodic macroeconomic
'smoothing' (whether this was counter-cyclical-style fiscal initiatives, or
attempts to alleviate sharp movements in the terms of trade).
Although the value and location of all hidden government reserves of
this sort were of course a closely guarded secret, it is possible, with con-
siderable digging, to generate some partial indicators that provide a
glimpse of the scale on which at least some of these funds were deployed.
Drawing on published hints of underlying World Bank disapproval and
statistical clues buried in reports, we can calculate the difference between
the Indonesian government's 'declared' level of capital expenditure and
an intelligent estimate of its actual capital expenditure. Because some of
the data necessary to perform these calculations are difficult to obtain
across years, figures for only one year are presented here (Table 6.1) .7 The
relevant data are calculated as follows. We start with the published figure
for the Development Budget (line A) and clean it up by removing the
major items which are not really of a capital expenditure nature (lines B,
C, D and F). The resulting figure (line G) represents a corrected capital
expenditure total based on official data. However, if we compare this fig-
ure with the World Bank's independent estimate of capital expenditure
which is derived from the national accounts by accounting first principles
(line H), there is a substantial residual amount ofjust over Rpl trillion, or
US$500 million (line I). In short, the difference between capital expen-
diture as reported in budget tables and an informed estimate of actual
capital expenditure is an amount the government has funded from off-
budget sources - half a billion dollars in 1991-92.

Off-budget activity and economic performance

Perhaps the most obvious conclusion to draw from the preceding dis-
cussion is that there was much more to fiscal policy in Indonesia than was
conveyed in the official budgetary figures. Moreover, even this initial
foray into the area of off-budget fiscal activity reveals that there was a ver-
itable smorgasbord of rent-seeking opportunities. For our purposes, the
key question centres on the consequences for national economic growth
of the rents arising from off-budget spending and, even more so, from
the rent-seeking activities surrounding them. Were the net efficiency
 FUNNY MONEY IN INDONESIA 261

Table 6.1 Off-budget capital expenditure, 1991-92 (trillion rupiah in current

prices)

Line item Amount

A: Official development expenditure total 21.764
B: Fertilizer subsidy 0.301
C: Defence 1.085
D: 'Development expenditure in reserve' 1.500
E: A-B-C-D 18.878
F: Operations and maintenance (=10% E) 1.888
G: Corrected official capital expenditure (=E-F) 16.990
H: World Bank capital expenditure estimate 18.000
I: Off-budget capital expenditure (=H-G) 1.010
Source: World Bank 1994

implications of activity of this sort positive, negative or neutral for

national economic growth? The prevailing presumption in both the
scholarly literature on Indonesian economic policy and, indeed, much
public discussion in Indonesia itself, is that the clientelistic nature of the
country's political economy ensured that most government-created rents
were so mired in cronyism and corruption as to be injurious to national
economic growth. And more so than most other cases of government-
created rents, off-budget fiscal activity would seem likely to have gener-
ated a frenzy of covert rent-seeking behaviour. We might expect this not
only because the subsidies to be had were potentially very large, but also
because the environment in which the political activity surrounding the
allocation of these rents took place was characterized by little or no trans-
parency. Depending on the precise source of the funding, the key fiscal
authorities may not have been able to scrutinize the expenditure, and if
it was effectively concealed, the parliament, the press and other non-gov-
ernment local and international financial analysts would not get to hear
of it, much less scrutinize it. In short, precisely because off-budget expen-
diture was either totally secret or not usually known till after the event, it
was subject to little if any scrutiny.
These points notwithstanding, generalizations about the economic
consequences of off-budget fiscal activity are difficult. In part, it depends
on the perspective from which the question is viewed. From a macroeco-
nomic perspective, the key issue is the extent to which off-budget gov-
ernment spending fuelled inflation, a concern which centres principally
around what we have called 'command lending' by the central bank.
When the central bank made resources available in this way, it was
increasing the money supply. If the resulting increase was greater than
the increase in demand for money arising from growth in the economy,
262 ANDREW MACINTYRE
then it would have been contributing to inflation. We know that this has
been a problem in many other developing countries (Rodriguez 1993).
What of Indonesia? Does evidence of this off-budget activity necessitate a
reassessment of its macroeconomic record?
Certainly, the existence of extensive off-budget fiscal activity calls into
question Indonesia's reputation for fiscal rectitude and its (already qual-
ified) balanced budget convention. Ultimately, however, we know that,
while command lending funded by the central bank contributed to
growth in the money supply, this could not have been on a truly alarm-
ing scale, simply because the country's inflation record was creditable.
Although not as good as some of its Southeast Asian neighbours, Indone-
sia's inflation over the period 1970-96 was much lower than the average
for all developing countries (Figure 6.1).
Of greater interest, for our purposes, are the microeconomic dimen-
sions of off-budget fiscal activity for at this level we directly engage the rent-
seeking issues. Unfortunately, assessing the microeconomic efficiency
implications is very problematic, for reasons of data quality and inherent
analytical difficulties. To begin with, although it is a significant empirical
advance, we have only partial estimates of the order of magnitude of off-
budget activity. Second, beyond a few particular cases which have come to
light, we know very little about the specific purposes to which off-budget
spending was put. As already noted, this ranged from innocuous counter-
cyclical-style macroeconomic smoothing to covert political side-payments,
or from prudent international debt repayment to subsidies for crony busi-
nesspeople that border on official theft. In other words, not all off-budget
fiscal activity generated rents to be captured by firms. More generally, in
the absence of detailed information, it is not possible to determine con-
clusively whether any particular subsidy generated net economic gains or
not. As the chapters by Khan demonstrate, it is unsatisfactory simply to
assume that government-created rents are necessarily inefficient. In order
to determine whether any particular subsidy generated net welfare gains,
we would need, among other things, to weigh the opportunity cost of the
provision of this subsidy, the extent to which it was used productively by the
recipient firm, and whether any significant externalities were generated.
Further, in addition to evaluating the efficiency implications of the rent
itself, we would also need to consider whether the costs of securing the rent
(and if it was of more than a one-off nature, the costs of sustaining the
rent) outweighed any net welfare gain arising from the rent. Here again,
the chapters by Khan demonstrate that, contrary to the neo-classical rent-
seeking literature, it is unsatisfactory simply to assume that costs associated
with rent-seeking activities outweigh any benefits of the rent.
Plainly, then, there is a high level of indeterminacy here. Even with
excellent data sets, reaching a determination on whether a particular rent
 FUNNY MONEY IN INDONESIA 263

o
CO
LO
OO CO
LO
CD
CD CD CD CD

Figure 6.1 Inflation comparators, 1970-96

Source: International Financial Statistics Yearbook (1997)

arising from off-budget expenditure and the politics surrounding it

assisted or hindered national economic growth is inherently a very diffi-
cult task - to say nothing of generalizations about whole categories of
rents. This basic difficulty besets not only an analysis of the political econ-
omy of off-budget fiscal activity but also most categories or sectors of rents
and rent-seeking. However, if we make some assumptions about likely out-
comes, we can proceed. As already noted, the conventional wisdom about
rents and rent-seeking in Indonesia is that the net effects were decidedly
injurious to the country's economic performance. This may or may not
have been true in the case of any particular rent arising from off-budget
fiscal activity (or any other government-created rent). But given the exact-
ing set of conditions specified by Khan for rents and rent-seeking
to be productive, and given our general understanding of Indonesia's
clientelistic political economy under Soeharto, it would seem entirely rea-
sonable to assume that, at a minimum, a very significant portion of gov-
ernment-created rents was ultimately productive of net welfare losses.
If this is accepted, we can proceed on a deductive basis to wrestle with
the basic puzzle posed at the outset of this chapter: explaining the coex-
istence of widespread rent-seeking and sustained national economic
success. In so doing, it is of course necessary to widen our focus beyond
just the rents and rent-seeking associated with off-budget fiscal activity.
264 ANDREW MACINTYRE
Significant though these assuredly are, they are only one segment of the
total spectrum of rent-seeking activity in Indonesia. With the entire
panoply of rent-seeking as our focus, we turn in the next section to a set
of ideas about the institutional underpinnings of rent-seeking.

Institutions and efficiency in rent-seeking

In a number of basic respects, Indonesia's political economy under Soe-
harto would seem to have been inviting of highly destructive patterns of
rent-seeking behaviour. First, by virtue of its factor endowments, there
were very large resource rents available to be captured. Second, as a
result of its long history of dirigisme, there were also many government-
created rents to be captured. Third, as a result of the country's highly
clientelistic political system, policy-making processes were quite porous
and very conducive to rent-seeking activity by officials as well as by private
actors. Rent-seeking surrounding off-budget fiscal activity provides a
clear and representative microcosm of these wider patterns. And yet, this
environment notwithstanding, it would appear that the existence of
widespread rent-seeking somehow did not exact the heavy economic toll
we might otherwise have expected. Why?
In the remainder of this chapter, I seek to develop a coherent and
plausible explanation for this puzzle. The argument I advance goes
beyond just off-budget fiscal activity and is cast in more generic terms so
that it might embrace all cases of rent-seeking. Simply stated, the argu-
ment is that, because the political character of the regime that evolved
under Soeharto was highly centralized, he had powerful incentives to
ensure that rent-seeking was managed in such a fashion as to prevent
excess and gross inefficiency emerging. The argument is derived from a
theoretical discussion of corruption by Shleifer and Vishny (1993),
which concentrates on bribery and the sale of government goods (per-
mits, etc.). Although their focus is on corruption, the essential logic they
set out can readily be applied to the wider phenomenon of rent-seeking.
They draw an analogy from industrial organization theory to model
the consequences of the political and institutional environment on the
level of corruption and the extent to which it inhibits investment and
economic growth. The underlying model comes from the work of the
nineteenth century French mathematician, Cournot, applied to comple-
mentary monopolies - that is, a contrast between the pricing decisions of
a single monopolist who produces strongly complementary goods and
individual monopolists each producing only one of the strongly comple-
mentary goods. The single monopolist will have an incentive to price his
goods in a concerted fashion, because pushing up the price of one of his
goods will tend to push down demand for the others since consumers
 FUNNY MONEY IN INDONESIA 265

require all. Conversely, where there are independent monopolists, even

though the goods remain strongly complementary, they will tend to push
up the price of their respective products and all will suffer because they
are in a 'prisoner's dilemma' type situation.
Shleifer and Vishny take this insight and apply it to corruption, by
focussing on bribery and the market for government regulatory goods
(i.e. licences and permits needed by firms to do business). They assume
that there are multiple regulatory goods involved and that there is strong
complementarity among them all (so that potential investors will need a
building permit, and an import licence, and an employment contract,
and so on). For present purposes, the relevant point is the contrast they
draw between two stylized models of the market for government regula-
tory goods under authoritarian or weakly democratic political conditions
and where corruption is rife: one highly centralized, and the other much
less so. In the first, national political leadership exercises sufficiently
strong oversight and control of regulatory agencies that we can think of
the relevant sections of the state as functioning as a unified or centrally
co-ordinated monopoly for bribe-collecting. Monitoring and enforce-
ment from the top are sufficiently strong that the political leadership is
able to prevent regulatory agencies from acting independently and to
ensure that a healthy share of the bribes collected flows upwards, with
the remainder being distributed proportionately among relevant offi-
cials at the coal-face. In short, officials in regulatory agencies are unable
to operate independently to maximize their own take. Under this model,
if a firm is seeking the necessary permits to, say, establish a factory, once
it has provided the appropriate corrupt inducements, it acquires secure
property rights to the package of regulatory 'goods' it has purchased.
The second model is one in which political control is weaker and less
centralized. Instead of there being a situation approximating a unified
monopolist, there is a multitude of independent monopolists selling
complementary regulatory goods. Because the political leadership is
unable to exercise effective control over bureaucratic agencies, officials
(and/or their respective agencies as a whole) seek to maximize their own
take by acting as independent monopolists and pushing up prices with-
out regard for the effect on overall demand for government goods. Also,
unlike the unified monopoly model, in this situation the firm purchasing
all these government goods can never be sure it has secure property
rights as any agency might subsequently seek to extract further bribes.
The weaker the political leadership's control, the greater the scope for
independent and unco-ordinated extraction by officials pursuing their
own individual interests.
The key insight to be drawn from Shleifer and Vishny (1993) is that
there may be an important analytical distinction to be drawn between
266 ANDREW MACINTYRE
situations in which corruption is pervasive but the framework of govern-
ment is tightly centralized, and those where it is only loosely centralized.
If the leader enjoys effective control over regulatory agencies, then we can
think of his or her interests on the pricing of bribes as being equivalent to
those of the unified monopolist under conditions of strong complemen-
tarity. As such, he or she has a direct interest in imposing co-ordination
and ensuring that no individual agency enriches itself at the expense of
the system as a whole, and the political leadership in particular. On the
other hand, where the leader enjoys only weak control over regulatory
agencies, officials will be far less constrained and, facing the incentive
structure of the independent monopolists under conditions of strong
complementarity, will seek to maximize their own take by driving up the
bribes necessary to obtain the particular regulatory good that they con-
trol, even though this will drive down demand. According to this logic,
although corruption is pervasive in both, strongly centralized govern-
ment will produce fewer individual bribes but a higher level of overall rent
collected (because more bribes will be collected), whereas loosely cen-
tralized government will produce more individual bribes but a lower level
of overall rent collection (because fewer bribes will be collected). And,
more importantly from an overall economic viewpoint, corruption under
conditions of loosely centralized government will be more injurious to
economic growth because it will reduce economic activity by driving down
demand for the government goods necessary for firms to go about their
productive business. Note the counter-intuitive result here - under con-
ditions of strong centralization, there will be more bribes collected and
higher total revenue extracted from the private sector, but less damage
will be done to the economy because the bribes will not be priced exces-
sively (that is, they will not drive down demand significantly).
In addition to being a model which provides a plausible theoretical
explanation of how, in certain political circumstances, it is possible for
the processes of rent-seeking and corruption to be 'managed' in a toler-
ably efficient manner, this framework fits the broad empirical realities of
the Indonesian case remarkably well - helping to explain both the woe-
ful economic conditions of pre-1967 Indonesia, and the increasingly
good economic conditions of post-1967 Indonesia.
During the 1950s and 1960s, the broad framework of Indonesia's
political economy approximated Shleifer and Vishny's weakly central-
ized, or independent monopolists, model reasonably closely. Although
some elements changed between the shaky period of Parliament Democ-
racy (early to mid-1950s) and the turbulent period of Guided Democracy
(late 1950s to mid-1960s), the general picture is one in which central
leadership and control were weak, and there were multiple independent
agencies and actors operating independently in pursuit of opportunities
 FUNNY MONEY IN INDONESIA 267
to collect rents. Given these conditions, under the Shleifer and Vishny
logic it should come as no surprise that there was nothing remotely
approaching co-ordinated rent management and that economic perfor-
mance slid from bad to worse. If we were to focus on fiscal performance,
we would see that, in addition to all sorts of off-budget activity, on-budget
fiscal activity became increasingly debauched. As the 1960s progressed,
unrestrained spending took place on the back of rapid money creation
which ignited hyperinflation and economic catastrophe at the same time
as the country slid into political chaos.
Following the upheaval of 1965-66, a military-based regime devel-
oped under the leadership of Lieutenant General Soeharto. In funda-
mental ways, the political economy of the New Order has differed from
that which preceded it. First, there was a process of enforced political sta-
bilization and centralization through the late 1960s and into the mid-
1970s. Second, the bureaucracy was overhauled, with bureaucratic
agencies and state enterprises being transformed from independent cen-
tres of patronage into something resembling instruments of the presi-
dency. A comparable process of organizational rationalization took place
in the armed forces as well. And, third, the political parties and the elec-
toral process were brought under close government control, with inter-
est group activity being channelled into a government-controlled
corporatist network. Above all, there was a centralization of authority
and patronage around the presidency. Along with a swing to much more
determinedly authoritarian politics, this political transformation was
greatly assisted by the oil bonanza of the 1970s and early 1980s which cre-
ated a vast and centrally channelled flow of revenue.
Although the realities of New Order political economy are by no
means as neat and tidy as the ideal-typical unified monopoly of Shleifer
and Vishny's highly centralized or unified monopoly model, the descrip-
tive fit seems remarkably good. Once Soeharto consolidated his grip on
the presidency and the administrative apparatus beneath him, he
achieved something approaching monopolistic rent management and
thus had a direct interest in ensuring that government goods were not
priced excessively and so did not depress economic activity. Two exam-
ples of rent management in off-budget fiscal activity will help to make
this clearer: one macroeconomic, and the other microeconomic.
The big macroeconomic issue is, of course, why there has not been
more resort to spending (on- or off-budget) on the basis of money cre-
ation. Although it cannot be known, it is certainly plausible to postulate
that the President acted in a manner entirely consistent with the behaviour
of someone facing the incentive structure of Shleifer and Vishny's leader
of a highly centralized regime, or unified monopolist. Once firmly estab-
lished in power, he not only had a direct material interest and, more
268 ANDREW MACINTYRE
importantly, a direct political interest in indulging in moderate borrowing
from the central bank (to fund rents for others), but also in ensuring that
this did not become too onerous an inflation tax, as this would have hurt
his economic interests (as the person who sits alone atop the pyramidal
network of patronage relationships) and his political interests, since,
beyond mere personal enrichment, these economic resources are essential
political tools for purchasing support and sustaining political alliances.
A more microeconomic illustration of behaviour consistent with the
highly centralized model centres on the earlier-mentioned drive to raise
contributions to fund (then) Technology Minister Habibie's new jet air-
craft project. Conveniently, this ties our generalized theoretical discussion
back to our earlier focus on off-budget fiscal activity. This is an interesting
case because, after Soeharto's children, Habibie was usually seen as the
most 'fiscally indulged' member of the government. If one was to look for
an example of rent-seeking which was clearly and directly injurious to the
economy, some of Habibie's activities would have been high on many
observers' lists. As such, his empire was a most unlikely place in which to
look for evidence of economically efficient rent management on the part
of the President. And yet, while the President indeed overrode the objec-
tions of the finance ministry and gave his blessing to another Habibie pro-
ject, there were two important restrictions. First, this measure was made
necessary presumably because the President would not allow Habibie his
first preference, namely to have the venture funded either from on-bud-
get sources or (more) extensively from hidden government reserves. Sec-
ond, the person put in charge of managing these funds was not a cipher
of Habibie, but a respected independent and technocratic senior official
(Cabinet Secretary, Minister Mursjid), who managed to insist on arm's-
length accounting and contractual arrangements governing access to the
funds raised. In short, at the same time as allowing major resources to be
diverted and rents to be captured, Soeharto also imposed some restraints
and checks. Even in this most unlikely of areas, there was apparently some
significant effort to limit inefficiencies. Such behaviour was entirely con-
sistent with the incentive structure facing a leader controlling a unified
monopoly on rent management.

Conclusions: before and after . . .

This chapter has had two goals. The first has been to cast light on an area
of economic policy that receives surprisingly little attention in discussions
about rent-seeking. Fiscal activity - both on- and off-budget - is a very
important area of economic policy and is quite susceptible to rent-seeking
behaviour. I have presented an overview of off-budget fiscal activity in
Indonesia, including previously unpublished empirical details of some of
 FUNNY MONEY IN INDONESIA 269
the processes involved. The central empirical message of this first section
is that there is much more to Indonesia's fiscal record than meets the eye,
with an array of off-budget resource transfer activities of a broadly fiscal
nature. Although we are unable to gauge the total scale of such activity,
there is good reason to believe that it has been substantial. (Indeed, why
else would the IMF strive to eliminate it?) In macroeconomic terms, there
have been no catastrophic consequences. In microeconomic terms, the
efficiency implications of the rent-seeking surrounding off-budget fiscal
activity remain necessarily indeterminate. Nonetheless, we do know that,
among the myriad of other cases of rent-seeking, this did not prevent the
achievement of strong economic growth.
The second goal of this chapter has been to experiment with a set of
ideas about the political economy of rent-seeking in an effort to generate
a broad-based theoretical explanation of the seemingly paradoxical coex-
istence of pervasive rent-seeking and economic success. Although this
chapter is only a first cut at applying the microeconomic logic of Shleifer
and Vishny, in my view it has yielded promising results. (The logic is
developed further in Maclntyre (forthcoming).) While not demonstrating
anything conclusively, I have argued that the model fits Indonesian expe-
rience surprisingly well: it offers an explanation both of why rent-seeking
proved so economically debilitating in the 1950s and 1960s, and why it was
economically bearable under the New Order. Now, to be sure, this does not
explain Indonesia's economic success, for there are many other causal fac-
tors that go into determining whether or not an economy grows rapidly.
Nevertheless, one area of enduring theoretical frustration in the literature
on rapid economic growth in Asia has been our difficulty in accounting for
the coexistence of rapid economic growth and pervasive rent-seeking and
corruption. I suggest that the ideas explored here offer the basis for an
explanation for Indonesia during the Soeharto period and, quite possibly,
for other countries that have paired very centralized political systems, on
the one hand, with rapid growth and pervasive rent-seeking, on the other
- for instance, South Korea under Park Chung Hee and Chun Do-Hwan,
Malaysia under Mahathir Mohamad, and Taiwan under Chiang Ching-
Kuo. Moreover, this analytical framework seems likely to help illuminate
useful comparisons that might be explored in future research: Indonesia
under Soeharto vs. Indonesia post-Soeharto; Indonesia under Soeharto vs.
the Philippines under Marcos; perhaps Thailand under Prem vs. Thailand
under Chatchai; and so on. In short, I believe this model carries very con-
siderable theoretical promise for tackling one of the enduring puzzles of
rapid economic growth in Asia. To be sure, this will not be the only model
that will help us here, for the political frameworks of successful Asian
economies are diverse (with the fiscal federalist explanations of China pro-
viding the most striking counterpoint).
270 ANDREW MACINTYRE
The core of this chapter was conceived and drafted some time before
the current regional economic crisis. What are we to make of a set of
ideas purporting to help explain why pervasive rent-seeking and corrup-
tion may not be inconsistent with economic success in Indonesia, when
that economy now lies a smouldering wreck? Surely, the current stark
realities suggest that such a line of inquiry, while perhaps interesting, is
nonetheless fundamentally misguided? I think not.
The pattern of rent-seeking that existed in Indonesia under Soeharto
was economically effective in the sense of producing a tolerable rather
than an intolerable drain on national economic efficiency. However, it
was also inherently fragile and, indeed, contained the seeds of its own
eventual destruction. The fragility of the system was rooted in the heavy
political centralization. With such a concentration of authority, if the
actions of the leader are misguided or, more simply, fail to engender
market confidence, very serious economic consequences can follow
quickly in a crisis environment as there are no institutional checks on the
leader's behaviour. In short, in such a political system, a great deal rides
on the behaviour of the leader. This applies both to the focus of this study
- the conduct of rent-seeking activity - and, more fundamentally, to the
overall management of economic policy. In the case of rent-seeking activ-
ity, it is plainly the case that a highly centralized political framework in no
sense guarantees effective rent management. Rather, it should be viewed
as an enabling set of conditions, creating incentives for a political leader
to promote a pattern of rent-seeking which is not too costly to national
economic efficiency. However, as we assess Indonesia's suddenly devas-
tated economy today, of even greater immediate significance are the
implications of the fragility of highly centralized politics for overall eco-
nomic policy management. The same autocratic political framework
which facilitated effective economic policy management and quite dra-
matic episodes of successful structural adjustment in the past also pro-
duced a highly destructive policy paralysis in late 1997 and early 1998. As
Soeharto's leadership increasingly vacillated and his commitment to eco-
nomic reform became more uncertain, market confidence very quickly
eroded. Serious doubts about his health and the process of political suc-
cession greatly exacerbated these problems. With no institutional con-
straints to put a break on his behaviour, market confidence simply
continued to slide until economic conditions became so severe that they
produced a political backlash which swept Soeharto from office.
More broadly, from a longer-term perspective there is a strong sense in
which this highly centralized political economy carried with it the seeds
of its own destruction. Inevitably, the rapid economic growth which it
helped promote produced long-run socio-political consequences as new
middle and working class formations emerged and demands for increased
 FUNNY MONEY IN INDONESIA 271
political openness and accountability mounted. The long-term conse-
quences of rapid growth were inimical to the original political framework
itself. In sum, rather than sweeping away the arguments that have been
made in this chapter, Indonesia's economic devastation underscores the
fact that the institutional framework which underpinned the country's pat-
tern of rent-seeking from the early 1970s until 1997 had real vulnerabili-
ties. But this should not be a complete surprise. An institutional framework
which produces satisfactory outcomes in one set of circumstances may pro-
duce quite different outcomes in other circumstances. Institutions clearly
matter, but so do their socio-economic contexts.
The political economy of rent-seeking in the new Indonesia - the
Indonesia that is now taking shape amidst the rubble of the previous
regime - will be different from that which prevailed under Soeharto.
Rent-seeking and corruption are likely still to be very widespread. But,
given that it is almost inconceivable that power will again be so tightly
centralized, the ironic logic of the argument presented here is that, at
least in the short- to medium-term future, the more open political frame-
work which seems now to be emerging may well impose a greater rather
than a lesser drag on the economy.

Notes

There are some notable exceptions to this generalization, such as Chang

(1994).
Although it is sometimes said that the Balanced Budget is a constitutional
provision, in fact, as McLeod (1997) notes, it appears not even an act of par-
liament but a convention which became established following a presidential
decree (PresidentialDecree no. 13 on the 1969/70Budget, issued 13 March). Not
only is it therefore of limited legal standing, it is possible that it is no longer
in force. Certainly, it could be overturned by the simple issuance of another
presidential decree overriding it.
The size of the budget 'deficit' depends on the method of measurement
employed. Hill (1996) provides an illuminating discussion of this.
As noted, this chapter focusses on the expenditure side of fiscal policy. For a
discussion of economics taxation in Indonesia, see Booth and McCawley
(1981), Gray (1986), Gillis (1989), Asher and Booth (1992) .and Hill (1996).
For details on the early development of informal financial linkages of this
sort, see Crouch (1978) and Robison (1986).
For a rare and very useful account of some of the larger foundations, see
Vatikiotis(1990).
Informed sources indicate that the relevant official figures published in the
Development Budget for 1991-92 are reliable. This, however, is reportedly
not true of all relevant figures in some other years. (One example of this is
the fertilizer subsidy figure.) Consequently, it is not possible to replicate these
calculations for all other years without a deep inside knowledge of the actual
expenditure levels for the relevant categories.
272 ANDREW MACINTYRE

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 CHAPTER 7

The Malaysian Development Dilemma

Jomo K.S. and E.T. Gomez

The East Asian economic crisis since mid-1997 has generated a popular
neo-liberal critique of crony capitalism as its ostensible cause. The argu-
ment is that cronyistic relations, especially between the state and business
interests, resulted in unsustainable gross inefficiencies which eventually
culminated in improper financial and other practices, that ultimately
sounded the death-knell for the East Asian economic miracle. Govern-
ment intervention generally as well as state-business relations are thus
blamed for precipitating the crisis. Put simply, government interventions
are said to have created economic rents, thus encouraging wasteful rent-
seeking activity (often involving corruption) and other inefficient eco-
nomic conduct, which eventually culminated in the collapse of financial
systems in the region.
Public opinion in Malaysia about government intervention has often
been divided along ethnic lines, especially since the early 1970s. After the
ethnic riots of May 1969, the redistributive New Economic Policy,
announced in 1970, sought to create the conditions for 'national unity' by
reducing poverty as well as inter-ethnic economic disparities. Since then,
the vast majority of the predominandy Muslim Malay Bumiputras (indi-
genes) have supported government intervention, which has become
closely identified with the new policy that has largely alienated most of the
mainly ethnic Chinese and Indian non-Bumiputras (non-indigenes).
While many among the Indians seek more inclusive government inter-
vention to benefit them, many Chinese - dubious of the likelihood of
intervention in their favour - prefer a minimalist role for government.
Hence, public opinion about government intervention tends to be ethni-
cally polarized and is generally associated with ethnic interests.
Increased government intervention since the 1970s is also widely asso-
ciated with greater opportunities for corruption and other forms of

274
 MALAYSIAN DEVELOPMENT DILEMMA 275

abuse, with which the predominantly Malay bureaucrats, politicians and

politically influential businesspeople are associated. There is also a
strong tendency to associate the creation and distribution of rents with
the New Economic Policy, particularly government efforts to create a
Bumiputra commercial and industrial community. Ironically, while inter-
ethnic redistribution efforts - officially and now popularly termed
'restructuring (society)' in Malaysia - were strongly associated with the
expansion of the public sector in the 1970s, they have increasingly been
linked with privatization in the last decade. Hence, although rents cre-
ated by government intervention have often been captured by non-
Bumiputras, including foreign business interests, they are generally
perceived in ethnic terms.
In Malaysia, then, government intervention has often been equated
with the inter-ethnic redistributive measures associated with the new pol-
icy that followed the consolidation of ethnic Malay political dominance
after the events of May 1969 (see Jomo 1986). Unlike the typically
medium-term structural adjustment measures introduced in the 1980s
after the debt crisis, the International Monetary Fund (IMF) demanded
immediate structural reforms in Thailand, South Korea and Indonesia as
they sought IMF help after succumbing to the crises from the latter half
of 1997 (Chin and Jomo's chapter in this volume addresses some finan-
cial aspects of the crisis in Malaysia; seejomo 1998 for analyses of the East
Asian crises, including Jomo's chapter on the Malaysian crisis). Hence,
the possibility of IMF intervention in Malaysia has generally been associ-
ated with the possible dismantling of the New Economic Policy or its ves-
tiges. Underlying this is a popular equation of Malay political hegemony
with government intervention (Bowie 1991), and thus, with rent-seeking.
As Khan and others in this volume have suggested, rents may be
understood as factor incomes in excess of their opportunity incomes. For
many economists, rents are not supposed to exist in the long run, as
resources will be re-allocated so that factor incomes from different activ-
ities will be equal. Rents are therefore presumed to persist because they
are maintained by interventions in the market.
Rent-seeking seeks to capture such rents, by maintaining or re-allo-
cating existing rents, or even by creating and capturing new ones. Rent-
seeking activities thus impose avoidable costs involving resource transfers
or, alternatively, resource use on socially unnecessary and unproductive
activities, which are deemed socially wasteful. In the former case, the
resources are merely transferred and are not lost to the economy; in the
latter case, the resources are dissipated. Rent-seeking is also deemed eco-
nomically wasteful because of the high costs of rent-seekers' attempts to
change the structure of rights, or regime of claims (to rents), by estab-
lishing new claims or rights.
276 JOMO K.S. AND E.T. GOMEZ

Elsewhere in this volume, Khan distinguished between value-creating

and value-reducing rights as alternative possible outcomes of rent-seek-
ing. In other words, the outcome of rent-seeking may well be a set of
rights, or a claims (to rents) regime, that is either net value-enhancing,
net value-decreasing, or even neutral in terms of its effects on net value
creation. As suggested by Figure 7.1, the net effect of rent-seeking there-
fore depends on both the direct effect of withdrawing inputs from pro-
duction as well as on the efficiency implications of the rights created,
both in terms of the inputs as well as the outputs involved.
Figure 7.2 shows how rent-seeking affects resource allocation, both in
terms of the availability of resources (through the effect on output) as well
as the deployment of resources (between production and rent-seeking).
Regardless of their origin, resources may be allocated to either rent-seek-
ing activity or to productive investments. Both in turn give rise to incomes
which become available for the next round of resource allocation.
While it may seem that rents are more likely to be deployed in further
rent-seeking, there is no compelling reason why this should be the case.
The converse could also be true. Profits secured from productive invest-
ments may well be deployed for rent-seeking purposes, especially if the
likely rate of return to such investments is higher or more secure. In many
real-world situations, however, the choice to investors is not so stark.
Investors are often obliged to deploy resources for both purposes simul-
taneously - for example, to secure permission to produce for the pro-
tected domestic market, or to qualify for a certain export or technology
development incentive such as a tax exemption by actually producing.
Hence, it is important to consider the creation of efficient rent-seek-
ing rights in relation to the origins, nature and distribution of rents in
the Malaysian context. In particular, the discussion in this chapter will
distinguish between 'developmentalist' and 'redistributive' rents, their
respective impacts on the economy, and the relationship between the
two. Developmentalist rents include those created and distributed to
encourage post-colonial diversification of the economy, industrializa-
tion, and technological development. Of course, the very creation and
allocation of rents has distributive consequences, but the main redistrib-
utive rents discussed here are those associated with New Economic Pol-
icy restructuring (which are generally considered to be 'political', mainly
because they are explicitly redistributive), although there are other redis-
tributive rents in the economy as well.
This study of the Malaysian experience will underscore the signifi-
cance of the changing political settlement in reshaping the rent-seeking
regime. While inertia undoubtedly also continues to influence this
regime, major changes in economic policy are largely attributable to
political changes, including international influences. The colonial state
 MALAYSIAN DEVELOPMENT DILEMMA 277

Inputs Outputs (outcomes)

Rent-seeking costs Rights structures

1. Transfers (e.g. bribes) 1. Maintenance of existing rights

2. Dissipation (e.g. lobbying) 2. Re-allocation of existing rights

3. Creation of new rights

Figure 7.1 Khan's rent-seeking process

Source: Adapted from Figure 2.1 (Khan, this volume)

privileged British interests, co-opted the Malay elite into the administra-
tive apparatus, and allowed some room for ethnic Chinese business activ-
ity, especially by English-educated Straits Chinese. In the postwar period,
it had to make more concessions to ensure minimal undermining of
British interests as anti-colonial agitation grew and independence
became imminent. While economic diversification, especially import-
substituting industrialization, and rural development efforts to secure
and consolidate ethnic Malay peasant support for the ruling coalition of
ethno-populist parties achieved sustained growth with low inflation,
growing economic inequalities and unemployment exacerbated regime

Output Production

(Know-how)

Income Resource
distribution allocation

(Know-who)

Rights Rent-
structure seeking

Figure 7.2 Resource allocation involving alternative investment options

Source: Adapted from Figure 2.3 (Khan, this volume)
278 JOMO K.S. AND E.T. GOMEZ

instability, culminating in the events of May 1969. The new regime's

emphasis on economic redistribution, involving greater government
intervention as well as the rapid expansion of state ownership, eventually
deterred private investments, especially by Sino-Malaysians, though poli-
cies for export-oriented industrialization induced transnational corpo-
rate investments. The new leadership in the early 1980s saw a new
emphasis on state-owned heavy industries until the recession of the mid-
1980s brought about less emphasis on economic redistribution, some
deregulation, privatization and new investment incentives - which have
achieved rapid growth, export-oriented industrialization and technolog-
ical upgrading. Since the early 1990s, a new institutional and regulatory
framework has sought to induce more high-technology investments,
especially for export.

Colonial heritage
As in so many other ex-colonies, post-colonial Malaysian history has been
shaped by developments in the earlier era. The colonial authorities
introduced the basic governance framework within which the economy
continues to function. Hence, Malaysian economic development has
been greatly shaped by the institutions of governance imposed by British
colonialism and the successor post-colonial state, though the relation-
ship between economic transformation and governance has been quite
dialectical.
Malaysia's growth record in the last century has been impressive. Dur-
ing colonial times, Malaya was, by far, Britain's most profitable colony,
credited with providing much of the export earnings which financed
British postwar reconstruction. The openness of the Malaysian economy
- high, even by developing country standards - has been a feature of the
structural transformation it has undergone, especially since the colonial
period. Only a few types of industries were allowed to develop by the
colonial authorities, who generally considered the colonies as suppliers
of raw materials and importers of manufactured goods. Most industries
were set up then to reduce transport costs of exported or imported goods
(e.g. for refining tin ore and bottling imported drinks). Local industries
developed most when economic relations with the colonial powers were
weak, for instance during the First World War, the Great Depression and
the Japanese Occupation.
Malaysia's economic infrastructure (e.g. railways, roads, ports, utili-
ties, etc.) - so crucial for profitable capitalist investment - was generally
more developed than in most other British colonies. Such construction
was paid for by taxes levied on the population by the colonial govern-
ment. Colonial monopolies thwarted the development of a strong local
 MALAYSIAN DEVELOPMENT DILEMMA 279

entrepreneurial class producing for the domestic market; instead, local

businesses found it more profitable to engage in production for export,
commerce and usury. Although the Malaysian economy has changed sig-
nificantly since independence, many differences reflecting uneven
development can be traced to the crucial formative decades under colo-
nial rule which shaped the economic structure. Ethnic differences often
coincided with class and occupational differences originating in the
earlier economy. Ethnic Malays remained largely marginal to the grow-
ing capitalist sector, with the Malay elite integrated into the colonial state
apparatus, and the masses remaining in the countryside as peasants.
Instead, emerging business opportunities were mainly taken by some of
the more urbanized and commercially better-connected Chinese.

Resource rents
Access to agricultural land, as well as to forest, mineral and other natural
resources, since the colonial period has increasingly come under the
control of the state. Needless to say, this has encouraged rent-seeking.
Earlier, the British authorities had allocated these land and other natural
resources according to several, sometimes conflicting, criteria. Gener-
ally, European, especially British, capital was favoured, mainly over eth-
nic Chinese capital. The old Malay elite was appeased and co-opted with
pensions, intermediate positions in the colonial administrative apparatus
and privileged access to these same resources (e.g. in the form of agri-
cultural land, mining and forest concessions). To enhance the prosper-
ity of the peninsula, peasant agricultural settlement from neighbouring
islands was encouraged by offering access to cultivable land, though such
access was largely denied to ethnic Indians and Chinese, who were thus
expected to have little option but wage labour.
Needless to say, larger concessions of the better land went to British
investors, ostensibly because they were generally better financed. In turn,
physical infrastructure development - in the form of roads, ports, rail-
ways, telecommunications, electricity and water supply - tended to
favour and further enhance these interests. In so far as there may have
been significant scale economies in some of these resource development
activities, favouring big British capital may have been efficient. However,
this was certainly not the case in the tin industry during the nineteenth
and early twentieth centuries before the advent of the tin dredge in the
second decade of this century (Jomo 1986, 1990). Nor was it true of the
rubber economy during the entire colonial era, as argued by Peter Bauer
and others (Jomo 1986). Hence, the rights regime was neither fair nor
efficient for most of the colonial period - or since then, in so far as the
post-colonial regime has protected the property rights regime inherited
280 JOMO K.S. AND E.T. GOMEZ

from the colonisers. Scale economies have become more significant with
technological changes, but this can hardly be a post hoc justification for
the property rights regime created by colonialism.
It seems worthwhile to consider the nature and fate of different types
of resource rents by comparing what has happened to those from petro-
leum and logging. In the mid-1970s, petroleum production - off the east
coast of Peninsular Malaysia - began providentially, as oil prices soared
after 1973. Although petroleum had long been extracted by Shell off
Sarawak, Malaysia became a net oil exporter only from the mid-1970s.
Since the early 1980s, petroleum gas production - almost exclusively for
export to Japan - has come on-stream. The controversial 1974 Petroleum
Development Act gave the federal authorities jurisdiction over petro-
leum resources, unlike other natural resources - including land, water,
forests and minerals - which have been state government prerogatives
under the post-colonial federal constitution. While petroleum royalties
are shared with the state government concerned, the federal govern-
ment controls Petronas, the National Petroleum Corporation, as well as
other petroleum revenues.
Petronas is widely considered to be a well-run company, with a good
international credit rating. However, since the 1980s, it has been forced
by the federal government executive to finance commercially unviable
prestige property development projects. These include the over-priced
Dayabumi project in the mid-1980s and the Kuala Lumpur City Centre
'Twin Towers' tallest building in the world in the mid-1990s. Petronas has
also been used to financially 'rescue' Bank Bumiputra Malaysia Berhad,
not once, but twice, first in the mid-1980s and then again at the end of
the decade. However, all this would only have been possible if the com-
pany was able to capture and retain petroleum rents reasonably well, in
sharp contrast to the situation with logging.
The authorities do not tax the logging companies much, certainly not
enough to cover the real costs of reforestation or for the strict enforce-
ment of logging and other related regulations. And the taxes collected
are not specifically designated for such purposes. Timber companies
hardly pay income tax, and their financial statements often show losses
or modest profits. The state governments collect a small royalty on the
logs extracted, amounting to barely 1 per cent of the timber price. Thus,
loggers minimize their tax liabilities by undervaluing both the type,
nature and quality of the timber extracted, as well as their quantity, vol-
umes or weights. Under-declaration of wood extracted and exported is
common, while accounts are 'fiddled' or officials bribed to reduce tax
and royalty liabilities and to maximize retained earnings. As the federal
and state governments realize that timber revenues have been well below
what they should be, tax rates have been raised, but this has often only
led to further tax evasion.
 MALAYSIAN DEVELOPMENT DILEMMA 281

Table 7.1 Malaysia: contribution of petroleum to government revenue,

1963-96 (RM million)

Year Petroleum Export duty Royalty Excise duty^1

1963 n.a. n.a. n.a. 16.63

1964 n.a. n.a. n.a. 68.87
1965 n.a. n.a. n.a. 76.40
1966 n.a. n.a. n.a. 89.06
1967 n.a. n.a. n.a. 100.24
1968 n.a. n.a. n.a. 113.53
1969 n.a. n.a. n.a. 120.96
1970 — n.a. 7.30 118.57
1971 4 n.a. 6.05 144.88
1972 — n.a. 22.67 189.62
1973 27 n.a. 25.12 194.45
1974 144 n.a. 46.22 201.30
1975 322 n.a. 78.43 216.77
1976 322 n.a. 83.98 291.31
1977 776 n.a. 110.79 344.44
1978 771 n.a. 116.16 389.96
1979 829 n.a. 165.90 410.17
1980 1,736 723.98 345.29 333.43
1981 1,978 1,240.80 417.00 280.07
1982 2,075 1,351.45 425.26 309.00
1983 1,998 1,476.70 491.00 438.36
1984 2,570 1,629.40 580.95 489.57
1985 3,130 1,639.31 619.30 427.37
1986 3,072 1,076.50 548.58 737.20
1987 1,533 1,170.14 410.28 691.24
1988 2,208 1,149.29 499.38 752.57
1989 1,847 1,431.61 509.08 795.07
1990 2,644 1,910.03 626.86 671.53
1991 4,052 1,981.00 875.31 942.89
1992 3,417 1,646.00 774.00 1,105.94
1993 2,859 1,429.00 741.23 1,423.94
1994 2,211 1,098.00 626.40 1,619.00
1995 b 2,185 751.00 778.00 1,871.90
1996 b 2,350 890.00 931.00 2,030.00
a
Locally refined petrol, locally refined heavy and fuel oils, liquefied petroleum
gas, diesel and kerosene
b
Estimates
Sources: Malaysia, Ministry of Finance, Economic Report, various issues; Malaysia,
Belanjawan Persekutuan, Anggaran Hasil dan Pekerjaan, Percetakan Negara,
various issues

With few taxes to pay, and poor enforcement by the authorities, the
loggers seek to maximize short-term, rather than long-term, returns,
especially with the political uncertainties which threaten policy change
and the security of their concessions. Having no stake in the forest's
282 JOMO K.S. AND E.T. GOMEZ

regeneration because of the generally short-term nature of the logging

concessions and the subcontracting arrangements to the loggers by the
concessionaires, the logging industry has been short-termist and largely
oblivious of the requirements of sustainable forestry practice. Much ille-
gal logging - outside concession areas, of immature trees, and so on -
also occurs as a result, with logging companies often disregarding restric-
tions for selective felling in order to maximize profits in the short term.
In other ways, too, logging's contribution to Malaysian capital accu-
mulation, investment and growth has been limited. Under-declaration of
timber production and exports - partly reflected, for example, by the
inconsistencies in official timber statistics - has not only facilitated tax
evasion but also capital flight. Many of the beneficiaries have not even
reinvested within the country, let alone in the areas from which the tim-
ber has been extracted. Thus, logging has exacerbated resource out-
flows, not only for the communities directly affected but also for the
national economy. Despite the considerable money to be made from log-
ging, both state and federal governments get relatively little.
Malaysia's resource wealth and relatively small population enabled the
public sector to develop in the 1970s and early 1980s with a 'soft budget
constraint', which not only allowed, but even encouraged, various extrav-
agances. Such fiscal irresponsibility seemed to increase with greater state
intervention and the availability of enhanced oil revenues from the mid-
1970s, until the economic and political crises of the mid-1980s brought
about greater fiscal discipline and harder budget constraints for public
enterprises, besides providing a rationale for privatization. As noted
earlier, the resources of Petronas have been used for various purposes
which have done little to enhance productivity. Instead, such state
resources have sometimes been used to finance economically problem-
atic, politically inspired projects and to fund protected, non-tradable
economic activities that do little to enhance either productivity or inter-
national competitiveness. The fact that resource rents have often been
abused in such ways does not mean, however, that they are necessary and
unavoidable consequences of the existence of such rents.

Post-colonial economic diversification

The Merdeka (Independence) Constitution largely preserved the colo-
nial legal and administrative framework, especially protection of the
property rights of British business interests. Besides providing for a
loosely Westminster-style parliamentary system, it included provisions for
'Malay privilege', for the purpose of ethnic affirmative action, not only
on the basis of the historical economic deprivation of the community but
also on the basis of its claim to indigeneity. The federal administrative
 MALAYSIAN DEVELOPMENT DILEMMA 283

Table 7.2 Malaysia: timber export duty revenue, 1968-96 (RM million)

Year Federal Sarawak Sabaha

1968 — 2.24 2.02b

1969 1.08 1.52b
1970 0.50 2.02
1971 62.40 1.84
1972 14.99 n.a. 1.23
1973 11.40 n.a. 0.83
1974 9.54 5.42 1.00
1975 5.74 3.88 1.60
1976 5.52 11.73 0.39
1977 3.51 13.49 0.45
1978 1.89 16.20 0.03
1979 3.66 40.04 0.10
1980 3.45 60.91 0.75
1981 2.81 80.50 0.08
1982 3.64 124.30 0.09
1983 3.50 118.50 0.09
1984 0.93 130.35 0.15
1985 0.28 136.77 0.15
1986 0.29 128.27 0.15
1987 0.93 192.15 0.16
1988 1.02 186.52 0.20
1989 0.54 22.85 0.40
1990 0.46 0.02 1.50
1991 81.80 82.00 0.55
1992 100.00 n.a. n.a.
1993 106.65 n.a. n.a.
1994 161.04 n.a. n.a.
1995 50.00a n.a. n.a.
1996 56.00a n.a. n.a.
a
Estimate
b
Inclusive of forest produce
Sources: Malaysia, Belanjawan Persekutuan: Anggaran Hasil dan Perbelanjaan,
Percetakan Negara, Kuala Lumpur; Sarawak, Estimates of Revenue and
Expenditures, Government Printer, Kuching, various issues; Sabah, Estimates of
Revenues and Expenditures, Government Printer, Kota Kinabalu, various issues

framework devolved authority over land and other natural resources to

the state governments. The formation of Malaysia in September 1963 -
including Singapore, Sabah and Sarawak - was pushed through by the
British, though Singapore seceded in August 1965.
With independence, the Alliance - a coalition of the political elite from
the three major ethnic groups - formally took over state power and politi-
cal jurisdiction over post-colonial Malaya. Not unlike other newly inde-
pendent countries, the post-colonial government embarked upon a
284 JOMO K.S. AND E.T. GOMEZ

program of economic development emphasizing economic diversification

and industrialization. In preparing for this political transition, the British
had ensured that the radical nationalist and leftist forces who threatened
their economic interests were contained, while ethnic elites committed to
protecting British interests were cultivated to eventually inherit state power
in 1957. A basically pro-business environment was therefore assured. Thus,
the post-colonial government continued to promote private enterprise,
while the economic interests of the ex-colonial power were protected and
greater foreign investment inflows encouraged.
In the post-colonial period, the newly independent government quickly
consolidated colonial property rights for fear of capital flight (which had
begun in the late colonial period in the 1950s). The independent Malayan
government extended the framework for governance to complete the
transition from colonial status to nationhood (e.g. with the establishment
of a central bank). Various rural and regional development efforts sought
to secure the crucial political support of rural Malays for the multi-ethnic
ruling coalition, the Alliance. New labour legislation replaced the special
regulations created during the Emergency against the communist-led
insurgency (Jomo and Todd 1994). New legislation and institutions were
created to promote import-substituting industrialization.
The Alliance government's policies reflected the interests and politi-
cal compromise it embodied. Consistent with this compromise, the state
pursued a modest development strategy, with minimal state intervention
except to diversify the economy and ensure suitable conditions for rapid
capital accumulation. The post-colonial government was committed to
defending British interests in Malaya, which also enabled the predomi-
nantly Chinese local businesses to consolidate and strengthen their posi-
tion. The government also made some modest attempts to promote the
interests of the still-nascent Malay business community, while undertak-
ing more ambitious rural development programs to consolidate rural
Malay electoral support.
Government agricultural development policies have been essentially
conservative. The main thrust of rural development efforts involved new
land development by the Federal Land Development Authority (Felda),
other measures to increase agricultural productivity and rural incomes,
and the provision of rural facilities such as roads, schools, clinics, irriga-
tion, and so on. Rural development was thus constrained by the govern-
ment's reluctance to act against politically influential landed interests.
Meanwhile, while biased and conservative, post-colonial rural develop-
ment efforts contrasted with British colonial neglect, especially in the
prewar period. Initially, such efforts were aimed at consolidating a polit-
ically supportive and loyal Malay yeoman peasantry without drastic redis-
tributive measures.
 MALAYSIAN DEVELOPMENT DILEMMA 285

Economic diversification efforts to reduce Malaysia's over-reliance on

tin and rubber were carried out on two main fronts. Plantations, includ-
ing an increasing number of Felda-sponsored schemes, were encouraged
to grow other crops, particularly oil palm. The state also encouraged
manufacturing by offering incentives, providing infrastructure and insti-
tuting other supportive economic measures. There were incentives for
manufacturing previously imported goods. The incentives tended to
favour large, capital-intensive, foreign companies. Import-substituting
industrialization was initially led by British investors anxious to preserve,
if not expand, their market shares from the colonial period (Junid 1980:
25). Most of the import-substituting industries were thus subsidiaries of
foreign companies, finishing goods produced with imported materials
for very profitable sale within the protected domestic market. Many of
these industries only replaced imports of finished goods with semi-fin-
ished goods (e.g. the motor car assembly industry). The technology
used, usually originally developed in foreign conditions, was typically
imported from the parent company, with the result that relatively few
jobs were generated, causing unemployment to rise.
The most important attraction for these industries has probably been
the tariff protection offered by the government. While the incentives
have been justified by infant industry protection arguments and were
meant to be temporary, tariff protection has tended to be protracted.
Investment incentives have not been offered in such a way as to encour-
age (eventual) export of initially import-substituting manufactures.
Meanwhile, the development of domestic industry remained limited,
mainly by the size of the local market, by continued commitment to eco-
nomic openness and by ethnic Malay concern that ethnic Chinese would
be the primary beneficiaries of protected domestic industrialization. The
extent of domestic capital participation in Malaysian import-substituting
industrialization in the 1960s was rather minimal, primarily involving
ethnic Chinese in relatively simple food, plastic and wood-based indus-
tries. With limited incentives and support from the government, the
manufacturing and technological base developed by Malaysians then
continued to remain small and heavily dependent on foreign technology
(Khorl983:25).
By the mid-1960s, it was quite clear that import-substituting industri-
alization was slowing down, due to the limited domestic market, and gen-
erating little employment because of the capital-intensive nature of the
industries as well as the limited linkages to the rest of the national econ-
omy. In the second half of the 1960s, the government moved towards
export-oriented industrialization, with the establishment of the Federal
Industrial Development Authority (now the Malaysian Industrial Devel-
opment Authority, or MIDA).
286 JOMO K.S. AND E.T. GOMEZ

The Industrial Incentives Act, passed in 1968, offered a different set of

incentives oriented to attracting more labour-intensive export-oriented
industries, rather than the import-substituting industries favoured by the
Pioneer Industries Ordinance of the previous decade. Labour legislation
was amended during the state of emergency after May 1969 to help cre-
ate an industrial relations climate more attractive to such industries by
limiting trade union organization and activity. The amendments also
allowed women to work around the clock (i.e. in shift-work), as desired
by many of the new industries envisaged. In the early 1970s, the Free
Trade Zones Act provided the legislation for the development of export-
processing zones. Together with other new incentives, free trade zones
and other facilities were set up for this purpose. The new export-oriented
industries seeking cheap labour reduced unemployment as well as wages,
until the fall in unemployment pushed wages up once again in the late
1970s and early 1980s.
Domestic firms were able to make greater headway in resource-based
industrialization, which also benefited from government promotion. For
instance, the temporary imposition of higher duties on the export of
crude palm oil induced investors to develop refining capacity, which
soon reached the world technological frontier by quickly developing
internationally competitive refining capabilities. However, the scope for
such resource-based industrialization growth has been limited by the
resources available and the limited scope for adding value within the
national economy in internationally traded commodities with a long-
developed pattern of international specialization.
Redistribution, especially along inter-ethnic lines, has been the other
major goal of rent creation and deployment in Malaysia. After increasing
Malay bureaucratic hegemony in the 1960s, the role and influence of the
predominantly Malay civil service were significantly enhanced with the
New Economic Policy, only to give way to an increasingly assertive execu-
tive and a more politically influential rentier business community since the
1980s. Public sector expansion under the new policy was also accompanied
by other interventions which had a cumulative crowding-out effect (with
specific ethnic hues), reflected in significant capital flight and declining
private investments from the mid-1970s, and especially in the early 1980s.
As ethnic Malay demands for increased efforts to economically
advance the community mounted from the mid-1960s, new institutions
were set up for this purpose, often in the form of public or state-owned
enterprises (SOEs). However, the private sector-oriented development
strategy of the 1960s largely precluded more direct government partici-
pation in profitable activities, which were otherwise left exclusively to pri-
vate business interests. Hence, a relatively low proportion of public
development expenditure was allocated to commerce and industry
 MALAYSIAN DEVELOPMENT DILEMMA 287

throughout the 1960s. Increased budgetary allocations for education

partly reflected the increased utilization of educational expenditure to
create a Malay middle class, besides meeting the human resource require-
ments of the rapidly growing and modernizing Malaysian economy.
There was worsening income distribution over the 1960s, involving a
growing gap between town and country and increasing inequality among
all the major ethnic groups. Inequality within the Malay community
increased most - from a situation of least intra-ethnic inequality in 1957
to one of greatest inequality in 1970. However, these trends did not result
in growing inter-class tensions but was primarily perceived in racial
terms, not least because of political mobilization along ethnic lines.
Hence, Malay resentment of domination by capital was expressed pri-
marily against ethnic Chinese, who comprise the bulk of business, while
non-Malay frustrations were directed against the Malay-dominated state.
Such widespread ethnic perceptions resulted in ethno-populist oppo-
sition to the ruling Alliance government of the 1960s. The general elec-
tion results and 'race riots' of May 1969 reflected the ethnic dimensions
of the new post-colonial socio-economic order. Meanwhile, the emerging
Malay middle class, who enjoyed nominal political control after inde-
pendence, perceived the decline of British economic hegemony giving
way to Chinese ascendance. They became more assertive from the mid-
1960s, establishing clear political dominance after May 1969.

Increased state intervention, 1970-85

The New Economic Policy of 1970 sought to create the socio-economic
conditions for 'national unity' through massive economic redistribution
programs to achieve its twin prongs of 'poverty eradication' and the
'restructuring of society'. The policy's Outline Perspective Plan envis-
aged the incidence of poverty declining from 49 per cent in Peninsular
Malaysia in 1970 to 16 per cent in 1990. 'Restructuring society' basically
refers to efforts to achieve inter-ethnic parity in occupations and corpo-
rate wealth ownership. The policy sought to eliminate the identification
of race with economic function, primarily through ethnically differenti-
ated financing of, and controlled access to, tertiary-level education and
public sector employment. It also expected to raise the Bumiputra share
of corporate equity from 2.4 per cent in 1970 to 30 per cent in 1990.
Redistributive efforts by the Malaysian government seemed to grow
with the increasing hegemony of the United Malays National Organiza-
tion (UMNO), the dominant member of the ruling Barisan Nasional
coalition. Despite the government's declared desire to promote Bumipu-
tra capitalism, Malay ownership of corporate assets in the late 1960s was
only 1.5 per cent. Ownership of the economy was still primarily in foreign
288 JOMO K.S. AND E.T. GOMEZ
hands, which held a 60.7 per cent stake in the modern corporate sector,
while the Chinese, controlling a significant 22.5 per cent, were a distant
second. Besides ownership, Malays were generally outside the modern
urban and corporate sectors, with very few businesspeople or managers
outside of the public sector. Most Malays were in peasant agriculture and
in the public sector. Income inequality apparently increased among all
ethnic groups between 1957 and 1970, with the greatest increase being
among ethnic Malays (Jomo and Ishak 1986).
In the mid-1970s, petroleum production began. As oil prices soared
after 1973, the federal government quickly pushed through the Petro-
leum Development Act of 1974 to ensure that it would capture the lion's
share of oil rents instead of the state governments, as would have been
the case under the federal constitution. While oil rents sustained much
of the public sector expansion from the mid-1970s until the early 1980s,
they have also been used since the mid-1980s to salvage government-
owned enterprises and to finance prestige projects.
Development policy in the 1970s after the declaration of the New Eco-
nomic Policy saw greater state intervention in fiscal resource allocation
as well as public sector ownership and control of business enterprises.
From the 1960s, and especially in the 1970s, the state established a large
number of public enterprises in all sectors, sometimes in collaboration
with private capital. The two main types of SOEs are statutory bodies
established by special legislation, and those operating as private compa-
nies registered under the 1965 Companies Act. The major SOEs owned
by the federal, state and regional authorities in turn have many sub-
sidiaries and joint ventures.
Public or state-owned enterprises were first introduced for the purpose
of ethnic affirmative action or positive discrimination from the early
1950s, and had grown modestly from the mid-1960s and very much faster
in the 1970s. From 10 in 1957 and 22 in 1960, the number of SOEs
increased to 109 by 1970, to 656 by 1980 and to 1014 by 1985, before
almost ceasing to grow, except for a few privileged projects favoured by
the executive. Since the mid-1980s, SOEs have been accused of increasing
the public debt and, more generally, of inefficiency; their accumulated
losses have wasted investment resources, increased the government's
financial burden and slowed down economic growth (Kamal and Zainal
1989). From the mid-1970s, there was a rapid increase in domestic and
external debt. Serious deficits in the current account balance also started
to emerge because of declining commodity export prices and weak
demand for manufactured exports; private investments outside of the oil
and gas sector were negative (World Bank 1989).
Meanwhile, the public sector's share of gross national product (GNP)
rose from 29.2 per cent in 1970 to a peak of 58.4 per cent in 1981, before
 MALAYSIAN DEVELOPMENT DILEMMA 289

falling to 25.3 per cent in 1993. In 1982, public sector expenditure con-
tributed 4.8 per cent to gross domestic product (GDP) growth of nearly
6 per cent, but, since 1984, its contribution has declined. The growth of
SOEs from the 1970s, especially in heavy industry in the early 1980s, was
accompanied by declining capital productivity in the economy. The aver-
age incremental capital-output ratio (ICOR) rose from 2-3 in the 1970s
to 5-6 in the early 1980s, while the public sector ICOR rose from 6-7 in
the 1970s to 15-16 in the first half of the 1980s.
The poor co-ordination and accountability of the SOE sector were
very evident. For instance, of more than 900 identified SOEs in 1984, the
Ministry of Public Enterprises could report annual returns for only 269,
which recorded an accumulated loss of RM137.3 million (Supian 1988).
Their rapid growth has also involved generally inefficient state interven-
tion, almost singularly committed to inter-ethnic wealth redistribution,
ostensibly favouring the politically dominant but economically deprived
indigenous community. In effect, however, such intervention has pri-
marily advanced the interests of self-aggrandizing, politically influential
rentiers including some non-indigenes, rather than genuine entrepre-
neurs, thus pre-empting achievement of industrial policy objectives.
Growing state ownership, and other measures to increase Bumiputra
ownership, were only two of several constraints encountered by non-
Bumiputras and foreigners after the advent of the New Economic Policy.
Various laws and regulations were promulgated to increase Bumiputra
participation, most importantly the 1975 Industrial Coordination Act
(ICA), which mainly alarmed Chinese investors, who perceived the Act
as an attempt to advance Malay interests in the manufacturing sector at
their expense. The ICA gave the government increased authority over
the establishment and growth of manufacturing enterprises. Most impor-
tantly, manufacturing licences from the Ministry of Trade and Industry
could be revoked if requirements for Bumiputra ownership and employ-
ment were not met. Thus, the bureaucracy developed the means to try to
induce manufacturing companies to sell stock, usually at discounted
prices, to Bumiputras to achieve the Bumiputra ownership requirements
set by the Act.
Meanwhile, the 1968 Investment Incentives Act was also used by the
government to induce foreign companies to increase Bumiputra equity
participation and employment. In 1968, the government set up a regula-
tory body, the Capital Issues Committee, to regulate the growth of the
capital market. By the 1970s, the committee had gained much more
clout to advance Bumiputra ownership of corporate stock. The Foreign
Investment Committee was established to oversee major issues involv-
ing foreign investments, particularly to ensure conformity with New
Economic Policy guidelines. Non-Bumiputras have also felt that Malay
290 JOMO K.S. AND E.T. GOMEZ

control over other discretionary powers of the state - such as licensing,

concessions for logging and mining, land alienation, protective tariffs
and import controls - have constrained and hindered their business
prospects (Low 1985: 83).
Following implementation of the ICA, Sino-Malaysian equity partici-
pation in the manufacturing sector only exceeded 30 per cent in four
years between 1975 and 1990, though ethnic Chinese had been much
more prominent in the sector prior to the ICA. Chinese firms, which had
dominated small manufacturing enterprises, were the most adversely
affected by the new government regulations. Although often quite effi-
cient, these small-scale manufacturers already faced great difficulty in a
sector dominated by large, often foreign-owned operations (Adam and
Cavendish 1995), without the additional handicap imposed by the New
Economic Policy.
Bumiputra (including government) participation in government-
approved manufacturing projects began to grow rapidly between 1975
and 1985, with equity participation always above 40 per cent, even well
exceeding 50 per cent in two years. The lower share of Bumiputra invest-
ment in the sector since 1986 reflects the rapid growth of private (foreign
and Sino-Malaysian) investments. Partial liberalization since the severe
mid-1980s recession has succeeded in attracting much foreign invest-
ment, especially from the East Asian region (see Yasuda 1991: 340-1).
Among the Chinese, the ICA, particularly its mandatory ruling that
foreign and Chinese companies should ensure a minimum 30 per cent
Bumiputra ownership in all firms beyond a certain size, provoked much
consternation. It prompted the Chinese Chambers of Commerce and
even the usually compliant Malaysian Chinese Association - the UMNO's
leading partner in the ruling Barisan Nasional coalition - to protest the
legislation. The government eventually conceded a little by amending
the Act, first in 1977, and again on several subsequent occasions, making
a few concessions each time. The essential premise of the ICA remained
intact, however.
Some Chinese businesses tried to conceal the extent of their invest-
ments by setting up complicated cross-holding networks. Others who
were already prominent or who owned listed vehicles had little choice
but to restructure, contributing to a spate of rights issues from the late
1970s. A number of prominent Chinese businessmen - like Robert Kuok,
Tan Chin Nam and Khoo Kay Peng - diversified their operations overseas
(see Tan 1993: 88). While many Chinese reacted by investing abroad,
others pooled their resources in efforts to gain new economic strength
(see Gomez 1991). Both Chinese and foreign companies began to
actively solicit business ties with politically influential, but co-operative,
Malays (Bowie 1991: 103-4).
 MALAYSIAN DEVELOPMENT DILEMMA 291

Deregulation and new regulation

Malaysia experienced a severe economic recession during the mid-1980s

as a result of a combination of economic problems. These included
global recession, tighter international liquidity, higher real interest rates
after the debt crisis from the early 1980s, lower primary commodity
prices, reduced international demand for manufactured exports (espe-
cially electronics), reduced foreign private investment inflows, the
decline (largely due to predatory policies directed at ethnic Chinese
business interests) and concentration of domestic private investments in
non-tradable sectors (e.g. property, construction), the concentration of
poorly chosen public investments in heavily protected import-substitut-
ing heavy industries (some of which also failed on technical grounds),
and deflationary fiscal and monetary policies from 1982 except for pri-
ority projects of the Prime Minister.
During the 1980-82 international recession, the government had
adopted counter-cyclical budgetary policies (increasing public sector
consumption, investment and employment) which undermined govern-
ment fiscal discipline. While the government may have underestimated
the nature and gravity of the recession, and therefore thought it could
spend its way out of it, the new Mahathir administration from mid-1981
probably also hoped to secure a new electoral mandate through such
generous deficit spending. Right after winning the April 1982 general
election, the government announced an austerity drive, cutting back
public spending and abandoning the earlier effort to increase public sec-
tor employment.
During the mid-1980s, private investments dropped from RM13.3 bil-
lion in 1984 to RM10.1 billion in 1986, before picking up to RM10.5 billion
in 1987. Perhaps more significantly, private investment as a percentage of
GNP had been declining since the beginning of the 1980s, from 19 per
cent during 1979-84 to 14.4 per cent in 1987 (BNM 1988: 2). Foreign cor-
porate investment declined by 19 per cent from 1984 to RM1.7 billion in
1985, and RM1.4 billion in both 1986 and 1987 (BNM 1988: 195). Mean-
while, public sector investment and higher real interest rates were con-
strained by reduced resource availability after the profligacy of the early
1980s. Public sector investment levels could only be sustained at the high
levels achieved then by incurring massive external debts.
Very importantly, by the mid-1980s there was growing dissatisfaction
with the government among some of the more capable Bumiputras, both
in the public and private sectors. At a conference in 1987, both private
and public sector Bumiputras criticized what they considered to be
unfair government interference in the business world. By this point,
large Malay-controlled business groups had already emerged on the
292 JOMO K.S. AND E.T. GOMEZ

corporate scene, and some were calling for a less regulated economy.
Indeed, some of them viewed excessive intervention as having slowed
economic growth, and hence counter-productive to their interests
(Khoo 1992). In other words, the government could no longer even
claim an ethnic Malay mandate for its role in the economy.
After the second Plaza Hotel (New York) meeting in 1985, the Japan-
ese yen began to appreciate greatly against other major world currencies,
particularly the US dollar. As the value of the currencies of most East
Asian industrializing economies subsequently increased, raising compar-
ative production (especially labour) costs in the process, the Malaysian
ringgit declined, even against the US dollar. The boom throughout
Southeast Asia from the late 1980s benefited greatly from investments
from the first-tier East Asian newly industrializing economies which were
experiencing rising production costs, tightening labour markets and
stricter environmental regulations. Some deregulation of the Malaysian
economy since 1986 has also been a boon to investments, with most busi-
nesses benefiting from, and hence supportive of, such liberalization.
The turning point for government policy thus occurred around 1986.
The major primary commodity price collapses (involving palm oil and
tin) and the electronics business cycle low point had occurred the previ-
ous year. After January 1986, when petroleum fell to its lowest price,
external demand for Malaysian exports, mainly primary commodity
prices, began to recover, albeit slowly. The structural transformation of
the economy has accelerated, with the primary sector declining in rela-
tive significance compared with the much more rapid growth of the sec-
ondary and tertiary sectors.
The government tacitly acknowledged some problems and limitations
of the state-led heavy industrialization strategy of the early and mid-1980s,
often dubbed as a second round of import substitution. Instead, the gov-
ernment sought to encourage private, particularly foreign, manufacturing
investments, especially in more technologically sophisticated, export-ori-
ented industries, with the enactment of the Promotion of Investments Act
in 1986. The timing was perfect, as manufacturers from Northeast Asia
(especiallyJapan and, later, Taiwan) rushed to relocate their industries and
thus take advantage of the enhanced incentives, relatively good infrastruc-
ture and lax environmental restrictions, as well as the comparatively low
production costs resulting from the new exchange rates. Initially driven
primarily by such East Asian export-oriented manufacturing investments,
the Malaysian economy recovered significandy from 1987 and maintained
growth rates of over 8 per cent per year from 1988 until 1997.
The policy changes of the mid-1980s thus appeared to have been suc-
cessful. The subsequent economic turnaround has encouraged the attri-
bution of the recovery to the policy changes. However, as the preceding
 MALAYSIAN DEVELOPMENT DILEMMA 293

account suggests, several different developments were occurring at the

same time and, while all may well have had some part in the recovery, it
is difficult to disaggregate their respective contributions. After all,
growth in most Southeast Asian economies seems to have accelerated at
around the same time (i.e. from the late 1980s).
In 1990, the twenty-year period of the Outline Perspective Plan came
to an end, its ambitious targets having been largely achieved. Despite
some controversy over the reliability and comparability of official data,
reduction in poverty incidence has been impressive, declining to 17 per
cent in 1990 from 49 per cent in 1970. By 1990 also, ethnic proportions
in economic activities and occupations broadly reflected demographic
shares, except in agriculture and government services, which are pre-
dominantly Bumiputra, and in the still Chinese-dominated wholesale
and retail trade. For eight well-remunerated professional categories, the
Bumiputra share rose from 6 per cent in 1970 to 25 per cent in 1990, with
inertia alone ensuring continued increases in the Bumiputra share
thereafter. Through government regulation of business opportunities
and investments, as well as preferential policies for Bumiputra busi-
nesses, the Bumiputra share of equity in public listed companies rose
from 1.5 per cent in 1969 to 18 per cent in 1983 and to 20 per cent in
1990. (Various observers have advanced persuasive arguments suggest-
ing considerable official underestimation of the actual Bumiputra share
of corporate wealth.)
Yet, despite considerable achievement of specific targets, it is far from
clear whether progress had been made in achieving 'national unity', the
New Economic Policy's ostensible purpose, usually interpreted in terms
of improved inter-ethnic relations. Relations between Malays and Chi-
nese were arguably tense in 1987 due to the political machinations of cer-
tain ambitious government political leaders. However, with the boom in
the economy by 1990, ethnic tensions largely receded. However, regional
grievances - especially in Sabah, Sarawak and Kelantan - became more
pronounced, while ethnic minorities — both non-Malay Bumiputras and
non-Chinese non-Bumiputras - were clearly more marginalized and
alienated than ever before.
Confirmation of the change in policy direction since the mid-1980s
came with the adoption of Vision 2020, seen to favour growth, modern-
ization and industrialization over the earlier emphasis on inter-ethnic
redistribution. While foreign investors continued to be courted, the gov-
ernment also liberalized some conditions for local Chinese investments.
Chinese capital has also been encouraged by various other reforms, such
as easier access to listing on the stock market, greater official encourage-
ment of small and medium industries, government efforts to mitigate the
1975 Industrial Coordination Act, and the overall emphasis on market
294 JOMO K.S. AND E.T. GOMEZ

rather than regulatory measures. More recently, the official policy of

encouraging Malaysian firms (especially large corporations) to invest
overseas - where the scope for obstructive or predatory Malaysian gov-
ernment intervention is even less and the prospects for Malaysian
government support more likely - has been perceived as a sign of good
faith that the government is committed to reducing intervention and to
supporting all Malaysian firms regardless of ethnicity. Although foreign
direct investment seemed to level off in the mid-1990s, increased domes-
tic investments - inspired by greater domestic investor confidence - have
sustained investment, while the continued inflow of foreign labour has
been crucial to maintaining rapid economic growth.

Rents, development and redistribution

Since about 1991, the state has been perceived as more restrained in
favouring the Malay business elite. Also, by providing lucrative business
opportunities to some Chinese and Indian businesspeople, it has man-
aged to reduce ethnic dissent among the non-Malay communities.
Hence, the impressive economic recovery since 1987 and government
efforts to deregulate and to de-emphasize the New Economic Policy -
long sought by many non-Bumiputras - have shifted much ethnic Chi-
nese sentiment in favour of the regime since the late 1980s, and espe-
cially since 1991. Meanwhile, the Mahathir administration's economic
and cultural liberalization has become more pronounced with the dec-
laration of Vision 2020 to achieve developed country status by the year
2020 (Jomol994).
Increased state intervention in the economy, including the growth of
public enterprises, was responsible for opening up new opportunities for
wealth accumulation and political patronage from the 1970s. Privatiza-
tion since the mid-1980s has not fundamentally reversed these earlier
trends but has, instead, mainly involved new modes of rent appropriation
and clientelism. Hence, while the significance of state patronage involv-
ing the public sector has diminished since the 1980s, executive patron-
age of access to rentier opportunities has become much more important,
involving a fast-growing, politically influential business elite, especially
ascendant since the middle of the decade.
In Malaysia, privatization has not been accompanied by a strong com-
mitment to promoting competition, allowing once-public monopolies to
be taken over by private interests, thus essentially becoming private
monopolies. Hence, market processes and mechanisms to reduce and
eliminate such rents hardly exist, while there is greater control over
resources in the hands of a UMNO-dominated executive and a corporate
sector dominated by politically linked companies and businesses. Much
 MALAYSIAN DEVELOPMENT DILEMMA 295

of the rent obtained by this select group has been secured by non-
transparent means, sometimes even avoiding the semblance of market
competition. These include the award of government contracts, the pri-
vatization of state enterprises, subsidies from the state in the form of
discounted loans and other privileges, and the appropriation of other
rents created by state intervention, for example through business con-
cessions carried out with government-issued licences.
Privatization has created a new rentier elite in the private sector, which
is not only politically influential and economically powerful but also
likely to be more competent, in order to maximize the rents obtainable.
For example, even though it had no previous experience in road con-
struction, the company connected to the ruling party which secured the
privatized North-South Highway running the length of the peninsula
completed construction well ahead of schedule in order to be able to col-
lect tolls sooner. Thus, privatization has offered opportunities to restruc-
ture rent-seeking and re-allocate rents with efficiency-enhancing
consequences, though this does not mean that efficiency could not have
been enhanced through means other than privatization.
It is widely believed in Malaysia that the public sector expansion and
increased government intervention of the 1970s and early 1980s caused
the economic and political crises of the mid-1980s. Most government
leaders, both politicians and bureaucrats, seem to accept the policy
changes since the mid-1980s, involving some economic liberalization, as
necessary to induce investments by ethnic Chinese and foreign capital in
order to sustain growth and industrialization. The success of Malaysia's
campaigns to attract foreign and domestic private investments, especially
since the late 1980s, has also enhanced state sensitivity to foreign and
Chinese capital. This is in sharp contrast to the situation in the 1970s and
early 1980s (see Jesudason 1989), which had led to a significant decline
in private investments as well as considerable capital flight. These policy
moves, coupled with the changed economic conditions in the region,
resulted in a resurgence of export-oriented manufacturing, largely
under the auspices of foreign capital, mainly from East Asia, which rein-
vigorated the economy enough for it to register over 8 per cent growth
annually since 1988.
It can be argued that such rent transfers have contributed little to
enhancing the productive capacity of the Malaysian economy. However, in
so far as these constitute straightforward transfers, there is relatively little
rent dissipation except for investors incurring additional transaction costs
(e.g. in trying to identify and perhaps even help finance suitable Bumipu-
tra partners). In any case, restructuring was not supposed to involve
'robbing Peter to pay Paul' (i.e. a zero-sum game), but to redistribute
new wealth created (i.e. a positive-sum game, ostensibly with a 'win-win'
296 JOMO K.S. AND E.T. GOMEZ

inter-ethnic outcome). Hence, existing property rights - though not nec-

essarily other 'rights' (e.g. concessions, licences, tender awards, etc.) -
have generally not been violated, but redistribution has been affected by
re-assigning other (especially new) rights and claims along ethnic - and
usually 'political' (i.e. by those with political power) - lines.
Also, such inter-ethnic redistribution efforts, and the structure of
rights thus created, may have been necessary to ensure the political and
economic stability so crucial to investment, growth and structural
change. However, even if this is conceded, the careful consideration of
alternative redistributive policies and their respective consequences
could well offer more efficient means of achieving similar ends.
Without such interventions, however, it is unlikely that Bumiputra
business interests would have made such significant inroads into sectors
of the economy long dominated by ethnic Chinese. If such redistribution
has contributed to the greater political and economic security so vital to
sustaining economic investments and growth, it may be considered a
necessary cost, though there may, of course, have been other cheaper
means of attaining such stability. Also, one has to consider whether this
was the cheapest or most economic option available, given the nature of
the political settlement.
The new Malay business community has developed rapidly, with many
individuals appearing to have developed various degrees of indepen-
dence from the state. However, most retain, cultivate and ultimately rely
on their connections with top UMNO leaders to secure continued
patronage while, in turn, providing financial and other backing for their
political patrons. Such rentier activities have had profound implications
for Malaysia's politics and business, particularly with the ascendance of
business-based political factions within the UMNO. For all sides, political
and business patronage involving the state has remained the primary
means to consolidate and enhance business as well as political interests
(Gomez andjomo 1997). However, the nature of the clientelism involved
is symbiotic or reciprocal, with both businesses and the state elite (pow-
erful politicians and bureaucrats) serving as patrons as well as clients to
the other, depending on the matter concerned. Of course, the nature
and degree of asymmetry in their relationship varies with its specific his-
tory and nature.
Restructuring, or inter-ethnic redistribution, seems to have been most
easily captured and abused, with some unfavourable consequences for
efficiency. Such abuse has been facilitated by the limited accountability
requirements imposed on the government, enhanced by the minimal
transparency of rent allocation processes (e.g. due to the exercise of
'executive prerogatives). Alleged organizational incapacity on the part
of the state has been less significant, judging by its governance capability
 MALAYSIAN DEVELOPMENT DILEMMA 297

in other regards - which suggests that the lack of transparency and

accountability is deliberate, and not merely institutionally inherited.
Thus, while some state interventions in the economy and the rents thus
created have enhanced accumulation, economic diversification and late
industrialization, not all interventions - especially those ostensibly ori-
ented to redistribution - have contributed to productivity enhancement.
Deeper understanding of such differences can only come from more
careful analysis of particular interventions and their consequences,
which should give due attention to the origins, the rationale and the
organization of such interventions. Identifying origins can be very
important because choices and change are very much shaped and influ-
enced by history, inertia and antecedents. It has been argued, for exam-
ple, that the ICA was promulgated to enhance the political standing of
the minister then responsible. Subsequent Malay politicians have fought
shy of repealing the legislation completely for fear of being seen to be
abandoning ostensibly pro-Malay legislation, despite recognizing its
deleterious effects for manufacturing sector growth.
Though the rationale for much government intervention in Malaysia
is ostensibly developmentalist, one can distinguish that intended to
induce growth and structural change from that with redistributive and
populist political motives. The political legitimacy, acceptability and pri-
ority of inter-ethnic redistributive economic measures have been espe-
cially important in shaping perceptions of government intervention,
especially along ethnic lines. Proponents of such redistribution not only
emphasize its progressive aspects - e.g. 'compensating for historical
(colonial) neglect or underdevelopment' - but also its alleged socially
and politically stabilizing consequences, so crucial for sustained eco-
nomic growth. Critics emphasize various abuses which have arisen, par-
ticularly in the course of implementing ostensibly ethnic redistributive
measures; most importantly, perhaps, the priority given to such measures
has tended to compromise and undermine the efficacy of interventions
with other objectives as well, such as privatization (Jomo 1995).
It is therefore quite feasible to distinguish between redistributive mea-
sures that also enhance productivity and those that merely involve wealth
transfers. The organization or structuring of rents, especially the rent-
seeking regime, shapes the consequences of the existence of the rents -
for example, the likelihood of dissipation of the rents as well as their effi-
cacy in enhancing productivity. At the risk of over-generalization, our
earlier review suggests that, while considerable rent-seeking has occurred
in Malaysia, not all rents have been dissipated by socially unproductive
rent-seeking activities. Thus, many of the rents created have not been as
much dissipated as claimed by many critics of rent-seeking on an a priori
basis. Some value-enhancing rights have, instead, actually contributed
298 JOMO K.S. AND E.T. GOMEZ

towards improving productive capacity, though this has generally not

occurred very efficiently except for a few notable exceptions, such as the
effect of the export duty on crude palm oil in inducing refining capacity
investments which eventually proved to be internationally competitive.
Thus, somewhat ironically, both the ethnic 'restructuring' agenda and
subsequent economic liberalization, especially privatization, have facili-
tated significant private capture of rents by the politically well-connected,
presumably with some sharing of these captured rents with those in a posi-
tion to allocate them. Such appropriation and transfer of rents may well
violate notions of fairness, including those deemed desirable for healthy
competition, but may not in themselves be socially wasteful since they
essentially only involve transfers. However, in so far as expenses may be
incurred in efforts to secure such rents (e.g. election campaign
expenses), they would largely be wasteful and would constitute dissipation
of the rents created. Their respective proportions would be mainly deter-
mined by the nature of the rent-seeking regime created by the interven-
tion and would have considerable bearing, together with other relevant
factors, on the efficiency of the new rights created by the intervention.
The more effective linkage of rent access and capture to the achieve-
ment of specific policy goals has enhanced efficacy in the use of rents as
incentives and may, in certain circumstances, have reduced rent dissipa-
tion. For instance, the greater use of performance criteria has presum-
ably reduced wastage and inefficiency, besides more effectively
rewarding businesses for improved efficiency and otherwise achieving
policy objectives. For example, allowing the company to collect tolls on
the privatized North-South Highway as soon as it was built created an
incentive for the company to speed up completion in order to do so.
Meanwhile, accumulation in the 'internationalized' sectors of the
economy has not been significantly undermined by the magnitude and
nature of these rents, but has instead ensured much of the growth and
dynamism of the Malaysian economy. The continued and recently
enhanced allocation oi rents in favour of industrialization, especially of
the export-oriented variety (Rasiah 1996), has ensured rapid growth,
particularly in recent years - albeit mainly under foreign control, which
raises some doubts about the sustainability of the process. Rents have
effectively served as incentives for foreign investors to relocate export-
oriented production in Malaysia, which has been responsible for the
rapid growth of most such manufacturing in the 1970s and since the late
1980s. Some government policy reforms - including more effective
implementation and enforcement (e.g. with the introduction of 'one-
stop agencies') - have reduced clientelist payoffs to government officials
and politicians for such firms, which essentially operate within the realm
of the global, rather than the national, economy.
 MALAYSIAN DEVELOPMENT DILEMMA 299

The new international economic governance and environment that

has emerged from the 1980s is likely to strengthen the position of
transnational corporations. For example, Trade-related Investment Mea-
sures (TRIMs) and imminent multilateral agreements on investment
rules will eventually eliminate many of the remaining restrictions on for-
eign investments in countries like Malaysia. The new rules on and
enforcement of intellectual property rights generally and of the World
Trade Organization's Trade-related aspects of Intellectual Property
(TRIPs) and Information Technology Agreement (ITA) will strengthen
transnational corporations' claims to the monopoly rents derivable from
strengthened intellectual property rights (copyright, patents, trade-
marks, etc.). Similarly, the General Agreement on Trade in Services
(GATS) will remove most obstacles to a greater foreign presence in the
services sector. Economic liberalization-cum-globalization is thus likely
to further limit the trade policy instruments that might be deployed for
the purpose of supporting late industrialization.

Conclusion
Now that rents are no longer simply equated with waste or corruption, as
has been common in popular political economy discourse since the
1980s, it is tempting to see developmentalist rents as 'value-enhancing'
and redistributive rents as 'value-reducing'. However, regardless of the
nature of the rent, if rent-seeking costs are relatively high, it is less likely
to be conducive to the efficient creation of rights, with the net outcome
more likely to be value-decreasing. Conversely, if access to rents involves
minimal rent-seeking costs, this is conducive to the efficient creation of
rights, with the net outcome less likely to be value-decreasing. Rent-seek-
ing costs may be high or low, depending on the manner in which access
to the rights is structured.
The other point to be reiterated in this connection is that, while rent-
seeking transfers are undoubtedly a cost to the rent-seeker, they do not
constitute a social waste in an economic sense in so far as they do not dis-
sipate the economic resource being transferred. Of course, if such trans-
fers are illicit, the transferee may well choose to hide them by transferring
and retaining the rents abroad, in which case they may no longer be avail-
able as an investment resource within the national economy. Expenses on
rent-seeking activities are dissipated and thus constitute a social waste.
Hence, the social implications of different types of rent-seeking costs may
be quite different from an economic perspective.
But the analysis is still partial, in so far as attention is confined to rent-
seeking inputs. As Khan emphasizes, addressing rent-seeking costs as
well as the associated waste due to dissipation on the input side begs the
300 JOMO K.S. AND E.T. GOMEZ

question of the nature of the rights being sought or created. In terms of

the rent-outcomes which are the output of rent-seeking, potentially
value-enhancing rights may be inefficiently allocated and regulated, so
that little value enhancement is actually achieved. In Malaysia, this seems
to have been the fate of many import-substituting industries that
emerged behind protective trade barriers but never developed the indus-
trial capabilities to become internationally competitive. On the other
hand, certain redistributive rights - for instance, involving human
resource development or production credit to the poorest - may be sig-
nificantly value-enhancing, even if not envisaged as such.
In Chapter 2, Khan discusses a number of conditions which facilitate
the creation of efficient rights (summarized in Table 2.2). Where rent-
seeking is through private bargaining, the only condition required is that
all losers are compensated. However, if all losers are not compensated,
which is typically the case for almost all rent-seeking in developing coun-
tries like Malaysia, there are a number of other conditions which may
contribute to value-enhancing rent-outcomes:
• The spending power of rent-seekers is proportional to their gain or
loss.
• The political power of rent-seekers is proportional to their gain or
loss.
• Political demands for transfers can be met with a stable set of
redistributions.
• State officials are value-maximizers and learn rapidly from their
mistakes.
• The costs of collecting bribes or taxes do not differ across groups.
• The state's institutional structure allows all costs and benefits to be
internalized.
• Losers do not have the power to politically resist the state.
These variables identify the importance of the ideology and cognition of
state officials, political institutions and particularly their degree of cen-
tralization, the relative success of different groups in organizing collec-
tive action, and the location and seriousness of political constraints for
explaining the efficiency or otherwise of the rights created through rent-
seeking. We conclude by commenting on how these variables relate to
the specific patterns of rent-seeking in Malaysia.

Ideology and cognition of state leaders

While Malaysia's leaders have often been criticized for poor decision-
making, they have equally often demonstrated a significant ability to cor-
rect themselves as well as to change their policies in the light of evidence.
 MALAYSIAN DEVELOPMENT DILEMMA 301

On the other hand, owing to the pervasive influence of Anglo-American

economic ideology as well as the weakness of nationalist - as distinct from
ethno-populist - economic thinking, economic nationalism in decision-
making and planning has been weak. However, technocratic and prag-
matic considerations have ensured that knowledge and cognitive failures
have not been too serious.

Political institutions
While the federal system has allowed many state-level officials to person-
ally profit from their control over most natural resources, there has been
considerable centralization of power and control over economic
resources (e.g. over petroleum resources), in the four decades since
independence. In general, while Malaysia's consociationalist ruling coali-
tion has been really effective in capturing the political centre in the face
of rival ethno-populist opposition parties, political institutions have not
effectively facilitated efficient bargaining between the state and private
business interests. Formal consultative mechanisms have not had a sus-
tained impact, though they have been of significant symbolic value.
Informal consultation involving peak business interests and key execu-
tive officials, however, has been important, though often compromised
by the interests of key rent-seekers who have secured the political 'inside
track'. The only partial incorporation of different productive interests in
state decision-making has inevitably meant that not all externalities were
internalized.

Success of different groups in collective action

The beneficiaries of value-enhancing rights have not been able to lobby
effectively in the Malaysian environment. It is difficult to explain
Malaysia's relative success in terms of the greater organizational success
of its emerging capitalist class.

Political constraints
The concentration of power in the hands of a developmentalist executive
clearly reduced political constraints on the creation of value-enhancing
rights, though the growing influence of rent-seeking business interests
with limited entrepreneurial capabilities has probably had the opposite
effect. Paradoxically, the Malay ethno-populist agenda, combined with
the executive's developmentalist ambitions, further helped by allowing a
stable set of redistributions to be organized for a substantial length of
time. This undoubtedly helped the creation of value-enhancing rights,
302 JOMO K.S. AND E.T. GOMEZ

though at the cost of a substantial component of redistributive rents.

This aspect of Malaysia's political system has played a significant role in
allowing substantial value-enhancing outcomes for a time.

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(ed.) Privatizing Malaysia: Rents, Rhetoric, Realities. Boulder and London:
Westview Press.
1995b. Early Privatizations, in Jomo KS. (ed.) Privatizing Malaysia: Rents,
Rhetoric, Realities. Boulder and London: Westview Press.
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Bowie, Alasdair 1991. Crossing the Industrial Divide: State, Society, and the Politics of
Economic Transformation in Malaysia. New York: Columbia University Press.
Gomez, E.T. 1991. Money Politics in the Barisan Nasional. Kuala Lumpur: Forum.
Gomez, E.T. and Jomo KS. 1997. Malaysia's Political Economy: Politics, Patronage
and Profits. Cambridge: Cambridge University Press.
Jesudason, James V. 1989. Ethnicity and the Economy: The State, Chinese Business and
Multinationals in Malaysia. Singapore: Oxford University Press.
Jomo K.S. 1986. A Question of Class: Capital, the State and Uneven Development in
Malaya. Singapore: Oxford University Press.
1990. Growth and Structural Change in the Malaysian Economy. London:
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1994. U-Turnf: Malaysian Economic Development Policies after 1990. Cairns:
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Jomo KS. (ed.) 1995. Privatizing Malaysia: Rents, Rhetoric, Realities. Boulder and
London: Westview Press.
1998. Tigers in Trouble: Financial Governance, Liberalisation and Crises in East
Asia. London: Zed Books.
Jomo KS. and E.T. Gomez 1997. Rents in Multiethnic Malaysia, in M. Aoki, H.-K
Kim and M. Okuno-Fujiwara (eds) The Role of Government in East Asian Eco-
nomic Development: Comparative Institutional Analysis. Oxford: Clarendon
Press: 342-72.
Jomo KS. and Ishak Shari 1986. Development Policies and Income Inequality in Penin-
sular Malaysia. Kuala Lumpur: Institute for Advanced Studies, University of
Malaya.
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Malaysia. Kuala Lumpur: Oxford University Press.
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icy and Framework for the Post-1990 Economic Policy. Kuala Lumpur,
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 MALAYSIAN DEVELOPMENT DILEMMA 303

Khor Kok Peng 1983. The Malaysian Economy: Structures and Dependence. Kuala
Lumpur: Maricans.
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Government Printers.
1996. Seventh Malaysia Plan, 1996-2000. Kuala Lumpur: Government
Printers.
Rasiah, Rajah 1996. State Intervention, Rents and Malaysian Industrialization, in
John Borrego, Alejandro Alvarez and Jomo K S. (eds) Capital, the State and
Late Industrialization: Comparative Perspectives from the Pacific Rim. Boulder:
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ment: Malaysia. PhD thesis, University of Malaya.
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dination Act, The Developing Economies 29 (4): 330-49.
 CHAPTER 8

Financial Sector Rents in Malaysia

Chin Kok Fay and Jomo K.S.

As the East Asian crisis swiftly unfolded from a currency crisis into a
financial crisis in the second half of 1997, many commentators were
quick to denounce East Asian style banking systems as the cause. In
particular, it is claimed that government interventions had distorted
these systems, resulting in unsound banking practices. Most importantly,
it is claimed that crony capitalism was rooted in the banking systems,
which deviated from neo-liberal Anglo-American norms. Thus, it is
said, improper state-business relations were responsible for the crises
that eventuated.
The popular neo-liberal interpretation of the East Asian crisis has
largely ignored the possibility that international financial liberalization,
especially since the 1980s, could have been a contributing factor. It
largely ignores the disastrous impact of massive capital flight, especially
from the region's newly emerging (stock) markets. The Kuala Lumpur
Composite Index collapsed from a February 1997 high close to 1300 to
an August 1998 low of 264 - that is, a drop of almost 80 per cent. Instead,
the focus has largely been on the banking systems and practices in the
region. For various reasons, the three most affected economies of Thai-
land, South Korea and Indonesia have all been much more bank-based
than Malaysia, especially in recent years, when considerable disinterme-
diation has occurred with the relative as well as absolute growth of the
stock market.
Thus, currently popular interpretations of the East Asian crises
largely reflect the ideas of proponents of financial liberalization, who
have criticized the 'financial repression' said to be a consequence of
government intervention and regulations in financial markets. Most neo-
classical economists assert that rents created through government inter-
vention encourage wasteful rent-seeking behaviour. Their arguments for

304
 FINANCIAL SECTOR RENTS IN MALAYSIA 305
financial liberalization have dominated the literature on financial devel-
opment since the mid-1970s (e.g. McKinnon 1973; Shaw 1973). Financial
repression is said to be detrimental to long-term economic growth. They
argue that fostering free competition and liberalizing the financial sector
from interest rate ceilings and other restrictions facilitate economic
development and growth. The theoretical and empirical foundations
of this hypothesis have, however, been subject to many criticisms (Cho
and Khatkhate 1989; Akyuz 1991: 2; Akyuz and Kotte 1991: 7). Hence,
there is no consensus on what kind of financial policy to pursue in devel-
oping countries.
Hellman et al. (1997) advocate a set of financial policies, constituting
what they call 'financial restraint', based on a stylized analysis of the poli-
cies of some high-performing East Asian economies. They argue that
rent creation in the financial sector may not necessarily hamper eco-
nomic growth, but can effectively promote desired growth under certain
conditions. The next section considers the theoretical rationale for
financial restraint as a viable alternative financial policy and discusses
the conditions for successful restraint identified by Hellman et al.
Increased government intervention in Malaysia's financial sector, espe-
cially since the New Economic Policy in the 1970s, has created a gener-
ous flow of rents, but these have not necessarily been created, distributed
and deployed efficiently, especially in the service of industrialization.
This is the main concern of the final section, which attempts to evaluate
how financial sector rents have been deployed in Malaysia as well as to
examine the reasons for the failure to ensure efficient deployment of
rents from the financial sector to favour productive investments, partic-
ularly in manufacturing.

Financial restraint
Financial restraint is aimed at the creation of rents in the financial
and productive sectors in order to induce agents in the financial sector
to engage in desirable or beneficial activities. Hellman et al. define
'rents' as returns in excess of those which would be generated in a com-
petitive market, and not income that accrues to an inelastically supplied
factor of production. Financial restraint is said to be more efficient than
either financial repression or laissez-faire policies. Unlike financial
repression, where the government extracts rents from the private sector,
financial restraint involves it creating rent opportunities for that sector.
Thus, the government provides the opportunities but allows profit-
maximizing firms to pursue and capture the rents, thus enabling private
information to be utilized in making allocation decisions. As Hellman et
al. (1997) put it:
306 CHIN KOKFAYANDJOMO K.S.

Rents in the financial and production sectors can play a positive role in reduc-
ing information-related problems that hamper competitive markets. In par-
ticular, these rents induce private sector agents to increase the supply of goods
and services that might be underprovided in a purely competitive market,
such as monitoring of investment or the provision of deposit collection.

Thus, this is different from conventional interventionist thinking in

which the government itself undertakes the supposedly socially beneficial
actions. By leaving the efficiency of execution to private agents, the numer-
ous inefficiencies that can be expected from direct government action can
be avoided, according to the proponents of financial liberalization. In
addition, the financial restraint approach differs significantly from that of
a government distributing rents through subsidies and other support pro-
grams, which typically are not performance-based and may create greater
dependency, rather than self-sufficiency, among subsidized firms.
Hellman et al. agree with McKinnon (1973) in warning against the
government depriving the private sector of a positive real return on
financial assets, and with Shaw's (1973) view that improving the quality
of financial intermediation is critical to increasing the efficiency of
investment. However, their analysis differs from McKinnon's and Shaw's
in arguing that financial restraint may help rather than hinder financial
deepening. They identify several ways in which financial restraint can fos-
ter this deepening.
Using a simple demand-supply model of the market for loans, Hellman
et al. illustrate the effect of interest rate controls as a mechanism for the
creation of rents within the financial sector. Figure 8.1 shows market

r s,
\
h
\
h
/ \

/ \ D

CL Q

Figure 8.1 Simple supply-demand model of the market for loans

 FINANCIAL SECTOR RENTS IN MALAYSIA 307

equilibrium at an interest rate r()at the intersection of a household funds'

supply curve and a corporate funds' demand curve.1 If the government
intervenes by regulating the deposit rate of interest, rents are potentially
captured by financial intermediaries. Given the equilibrium lending rate
rL, the difference between the equilibrium lending rate and the deposit
rate (rL - rd) defines the economic rents accruing to banks. In this case,
the lending rate is greater than it would be in the absence of interven-
tion, allowing banks to capture rents both from households (r0 - rd) and
from firms (rL - r()).
In their analysis, there are two broad categories of rent effects. First,
they argue that the rent effect on savings is large. They claim that house-
holds are likely to be more responsive to deposit security and intermedi-
ation efficiency than to interest rates. This is because households are
typically risk-averse, placing greater emphasis on the security of deposits.
Besides, household savings depend crucially on the availability of effi-
cient facilities and infrastructure for deposit collection, in particular on
the extent of the bank branching network and the efficiency of services
provided to local communities (Hellman et al. 1997). Under financial
restraint, the creation of rents in the financial sector can increase savings
by inducing greater security and improving deposit infrastructure; this
rent effect also dominates the interest rate effect. How rents can increase
savings by affecting these two non-price factors will be discussed here.
A simple graphical way of illustrating this rent effect is a rightward shift
in the supply curve from S, to S2 (Figure 8.2). Given the controlled
deposit rate, rd, the excess for loans gives an equilibrium lending rate of
rL1 and banks capture rents of rL1 - rd. Despite the rent captured by banks,
firms are better off with the rent effect. They obtain a greater volume of

Figure 8.2 Rent effect of financial restraint

308 CHIN KOK FAY AND JOMO K.S.

loans at a lower interest rate than they would under 'free market' equi-
librium (Qd>Q0 and r{ j<r0). This is possible if the rent effect is large rela-
tive to the interest elasticity of savings, as they assert to be the general case.
Regarding the question of how rents can affect financial intermedia-
tion, Hellman et al. (1997) emphasize two important functions of the
creation of economic rents for financial intermediaries under a regime
of financial restraint. First, by creating an ongoing flow of profits from
continuing bank operations, these rents create incentives for banks to
operate as long-run agents - by creating 'franchise values' for the banks
- so that they will effectively monitor firms and manage their loan port-
folio risks. (An important aspect of franchise value is that it creates long-
run equity that cannot be appropriated in the short run since banks have
an ongoing interest in staying in business. Thus, franchise value creates
commitment for a bank to act as a long-run agent.) Second, by increas-
ing the returns to intermediation, banks have a strong incentive to
increase their own deposit bases. Banks are therefore more likely to
make investments to attract incremental deposits, for example, by open-
ing new branches in previously unserved rural areas or by making other
investments to attract new depositors into the formal financial system.
Rents do not so much involve wealth transfers as provide opportunities
to create wealth (Hellman et al. 1997). Unlike rent transfers, which alter
the distribution of income without directly changing incentives for the
parties competing for these transfers, rent opportunities are contingent
on the agent's actions. With financial restraint, a bank may only capture
rents through its own efforts - by attracting new deposits for loans to rent-
generating sectors and by rigorous monitoring of its portfolio of loans to
ensure maximum return on its investments. As pointed out by Hellman et
al. (1997), 'in the case of financial intermediaries, rent opportunities
would include incentives to promote deposit mobilization - both in the
wealth and intensity of financial services - and to encourage efficient port-
folio allocation and loan monitoring on the parts of banks'.
Some further policies are necessary to support efficient financial rent
creation. It is important to note the assumption, crucial to their argu-
ment, that the rents generated in the financial sector can even persist in
the long run. Thus, the government needs to restrict competition in the
banking sector, as such competition could eliminate the rents.2 The gov-
ernment needs to control entry into the industry so that 'new entry does
not erode the rents that are necessary to induce banks to value their fran-
chise. Also, too much entry would prevent most competitors from achiev-
ing the efficient scale, thus lowering their ability and desire to invest in
better information and monitoring capabilities, and worsening the over-
all quality of intermediation' (Hellman et al. 1997).
 FINANCIAL SECTOR RENTS IN MALAYSIA 309

While there is no price competition under financial restraint, there

can be non-price competition, such as in the locality and quality of ser-
vices. There is a possibility that rent will be competed away or at least
reduced through non-price competition. In addition, there are other
socially wasteful forms of competition - for example, 'a bank which
opens a branch next to a competitor's branch does not mobilize any new
funds; the new branch only competes for existing depositors' (Hellman
et al. 1997). Thus, restrictions on such competition are necessary to pre-
vent socially wasteful duplication of activity.
Another set of policies restricts households' ability to substitute out of
financial sector deposits. An undesirable side-effect of financial restraint
is that deposit rate controls may lead to asset substitution, with depositors
seeking out alternative savings vehicles (Hellman et al. 1997). Restric-
tions on competing asset markets are therefore necessary to limit the re-
allocation of savings in response to deposit rate control. For financial
restraint to operate effectively, savings in domestic banks need to be
more attractive than other alternatives.
There are four important asset alternatives. First, in developed coun-
tries, bond and stock markets have become an attractive option for
households in which to invest their savings. However, it is argued that the
development of security markets may not be desirable, as

[they] would compete with the banking sectors for household funds. Security
markets can only be used by the largest and most reputed firms in the econ-
omy. If they were to go to the security markets, banks would lose some of their
most profitable business and there is a loss of franchise value. It follows that
security markets provide an alternative savings vehicle that undermines the
rents in the banking sector, and may threaten the stability of the financial sys-
tem. (Hellman et al. 1997)

This argument suggests that security markets should not be emphasized

while an effective banking system is being developed.
Foreign deposits are another alternative to deposit savings with
domestic financial intermediaries. While serious attempts should be
taken to control international capital movements, alternative investment
options should be provided to investors to discourage capital flight
(Hellman et al. 1997).
A third threat to the formal banking sector comes from the informal
sector, which invariably pays much higher rates to attract deposits. The
decision to deposit funds in the informal sector is not so much a function
of the rate differential as a function of the efficiency and safety offered
by this sector. If this argument is correct, then financial restraint may
310 CHIN KOKFAYANDJOMO K.S.

actually encourage and facilitate theflowof funds from the informal sec-
tor to the formal sector.
The fourth asset alternative is real assets such as gold. These assets are
inflationary hedges, as their values are not adversely affected by inflation.
Real asset substitution poses a greater threat to financial sector deposits
whenever real interest rates are negative. Consequendy, real interest
rates must be kept positive, usually by ensuring a stable macroeconomic
environment, where inflation rates are low and predictable.

Financial sector rents and their deployment

In the colonial and early post-independence periods, the Malaysian
financial structure was relatively simple, with a few commercial banks
basically serving trade requirements. Most were foreign-owned, mainly
by the British. The intermediary role was minimal, as the main function
of banking services was to facilitate trade. During the British colonial era,
banks mostly provided funds for major agency houses, which dominated
the export of the country's primary commodities (tin and rubber) as well
as the import of consumer goods. Loans advanced to the industrial
sector were negligible during the colonial period and even in the imme-
diate post-independence era. As Ho (1990: 2) comments: 'Banks con-
centrated on discounting of trade bills, providing the letters of credit and
checking the credit-worthiness of traders and merchants. In this sense,
they were nothing more than foreign outfits to process trade papers and
to act as insurers for merchants.'
Only after the setting up of the Central Bank of Malaya (renamed
Bank Negara Malaysia after the formation of Malaysia in September
1963) was there a conscious effort to develop the financial system. From
1959, the commercial banks were brought under central bank supervi-
sion through the Banking Ordinance 1958 (later, Banking Act 1973).
Today, Bank Negara Malaysia (BNM) is vested with comprehensive legal
powers under various Acts and ordinances to regulate and supervise
much of the financial system.3 The introduction of the Banking and
Financial Institutions Act 1989 marked a special milestone in the legisla-
tion governing financial institutions, as the Act gives extensive powers to
the BNM to regulate and supervise financial institutions, which range
from those involved only in deposit-taking to those also engaged in the
provision of finance.
The early domestic banks were generally small, Chinese family-owned
entities. These included Kwong Yik Bank, Lee Wah Bank, Malayan Bank-
ing and United Malaysian Banking Corporation.4 Until 1985, there were
no restrictions - in the laws governing banks and finance companies - on
the size of shareholdings in these institutions, on transactions in their
 FINANCIAL SECTOR RENTS IN MALAYSIA 311
shares, or on who could be shareholders in these institutions (Lee 1992:
243). The family-owned shareholding structure of domestic banks grad-
ually changed, especially after the banking law was amended in 1985 to
prohibit an individual from owning more than a 10 per cent interest in a
bank, while the limit for an entity other than an individual was set at 20
per cent. The ostensible rationale of the BNM policy was to prevent the
banking system from becoming the captive of a small number of owners
who might unduly influence the banks to provide credit to companies
belonging to them (Lin 1994: 219). The provision was also supposed to
ensure diversified bank ownership, as 'a rapidly growing economy neces-
sitates a rapidly expanding banking sector, which is not possible if the
banks are constrained by the limited funds available to a single family'
(Lin 1994: 220). Since then, the BNM has actively encouraged banking
institutions to seek public listing and to offer at least 25 per cent of their
shares to the public (BNM 1985: 40).
To ensure no circumvention of the limits imposed on shareholdings,
Section 45 of the Banking and Financial Institutions Act requires prior
written approval of the Minister of Finance before any person can enter
into an agreement or arrangement to acquire or dispose of any interest
in the shares of a locally incorporated banking institution if the interest
in the shares is 5 per cent or more. The Minister of Finance, on the
advice of the BNM, is empowered to prevent the acquisition of shares in
such institutions by irresponsible and undesirable persons. Besides regu-
lating entry into the finance industry, this provision protects domestic
banks from foreign bank ownership and control (Lee 1992: 246). Cross-
holdings of shares among financial institutions are also prohibited, but
the Minister of Finance, on the recommendation of the BNM, can grant
exemptions when he or she deems it fit to do so.
Since its establishment, the BNM has promoted the development of
Malaysian banks, as the financial system was dominated by foreign banks
during the colonial period. Since 1974, only one new banking licence
has been given to a foreign bank.5 Rents in the financial sector have been
created by limiting competition in some areas, especially from foreign
banks. The BNM was empowered by the 1958 Central Bank Ordinance
to regulate interest rates on the deposits and loans of commercial banks,
finance companies and merchant banks.6 Until 1978, it directly set min-
imum lending rates for commercial bank loans and maximum deposit
rates for commercial bank deposits, in consultation with the Association
of Banks.7 The objectives of the 'administered' interest rate regime dur-
ing the period 1959-78 were to encourage savings, to promote the
growth of Malaysian banks by limiting interest rate competition from for-
eign banks, and to protect the balance of payments from being adversely
affected by capital outflows due to interest rate differentials between
312 CHIN KOK FAY AND JOMO K.S.

Table 8.1 Malaysia: interest margins of commercial banks, 1984-95

Average Average cost Interest

Year lending rate of deposits margin

1984 13.14 8.22 4.92

1986 12.20 6.80 5.40
1988 11.30 5.60 5.70
1990 8.99 4.50 4.49
1991 9.72 5.89 3.83
1992 10.29 6.15 4.14
1993 9.65 4.95 4.70
1994 8.24 3.78 4.46
1995 9.28 4.67 4.61

Source: BNM, Annual Report, various issues

Malaysia and the rest of the world (BNM 1994: 131). These rents were
created and allocated in ways that transformed the role of the financial
system, from financing trade to mobilising and channelling financial
resources more effectively to fund investments in new activities. Table 8.1
shows the interest margins enjoyed by the protected commercial bank-
ing sector in Malaysia in the period 1984-95. These margins remained
quite stable, hovering around 4-5 per cent.8
Redistribution, especially along inter-ethnic lines, has been another
important goal of rent creation and deployment in Malaysia. The coun-
try's financial sector has also been used to reduce inter-ethnic disparities,
especially since the promulgation of the New Economic Policy. The
economy has seen the spawning of various government agencies, bureau-
cratic devices and legal measures to enhance Bumiputra ownership, eco-
nomic control and participation.9 A specific set of guidelines on lending
was introduced in October 1976, aimed at promoting a 'fair distribution'
of bank credit among the various sectors and ethnic groups in line with
the policy's emphasis on achieving inter-ethnic parity. Since 1979, the
BNM has issued annual priority-lending guidelines each March to ensure
that the priority sectors continue to have ready access to credit at rea-
sonable cost, and to modify and adjust these guidelines in line with devel-
opments in the economy (Zainal et al. 1994: 284). Thus, the guidelines
could differ from year to year; since their introduction, priority sectors
have included the Bumiputra community, small-scale enterprises,10 hous-
ing (including low-cost housing), manufacturing, and agriculture. Bank-
ing deregulation in recent years has reduced the number of priority
sectors as well as the proportion of total loans subject to such guidelines;
however, priority lending to the Bumiputra community has not been
affected (see Table 8.2). The target set by the guidelines for this sector
has been maintained at 20 per cent of total loans outstanding, while the
Table 8.2 Malaysia: priority-sector guidelines and achievements of commercial banks, 1979-91 (% and RM million)

Bumi[putra Manufacturing Agricultural food Small-scale Individual Low-cost

Year community sector production enterprises housing loans housing

Target Achieve- Targe ta Achieve- Target Achieve- Target1 Achieve- Target11 Achieve- Target0 Achieve-
ment ment ment ment 1 ment b ment0

1979 17.0 n.a. 6.0 n.a. 20.0 n.a.

1980 17.0 29.8 RM2,573 RM3,951 6.0 9.5 20.0 28.9 RM1,417 RM2,233
1981 17.0 25.0 RM4,018 RM5,166 8.0 11.1 12.0 13.7 10.0 13.4
1982 18.0 27.5 RM5,166 RM5,386 10.0 12.4 12.0 12.9 10.0 13.7 20,000 19,503
1983 18.0 29.7 [31.12.82] 6.0 6.7 5.0 3.8 [31.12.82] 20,000 21,708
1984 20.0 31.7 6.0 6.2 5.0 3.2 20,000 25,738
1985 20.0 32.7 6.0 6.7 5.0 3.5 20,000 26,334
1986 20.0 31.9 6.0 5.4 RM150 RM235 80,000 32,658 48,000 12,458
1987 20.0 32.2 6.0 5.4 RM150 RM217 80,000 68,342 48,000 29,772
1988 20.0 31.8 6.0 5.2 RM300 RM831 75,000 43,156 45,000 17,903
1989 20.0 37.0 RM600 RMl,012 75,000 95,069 45,000 39,525
1990 20.0 39.6 RM200 RM132
1991 20.0 n.a. RM150 n.a.
a
Initially in percentage of total, then switches to RM
b
1980 in RM; 1981-82 in percentage of total; 1986-89 in units of houses
0
Units of houses
n.a. = not available
. . = not applicable
[31.12.82] = loans to be maintained at the level of that date

Source: Zainal et al. 1994: 285

314 CHIN KOKFAYANDJOMO K.S.

Table 8.3 Malaysian commercial banks: lending to Bumiputra community,

1986-95a (RM million)

Sectors 1986 1988 1990 1991 1992 1993 1994 1995

Agriculture 922 827 784 665 125 820.4 623.7 437.0

Mining and
quarrying 89 137 274 262 22 125.7 73.4 159.2
Manufacturing 1,601 1,719 2,068 2,262 244 3,313.4 3,991.3 3,678.1
Real estate and
construction 4,510 4,939 5,679 6,431 1,466 8,815.5 8,435.7 10,340.3
General commerce 1,574 1,649 1,994 1,989 354 2,075.1 1,838.7 1,669.9
Transport and
storage 243 253 333 496 684 540.8 907.9 1,163.6
Finance, insurance,
business services 2,011 1,974 3,561 4,637 420 6,916.5 7,857.5 9,822.2
Housing loans to
individualsb 2,204 2,607 3,269 3,634 1,199 4,456.2 4,750.6 5,388.0
Purchase of stocks
and shares 892 759 1,699 1,955 557 2,004.8 6,037.9 6,165.4
Consumption
credit' 256 270 690 904 5,714 1,220.5 1,445.9 1,970.6
Others 1,030 1,269 2,083 2,333 1,948 3,433.4 4,128.1 8,710.6

Total 15,332 16,403 22,434 25,568 12,733 33,722.3 40,090.7 49,504.9

a
Refers to Bumiputra individuals and Bumiputra-controlled enterprises only
Government agencies and government-controlled corporations are excluded
b
Includes housing loans sold to Cagamas Berhad
c
Refers to lending to Bumiputra individuals only
Source: BNM, Annual Report, various issues

manufacturing sector has not been a priority sector since 1984. Develop-
ment finance institutions,11 basically owned by the public sector, have
been set up to mobilize financial resources to supplement and comple-
ment official development efforts as well as to accomplish New Economic
Policy objectives.
However, the government does not seem to be encouraging banks to
more effectively finance productive investments in manufacturing. As a
percentage of the total loans outstanding extended by commercial banks
to the Bumiputra community at the end of 1995, the manufacturing sec-
tor accounted for only 7.4 per cent, while the real estate and construc-
tion sector and purchases of stocks and shares accounted for much
higher shares - 20.9 per cent and 12.5 per cent, respectively (Table 8.3).
 FINANCIAL SECTOR RENTS IN MALAYSIA 315
It appears that the official preoccupation with inter-ethnic economic
redistribution has undermined the efficacy of government policies to
encourage bank financing of productive investments (Jomo 1993).
The ownership and dominance of financial institutions by the gov-
ernment and the politically influential have privileged the financial sys-
tem, ensuring a generous flow of rents to the financial sector.12 Increased
government intervention in the financial sector since the New Economic
Policy has meant even more rents captured by the select group of
bankers. In these circumstances, the financial system has not been effec-
tively used to increase equality, as the effective exercise of voice is almost
entirely confined to a select elite of political leaders and business-
people.13 Alternatively, in formulating genuinely egalitarian policies, the
principal concern would be to restructure the financial system to provide
a more effective context for the democratic exercise of voice by many
more than this small group (Pollin 1995: 29).
Moreover, much of the rent obtained by this select group has been
captured by non-transparent means - for example, in the form of soft
loans from state-owned banks and government approval to acquire a
controlling interest in a locally incorporated banking institution. Such
minimal transparency in the rent allocation process facilitates abuse of
the rents created. The 1970s and 1980s saw a plethora of abuses by the
directors and staff of banks and finance companies in lending opera-
tions. As noted by Hing (1987: 423): 'When people who manage and
control top corporations and financial institutions belong to the same
circle - for instance, the government owns the largest corporations and
banks - loans involving a few hundred millions can even be drawn down
without going through proper investigations and procedures, and usu-
ally given, not for productive activities but for some speculative get-rich-
quick schemes'.14
The most infamous case saw the involvement of the state-owned Bank
Bumiputra - through its Hong Kong-based subsidiary, Bumiputra
Malaysia Finance Bhd - in massive fraud, resulting in losses amounting
to over RM2.5 billion. The subsidiary had approved huge loans to Hong
Kong-based property speculators associated with highly placed ruling
party leaders (Gomez 1994: 59), who then lost a great deal when prop-
erty prices slumped in the early 1980s. Another scandal, involving the
D&C Bank, resulted in the removal of the BNM governor - instead of the
errant politician involved, who went on to serve two terms as a deputy
minister (Gomez 1991).15
The government has not been able to ensure that the rents created in
the financial sector have been effectively deployed to promote long-term
productive investments. Hence, 'while some state interventions in the
economy - and the rents thus created - have enhanced accumulation,
316 CHIN KOKFAYANDJOMO K.S.

Table 8.4 Malaysian banking system: loans and advances outstanding by sector,
1978-90 (% share)

Sectors 1978 1980 1982 1984 1986 1988 1990

Agriculture 7.2 8.1 7.3 6.1 5.7 5.4 5.0

Mining 1.0 1.1 1.6 1.2 0.9 1.3 0.9
Manufacturing 15.6 20.7 19.1 16.0 14.9 16.9 18.9
General
commerce 22.6 19.8 18.1 16.1 14.9 14.2 11.9
Broad property
sector 22.4 26.4 31.0 33.5 35.9 35.9 29.9
construction 6.3 6.9 6.4 6.9 6.8 7.4 7.1
housing 10.5 10.8 12.0 11.5 13.0 13.0 11.4
real estate 5.6 8.7 12.6 15.0 16.1 15.5 11.3
Transport and
storage 1.9 2.5 2.9 2.1 1.7 1.6 2.1
Electricity 0.0 1.1 0.4 0.1 0.1 0.1 0.2
Finance,
insurance 6.2 5.4 7.8 10.2 10.5 10.6 10.6
Consumption
credit 2.9 3.7 3.9 4.5 4.0 4.9 10.3
Others 20.0 11.2 7.8 10.1 11.5 9.2 10.3

Source: Bank Negara Malaysia, as cited by Zainal 1992: 40.

economic diversification and late industrialization, not all interventions

- especially those ostensibly oriented to redistribution - have con-
tributed to productivity enhancement' (Jomo and Gomez 1997: 5).
Banks' preferences are reflected in the increase in the property sector
share of credit (i.e. construction, housing and real estate) - from 21.6
per cent in 1977 to 35.9 per cent in 1988 - following the liberalization of
interest rates which coincided with a property boom. The growing share
of property loans contrasted with the modest increase in the relative
importance of the building and construction sector in total gross domes-
tic product (GDP) and reflected the security and greater profitability of
the sector due to capital appreciation.16 'The liberalization of interest
rates allowed banks to charge higher interest rates for the property loans,
yet the real interest rates were low relative to gains from capital appreci-
ation and perhaps included some speculative element as well. This has
made property projects profitable, at least ex ante and hence "bankable"'
(Zainal et al. 1994: 307). As a result, the share of credit to the manufac-
turing sector declined during this period (Table 8.4), despite a sharp
increase in manufacturing's share of total GDP.17 Lately, the BNM has
expressed its concern over increased financing for unproductive activi-
ties (e.g. consumption credit). Loans by the banking system for con-
sumption credit soared by RM1329 million in April 1996 alone, from
 FINANCIAL SECTOR RENTS IN MALAYSIA 317

Table 8.5 Malaysia: financing of private capital expenditure, 1986-90

(% share)

Sources of financing 1986 1987 1988 1989 1990a 1986-90

b
Internally generated funds 52.0 64.2 53.3 65.8 50.1 56.4
Share issues/premiums 1.6 6.1 1.3 2.3 8.3 4.4
Proceeds from sale of
property/investment 5.8 1.8 0.9 1.3 2.2 2.3
Inter-company loans0 13.5 12.1 28.8 15.8 19.2 18.2
Loans from financial
institutions 27.1 15.8 15.7 14.8 20.2 18.7
in Malaysia 10.3 10.5 11.0 13.9 14.3 12.5
abroad 16.8 5.3 4.7 0.9 5.9 6.2
Total 100.0 100.0 100.0 100.0 100.0 100.0
a
Forecast
b
Comprising utilization oi depreciation charges, retained profits, reserves, and provisions
c
For Malaysian firms, this would mean borrowings within the group; for foreign firms,
this has usually meant borrowings from the head office or subsidiaries or associates
abroad
Source: Bank Negara Malaysia, cited by Lin 1992: 34

RM583 million a month earlier, while loans for the purchase of stocks
and shares rose to RM277 million in April 1996 from only RM55 million
in the month before (New Straits Times 1996).
This reduction in the share of credit to the manufacturing sector led
it to increasingly rely on internally generated funds, as indicated by the
BNM's Survey of Private Investment in Malaysia (Table 8.5).18 For the
period 1986-90, the surveyed firms financed, on average, 50-66 per cent
of their capital expenditure from internally generated funds. Bank
financing accounted for only 10-14 per cent of total financing. Although
banks provided a larger share of external finance than the capital mar-
ket (1-8 per cent), this merely reflected the less developed state of the
capital market vis-a-vis the banking system then.
As noted by Hing (1987: 422), the main criteria for extending bank
loans have been track record and collateral rather than project viability:

For instance, they will finance companies based on their past record, current
solvency and liquidation value rather than their long-term prospective prof-
itability. They also demand greater security for loans. These policies separately
and conjointly restrict the availability of funds and increase the cost of capital
to industry. What is worse is that they in turn impose on industry a similarly
cautious and short-term view of investment, profitability and profit allocation
and inhibit long-term or high-risk industrial investment.
318 CHIN KOKFAYANDJOMO K.S.

Table 8.6 Malaysian listed companies: average cost of credit, 1983-90

(measured by ratio of interest payments to total debt)

Company size Period BL/BTa F/BTb

Small and medium0 1983-84 0.996 0.142
1985-86 0.963 0.216
1987-90 0.991 0.153
Larged 1983-84 0.964 0.112
1985-86 0.973 0.108
1987-90 0.662 0.088
a
BL = loans from financial institutions; BT = total debt
b
F = interest payments
c
Shareholders' funds <RM2.5 million
d
Shareholders' funds >RM2.5 million
Source: Adapted from Zainal et al. 1994: 314

A study by the Central Information Collection Unit of Permodalan

Nasional Berhad showed that company size was an important determi-
nant of access to credit, and that larger companies had lower credit costs
on average. This could be due to the less stringent requirements imposed
by financial institutions on bigger companies presumed to have better
track records and reputations (Zainal et al. 1994: 313). This 'discrimina-
tion' was more pronounced during the recessionary years of 1985-86,
when the average cost of credit for large companies was almost 11 per
cent lower than for small and medium-sized enterprises (Table 8.6).
The creation of rents in the banking sector has not been comple-
mented by many effective policies to restrict wasteful competition that
would erode the rents. For example, although entry into the sector is
regulated, there has been wasteful competition among existing bank
branches for existing depositors in the same localities, as well as among
the extensive branch networks of other savings institutions (particularly
the National Savings Bank and the credit co-operatives which include
Bank Rakyat), resulting in socially wasteful duplication, which also
undermines the likelihood of scale economies in the provision of
banking services.
More recent government efforts to promote securities markets have
also adversely affected banking deposits. Proposed in the 1955 World
Bank Report for post-colonial Malaya, Malayan - later Malaysian - Indus-
trial Development Finance (MIDF) was set up in 1960 to help foreign
companies to tap the Malaysian capital market more easily, ultimately
leading to the official establishment of a stock market in the country.
Through MIDF, foreign firms gained access to substantial local financing
in the form of cheap loans (increasingly from the government) or stock
 FINANCIAL SECTOR RENTS IN MALAYSIA 319

Table 8.7 Malaysia: commercial banks' and stock exchange's market share of
funds, 1990-94a (%)

1990 1991 1992 1993 1994

Commercial bank depositsb 22.8 23.1 20.1 13.4 16.1
Kuala Lumpur Stock Exchange 48.2 48.8 53.3 69.4 62.1
a
Allow for +/- 3% variation
b
Figures do not include negotiable certificates of deposit or repurchase
agreements
Source: Adapted from Banker's Journal Malaysia 1995: 33

issues for their subsidiaries in the local market. Effective control was gen-
erally unaffected by local financing. In the former case, management
prerogatives were generally undiminished by access to loan funds,
though loan conditions tended to favour large, highly capitalized, usu-
ally foreign industries. In the latter case, as the stock was usually sold to
a large number of small investors, various management practices - such
as transfer pricing as well as licensing and management contracts -
ensured that the bulk of the economic surplus still went abroad.
Increased trading of stocks and shares of these and other companies
eventually led to the establishment of the Kuala Lumpur Stock Exchange
(KLSE) in the early 1970s after the separation of Singapore in 1965.
However, stocks listed on the KLSE were mainly traded in the Stock
Exchange of Singapore (SES) until the late 1980s, when the KLSE broke
with the SES. Stock market development in Malaysia has been encour-
aged by neo-liberal ideology and international institutions (such as the
World Bank's International Finance Corporation) favouring stock mar-
ket development, and the licensed securities firms enjoying handsome
trading margins set by the government. They were supported by those
who stood or expected to be able to utilize the stock market and publicly-
listed firms to capture various types of rents as well as secure better access
to relatively cheap funds through the securities markets or from financial
institutions which increasingly used stock market listing and perfor-
mance as loan market signals. The political influence of many of the key
players ensured that the stock market grew rapidly in the 1990s with con-
siderable support from the government. Rapid economic growth, the
amnesty on repatriated funds, the 1992 establishment of the Securities
Commission, the privatization of state-owned enterprises, the rapid
growth of the KLSE's Second Board, increased foreign as well as 'retail'
interest in the 1990s, and other factors have also contributed to stock
market growth. The argument for financial restraint suggests that the
securities market should not be emphasized while an effective banking
320 CHIN KOK FAY AND JOMO K.S.

system is being developed. Table 8.7 reveals that Malaysia experienced a

dramatic disintermediation of traditional bank deposits to the stock
exchange, particularly in the bull-run years of the early 1990s.
In recent years, the BNM has sought to consolidate Malaysian banks,
in anticipation of foreign competition with impending financial liberal-
ization. A new two-tier regulatory system was introduced in December
1994 with the intention of persuading smaller banks to merge and
expand. This new system should hasten consolidation and give rise to
fewer, but stronger, banking institutions which are better able to face for-
eign competition. To qualify for privileged first-tier status, banks must
have an equity base of at least RM500 million. Tier-one banks are now
allowed to handle transactions previously denied to all banks, such as
opening foreign currency accounts. However, there is concern that
mergers of small banks may produce bigger banks without significantly
enhancing their competitiveness. Financial liberalization is also
expected to further discourage banks from long-term industrial financ-
ing, in favour of more secure or profitable short-term lending.

Conclusion
Many government interventions in Malaysia's financial sector do not sat-
isfy the efficiency desiderata identified by Hellman et al. The failure of
the government to efficiently create rents to encourage lending for pro-
ductive investments appears to be primarily due to its preoccupation
with inter-ethnic economic redistribution. The result has been the cap-
ture of rents created by protection of the domestic banking sector and its
generally politically influential, mostly Bumiputra, owners who have priv-
ileged access to credit. However, the government, despite some talk of
emulating the Japanese 'main bank' system in the early 1980s, has not
been encouraging banks to more effectively finance productive invest-
ments, especially in potentially export-oriented manufacturing.
As the private sector has been expected to be the main engine of growth
since the mid-1980s, one might expect the financial system to accordingly
be more effective in mobilizing funds to finance private sector invest-
ments. To better support product investments, for example, Malaysian
banks should be allowed to change the basis for extending loans from col-
lateral to project viability, like their counterparts in Japan, Korea and Ger-
many. Appropriate government policy would therefore be vital for creating
a more conducive environment to encourage financial institutions to
provide venture capital instead of the traditional loan arrangements. One
conclusion from this study is that financial restraint, based on a stylized
analysis of the financial policies of Japan and some first-generation East
Asian newly industrializing economies, may be a desirable policy for late-
 FINANCIAL SECTOR RENTS IN MALAYSIA 321
industrializing countries like Malaysia. The issue here is whether the
Malaysian government will assume the kind of leading role played by the
governments in Japan and other East Asian economies.
Since the 1980s and especially since 1990, there has been some reduc-
tion in the previous preoccupation with inter-ethnic economic redistrib-
ution, allowing a different role for the state, especially in support of
manufacturing growth and technological progress, thus improving the
prospects for rapid, sustained, balanced and domestic-led industrializa-
tion. This has involved the creation of some new financial institutions
and programs to support industrial and technological development, but
their overall impact has been rather limited. On the other hand, finan-
cial sector liberalization has seen the end of priority lending to the man-
ufacturing sector. There is also little evidence that such liberalization has
significantly reduced reliance on corporate savings for investments, espe-
cially in the manufacturing sector.
The preceding argument has suggested that there has been some gov-
ernment intervention in the banking sector, mainly for inter-ethnic eco-
nomic redistribution in favour of Bumiputras. Although there were some
efforts in the past to direct lending to finance manufacturing invest-
ments, such policies were abandoned more than a decade ago. Conse-
quently, the rents created by financial restraint have not had the positive
consequences for industrial financing envisaged by the proponents of
such policies.
However, such a view of desirable policy ignores the political realities
and constraints within which policy is made. It is also likely that inter-
ethnic redistribution through the New Economic Policy's Bumiputra
bias has probably involved considerable efficiency costs, but it has also
ensured a certain intangible, but nonetheless vital, political and hence
economic stability, with positive consequences for economic develop-
ment and industrial growth. The real challenges for Malaysian economic
policy-making in this regard then involve ensuring that developmentalist
interventions, including financial restraint in favour of industrial financ-
ing, also have stability-inducing re distributive consequences as well as
minimizing the adverse and maximizing the positive efficiency conse-
quences of government redistributive policies.
The Southeast Asian crisis since mid-1997 can be traced to several fac-
tors, including the maintenance of unofficial currency pegs against the
US dollar since the 1980s, but especially from mid-1995, when the yen
started to depreciate from 79 yen (to the US$) in June 1995 to almost 130
yen by mid-1997. Although this currency appreciation effectively under-
mined Southeast Asian export competitiveness and, ultimately, growth,
powerful financial interests as well as others benefiting from the stronger
currencies, financial inflows and consequent asset price inflation
322 CHIN KOK FAY AND JOMO K.S.

defended the sustainable policy generating large current account

deficits. Currency speculators saw an opportunity for a big killing from
attacking the weakest link, Thailand, which had seen export growth col-
lapse and a significant slowing-down of economic growth in 1996. Even-
tually, their efforts paid off on 2 July 1997 when the Bank of Thailand
'floated' the baht.
The Malaysian government lost valuable foreign exchange reserves in
mid-July 1997 in a vain attempt to try to defend the ringgit after the col-
lapse of the Thai baht and other regional currencies due to contagion
from Thailand. Since then, the currency crisis has seen the collapse of
asset (property and share) prices, precipitating a financial crisis in its
wake (Jomo 1998). With limited financial liberalization, the banking sec-
tor was no longer required to lend primarily for productive purposes.
Hence, barely a quarter of commercial bank land lending was for manu-
facturing, agriculture and mining. Instead, there has been much lending
for property and share purchases, with the assets purchased themselves
serving as collateral. Asset price deflation has meant lending institutions
demanding that borrowers top up their collateral, which has in turn
increased the likelihood of non-performing loans, if not default. The gov-
ernment's reversal of the earlier decision to reduce the time period
involved before treating a loan as non-performing will buy some time for
borrowers (and perhaps lenders), but will not fundamentally alter the sit-
uation. Meanwhile, private sector medium- and long-term foreign debt
jumped by more than half, from 38.65 to 61.09 billion ringgit between
June and December 1997 (BNM 1998: 103), probably mainly due to the
collapse of the ringgit and the high proportion of unhedged loans despite
the relatively low costs of hedging for foreign loans taken out in Malaysia.
Several government reactions since the second half of 1997 have exac-
erbated the situation in Malaysia. The Prime Minister's claim of an inter-
national conspiracy to undermine Malaysian success was widely seen as
reflecting a poor understanding of the international currency and finan-
cial system, though his accusations of the damaging consequences of cur-
rency speculation have had much greater credibility. His 27 August 1997
attempt to check 'short-selling' by 'designating' the leading 100 stocks of
the Kuala Lumpur Composite Index effectively reduced all market trad-
ing and aggravated the situation instead. The 3 September 1997 cabinet
decision to set up a RM60 billion fund to buy stocks from particular
Malaysians (but not foreigners) was immediately seen as an attempt to
selectively save politically influential share owners who were in trouble.
While some of these measures were quickly reversed or amended, mar-
ket confidence had been undermined and capital took flight as panic set
in. In November 1997, when rules were bent to enable the ruling party
controlled Renong conglomerate to be partially bought over by one of its
 FINANCIAL SECTOR RENTS IN MALAYSIA 323
subsidiaries, then cash-rich United Engineers Malaysia, the stock market
collapsed by 20 per cent in three days.
From late 1997, the government cut its spending, reduced liquidity
and raised interest rates in line with International Monetary Fund pre-
scriptions to deal with the crisis, but to no avail. The recession which
emerged in 1998 - after 7.3 per cent growth in 1997, despite the crisis -
will only exacerbate the situation. From June 1998, then Finance Minister
Anwar Ibrahim reversed some of these policies gently, again with little
effect. Barely two months later, in early September, Anwar was sacked as
the government introduced currency and capital controls in a desperate
attempt to regain greater control over monetary policy in order to reflate
the economy. However, such efforts are expected to primarily benefit the
politically well-connected as government-controlled institutions have
helped to revive share prices, reflecting the government's emphasis on
resuscitating the stock market rather than the real economy.
The Malaysian experience thus shows how financial interests and their
allies managed to sustain policies largely consistent with financial liberal-
ization which strengthened the exchange rate at the expense of export
competitiveness. These policies contributed to an asset price inflation that
was unsustainable and eventually led to the deflationary tail spin which has
devastated Malaysia and other economies of Southeast Asia. Financial
restraint as an instrument of industrial policy and to ensure sound pru-
dential regulation of financial institutions designed to promote export-ori-
ented growth would instead have entailed the creation and deployment of
rents for developmentalist purposes. Unfortunately, Malaysian financial
regulation in recent decades has been primarily oriented to inter-ethnic
redistributive goals without much attention being given to enhancing
development performance. With growing recent pressures for greater
financial liberalization despite its dubious benefits (Eatwell 1997), the
Malaysian monetary authorities have sought to induce consolidation of
domestic banking institutions by offering additional financial business
opportunities for those achieving tier-one status; thus, rents have also been
effectively used to strengthen Malaysian financial institutions in prepara-
tion for what is seen as inevitable financial liberalization.

Notes

This simple demand-supply model assumes no transaction costs in inter-

mediation.
Hellman et al. distinguish between two potential sources of competition:
excessive entry into the banking sector, and excessive competition among
existing banks.
324 CHIN KOK FAY AND JOMO K.S.

3 These laws include the Central Bank of Malaya Ordinance, 1958; the Bank-
ing and Financial Institutions Act, 1989; the Islamic Banking Act, 1983;
and the six laws setting up Labuan as an international offshore financial
centre.
4 Ban Hin Lee Bank is one of the last family-owned banks in Malaysia.
5 In 1994 the Bank of China was set up in Kuala Lumpur in return for Malayan
Banking getting a licence to operate in China (Asiamoney, 1995, 6(4): 84).
6 This power to regulate interest rates does not apply to Islamic banks.
7 The commercial banks were allowed to determine deposit and lending rates
(except for interest rates on loans to priority sectors) in October 1978. Sub-
sequently, bank lending rates tended to be downwardly sticky, with a pro-
longed lag (BNM 1994: 43). To cope with this problem, the BNM introduced
the base lending rate on 1 November 1983. Every bank's or finance com-
pany's lending rates had to be tied to its declared base lending rate, to be
determined by the cost of funds after providing for the cost of statutory
reserves, liquidity asset requirements and overheads.
8 Thillainathan (1985) argues that the wide interest margin should not be mis-
construed as excessive profits made by banks, as the divergence between the
lending rates and the cost of funds has to cover the losses sustained by banks
in making priority sector loans, cover their overhead expenses, provide a
reserve for potential loan losses and obtain a reasonable return on share-
holders' funds. However, several qualifications should be noted: first, the pri-
ority-lending guidelines have been kept broad-based, with considerable
discretion left to indhidual institutions in assessing and monitoring their
credit. Second, in April 1987, interest rates for priority lending were pegged
to the base lending rate and kept within a certain range, which means that
the rates were not seriously distorted, as they could still reflect the actual cost
of funds to the banking institutions. Third, with banking deregulation, the
BNM has reduced the number of priority sectors.
9 The Bumiputra or 'indigenous' population comprises ethnic Malays, the
Dayak of Sarawak, Kadazan, Murut, and others considered autochthonous to
the territories of Malaysia.
10 From 1981, small-scale enterprises were defined as businesses with net assets
of up to RM250,000 each. The limit was raised to RM500,000 from 1988. In
view of the high risk involved in lending to small-scale enterprises, the Credit
Guarantee Corporation was established by the government in July 1992 to
provide guarantees against default for loans extended by commercial banks
to eligible small-scale enterprises.
11 Comprising Malaysian Industrial Development Finance (MIDF), the Devel-
opment Bank of Malaysia, the Sabah Development Bank Berhad, and so on.
12 Rents can be presumed to exist in all situations of imperfect competition,
especially monopolies (Jomo 1995).
13 'Voice' here refers to the ability to directly express one's dissatisfaction to the
relevant person or organization, whereas 'exit' refers to withdrawal from a
relationship with a person or organization when one becomes dissatisfied
with the relationship (Hirschman 1970, as cited in Pollin 1995: 29).
14 This conclusion is drawn from interviews with bankers and credit officers of
three local banks and MIDF officers.
15 For more examples of financial abuses by Malaysian politicians, see Gomez
(1994:59-60).
16 Recently, lending for the purchase of stocks and shares and loans secured by
stocks have been growing sharply, especially since 1989 (Zainal 1992: 42).
 FINANCIAL SECTOR RENTS IN MALAYSIA 325

17 For details of the composition of GDP by industry of origin, see Table 1.2 in
BNM (1994:6).
18 As noted by Lin (1992: 33): 'These [survey results] provide no more than a
likely "scenario" regarding financing since the survey results were rather
aggregative in nature. These surveys covered only 377 firms and they could
provide, at best, fragmented information of the whole since the methods of
financing could differ depending on whether the firms were: big or small;
domestic or foreign or joint ventures; new or matured; engaged in what type
of activity.'

References

Akyuz, Y. 1991. Financial Liberalization in Developing Countries: A Neo-Keyne-

sian Approach. UNCTAD Discussion Paper 36, March.
Akyuz, Y. and DJ. Kotte 1991. Financial Policies in Developing Countries: Issues
and Experience. UNCTAD Discussion Paper 40, August.
Banker's Journal Malaysia 1995. October/November.
BNM (Bank Negara Malaysia). Annual Report, various issues. Kuala Lumpur:
BNM.
BNM 1994. Money and Banking in Malaysia. 35th Anniversary Edition 1959-94.
Kuala Lumpur: BNM.
1998. Monthly Statistical Bulletin, February. Kuala Lumpur: BNM.
Cho, YJ. and D. Khatkhate 1989. Financial Liberalism: Issues and Evidence, Eco-
nomic and Political Weekly 24, May: 1105-14.
Eatwell, J. 1997. International Financial Liberalisation: The Impact of World Develop-
ment. New York: United Nations Development Program.
Gomez, E.T. 1991. Money Politics in the Barisan Nasional. Kuala Lumpur: Forum.
1994. Political Business: Corporate Involvement of Malaysian Political Parties.
Townsville: James Cook University of North Queensland.
Hellman, T, K. Murdock and J. Stiglitz 1997. Financial Restraint: Towards a New
Paradigm, in M. Aoki, H. Kim and M. Okuno-Fujiwara (eds) The Role of Gov-
ernment in East Asian Economic Development. New York: Oxford University
Press.
Hing Ai Yun 1987. The Financial System and Industrial Investment in West
Malaysia, Journal of Contemporary Asia 17(4): 409-35.
Ho Ting Sing 1990. The Financial Industry of Malaysia: Toward a New Era of
Technological Change. MIER Discussion Paper 33, September.
Jomo K.S. 1993. Prospects for Malaysian Industrialisation in Light of East Asian
NIC Experiences, in Jomo K.S. (ed.) Industrialising Malaysia: Policy, Perfor-
mance, Prospects. London: Routledge.
(ed.) 1995. Privatizing Malaysia: Rents, Rhetoric, Realities. Boulder and Lon-
don: Westview Press.
(ed.) 1998. Tigers in Trouble: Financial Governance, Liberalisation and Crises in
East Asia. London: Zed Books.
Jomo K.S. and E.T Gomez 1997. Rents and Development in Multiethnic Malaysia,
in M. Aoki, H. Kim and M. Okuno-Fujiwara (eds) The Role of Government in
East Asian Economic Development. New York: Oxford University Press.
Lee Hock Lock 1992. Regulation of Banks and Other Depository Institutions
in Malaysia: A Study in Monetary, Prudential and Other Controls. Singapore:
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326 CHIN KOK FAY AND J O M O K.S.

Lin See Yan 1992. The Saving-Investment Gap, Financing Needs and Capital
Market Development, 1960-95. Bank Negara Malaysia Discussion Paper 10.
Kuala Lumpur: BNM.
1994. The Institutional Perspective of Financial Market Reform: The
Malaysian Experience, in Shakil Faruqi (ed.) Financial Sector Reforms in
Asian and Latin American Countries: Lessons of Comparative Experience. Wash-
ington, DC: World Bank.
McKinnon, R.1.1973. Money and Capital in Economic Development. Washington, DC:
Brookings Institute.
New Straits Times 1996. Reminder against Unproductive Credit, 5 June: 23.
Pollin, R. 1995. Financial Structures and Egalitarian Economic Policy, New Left
Review 214, November-December.
Shaw, E. 1973. Financial Deepening in Economic Development. New York: Oxford Uni-
versity Press.
Thillainathan, R. 1985. Are Malaysian Bank Lending Rates Too High? ISIS Issue
Paper. Kuala Lumpur: ISIS.
Zainal Aznam Yusof 1992. Financial Services: The Task Ahead. Bank Negara
Malaysia Discussion Paper 11. Kuala Lumpur: BNM.
Zainal Aznam Yusof et al. 1994. Financial Reform in Malaysia, in Gerard Caprio,
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versity Press.
 Index

Page references followed by n indicate an endnote; those followed by fig

indicate figures; those followed by tab indicate tables.

Adireksan family, 158 rent-outcom es in, 88-9, 90fig

Alchian, A., 53-5 stock m arkets, 62-3, 304
Am sden, A., 47-8 types o f rents in, 77
A nand governm ent, 197 Assakul family, 158
A nand Panyarachun, 171 asymmetric inform ation, 47, 54, 56
Anwar Ibrahim , 323 authoritarian rule
Aquino, Corazon, 208 effect on rent-seeking expenditures, 15,
A rthit Kamlang-ek, 160 111-14, 265-7, 269
Asian econom ic crisis Indonesia, 267
exchange rate aspects, 321-3 Philippines, 223-4, 227
financial sector rent-seeking as cause, authority structures, disjuncture with
140-1,323 power, 217-20, 226, 242n6
governm ent intervention in financial Ayub Khan, 111
m arkets as cause, 304-5
international financial liberalization as BAFIA, see Banking and Financial
cause, 140, 304, 321-2 Institutions Act (Malaysia)
rent-seeking and corruption as cause, B am bang Trihatm odjo, 257
1, 18, 140 Bam bang Yoga Sugam a, 257
Asian econom ies Ban H in Lee Bank, 324n4
autonom ous roles o f states, 128-37 Bangkok Bank, 164, 189
banks, 58-62 Bangkok Bank o f Com m erce, 172
corruption levels and ratings, 83tab, Bangkok M etropolitan Bank, 158
84-7, 242nl Bangkok Weaving Mills, 158
dem ocratic com petition and the in p u t Bangladesh, see under Indian subcontinent
costs o f rent-seeking, 110-13 B anharn Silpararcha, 177n25, 197-8
as developm ental states, 76-7 Bank Bum iputra, 315
financial sector rents, 55-63, 304-5 Bank Duta, 258
GDP growth rates, 83tab Bank N egara Malaysia, 310-12, 315,
in p u t costs o f rent-seeking, 83-8, 90fig 316-17, 320
n e t effects o f rent-seeking in, 77 Bank o f China, 324n5
patro n -c lie n t networks in, 89-104, Bank o f T hailand, 156
137-9 financial liberalization by, 169, 198-9
puzzle o f rent-seeking with growth, 3-4, political autonom y of, 171-2
140-1, 146, 248-9 Bank Rakyat, 318

327
3 28 IN D E X
Banking and Financial Institutions Act
(Malaysia), 310-11
banks, see also nam es of specific banks
Malaysia, 310-23 passim
consolidation of, 320, 323
governm ent regulation, 310-12
inefficient deploym ent of rents by,
315-19
inter-ethnic redistribution by,
312-14, 320-1
lending to priority sectors, 312-13
portfolio m onitoring by, 17, 56-62, 308
power to discipline borrowers, 60
role in Asian econom ic crisis, 58-62,
304
South Korea, 58-60
T hailand, 187
Bapindo, 257
Barito Pacific Company, 257
barriers to entry, 29
Bauer, P., 279
Benedicto, R oberto, 224fig
Bhagwati,J., 76, 251
B hotiranankun family, 158
BMF, see B um iputra Malaysia Finance Bhd.
BNM, see Bank N egara Malaysia
Board o f Investm ent (T hailand), 154, 167,
190-1
B oonchu Chantarubeksa, 158
bribes, 70, 73fig, 90fig, 106-7, 264-5,
277fig, see also corruption;
Shleifer-Vishny m odel
effect o f costs o f collecting, 130-1
policies that allow taking of, 8
‘broker polity’, 192
budget constraints, Thailand, 151-5,161
Bum iputra capitalism, 287-9
B um iputra Malaysia Finance Bhd., 315
B um iputra population o f Malaysia, 324n9
bureaucratic polity, T hailand as, 173,
183-4, 192-3, 212
Campos, J.E.L., 222
capital flight, 228
from Malaysia, 286, 295, 304, 322
from Philippines, 228
C entral Bank o f Malaya, 310
C entral Bank of the Philippines, 234
centralized clientelism, 16, 99
chaebol, 114
Chakravarty, S., 129
Cham nam Panchat, 157
Chang, H .J., 98, 112, 147
C hart Thai Party, 197
Chatichai C hoonhaw an, 171, 197
C hatri Sophonpanich, 164
Chin S ophonpanich, 158, 164
China
decentralized federalism , 249
role o f state, 151
Chinese-Filipino capitalists, 224
Chinese-Malaysian capitalists
econom ic ascendancy of, 98-100,
113-14, 279, 287
local investm ent by, 285, 295
overseas investm ent by, 287
ow nership o f m anufacturing sector,
287
policy liberalization for, 293- 4, 295
redistribution from , 98-100
resentm ent towards, 287
Chinese-Thai capitalists, 101, 151-2
C hristensen, S.R., 156
C huan governm ent, 197
classical political econom y
concept of econom ic surplus, 23-4,
64-6
profits as a surplus, 53
unproductive activities, 7
clientelism , see also p atro n -clien t
exchanges; p atro n -clien t networks
centralized- (Malaysia), 16, 99
com petition facilitated by, 147
competitive- (T hailand), 14, 16, 102,
126, 159, 172, 229
contributes to m arket com petition,
158-9
definition, 153
effects on rent-outcom es, 124-8,
134-6
entry o f firms allowed by, 147
fragm ented- (Indian subcontinent),
93-5, 135-6
Indian subcontinent, 91-5, 135- 6
literature on, 215-16
Malaysia, 16, 98-101, 296
monopoly- (Philippines), 15-16, 135-6,
229
overlap with corruption, 215
Philippines, 16, 229
as power relationship, 215-16
South Korea, 95-8, 137
 IN D E X
T hailand, 14, 16, 89, 101-4, 151-5, 159,
172,229
types, 228-9
Clove M arketing Board, 257
Cojuangco, E duardo, 223, 224fig, 227-8
collective action problem s, 123
in T hai textile sector, 155-6, 162-7
colonialism , different effects of, 92, 96-8,
101
com petition, am ong new entrants, 151
competitive clientelism, 14, 16, 102, 126,
1 59,172,229
competitive m arket m odel
absence o f rents, 27-8
incentives for cost reductions, 32
rent-seeking, 75, 76fig
weaknesses, 29
conditional subsidies, 48-53, 88-9, 190, see
also rents: rents for learning
Congleton, R., 109
consum er surplus, 29
corruption, 8-10, 212-15, see also bribes
in Asian econom ies, 77, 83tab, 84-8,
242nl
counterbalances to, 237-9
definition, 8, 213
effects
o f dem ocracy on, 110-13
on econom ic growth of, 9-10,
230-3
o f fragm ented institutional
structure on, 9, 131-4
on political parties of, 235-7
on state institutionalization of,
235-6
evidence of, 83-8
illegal rent-seeking as, 70
incidence and m agnitude, 9, 83tab,
217,232
India, 85
Malaysia, 86-7, 99-100
overlap with clientelism, 215
in p atro n -clien t networks, 94, 96- 8,
99-100, 102-3
Philippines, 208-9, 234-5, 237-9,
242nl
Shleifer-Vishny m odel, 16, 131-4,
264-7
social cost of, 106-7
South Korea, 85-6, 96-8
studies of, 8, 9-10, 212-15
329
T hailand, 87, 102-3, 170, 198
cost efficiency, 32
cost o f rent-seeking, see rent-seeking: input
cost of
crony capitalism, 1, 140, 208, 212, 274, 304
Damri D arakananda, 188-9
D ana R ekening Investasi, 259
Dasgupta, P.S., 46
D&C Bank, 315
deadw eight welfare loss, 30-3, 36-7, 43-5,
49-50
dem ocracy
effects on in p u t costs of rent-seeking,
107-13
incentives for corruption under, 233
T hailand, 192, 196-7
Demsetz, H., 513- 5
D epartm ent of E xport Prom otion
(T hailand), 166-7
developm ental state models
rent-seeking analysis in, 77, 146
role o f state, 150-1
Disini, H erm inio, 223, 224fig, 228
dissipation o f rents, 34-5, 221, 223, 275,
295
distributive conflicts, as rent-seeking, 6,
35-40
East Asian crisis, see Asian econom ic crisis
econom ic growth
conditions for, 150-1, 155
d e p en d e n t on econom ic surplus, 25,
63-6
effect of rent-seeking on, 141, 145-7,
225, 248-9, 262-3
im pact o f corruption on, 230-3
Indian subcontinent, 83- 4
Indonesia, 252
T hailand, 147-50
econom ic perform ance, comparative, 82-3
econom ic surplus
definition, 64
in M arxian analysis, 24-5, 64-6
econom ies o f scale, as entry barrier, 29, 32
efficiency
o f m onitoring and m anagem ent rents,
55-8
o f rents, 21-6, 46-7, 222
static neo-classical analysis of, 26
Eisenstadt, S.N., 153
3 30
electronics industry, T hailand, 190-1
entry barriers, 29
Estrada, Joseph, 208
ethnic-based redistributive transfers, see
Malaysia: inter-ethnic redistributive
transfers
ethnic-C hinese capitalists, see Chinese-
Filipino capitalists; Chinese-Malaysian
capitalists; Chinese-Thai capitalists
Evans, P., 210-11
export prom otion, T hailand, 166-7, 194
export-oriented industrialization
Malaysia, 285-6, 292, 295
South Korea, 194
‘federalism , Chinese style’, 151, 249
financial deepening, 306
financial fraud, 315
financial interm ediation, rents for, 308
financial liberalization
consequences, 320, 323
dubious benefits, 305, 323
financial repression, in Asian econom ies,
304, 305
financial restraint m odel, 56-63, 305-10,
323
financial sector
financial restraint policies, 56-62,
305-10, 323
m onitoring a n d m anagem ent rents,
55-63, 308
m onitoring efficiency m odel, 56-8
financial sector rents
efficient creation of, 308-10
Malaysia, 310-25 passim
role in Asian growth and crash, 55-6,
5 8 -6 3 ,3 0 4 -5
through financial restraint policies,
305-10
fiscal federalism , 249
fiscal policy, sec also budget constraints;
m acroeconom ic stability; o f f budget
spending
Indonesia, 252-64
rent-seeking opportunities, 250
fragm ented clientelism , 93-5, 135-6
franchise values, 58, 308
fraud, 315
garm ent sector, sec textile and garm ent
industry (T hailand)
IN D E X
Girling, J.L.S., 219-20
globalized financial flows, 125-6, 168-9,
174-5
Gomez, E.T., 211, 222
governm ent-business relations, 211
Greenwald, B., 46
growth, sec econom ic growth
G.S. C otton mills, 161
Habibie, B.J., 258, 268
‘hard b u d g e t’ clientelism , 14, 152tab
Heal, G.M., 34
H eilm an, T., 17, 55-8, 61, 305-10
Hewison, K., 156
H ingA iY un, 315, 317
H utorno M andala Putra, 257
Ibnu Sutowo, 255, 259
ICA, see Industrial C oordination Act
(Malaysia)
IMF, see In ternational M onetary Fund
im port-substitution industrial policies
Malaysia, 284-5, 292
T hailand, 188
India, see under Indian subcontinent
Indian subcontinent
Bangladesh, 15, 83tab, 91-2, 111-13,
117
corruption, 83tab, 84-6, 94
dem ocracy and the input cost o f rent-
seeking, 110-13
factions com peting for rents, 91-3
fragm ented clientelism , 93-5, 135-6
fragm ented institutional structure,
132-3
India, 53, 85-6, 88, 94, 110-11, 113,
129
industrial policy, 53, 88, 90fig
infant industry protection, 53
in p u t cost o f rent-seeking, 84-5, 87-8,
90fig, 93- 4, 110-13, 117-18
insider advantages fo r rent-seekers, 113
interm ediate classes, 91-3
liberalization, 85, 88, 95
Pakistan, 15, 53, 83tab, 91-2, 97,
111-13,133
p a tro n -c lie n t networks, 93- 5
‘political’ rent-seeking, 94
rent-outcom es, 88, 90fig, 94-5, 125-31,
133, 136-9
 IN D E X 331

rents based on transfers (redistributive institutional rules

transfers), 94, 102-3, 127 as d e te rm in a n t o f in p u t cost o f rent-
rents for learning, 53, 94, 127, 129, 136 seeking, 107-13
social fragm entation, 112-13 as determ in an t o f rent-outcom es,
state capacity, 129 131-4
Indonesia im pact o f social structure on, 112-13
aircraft projects, 258, 268 institutions, definition, 155
business contributions to governm ent, interest rate controls, 61, 306, 311-12
257-8 inter-ethnic redistributive transfers, see
centralized control of re n t allocation, under Malaysia
249, 267-71 interm ediate classes (or m iddle classes),
Developm ent Budget, 254 35-40
econom ic perform ance, 252 Indian subcontinent, 91-3
foreign aid recycling, 259 Malaysia, 98-100, 117, 127
fragile rent-seeking system, 270-1 South Korea, 96-7, 111, 117
m acroeconom ic fiscal discipline, 252-3 T hailand, 101- 3
New O rd e r political economy, 252-3, International M onetary Fund, 1, 169, 275,
267-9 323
off-budget fiscal activity, 255-64 Investm ent Incentives Act (Malaysia), 289
rents
efficiency implications, 260-3 Japanese jo in t ventures, 158
rent-seeking Jo m o K.S., 211, 222
growth implications, 260-2, 263-4,
269-71 Keynes, J.M ., 62
opportunities, 260 Khan, M.H., 8, 135, 251, 262, 275
as paradox, 263-4, 269-71 Khoo Kay Peng, 290
restraints on, 268 Kia, 97
Soeharto regim e, 252, 258, 267, 270-1 Kim Young Sam, 97
tim ber industry, 259 Krit Sivara, 158
Industrial C oordination Act (Malaysia), Krueger, A.O., 83-4, 251
289-90, 297 K rueger-P osner m odel, 7, 105-6
industrial policy Kuala L um pur Stock Exchange, 304,
India, 88 319-20, 322-3
rent-seeking in, 183-6 Kuok, Robert, 290
South Korea, 88, 98, 194 Kwong Yik Bank, 310
T hailand, 185-6, 188-91, 193-6
infant industry protection, 53, 61, see also Laotham atas, Anek, 156
rents: rents for learning learning, 12, 47, 50, see also rents: rents for
inform ation rents, see under rents learning
innovation, 40-6 Lee Wah Bank, 310
contrasted with learning, 47-8 Leff, N., 8-9, 221, 231
Marx on, 23, 40-2 liberal corporatism , 191-2
rents for, see rents: Schum peterian liberalization
rents financial, 305, 320, 321, 323
Schum peter on, 23 India, 85, 88
in p u t cost o f rent-seeking, see rent-seeking: Indian subcontinent, 95
in p u t cost o f Malaysia, 305, 320, 321, 323
insider advantages for rent-seekers, 113-14 South Korea, 86, 88, 98
institutional change, as rent-seeking, 6, T hailand, 169, 198-9
118-20 Liem Sioe Liong, 257-8
institutional econom ics, 13, 70, 76, 129 Little, I.M.D., 253
33 2
lobbying, 70, 73fig, 84-5, 86-7, 90fig,
277fig
Luckytex Ltd, 159, 176nl8
m acroeconom ic fiscal discipline
Indonesia, 252-3
m acroeconom ic stability
Thailand, 147, 161-2, 184-5
M ahathir M oham ad, 322
Malayan Banking, 310
Malays, 279
equity participation by, 287-90, 293
new business elite am ong, 296
p a tro n -c lie n t relations am ong, 99,
296
Malaysia, see also Chinese-Malaysian
capitalists
Alliance governm ent’s policies,
283-7
attitudes to governm ent intervention,
274-5, 291-2, 297
banking system, 310-23 passim
B um iputra capitalism, 287-90, 293,
296, 312-14
B um iputra population, 324n9
capital flight from , 286, 295, 304, 322
centralized clientelism , 16, 88-9,
98-101, 127
clientelism, 98-101, 296
colonial heritage, 278-9
corruption, 86-7, 99-100, 315
dem ocracy and the in p u t cost o f rent-
seeking, 110-13
econom ic crisis, 322-3
econom ic deregulation, 291-4, 295
econom ic diversification, 285-7
financial fraud, 315
financial liberalization, 320, 321, 323
financial sector, 310-23 passim
financial sector rents
abuses, 315
creation of, 311-14
inefficient deploym ent of, 314-18,
320-3
foreign investm ent by, 294
foreign investm ent in, 101, 292, 295
im port-substituting industrialization,
284-5, 292
in p u t cost o f rent-seeking, 83- 7, 90fig,
99-100, 110-14, 117-18
insider advantages for rent-seekers,
113-14
interest rate controls, 311-12
IN D E X
inter-ethnic redistributive transfers, 17,
89, 98-100, 274-8, 286-7, 295-8,
312-15, 320-3
interm ediate classes, 98-100, 101, 127
lobbying by business, 86-7
logging industry, 279-80
Malay equity share, 287-90, 293
m ultinationals in, 89, 101, 299
natural resource rents, 99, 279-82
New Econom ic Policy (1970- ), 274-5,
287-90, 293
p a tro n -c lie n t networks, 98-101, 136
petroleum industry, 280-2
political stability, 100-1, 296, 321
privatization, 294- 5
race riots (1969), 274, 278, 287
rent-outcom es, 88-9, 90fig, 99-101,
124-8, 136-9, 138tab
rents for learning, 90fig, 100
resource-based industrialization, 286
ru b b er industry, 279
state-owned enterprises, 288-9
stock m arket, 304, 319-20, 322- 3
UMNO, 99, 101, 296
value-enhancing rents, 297-8
Vision 2020, 293, 294
Malaysian C hinese Association, 290
Malaysian Industrial D evelopm ent
Authority, 285
Malaysian Industrial D evelopm ent
Finance, 318-19
m anagem ent rents, see rents: m onitoring
and m anagem ent rents
Marcos, Ferdinand, 208
Marcos regim e, beneficiaries of, 223-5,
227-8
m arket power, 30
m arkets, 150-1, 152tab
Marx, Karl
on innovation, 23
on primitive accum ulation, 25
on unproductive activities, 7
M arxian analysis, o f econom ic surplus,
2 4 -5 ,6 4 -6
M cKinnon, R.I., 306
M endoza, Am ado, 222
m iddle classes, see interm ediate classes
MIDF, see Malaysian Industrial
D evelopm ent Finance
military rule, sec authoritarian rule
m onitoring, see perform ance m onitoring
m onitoring and m anagem ent rents, see
under rents
 IN D E X
m onopolies
cost efficiency under, 32-3
dynamic effects, 32-3
growth implications, 32-3
social cost of, 30
m onopoly clientelism , 15-16, 135-6,229
m onopoly rents, see under rents
M ontinola, G., 151
Multi-fibre A rrangem ent, 165, 177n22, 189
m ultinationals, in Malaysia, 89, 101
Murphy, K.M., 146-7
Myrdal, G., 8-9
National Econom ic and Social
D evelopm ent Board, 190, 193
National Savings Bank (Malaysia), 318
natural resource rents, see under rents
neo-classical econom ic analysis, see also
competitive m arket m odel;
K rueger-P osner m odel
o f institutions, 23
policy implications, 7, 23
o f profits, 52-4
o f rents, 21-3, 26-33
of rent-seeking, 6-7, 12, 70-1, 75- 6,
76fig, 104-7
weakness of, 23, 32-3, 37-9, 70-7,
210-12
static welfare analysis in, 32-3
NESDB, sec National Econom ic and Social
D evelopm ent Board
n et (or overall) effect o f rent-seeking, 13,
72-3, 75-9, 276
in Asian econom ies, 77
conventional rent-seeking m odel of,
80-2
n e t social benefit (of rents), 43-4, 45tab,
68tab, 72-3
decom position of, 118-20
New Econom ic Policy (Malaysia)
effect on private investm ent, 278
inter-ethnic redistribution under,
274-5, 293, 295-6, 321
N orth, D., 76, 110, 111
Nye.J.S., 8, 213
off-budget spending, 250, 255-64
Olson, M., 123
Pakistan, see under Indian subcontinent
Park C hung H ee, 85, 97, 111, 114,226
patents, 41, 45-6
patrim onial patronage networks, 135-6
333
patrim onial state, 212, 229
p a tro n -c lie n t exchanges, 10-11
p a tro n -c lie n t networks
clientelist, 135-6
patrim onial, 135-6
power within, 89-104, 114-18, 124-8,
135-6
structures of
Indian subcontinent, 91-5
Malaysia, 98-101, 136, 296
South Korea, 95-8
T hailand, 101-4, 136
perform ance m onitoring, 51-3, 55-63, 62,
88, 226-7
Malaysia, 298
Philippines, 227-8
Pertam ina, 255, 259
Petronas, 280
Philippines
bureaucratic fragm entation, 220-1
Chinese-Filipino capitalists, 224
corruption, 208-9, 234-5, 237-9, 242nl
decentralized power, 218, 239
econom ic perform ance, 207
extra-bureaucratic power, 218-19
form s o f re n t allocation, 223-5
limits to corruption, 237-9
Marcos regim e, 223-5, 227
‘m onopoly clientelism ’, 229
as oligarchic patrim onial state, 212, 229
perform ance m onitoring, 226-7
political parties, 237
prevalence o f corruption, 209, 234
reform m easures, 208, 240
spoils system, 218-19
state institutionalization, 235
Plaek Phibisongkram , 157
political parties, 235- 7
political power, see power
‘political’ rent-seeking, 94
political stability
rents to secure, 25, 37-40
Malaysia, 100-1, 296,321
political transfers, see rents: rents based on
transfers
Posner, R.A., 21
power
o f business in T hailand, 102-3, 125,
242n6
disjuncture with authority structures,
217-20, 226, 242n6
effect on in p u t costs o f rent-seeking,
114-18
334 IN D E X

power (cont) circular flow of, 91

effect on rent-outcom es, 123-8, 134-6 definition, 5, 21-3, 210, 275, 305
in p a tro n -c lie n t networks, 11, 89-104, deploym ent of, 196-7, 225-8, 276
108, 112, 114-18, 135-6, 215-16 developm entalist versus redistributive,
o f productive groups, 124-6 276
o f rent-seekers, 98-9, 122-8, 134-6 dissipation of, 34-5, 221, 223, 275,295,
to resist state, 134-6 299
Prajogo Pangestu, 257, 258 efficiency implications, 21-6, 67-8,
Pram an Andireksan, 159, 176nn9-19 68tab, 222, 276
Prem T insulanonda, 193, 197 financial sector rents
primitive accum ulation efficient creation of, 308-10
Marx on, 25, 37- 40 Malaysia, 310- 25 SDVVLP
T hailand, 102-3 role in Asian econom ies, 55-6,
through financial sector rents, 61 58-63, 304- 5
variable outcom es of, 25 through financial restraint policies,
privatization 305-10
Malaysia, 294- 5 generalizable versus particularistic, 212
rent-seeking under, 211, 241 growth implications, 23-6, 67-8, 68tab,
p roducer surplus, 28-9 261
profits, 53-5 inform ation rents, 46-7, 62-3
Prom otion o f Investm ent Act (Malaysia), m onitoring and m anagem ent rents, 25
292 efficiency of, 25, 54-5
property rights for financial institutions, 17, 54-63,
as basis o f rents and surpluses, 7, 35, 308
64-5, 70 for overcom ing asymmetric
changes in, through rent-seeking, 78 inform ation, 54- 5
creation, 25, 38, 78 m onopoly rents, 12, 26-33, 43-6, 90tab
for econom ic growth, 150-1 costs in seeking, 71
as rent-outcom es, 276-7 dynamic effects, 32-3
T hailand, 153 natural resource rents, 12, 24-5, 33-5
PT Kanditotex, 257 Malaysia, 279-82
public choice econom ics, 145-6 neo-classical trea tm e n t of, 21-3, 32-3
n e t social benefit of, 43-4, 45tab,
Ramos, Fidel V., 208, 219, 240-1 68tab, 72-3
Ramseyer, M., 109 decom position, 118-20
Rasmusen, E., 109 outcom es, see under rent-seeking
R&D, 46 property rights sustaining, 64-5
redistributive rents, see rents: rents based rents based on transfers, 12, 25, 35-40,
on transfers 90tab
Renong, 322 Asian patterns in the allocation of,
re n t allocation 88-9, 92-4, 99, 102-4, 127-8, see
forms of, 222-5, 265-9 also Malaysia: inter-ethnic
objectives of, 226-7 redistributive transfers
rules for, 107-13 conditions u n d e r which value-
re n t capitalism, 212, see also crony enhancing rent-outcom es
capitalism em erge, 126-8
re n t flows, 89-104 to create a capitalist class, 37-8
rent-outcom es, see rent-seeking: rent- fiscal constraints on, 250
outcom es o f growth im plications, 39-40
rents, see also property rights to secure political stability, 38-9,
allocation of, 107-13, 222-5, 265-9 296, 321
artificial versus natural, 66 rents for learning, 25, 47-53, 61, 90tab
based on property rights, 64- 5 Asian patterns, 88- 9, 90tab
 IN D E X
conditionality of, 48-52
efficiency of, 25, 50-3
India, 53, 94, 127, 129, 136
Malaysia, 100, 127, 136
Pakistan, 53
policy m echanism s for, 50
South Korea, 48, 52, 88, 90fig, 96-8,
127, 136-7
T hailand, 52-3, 136
Schum peterian rents, 12, 25, 40-7
d an g er o f becom ing m onopoly
rent, 43-6
definition, 40
efficiency and growth implications,
25, 43-5
to secure political stability, 25, 37-40
types, 12, 24-5, 68tab, 276
value-enhancing, 68tab, 77, 118, 294,
297-8
conditions for the creation of,
118-39, 121 tab
rents based on transfers, see under rents
rents for learning, see under rents
rent-seekers
as outsiders, 126-8
power of, 98-9, 122-8, 134-6
rent-seeking, see also corruption;
p atro n -c lie n t exchanges
as cause o f Asian econom ic crisis, 1, 18,
139-41
coexistent with econom ic growth, 225,
248-9
com peting approaches to, 6, 76tab
as competitive process, 211, 221-2,
224-5
conditions for efficient outcom es, 13,
118-39, 300
decom posing effects of, 12-13, 71-82
definition, 5-6, 275
dem ocracy and, 110-13
in developm ental state models, 76tab,
77
distributive conflicts as, 6, 114-17
forms of, 5
Indian subcontinent, 91-5, 137
by influencing the state, 122-8, see also
rent-seeking: scenarios
in p u t cost o f (or rent-seeking cost),
12-13, 71-2, 73tab, 76tab, 79tab,
104-18, see also rent-seeking: n e t (or
overall) effects o f
Asian evidence, 83-8, 90fig
m easurem ent of, 83-8, 90fig, 104
335
versus rent-seeking expenditure,
106-7
as in p u t-o u tp u t process, 72-3, 73fig,
78, 251, 277fig
institutional change as, 6, 118-20
institutions and the in p u t cost of,
107-13
institutions a n d the rent-outcom es of,
131-4
insulation o f state from , 248
Malaysia, 17, 98-101, 137
neo-classical econom ic m odels, 6, 7-8,
12, 75-6, 80-2, 104, 105-7, 210
policy prescriptions, 7, 23
weaknesses of, 2, 23, 32, 210-12
n et (or overall) effects, 7, 13, 72-82,
276
paradoxes concerning, 146, 248-9,
263-4,269-71
u n d e r privatization, 211
public choice analysis, 145-6
with rapid econom ic growth, 146
rent-outcom es of, 13, 71-4, 73fig,
75-82, 76tab, 79tab, 118-39
Asian evidence, 88-9, 90fig
India, 88, 94
Malaysia, 88-9, 98-101
South Korea, 88, 96-8
T hailand, 89, 102-4
scenarios, 118-39, 121 tab, 300
South Korea, 95- 8, 137
as state-led, 128-36, see also rent-
seeking: scenarios
T hailand, 101-4, 137-8, 183-6
through off-budget spending, 250
through private negotiation, 120- 2, see
also rent-seeking: scenarios
value-enhancing versus value-reducing,
7-8, 261, see also rent-seeking: n et
(or overall) effects of
rent-seeking cost, see rent-seeking: input
cost of
rent-seeking expenditure, as
approxim ation o f rent-seeking cost,
106-7
research a n d developm ent, see R&D
resource flows, see re n t flows
‘re structuring’, see Malaysia: inter-ethnic
redistributive transfers
R hone Poulenc Textiles, 189
Ricardo, David, 64
Riggs, F., 146
rights, see property rights
336 IN D E X
Roniger, L., 153
Rose-Ackerman, S., 220
Saengthongkam , W irat, 158
Saha U nion G roup, 165, 188-9
Samsung, 97
San Miguel C orporation, 228
Sarit T hanarat, 153-4, 157-8, 159,175nl,
184
Schum peter, Joseph, 23
S chum peterian rents, seeunder rents
Scott, J.C., 213-14, 222
secondary rent-seeking, 108, 112
second-generation models, 75-6
Shaw, E., 306
Shleifer, A., 9, 16
Shleifer-Vishny m odel, 16, 131-4, 264-7
Siam C em ent G roup, 191
Silverio, Ricardo, 224fig, 228
Sino-Malaysian capitalists, see Chinese-
Malaysian capitalists
Sino-Thai capitalists, see Chinese-Thai
capitalists
Sinpatanasakul family, 158
Skinner, G.W., 155-6
Smith, Adam, 7
social costs
o f m onopoly, 30
Soeharto, President, 258, 267
children of, 257, 268
‘soft’ state countries, 151
South Korea
chaebol, 114
banks, 58-60
corruption, 83tab, 85-6, 97-8
costs o f lobbying, 86
dem ocracy and the in p u t costs o f
rent-seeking, 110-13
industrial policy, 88, 98, 194
input cost o f rent-seeking, 83-6,
90fig, 96, 111-14, 117-18
insider advantages for rent-seekers,
114
liberalization, 86, 88, 98
patro n -clien t networks, 95-8, 137
rent-outcom es in, 88, 90fig, 96-8,
124-7, 129, 133-4, 136-9,
138tab
rents for learning, 48, 52, 88, 90fig,
96-8, 127, 136-7
rent-seeking patterns, 95-8, 137
state power, 95, 112-13, 135-6
spending power, o f rent-seekers, 123-4
state intervention
creation o f rents through, 6
state-owned enterprises
Malaysia, 288-9
states
capacity to create value-enhancing
rents, 128-36
capacity to enforce perform ance
criteria, 51-3, 226-7
capacity to pick potential winners, 51
capacity to restrain rent-seeking,
210-11, 248
centralized co-ordination, 131-4
cognitive failures, 128-9
effect o f corruption on, 235-6
institutional structure, 16, 131-4
rent-seeking led by, 128-39
role of, 150-1
‘soft’ state countries, 151
statist econom ic m odels, see developm ental
state models
Stiglitz, J., 46, 62
Stiglitz-Weiss m odel, 55-8
stock m arkets
as th rea t to banking sector rents, 309
inform auon rents in, 62-3
Malaysia, 304, 319-20
subsidies for learning, 12, see also rents:
rents for learning
Sukree P hodratanangkun, 157-60, 169,
176n 19, 188-9
sunk costs, 46, 113-14
Tan, Lucio, 224
Tan C hin Nam, 290
TBI, see T hai Blanket Industry G roup
technocratic influence, T hailand, 197
technological learning, see learning
technology acquisition
Malaysia, 17, 101
T hailand, 14, 191
textile a n d g arm ent industry (T hailand),
149, 156-68
com petition in, 158-9, 160
export perform ance, 161, 166-7, 189
export quota allocation, 165-6, 189
growth, 156-7, 161-2
jo in t ventures, 158, 189
loss o f competitiveness, 168- 9
 IN D E X
overcapacity, 161
overcom ing collective action problem s,
162-7
overproduction, 162-5
patronage in, 157-62
property rights in, 157-8
T hai Am erican Textile Co. I.td, 169
T hai Blanket Industry (TBI) G roup, 188-9
T hai D urable Textile Co. Ltd, 158,176nl8
T hai M elon Textiles, 160, 169, 176nl8, 189
T hai Textile M anufacturers’ Association,
162-5
Thailand, see also textile and garm ent
industry (T hailand)
banking system, 187
Board o f Investment, 154, 167, 190-1,
193
as broker polity, 192
budget process
insulation of, 184-5
politicization of, 197-8, 199
as bureaucratic polity, 183-4, 212,
219-20
transform ation of, 173, 192-3
business
political power of, 102-3, 125,
242n6
relations with governm ent, 192-3
capitalist class, 15, 101, 151-2
Chinese-Thai capitalists, 101, 151-2
‘competitive clientelism ', 14, 16, 89,
102-3, 153-4, 184, 229
corruption, 83tab, 87, 170, 197-8
dem ocratization, 111-12, 173-4, 192,
196-7
econom ic growth, 147-50, 182
rent-seeking with, 145-7
educational system, 170
electronics industry, 190-1
export prom otion, 194
exports, 150
financial crisis, 168-74
financial liberalization as cause,
198-9
global capital flows as cause, 125-6,
168-9, 174-5
technocrats’ failure to foresee,
170-2, 199
weak financial oversight as cause,
171-2, 174-5, 199
IMF assistance, 169
337
industrial policy, 185-6, 188-91, 193-6
infrastructural reform , 170-1
in p u t cost o f rent-seeking, 83- 7, 90fig,
102, 111-12, 117-18
jo in t ventures, 158, 189
‘liberal corporatism ’, 191-2, 197
m acroeconom ic stability, 147, 161-2,
184- 5
National Econom ic a n d Social
D evelopm ent Board, 190, 193
physical infrastructure, 170
policy-making
fragm entation of, 159-60, 185
politicization of, 173, 197-8, 199
technocratic influence in,192- 3
property rights, 153
ren t flows, 101-4
rent-outcom es in, 89, 90fig, 102-4,
125-8, 134, 136-9, 138tab
rent-seeking
capitalist-led, 101-4, 125-6
competitive character, 89,102-3,
184,229
constraints on, 153, 161, 184-5
econom ic growth with, 145-7, 182
efficiency of, 103-4, 196-7
expenditures, 87
following dem ocratization, 184-5
m arket com petition through, 147,
153
as paradox, 145-7, 182
p attern of, 101-4
as pervasive, 146, 183-7
resource flows, 102-3
variable incidence of, 232-3
rice price policy, 187
role o f institutions, 156
technology transfer, 191
textile and garm ent industry, 149,
156-68,188-9
tourism industry, 190
transfers
for prim itive accum ulation, 102-3
redistributive, 102, 127-8
as rents for learning, 52-3
T hailand Textile Industry Co. Ltd, 158
T hanom Kittikachorn, 87
tourism industry, T hailand, 190
tragedy o f the com m ons, 35
transaction cost econom ics, 109
transaction costs, 109-10, 130-1
3 38 IN D E X

transfers, see rents: rents based on transfers U nited Malaysian Banking C orporation,
transition costs, 135 310
TTMA, sec T hai Textile M anufacturers’ unproductive activities, 7
Association
Vishnv, R.W., 9, 16, 131-4, 264-7
U C hu Liang, 158 vision 2020 293, 294
UMNO, see also Malaysian Chinese
Association
factionalism in, 99, 101, 296 Weber, Max, 217
hegem ony of, 287 Weiss’ A- 55- 8
organizational power of, 99 Wilson, D., 146
U nion Bank, 157 W orld Bank, 48, 151
U nion Textiles, 176nl8, 188
U nited E ngineers Malaysia, 323 X-inefficiency, 32
U nited Malays National O rganization, see
UM NO Zhou, H., 147