WHICH CAPITALISM? LESSONS FORM THE EAST ASIAN CRISIS

Raghuram Rajan and Luigi Zingales

Journal of Applied Corporate Finance, 1998, vol. 11, issue 3, 40-48

Abstract: As a result of the Asian crisis, relationship‐based economic systems are now under attack for corruption and inefficiency. Yet, until recently, they were held up as an alternative (and in some respects superior) form of capitalism to the arm's‐length, market‐based, Anglo‐Saxon systems of the U.S. and the U.K. What went wrong? This paper suggests that relationship‐based systems work well when contracts are poorly enforced and capital is scarce. Power relationships substitute for contracts, and can achieve better outcomes than a primitive contractual system. But a relationship‐based system suppresses the price system and the signals it provides. As a result, relationship‐based systems are likely to misallocate capital when presented with large external capital inflows. Since the external capital comes from arm's length investors who typically have few contractual rights or little power in a relationship system, and since these investors are aware of the potential for misallocation, they rationally choose to maintain control over borrowers by keeping their claims short term. Thus, the contact between the two systems creates a fragile hybrid that, while mutually beneficial to relationship borrowers and arm's length investors in normal times, is excessively prone to shocks. Where do we go from here? The authors suggest that while there may be some short‐term benefits for emerging economies from reverting to the pure relationship‐based system, in the long run such economies will be held back unless they develop the greater disclosure, contract enforcement, and competition of the arm's‐length system. The current Asian crisis may be the most opportune moment for these economies to effect the transition between systems.

Date: 1998
References: Add references at CitEc
Citations: View citations in EconPapers (48)

Downloads: (external link)
https://doi.org/10.1111/j.1745-6622.1998.tb00501.x

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:jacrfn:v:11:y:1998:i:3:p:40-48

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=1078-1196

Access Statistics for this article

Journal of Applied Corporate Finance is currently edited by Donald H. Chew Jr.

More articles in Journal of Applied Corporate Finance from Morgan Stanley
Bibliographic data for series maintained by Wiley Content Delivery ().