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Role of Culture in Economic Development: China Study of China and Latin America by Amira Fellner A thesis submitted in partial fulfillment of the requirements for the degree of Master of Arts Department of Political Science College of Arts and Sciences University of South Florida Major Professor: Dajin Peng, Ph.D. Steve Tauber, Ph.D. Harry Vanden, Ph.D. Date of Approval: April 11, 2008 Keywords: informal networks, foreign direct investment, business funding, compadrismo, ethnic Chinese business networks Copyright 2008, Amira Fellner
i Table of Contents Abstract ...................................................................................................................... ......... ii Introduction .................................................................................................................. ........1 Chapter One: How Culture is Applied to Capital ...............................................................5 Chinese Culture ......................................................................................................13 Latin American Culture .........................................................................................22 Chapter Two: Informal Networks in China and Latin America .......................................35 Overseas Chinese ...................................................................................................52 Networking in Latin America ................................................................................56 Chapter Three: Foreign Direct Inve stments in China and Latin America ........................69 FDI in Latin America .............................................................................................71 FDI in China ..........................................................................................................80 Chapter Four: Labor Markets in China and Latin America ..............................................90 Chapter Five: Business Funding in China and Latin America .........................................99 Chapter Six: Latin American and Chinese Economic Situation .....................................104 Chapter Seven: Conclusion .............................................................................................109 Bibliography .................................................................................................................. ..114
ii Role of Culture in Economic Development: Case Study of China and Latin America Amira Fellner ABSTRACT The purpose of my thesis is to demonstrate the economic development of China and Latin America. My reason for choosing these two regions for my study is because they are both Third World Nations. My intention on writing this thesis is to prove that culture and the informal business networks of China are the major forces of what is driving the Chinese economy ah ead of Latin America. I will explain how the defin ition of culture ties in with the economic society of both regions. In writing about cu lture, I will attempt to e xplain if there really is a difference between trust in each society. To be tter interpret this thesis, I came up with several variables of economy that will help explain each regions development. These variables are federal direct investment (FD I), labor, and funding of businesses in each region. In my study, I present the different appr oaches that are taken by each region to attract FDI. In addition, I will explain how and if informal ne tworking is beneficial to the work force and the funding of businesses in each region. The majority of my research for this thesis consisted on reviewing past articles of scholarly journals. From these journals I drew conclusions of my own and compared
iii them to other scholars work. I also an alyzed such websites like the International Monetary Fund (IMF) and the World Bank and vari ous others to be able to come up with my own findings necessary to complete my thesis. To anticipate the conclusion, this thesis notes how important it is for each region to find its own unique way to attract FDI and how culture can impact the development of an economy. In my thesis, I am including the importance of trust in the society and the significance of the informal business networks on the Chinese economy.
1 Introduction Historical developments and a regions culture have an extreme impact on a countrys economy (Greif, 1994). In additi on, a regions culture strongly defines the history of economic development. Thus, culture is colossally important in demonstrating traditions of the society from past to present. Cultural perspectives provide researchers with references, which exemplify values, attitudes, and behaviors that influence economic development in China and Latin Ameri ca. Culture is a combined reflection of politics and economics in any society. Culture can also be perceived as a type of productive force. As some Chinese scholar s claim, politics, economics and culture are the three gears of any society and only wh en they move harmoniously can the whole society develop rapidly (Xuewen, 1997). The study of the interac tion between culture and economic development is not new. However, economists often overl ook the role of cultu re in the economic development of countries. Culture generates assets such as skills, products, expression and insights that contribute to the social and economic well being of a community. Both culture and values shape economic development. According to Sen, the values held by a society will affect economic development efforts (Sen, 1997). I chose to incorporate the im portance of trust in this thesis to demonstrate how it ties in with economic development. Trust is vita l to the social capital of a country. It is the mutual acceptance between two or more enti ties that behavior will be honest. Trust is
2 a symbolic credit which enhances the ability of individuals to cooperate and to forgo short run gains in transactions. Since China and Latin America are both low-trust regions, I felt that it was important to try to prove that trust is more easily placed within the Chinese informal networks th an Latin America (Tsui, 1997). Many countries in East Asia, particularly China, are resisting traditions from Western culture. It is the use of Asian values and inst itutions that are responsible for the Chinese economic advancement over Latin Ameri ca. Despite the fact that the Chinese and Latin American culture are very similar, what I propose as well is that China has a more collective society. This is attributed by its Confucian influence. Confucianism heavily benefits Chinas economic developmen t because it encourages savings and places high value on education. China has a higher le vel of trust than Latin America being that it has a homogenous population and a more equal distribution of wea lth. According to Fan and Wang, the more China has been market ized, the higher its trust level is (Fang and Wang, 2001). Latin America is very diverse along most human dimensions: ethnicity, language, culture, history and economic well-being. Despite the diversit y, there are common threads that contribute to th e lack of economic development. These include the politycorrupt politicians, the corrupted military a nd business elites who pr otect their privileged positions (Montaner, 2000). Although, Brazil, Chile and Costa Rica have shown some progress toward human economic development, for the most part, Latin America has an unresponsive and corrupt bureaucratic structur e that hinders the prospect of economic growth. This includes oppor tunities for small and medium sized enterprises (Warner,
3 2001). Since Latin America is composed of many counties, I find that overall, the society is very individualistic. Latin America and China are among th e two most active regions in the developing world for private infrastructure i nvestment. They also receive the bulk of foreign investment directed at emerging economies. These two regions have also been evaluated in terms of their economic devel opment progress and thei r ability to attract Foreign Direct Investment (FDI). By co mparing and contrasting both the business and the cultural aspects of each region, I will demonstrate the adva ntages that China has over Latin Americas economy. I chose to compare Latin America to Ch ina because these two regions share some basic similarities in terms of economic de velopment, colonial history, competition for FDI, and recent experiences with privatization and other market-opening initiatives. Additionally, policy makers within the La tin American region often point to the economic development paths followed by China as prescriptive models. While explaining each regions society and economy, I also elaborate on how corruption is portrayed and how it factors out in economic development. For the purpose of my thesis, I have used the defi nition provided by Robert Williams to best describe corruption: abuse of public offi ce to for private gain (Williams, 2000). According to economists, corruption increase s transaction costs, reduces investment incentives, and, therefore, reduces economic gr owth. In countries with high levels of corruption, the public is hostile to people who have more. Taking this into account, I explained how corruption is portrayed in each of these regions, being that both China and Latin America both have corrupted political and economic systems.
4 Throughout this thesis, economic developm ent will be the increase in the ability to choose and make decisions for the ma ximum number of people during the maximum length of time that will result in a sustainabl e increase in material and social welfare. This in turn will give allowances for both interpersonal and intergenerational criteria. I will be using the cultural approach to explain why China and Latin America have had different economic performances during the past several decades. I will attempt to answer how important the cu ltural factors are in the econom ic performances of the two regions. In this thesis, I will review the notion of culture and the relationship between culture and economic development.
5 Chapter One How Culture is Applied to Capital For the purpose of my thesis, culture is defined as the socially transmitted behavior, patterns, norms, beliefs and values of a given community. Others would have that culture is a set of shared and en during meanings, values, and beliefs that characterize national, ethnic, and other groups and orient their behavior (Faure and Sjostedt, 1993). According to Samuel Huntingto n, culture is the values, attitudes, beliefs, and underlying assumption prevalent among peop les in a society. Culture is dynamic, interactive, and synergistic, and it intermixes w ith all the elements of a society, especially economic development and the milieu of entrepreneurs (Huntington, 2000). Culture is measured by indicators of indi vidual values and beliefs, such as trust and respect for others, and confidence in individual self-deter mination. Culture, like institutions, is a vague concept. Culture co rresponds to the social norms and individual beliefs that sustain equilibria as focal points in repeated social interactions (Greif, 1994). In this interpretation, culture is one aspect of broadly defined institutions and contributes to shape individual incentives. A more radical view is that culture directly influences individual behavior through va lues and preferences (Akerlof and Kranton, 2000). Others have pointed out that social norms and indivi dual values could interact in systematic fashions (Benabou and Tirole, 2006).
6 Sociologists have tended to believe that cultural norms pervade economic life and that to understand economy it cannot be sepa rated from culture. Many economists point out that the differences in economic performa nce from one society to another are better explained by differences in institutions and in the policies undertaken by those institutions than by cultural factors (Bell, 1994). Culture also affects the ability of societies to create and properly manage ins titutions. For example, in the postwar period Japan, South Korea and other East Asian coun tries employed industrial policies, in which the state rather than the market allocated credit to national industries to encourage economic growth. The notion of culture has witnessed cha nges from time to time. More than one hundred years ago, E.B. Taylor defined culture in his book Primitive Culture where he defined culture as the complex whole which included knowledge, belief, art, morals, and customs acquired by man as a member of soci ety (Greif, 1994). In the middle of this century, A.L. Kroeber described culture in his Anthropology as consisting of speech, knowledge, and beliefs that is learned from other man and elders (Kroeber, 1948). In Culture: A Critical Review of Concepts and Definitions, A.L Kroeber and Clyde Kluckhohm stated that culture consists of pa tterns, both explicit and implicit of behavior acquired and transmitted by symbols, consisting the distinctive achievements of human groups, including their embodiment in artif acts (Kroeber and Kluckhohm, 1952). They said that the essence of culture consists of traditional ideas. In short, culture is the total social heritage acquired by man as a member of the society. Culture is shared and distinctive forms or patterns, that shapes human behavior, and its essence is the values embodied in th e beliefs of the people. This makes value
7 orientation patterns the essent ial features of culture (Ale xander and Kumaran, 1992). In discussing the relationship between culture and development, Gao Xian raises he issue of macro-culture. He points out that macro-cu lture includes not only culture in the narrow sense (art and literature), but also culture in the broadest sense (Xian, 1996). Therefore, the macro-culture approach to development is a holistic exploration of the development process, material and moral, current and histor ical partial and total. According to Xian, the macro-culture approach primarily addresse s the issue of an objective attitude towards tradition and their relationship between traditional culture and modernization development (Xian, 1996). In discussing the notion of culture, we also need to pay attention to a nations traditi on. According to Xian, traditio n is what a society inherits from its history and which forms the norms of morality, concept of values, modes of behavior, methods of thinking and ideas (Xia n, 1996). This serves as the foundation of the cultural identity of th at particular society. However, tradition should not be seen as good or completely bad. In other words, in dealing with tradition, people should not blindly accept everything past, nor get rid of the tradition because it is tota lly harmful. Traditions, whic h are very closely linked to culture, should be renewed and improved constantly. Mao Zedong once said Our national history goes back several thousand years and has its own characteristics (Zedong, 1952). It has been acknowledged that the primary aim of the contemporary era is to seek development and peace. In pinpointing th e causes of underdevelopment, some people would put more emphasis on external factor s, such as a long history of colonial dominance and exploitation, unequal exchanges and the absence of a just international
8 economic order. However, it is also necessa ry to pay attention to internal factors. Development is the result of bot h external and internal factors and in many cases, internal factors should always play a more important role. In terms of internal factors determ ining economic development, people are increasingly emphasizing the non-economic ones like culture. As Augusto Salazar Bondy stated, underdevelopment is a state of mind, a way of expression, and a collective personality marked by chronic infirmities and forms of maladjustments (Harrison, 1985). Similar institutions created in Latin Am erica and other parts of the world proved much less effective than their Chinese counterparts. While e ffective industri al policy is partly a matter of institutional design, it is also heavily influenced by culture. As the world has become richer and bette r educated, religion ha s not withered and nationalism and tribalism have not faded away (Hofsted and Bonds, 1988). Global economy and technological forces do not erode local cultures and values. Instead, culture and values shape economic development. For instance, when we look at Chinas economy, it is important to look at the fact th at China has a long and complex history as well as a rich cultural tradition. Chinas cultural traditions st ill continue to exert a strong influence on almost every aspect of hu man interaction, including business. Cultural differences have become more pronounced as people are empowered by greater wealth and education. Once worl dviews have been absorbed, they produce different levels and types of so cial and cultural capital. Culture extends across all the dimensions of the social capital of a society, underlying the basic components of social capital such as mutual confidence and responsible civic behavior. The values held by a society will affect development efforts.
9 The ethical codes used by businessmen and professionals form part of the productive resources of a society. According to Sen if these codes place emphasis on values in keeping with the project of development with equity, they will favor development (Sen, 1997). Values rooted deeply in the prev ailing culture are esse ntial for sustained development. UNESCO emphasized that culture is a ke y element in the fight against poverty (UNESCO, 1995). The poor have their own values that are often all they have to assert. Under-privileged groups have values, which give them an identity of their own. If these values are not respected, then, even the best productive proposals can be blocked. Preserving cultural values is very important for development. Taking culture into account requires integrating information about culture into development economic analysis in an informed wa y. It is evident that culture exerts real effects on development outcomes and developm ent projects. Cultural differences might also influence governmental tendencies to structure foreign investment along certain dimensions. China has been able to organize their economy more efficiently because of their continued reliance of guanxi a nd their informal networks in spite of their economic reform. China is a country that has distinctive political, institutional, and cultural characteristics, and it is rec ognized that such factors can give rise to different modes of economic organization. Another category in which culture is sa id to affect economic behavior is the formation of social networks. The differing impact of cultural values on networks of social relations is the basis for the concept of social capital. So cial networks affect
10 economic growth via enforcing informal institutions. My thesis focuses on the economic payoff of kinship networks in the context of Chinas industrializati on to argue that kin solidarity and trust plays an important role in Chinas advancement in the economic world over Latin America. Reform economies, such as China, strive with informal institutions because informal norms are much more impervious to deliberate designing and take time to change. Another factor that affects economic de velopment is trust. Although both China and Latin America are low-trust societies, ther e is more trust within the Chinese informal networks than Latin America (Tzu, 1997). To define trust, I will use Francis Fukuyamas definition. Trust is the mutual acceptan ce among two or more entities (persons, organizations) that regular day-to-day behavior will be honest, cooperative, and predictable based on shared norms. Also, that parties to markets transaction will not exploit others vulnerabilities (Fukuyama, 1995) Trust is a measure of how people evaluate the moral fabric in their society. When dealing with specific nations, there are different levels of trust that must be taken into consideration. The importance of trust gives a positive outlook at the societal level. Cities, regions, and countries with more trusting people are more inclined to have better working democratic institutions, to have more open economies, greater economic growth, and less crime and corruption. Countries with an in itial level of high inequality and with dishonest governments are less likely to es tablish universal programs (Child, 2005). This is because such programs are usually based on the idea that all groups in society have a shared fate. People will place their trus t only in their own groups or class.
11 In low-trust societies, such as those in Latin America with high degree of economic inequality, universal programs are likel y to fail because of the lack of potential support. Latin America has felt the impact of low trust on economic development. For the most part, Latin America is stuck in the backwardness of social and governance dysfunction. It is imperative fo r entrepreneurs to create trust and social capital in order for the economy to be successful. The more trust there is the better it is for human progress and economic development. Accordi ng to Evans and Flora, low-trust societies are filled with traditional values and corrupt bureaucratic structures, and the prospect of good economic development is not promising (Evans and Flora, 1996). In Latin America, since there is a lack of trust, it has been difficult to stimulate entrepreneurial activity and investment in business developm ent leading to more jobs, innovation, and increased productivity; factors that the Chinese bode well in. Trust is a vital part of the social capita l of a country that includes institutions, networks, and attitudes. Social development in the form of higher trust is supposed to be strongly related to economic development. The higher trust encourages economic development and at the same time, economic development promotes trust especially in the long run. However, it is possible that the relationship between trust and growth will work in opposite directions. According to Fukuyama, because trust depends on expectations about future actions of others, the formation of ex pectations in a situation of growth should positively affect our pr opensity to trust others (Fukuyama, 1995). Furthermore, it is possible that in a situati on of growth individuals are willing to take higher risks in trusting others because of higher potential benefits. Fukuyamas
12 assumption is that trust is a product of i nherited and inflexible patterns of cultural inheritance. Trust influences the decision of whether to invest or not only in low-income countries where trust between investor and reci pient replaces absent, formal institutions. In high-income countries, trust affects inve stment choices by real locating funds across sectors. Individuals who take higher risks mi ght invest in future technologies where they expect high future returns on th eir investment. In contrast, missing trust might determine the preference for more secure investment opti ons. It is imperative for entrepreneurs to create trust and social capital in order for the economy to be successful. The more trust there is the better it is for human progre ss and economic development. According to Evans and Flora, low-trust societies are f illed with traditional values and corrupt bureaucratic structures, and th e prospect of good economic development is not promising (Evans and Flora, 1996). When there is economic progress, the im portance of trust increases because the exchange system becomes more complex, the pr obability of repeated interaction falls and specialization deepens. All in all, the prom otion of trust encourages domestic exchange and therefore, economic progress through si ze and specialization is stimulated. Trust encourages growth and economic development by affecting the efficiency of production, exchange, formal instituti ons and governmental actions. Formal institutions stimulate production and exch ange but also employ resources from productive and commercial activities, becomi ng sources of inefficiencies. Reducing transaction costs, uncertainties and informati on restrictions, increases the efficiency of formal institutions. Furthermore, formal institutions do not cover the entirety of
13 economic activities and such institutions have to be enforced by a third party (ex, courts, or the government). Similarly, trust raises the efficiency of government performance. While some economic activities based on trust may also foster inefficiencies, in general trust increases the efficiency of an economy. This view pa rallels that of Edward T. Hall and Mildred Reed Hall, who say that culture can be comp ared with a giant, extraordinary complex, subtle computer. Its progress guides the acti ons and responses of hu man beings in every walk of life (Hall and Reed Hall, 1990). It is imperative to point out that, al though the cultural factor is important, its importance should not be exaggerated. In ot her words, compared with other internal factors determining economic performance, cu ltural factors occupy a lower position than economic policies. Culture only serves to facilitate or hinder the creation of an environment where sound economic policies can be made and implemented. Chinese Culture The last few decades have seen remarkable economic progress in China and their achievements are impressive. This success has been accompanied by the emergence of new theories on the role of the Chinese culture in achieving economic success (Frank, 2003). An emerging theory attributes th ese successes largely to the role of Confucianism. This theory has been follo wed more recently by the rapid transformation of the Chinese economy and society. Attention has now shifted to the special virtues of Confucianism, including the cultural tie binding China and much of East Asia.
14 The Confucian culture originated in Chin a, but its influence has expanded to the whole East Asian region. Confucianism has th ree significant stages of development. The days of Confucius mark the be ginning stage of Confucianism The second stage is the School of Principle and the Ming Dynasty during the Song Dynasty (960-1280 A.D.). Currently, we are in the third stage of Confucianism, called the renaissance of Confucianism (Zhang, 2001). These proponents claim that Confucianism will continue to occupy a pivotal position in Ch inas cultural traditions, as well as to contribute to the modernization process in this country. So me people contend that Confucianism will continue to manifest valuable positive poi nts and play a role in the modernization process. Confucianism has many components. Zhang Hongyi lists the following: 1) Economic functioning should rely on comprehensive harmony, consistency with natural laws, human supremacy and avoiding extremes. 2) Economic relations should be used to curtail selfishness and reduce in equality. 3) Economic be haviors should emphasize using small ways of making fortunes, living a thri fty life and working hard. 4) Economic policies of the government should stress ma king people rich and reducing poverty. 5) Economic management should highlight effici ent government. 6) Economic life should be integrated with economic morality (Hongyi, 1989). Confucianist ethics is best summari zed by Herman Kahn in his World Economic Development: 1979 and Beyond (1979). He states that Confucianism promotes a high value on education, a desire for accomplishmen ts in various skills, and seriousness about tasks, job, family, and obligations in the indi vidual and the family. There is very little interest in advancing indivi dual interests (Kahn, 1979).
15 Westerners, such as Christopher Engholm, agree that Confucianism inculcates diligence, hard work and family devotion. For Keun Lee, Confucian values and traditions include stress on worldly achievem ent, discipline, and a commitment to education. These qualities ar e what Max Weber found in th e Protestant ethic, which played a decisive role in de veloping Western capitalism. While many scholars believe that Confuc ianism possess certain advantages over the other traditions, such as th e Ibero-Catholic or Hispanic heritage in Latin America in promoting economic development, other scho lars point out that simplistic cultural arguments yield several problems. According to Gary Geretti, these problems include: 1) Timing-the Confucian and Ibero-Catholic trad itions have existed for centuries, but the dynamic shifts in economic performance that gave rise to the East Asia have occurred in recent decades. 2) Discussions of culture have been as inconsistent as the same Confucian beliefs that are now claimed to facilitate rapid industrialization in East Asia. Despite the debate, there are still several codes determined to be beneficial to economic development. One of them is that Confucianist culture encourages thrift and savings, which in turn benefits the growth of investment. No economy can grow unless surpluses are created that can increase the economys productive capacity. Economic development relies heavily on investment of physical capital in the form of roads, machine tools, and telephones. In 1965, invest ment rates in East Asia equaled about 20% of GDP, only a shade above the figure in Latin America. By 1990 the East Asian investment rate was 35% more than twice th e Latin American investment rate (Rohwer, 1995).
16 Another code is that Confucian beliefs place a high value on education. This, in turn, promotes the development of human resources. Long before the European Renaissance, Confucianism heavily influenced education in China. Many other scholars emphasize the importance of investment in education. In Economics Value of Education, Theodore Schutts mentioned the following im pacts that education had to economic development: it improves the quality of labor through the promotion of skills, efficiency and work knowledge; education increases labor mobility to promote division of labor and to strengthen labor force participation rate s; scientific and te chnical knowledge is increased to promote invention; entrepreneur s gain more ability to improve management and the allocation of production factors, and pe ople become more responsive to economic change (Schutts, 1967). In spite of the impact that Confucianism has on Chinas education, it is erroneous to say that Latin American countries totally ignore education. Highe r education in that region has advanced remarkably. However, primary education has developed at a slow rate in Latin America. China spends more on primary schooling then on secondary schooling. The final code of Confucianism is that it stresses work ethic. According to Jack Barbash, work is an end, which is expected to bring the reward of material success. Work includes the discipline of work, punc tuality, obedience, and diligence. The Confucianist teaching has it that working is a virtue, which, in turn can create high morality for anyone. Laziness generates immo rality and degradation (Barbash, 1983). In the past two decades, Chinas transition from a planned to a market system followed a different path from those countri es in Eastern Europe. Chinas economic
17 reform and transition to a market system o ccurred without democra tization, liberalization proceeded incrementally and privati zation was delayed until recently. Since 1949, the Chinese economy had been cl osed to the Western countries. When the conflict with the Soviet block broke in the early 1960s, the Chinese economy became one of the most closed economie s in the world. During the Cultural Revolution from 1966-1975, no advertising wa s allowed because the Chinese economy was managed through the Soviet five-year plan (Zhang, 1996). After 1978, when the open-door policy was adopted, Chin a evolved from an egalitarian Marxist state to a more socialist market economy, which was orie nted toward economic development and modernization. In 1979, the government deci ded to expand foreign trade and welcome foreign investment. As a result, China is char ging ahead in its efforts to become one of the key global economies. China has had one of the highest growth ra tes in the world over the past quarter of a century. Enormous capital inflows and cheap migrant labor have fuelled economic growth, making China the worlds factory. Fo r the most part, Chinas economic success has occurred in the absence of democracy. It is true that freedom of speech is tolerated now more than at any other time since the f ounding of the Peoples Re public and there is a growing majority of social interests re flected in the emergence of village selfgovernment. However, these changes have not been reflected in greater tolerance (Marshall, 2006). Studies by political scientists have found that economic growth generates demands for political rights. At one level, casual practices also s eem to support the view that economic growth promotes democracy in that all the developed, industrialized
18 nations have democratic political systems. On the contrary, most nations in the poorest segment of the world operate unde r various non-democratic politic al systems. But, with simple observation, one can see that this is not true. Casual obs ervation also suggests that economic growth does not necessarily bring about a demand for democracy. There are examples of authoritarian regimes in S outh-east Asia and th e Middle East where citizens are willing to forgo demand for polit ical liberalization, provided their economic needs are being met (Smyth, 2007). It is on ly when the authoritarian government stop delivering on the economic front that ther e are calls for more political rights. An example is the fall of the Soeharto regime in Indonesia following the Asian financial crisis, when spiraling inflation and unemployment prevented Soeharto from delivering in the economic sphere. In China, the fact is that the government is delivering on the economic front. The urban population at least has experienced a substantial improvement in living standards since the start of the late 1970s (Child, 2005). Corruption can exist in democracies and dictatorships. China has a serious problem with corruption. Some see corrupt ion as undermining Chinas growth prospects into the 21st century; but corruption does not need to be detrimen tal to economic growth. While some studies have found that corruption have desirable properties for growth. The latter perspective suggests corruption can act as a lubricant that makes it easier for business to get things done by cutting through bureaucrat ic red tape and thereby increasing the efficiency of the economy. Hong Kong economist Steven Cheung has suggested that corruption is more likely to flourish under democracy rather than dictatorship. Che ungs rationales for his position is that in an authorit arian regime people on top want to maintain their hold on
19 power and corruption is one thi ng that will most likely destro y this. Thus, the cost of corruption is high for single-party states. Bu t in a democracy, because power is transient, there is more incentive for elected official s to profit while they can (Smyth, 2007). Cheungs view, however, overlooks sub tleties between regime types. There are three factors that lead to belie ve that corruption has different economic implications depending on the context in whic h it occurs. The first is comparative advantage. Economies inhabit di fferent niches in the internat ional division of labor, and these may require different sets of instituti onal capacities (Hall a nd Soskice, 2001). For instance, corruption may be weakening if a c ountry is competing for trade and investment with countries where corruption is much le ss prevalent, but it may constitute less of a problem if it is competing mainly with countri es that are equally plagued by corruption. The second factor is political organization. It is argued that the organization of the corruption network has implications for bot h the level of corruption and the effect on economic activity (Shliefer and Vishny, 1993). On e of the distinctions made is between a regime in which the person paying the bribe is assured that he gets the government good that he is paying for, and a regime in whic h numerous bureaucrats need to be bribed to get a government permit, and bribing one doe s not guarantee that some other bureaucrat or even the first one does not demand a nother bribe (Shliefer and Vishny, 1993). Kahn notes that the effects of corruption are specif ic to the particular distribution of power between the states and compe ting groups of potential client s (Kahn, 1996). This makes it possible for similar corrupt transactions to have different effects in different countries. The third factor is rent creation. This f actor explains that besides corruption being regarded as rent seeking, it is also both a response to situat ions where rent already exist,
20 and an incentive for state officials to create new rents. This latter point is one of the keys to understanding the economic impact of co rruption. Many rents exist because of the opportunities for corruption they create. Howeve r, different types of rents have different implications for economic efficiency and grow th. Thus, there is a distinction between growth-reducing rents, generally growth-e nhancing rents, and rents that have undetermined effects on economic growth, de pending on the institutional context, which include rent-like transfer and rent for m onitoring (Khan and Sundaram, 2000). When China launched economic reforms, its compar ative advantage lay in low-tech, laborintensive production. In this stage, China competed for investment and export markets with other low-wage economies, many of which were also highly corrupt (Wei and Sievers, 2000). Often, analysts make the mistake of equating formal structures with organizational capacity. It is, however, important to recognize that it is possible for states with formally centralized institutional stru ctures to behave in a fragmented way if powerful but dispersed interest groups can pr event co-ordination by state agencies (Kahn, 2000). Conversely, states and society that ar e formally fragmented may nevertheless have the capacity to coordina te corrupt activities. The Ch inese communist party retained its ability to control corr uption, which paved the way for strong economic growth (Blanchard and Sclieifer, 2000). In China, the large variation in the patterns of corruption at provincial as well as local level suggest that the Chin ese state and party agencies have in fact not been able to effectively control or coordinate corruption and other forms of rent seeking. Pei has argued that Rampant corruption in post-Mao China arose because the decentralization of
21 power was accompanied by low-levels of accountab ility and a lack of civic participation (Pei, 2001). The continued power of the comm unist party suggests that China may have been in a better position to impose some semb lance of order on corruption. However, the political turmoil unleashed by co rruption in the form of prodemocracy demonstrations of 1989 indicates that the Chinese communist pa rty was unable to restrain the predatory behavior of cadres. In the market reform era, organized crime has expanded on a massive scale under the political patronage of lo cal officialdom (Chen, 2005). Corruption intensified in the sense that it increasingly involved big-stakes co rruption rather than ordinary forms of official malfeasance (Wedeman, 2004). Chinese officials have had to create rents more compatible with efficiency and long-term growth. Chinese policy makers have been more inclined to engage in rent-like transfers of a growth-enhancing nature (Pei, 2001). These transfers have encouraged new entrants to markets and intensified competition. The effect of these rent-like transfers has been to promote new entrants into high-rent markets. In China, bureaucratic resources have increasingly been put to use to enhance rather than restrict competition. Loca l state governments account for a substantial portion of all the entrepreneurial activity in China. Duckett argues that these activities, which may be illegal, tend to be productiv e rather than profit eering, since the local entrepreneurial state is removed from the centralized administra tive control of the command economy and operates in an increasingly competitive market economy (Duckett, 2001). These econom ic activities are not characterized by monopoly and may promote the growth of competitive markets.
22 Duckett also argued that corruption in reform-era China has taken two main forms. First, corruption has served as a means for non-state actors to develop alongside the planned economy, dominated by large state owned actors. Second, corruption became a means by which local governments competed for favors from the central government (Duckett, 2000). These favors took the form of both preferential financial treatment and flexibility of the kind initially accorded only to special economic zones. Thus, political zones have contributed to the establishment and spread of competitive and growth-enhancing markets and institutions (Wedeman, 2004). Latin American Culture The Latin American region is composed of many countries, each of which has its own cultural identity. As Frederick Turner st ates, whereas some social scientists view political culture as a national phenomenon enco mpassing the distinctiv e values of each national community, shaped by th e communitys distinctive hist ory, others feel that there is a Latin culture that defines the region as a whole (Turner, 1995). After separating from Spain, each nati on in Latin America created their own social characteristics with local traditions and histories. Lawrence Harrison believes that values, attitudes, and culture are what differe ntiates ethnic groups and is responsible for Latin Americas persistent instability and inequality (Harrison, 1992). Latin America still possesses a dominant Iber ian Catholic political culture Religion, culture, language, and history are all important to understandi ng the institutional framework through which development is filtered and the shaping of economic development. According to Wiarda, Latin America remains authoritarian, Catholic, and elitis t (Wiarda, 1992).
23 Latin America has a long history of so cial activism and is the source of many studies chronicling successes a nd failures of culture as for ces of societal well-being or backwardness. Trust, social capital and civi l society are conditions that are studied and that aim to benefit people at the lower end of the socio-politico-econom ic scale. None of the twenty republics in Latin America can be classified as developed, and some remain poor. Pockets of wealth are found in all republics; however, these cannot conceal the deprivation and hardship suffered by the re gions poorest inhabitants. Although Latin America is not among the poorest regions in th e world, it has been overtaken by parts of Asia, such as China that had much lower standards of living throughout the nineteenth century. Latin America is very diverse along the following human dime nsion: ethnicity, language, and history. It has been found that there are several elite groups that have contributed to the lack or backwardness of economic development in Latin America. Montaner identifies them as the polity-corrupt and wrong-headed politician; the militarysometimes imposing their own systems of o ccupation and social justice; the business elite-protecting their privilege d positions; the clergy-using th eir altruistic quest, which often leads to anti-markets actions, the inte llectuals-espousing view s that have little credibility when laid alongside to the United State; and the left-which are the revolutionaries, who at times oppose everything (Montaner, 2000). The Latin American culture is unders tood through the concepts of power, uncertainty avoidance, individualism, ma sculinity, context, and time orientation (Hofstede, 1980). Power orientation is the ma nner in which people in a culture defer to legitimate authority in societal structures. Un certainty avoidance is the extent to which a
24 culture relies upon, and expects information to accomplish a task. Individualism is the degree to which a culture emphasizes the we ll-being of a group over the benefit of an individual; and masculinity is a cultures perspective about the roles that men and women play in society. Context is the pattern of physical cues, environmental stimuli, and implicit understanding that convey meaning be tween two members of the same culture (Thill and Bovee, 2005). Lastly, time orientat ion describes the cultures attitude towards time. Time is infinite in Latin American culture. The problems that Latin America faces are many. It is a very low-trust society and the radius of trust is very narrow compared to that of China. Low trust limits opportunities for economic growth and innovation. There is a cultural heritage of not trusting others. Another problem is the pers istence of the depende ncy theory. Harrison and Huntington both agree that in order for Latin America to grow economically, there must be a shift from the dependency theory toward a more open-market democratization process (2000). Other proponents who believe that culture does matter in economic development, and that the dependency theory should be done away with are Max Weber and Landes (Weber & Landes, 1998). As Lande s puts it, culture makes almost all the difference. Inglehart also claims that cultures trust, tolerance, and values are crucial for economic development (Inglehart, 2000). Tr ust is necessary and it is also a major resource for starting and sustaining new enterprise s (Cohen, & Fields, 1998). For the most part, Latin America is stuc k in the backwardne ss of social and governance dysfunction. In Latin America, sinc e there is a lack of trust, it has been difficult to stimulate entrepreneurial activity and investment in business development
25 leading to more jobs, innovation, and incr eased productivity; factors that the Chinese bode well in (Thomson, 2007). Latin America has seen many decades of dysfunctional polity, which has decimated many traditional cultural and social structures. Therefore, this has left many Latin American societies bereft of trus t and social capital (De Ferranti, 2004). In a study created by M.B. Neace, with th e purpose of giving understanding to the significance of trust, it was f ound that the entrepreneurs that he interviewed over the past decade that have succeeded have done so by developing socio-economic networks, built on trust of their own behavior. Neace conclu ded that trustworthy entrepreneurs have a contagion impact throughout their networks. As the enterprises gain market success, the trust component becomes more important, whic h serves as an inspiration to members of the networks because of the realization of both social and financial rewards (Neace, 2004). This kind of success leads to respec t for diversity, necessary for innovation and increasing productivity, elevating levels of civil society in communities where these socioeconomic networks are active. As Cohe n and Fields put it, trust and social capital created by entrepreneurs have benefits for the larger society fa r beyond their immediate organizations (Cohen & Fields, 1998). In developing countries like Colombia long-term economic progress depends on the growing networks of sma ll entrepreneurial enterprises (Birch, 1979). For many of the economies in the Latin American countries, th eir progress requires a dynamic interaction of culture and trust amon g a host of actors. Several countries, such as Argentina, Br azil, Costa Rica and Mexico have started to move toward civility but the results are mixed. Argentina currently faces some civil
26 unrest and economic downfalls because of poor governances regarding the economic policy (World Bank, 2006). In fact, Latin America is faced with poor governance, particularly Colombia, which is no stranger to civil unrest. Civil unrest is attributed to low levels of trust. As Fukuyama puts it, economic development parallels the movement toward democratization, the gr owth of civil society, and a culture that has a high amount of trust (Fukuyama, 1995). Consideration and due appreciation of the culture of under-privileged sectors is a key point in the crucial matter of collective identity and self-esteem. Poverty is often accompanied by the depreciation of cultural values (USA Today, 2006, Nov. 28). Others look down the culture of the poor upon as bei ng inferior and backward. Cultural patterns of the poor are sometimes blamed for be ing responsible for their poverty. Not appreciating their culture means weakening thei r identity, and that w eakening can lead to feelings of low individual a nd collective self-esteem. In the recent decades, Latin America has witnessed corruption in all aspects of society. This has ultimately resulted in reduced economic growth. Using data on national level of corruption from 1997 a nd individual opinion from 1995-1997, it was found that Latin America is aware of the se riousness of corruption in their countries (Transparency International 1997, CPI index) Pervasive misconduct may poison public sentiment toward democratic politics. Political corruption is a si gnificant problem in Latin America, where corruption scandals tarnished many Latin American gove rnments in the 1990s (Gould, 2006). In Brazil, President Fernando Collor de Mello was forced to resign following a chain of scandals involving an influe nce-peddling ring during the electoral campaign, and reports
27 of a lavish private life. In Venezuela, Carlos Andres Perez was suspended from the presidency in the midst of impeachment proceedings that were initiated following news of his misappropriation of public funds. In Ecuador, the media uncovered evidence that President Bucaram stashed away for himself money that had been raised during a Christmas telethon to help the poor. This tr iggered a political process ending with his removal by Congress for mental incapacity (S tapenhurst, 2000). Recent history in Latin America illustrates both the extent of corrupt ion at the national level and the difficulties of combating it. Since the early 1990s, ni ne Latin American presidents or former presidents have faced judicial proceedings or have been dismissed on corruption charges. Political corruption raises several issues regarding the relationship between citizens and their governments. At one level, when the highest authorities are frequently implicated in electoral manipul ation, financial scandals, or the abuse of public resources to achieve personal benefits, their bases of authority and legitimacy may be undermined. At another level, corruption constitutes a violation of th e unwritten contract between citizens and public official. Political corr uption distorts public demands, increases the cost, reduces quality, and delay the competition of public works. It also delays access to public administration for those people who do not pay bribes and reduces the productivity of all those involved with th e state (Delia Porta, 2000). Corruption reduces investment and slows gr owth for a variety of reasons. Either parties to the transaction do not report bribes. This deni es the treasury needed tax revenues. Public services are focused towa rd assisting those who pay bribes, denying those services to those who do not. Bribes enable service pr oviders to ignore established standards and offer substandard goods or se rvices from which the economy suffers.
28 Corruption also weakens the rule of law. As a result, the transactions are made irrational from an economic point of view. The World Bank found that among countries in which bribery was both high and unpredictable, the rate of investment was half of what it was in low-corruption companies (World Bank, 1997). High levels of corrupt ion encourage businesses to go underground, which denies the government tax revenue and produces smaller, less effective governments. While corruption may have had its positive functions under dictatorships, it is seen as being dysfunctional under democr acy. Della Porta argues that corruption is both a cause and an effect of poor govern ment performance (Della Porta, 2000). Therefore, it reduces trust and the government s capacity to address citizens demands. Two decades after Latin America began re turning from authoritarian rule to democracy, public opinion in the region rema ins very conflicted. In most of Latin America, the majority of the public accepts democracy as the best form of government (Kauffman and Mastruzzi, 2005). But, ther e are many countries th at have sizeable pockets of authoritarian sentiment. Most Latin Americans are skeptical about key institutions of democracy, and Latin American s manifest some of the lowest levels of interpersonal trust observed a nywhere in the world (Payne, Zovatto Carrillo, and Zavala, 2002). There is a relative stabilit y of public attitudes and valu es in Latin America. Many countries in the region are not showing suffici ent changes in their political and social culture to indicate movement toward democra tic consolidation. In countries such as Colombia and Venezuela, public opinion data indicate that democracy is in serious difficulty. Democracy in these two regions has had a poor performance, which has
29 contributed to the decline of popular democr atic commitment. Economic difficulties in these countries have also b een a contributing factor. Political institutions command a low level of trust in Latin America. Low levels of trust among people constitute a declining feat ure of Latin American political culture. This low level of confidence in other people derives from a common regional heritage of distrust. This includes the hierarchical st ructure of authority at many levels and the passivity of citizens towards the patron, the lo cal boss, and the state. People are still accustomed to hoping that someone will solve their problems for them as opposed to solving it him or herself. Now they look to democracy to solve all of their problems. Latin Americans want democracy because they see it as a new type of patron. As Marta Lagos contends, these people want the rights but not the obligations of citizenship (Lagos, 2006). Official corruption and bureaucratic ine fficiency aggravate another problem in emergent economies by slowing down access to credit, thus making it difficult to create businesses and generate employment. For the poor, access to credit is almost impossible, given the difficulties they encount er in establishing legal owners hip of their assets. In an interview with PBS, Peruvian economist de So to credited the lack of property rights as the main reason why capitalism has not yielded the anticipated results in Latin American and other underdeveloped areas (de Soto, 1989) In the long run, the fact is that by denying the majority of the population full pa rticipation in the economy the system is endangering the implementation of economic re forms crucial to the prosperity of the nation.
30 Political clientelism has been a recurrent theme in studying the links between the poor masses and political elites in Latin Ameri ca. Clientelism has been examined as one of the possible relationships between the poor masses and political elites in Latin America. At a time when public discourse is dominated by neo-liberal rhetoric that stresses the salutary retreat of the state from markets, Javier Auyero argues that politics, and personal ties are important for gaining access to resources Clientelist networks are important because they fulfill the functions that the state is abandoning (Auyero, 2000). In Latin America, the widespread material deprivation, persistent joblessness and misery, and unmerciful economic pressure in the working-class ne ighborhoods have been caused by a combination of factors: the la nguishing of the wage-labor economy; the casualization of blue-collar j obs, and state-neglect provoked by structural adjustment policies. According to Ricardo Ffrench-Davis, ther e is a need for reforming the Latin American economy (Ffrench, Davis, 2005). Short-term macroeconomic balances affect long-term economic performance (Ffrench-Da vis and Tapia, 2004). However, a policy that increases the rate of us e of productive factors will contribute to long-term growth only if its positive effects are permanent. Latin American countries (LACs) econo mic reforms in the 1990s (trade and financial liberalization, larg e privatization processes, fiscal reforms), may have contributed to a recovery in actual GDP, but it was coupled only by a temporary and slight rise in capital formation. What is argue d to be needed are more structural reforms. Fostering investment must be given priority. After the implementation of liberalizing reforms in LACs, economic growth has been disappointing and investment rates have
31 reached historical minimum levels. Even in the three peak years of 1994, 1997 and 2004, productive investment was low compared to ratios in East Asia (MOFTEC, 2005). Economic reforms aimed to make room for pr ivate agents in a market economy have ended up damaging the environment for i nvestment, challenging the long-term development of the private sector. Economically, the greatest differences betw een the liberalization efforts of LACs and the way in which Asian countries, such as China have opened up their economies are that most Latin American liberalization progr ams have been carried out rapidly and the state has played a passive role (IDB, 1998). Whereas in China, for example, the economy has been a long, state-led process, involving the constr uction of a production apparatus oriented towards international markets. Most Latin American governments have only recently responded more positively to the need for modernization programs with sound macroeconomics. Among those analyzing economic reform in Latin America, there is growing recognition of the cultural or institutional factor as it operates on leaders. Countries with institutions of Spanish origin are characterized by personal relationshi ps that often impede political stability and broadly based and shared economic growt h. As Nobel Prize winner Douglas North wrote, Informal constraints embodied in cu stoms, traditions, and codes of conduct are much more impervious to deliberate polic ies (North, 1990). North traced Latin Americas limited and unequal development to the deep-seated inheritance from Spain. Mexicos Nobel Prize author Octavi o Paz pointed out the following: Though Spanish-American civilization is to be admired on many counts, it reminds one of a structure of great solidity-at once convent, fortress, and palace built to last, not to change. In the long run, that construction became a confine, a prison (Paz, 1979).
32 The region constituted by Latin America as a whole has the highest level of inequality in the world, as mentioned before and during the last three decades of the 20th century, inequality increased in most countri es of the region (Morley, 2001). There is consensus that this inequality is a seri ous obstacle to both poverty reduction and economic growth (Economic commission on La tin America and the Caribbean [ECLAC], 2004). Inequalities in landholding and political power originating in the colonial order are at the center of theoretical explanations for the deep roots of inequality in Latin America. After Independence, inequalities in assets and income was conditioned by reinforced inequality in political influence, and thus, in political in stitutions policies. This, in turn, perpetuated the vicious cycle of inequality. Latin America has a weaken record of democracy, less consolidated pa rties, and weaker organizations of the underprivileged, weaker labor uni ons and weaker partie s of the left (Bradley et al. 2003). The weakness of democracy obstructed the formation of strong political parties in general, and combined with the weakness of labor, hampered the development of parties to the left of center. This hampered forces that could build the re distributive capacity of the state and shape a model of political econom y that would produce growth with equity. The small proportion of formal sector in adva nced industrial countries had very different effects, covering a much smaller proportion of the population and t hus being regressive instead of progressive (Lindert, Skoufias, and Shapiro, 2005). The neoliberal economic reforms of the past three decades have had a further regressive impact, due to the shrinking of the already small proportion of the formal sector employment.
33 Scholars also have found very significan t differences among countries in Latin America, in terms of other dimensions. Fo r instance, some countries, such as Chile, Uruguay, and Costa Rica, have long been recogn ized as having more effective states and social policies than other countries in La tin America. Mainwaring and Sailly show important differences in the institutionaliza tion of party systems (Mainwaring and Sailly, 1995). In some countries, such as Brazil, stronger, more programmatic and disciplined parties have emerged more recently (Hagopia n, 2004). It has been demonstrated on the basis of elite and mass survey evidence that the degree of programmatic orientation and coherence of political parties varies greatly between countries and between parties within the same country (Luna and Zechmeister, 2005). Moreover, Colomer and Escatel show that citizens in Latin America find the left-ri ght dimension meaningful for the structuring of politics (Colomer and Escatel, 2004). The prime policy instruments for shaping th e distribution of income are taxes and social expenditures. In Latin America, the evidence for the distributive impact of social spending is more mixed and tends to be different for differe nt kinds of expenditures. Social security spending is regressive (F erranti, 2004). Social security schemes are typically tied to the formal sector and exclude the sizable informal sector. Even within the formal labor force, more highly educat ed force, more highly educated and more highly paid employees are the most likely to be covered by social security. Moreover, because benefits are tied to earnings, the system are highly segmented (IDB, 1998). In an analysis done by Lee, it is shown that the impact of government spending on inequalities is dependent on regime type (Lee, 2005). In authoritarian regimes, greater government spending is associated with great er inequality. In democracies, greater
34 government spending is associated with less ineq uality. This is very plausible for social spending in Latin America, where the main a lternative to democracy has been right-wing authoritarian not communism.
35 Chapter Two Informal Networks in China and Latin America It has been concurred that informal institutions, such as informal networking, matter for economic performances because they reduce uncertainty and lower the cost of transactions and productions (North, 1990). North emphasized that informal rules provide legitimacy to formal rules. A form al institution can achieve positive results if informal institutions such as customs, tr aditions, and codes of behavior support it. Kinship relations provide economic payoff to both Latin American and Chinese social relations. Lineage networks are a prominent f eature of Chinese and Latin American life. Informal networks exist in every society. These networks play an important role in maintaining political order and facil itating economic activiti es, not to mention providing social cohesion. According to Wang, there are three reasons why informal networks in Chinese society stand out more The first is that the degree to which informal networks contradict and undermin e formal institutions is high. Secondly, the influence of informal networks is unusually strong in every aspect of Chinese life. Lastly, the level of institu tionalization of Chinese networ ks is very low (Wang, 1997). The influence of informal networks in Chinese society is extraordinary. Historically, informal institutions, such as ki nship, ancestor worship, and ritual played a central part in sustaining political order in China (Chang, 1983). While informal politics exist elsewhere, it rules Chinese politics. The Chinese informal sector has been
36 historically dominant, with formal polit ics often providing no more than a faade (Dittmer, 1995). The role of informal networks in eco nomic production and exchange has been salient throughout Chinese history and in Chinese communities all over the world. In traditional China, family, kinship, and clans were not only social organizations but important economic organizations as well. Augmented by the stat e, these informal networks formed the basis of petty capita lism, which dominated the Chinese economy for centuries (Gates, 1996). During the reform er a, which is marked by the introduction and expansion of market mechanisms, informal ne tworks continue to feature prominently in Chinese economy (Boisost and Child, 1996). Chinese informal networks are less institutionalized. In Chinese politics, the ti es among member of a faction are secretive and do not have to be hierarchical (Lincoln, 1996). Transnational relations can be defined as regular interact ions across national boundaries when at least one actor is a non-stat e agent or does not operate on behalf of a national government or an intergovernme ntal organization (Rise-Kappen, 1995). A number of recent case studies of transna tional relations demonstrate that domestic structures mediate, filter, and refract the e fforts by transnational actors and alliances to influence policies in the various issue-areas Specifically, they find that the more fragmented the state structure, the less capable should national governments be to prevent transnational activities (Rise-Kappen, 1995). This leads to the point that the fragmented nature of Chinas political and econo mic system has been conducive to the transnationalization of informal networ ks facilitating foreign investment.
37 In addition to the fragmented nature of Chinas domestic structure, which makes room for transnational relations, the tens of millions of ethnic Chinese living outside China have been active agents of the tran snationalization of guanxi networks. Ethnic Chinese outside of China have a number of advantages over other foreign investors in resorting to personal networks for investment purposes. First, they have the cultural advantage, which has two aspects. One aspect of the cultural advantage is distinctively Chinese. It refers to their understanding of the Chinese language a nd the art of personal relationships in a culturally Chinese context. Wherever they live, whether in Hong Kong, Taiwan, and Southeast Asia, most ethnic Chinese know at least one dialect. The economic success of overseas Chinese in recent years has in large part resulted from the informal networks they have created (Ham ilton, 1996). These networks based on family kinship, and other types of common bonds provide an effici ent way for Chinese business people to obtain information, raise capital, reduce labor cost, and enforce contracts (Wang, 1997). The other aspect of the cultural advant age, which is often neglected is not uniquely Chinese. It refers to the pr actical knowledge of operating in developing countries where the institutional environment is similar to one in China. Ethnic Chinese have concrete human connection in China. Since ethnic Chinese have ancestral homes and roots in China, they can invoke these ti es as the basis of familiarity and close relationships. Moreover, many Chinese living elsewhere in th e world still have relatives and friends in China, with whom they can easily reconnect and de velop strong personal ties (Liu, 1998).
38 In China kinship networks function to prot ect private property rights and facilitate the growth of private entrepreneurship in China before formal property rights laws became effective. Max Weber observed that clan organization was preserved completely in China (Weber, 1951). He observed that this clan organization was the most important actor in the Chinese countryside, which ran schools, owned land and extended cheap credit to its members (Weber, 1989). This was transformed by the Communist revolution. The Communist Party made assaults on the lineage organizations. It c onfiscated clan communal land and injected the ideology of class consciousness a nd class struggle to diffuse clan identity (Wang, 1991). The economic foundation and organizational st ructure of the lineage system were replaced with collective farms and grassr oots administration from 1949-1979. However, the lineage culture became vibrant again during the market reform era. Despite changes, such as the shift from the extended to the nuclear family and the phasing out of prearranged marriages, some features of Chinese familism persist (Whyte, 1995). These features include lo yalty to the larger kin group s and sacrifice of personal interests for the sake of the family. The Ch inese society is organized by guanxi circles, extending from the family, to relatives and friends. Even though it is no longer considered a corporate actor, lineage remains the locus of collective action and normative cont rol in contemporary China (Bian and Ang, 1997). Those structural features are equal to social capital benefits Strong ties provide the bond obligations, cultural identity generaliz es bilateral bonds a nd obligations into group loyalty, and leadership and density help to mobilize resources into collective action and normative control.
39 In a study done by Yusheng Peng, he conc luded that kin solidarity and kin trust played an important role in protecting the property rights of priv ate entrepreneurs and reducing transaction costs during the early stages of market reform, when formal property rights laws were ineffective and market inst itutions undeveloped. Data was taken from 366 villages in 1994 to determine that kinship networks in Chinese villages have large positive effects on the development of private enterprises and insignificant effects on the development of collectiv e enterprises (Peng, 2001). Rural industry has been the most dynam ic sector in China over the past two decades and has played a crucial role in Chinas successful transition from a planned economy to a market economy. While Chinas gross domestic product (GDP) maintained an annual growth rate of 9.5% from 1978-1997, ru ral industry output achieved an annual rate of 27% during the sa me period (China State Statistical Bureau, 1998). As China moves away from a centrally planned economy, Chinese managers are still aware that with strong lineage networks, family businesses have a better chance to prevail (Hill, 2007). In China, familism a nd kinship loyalty are the social roots of economic development. Kinship solidarity refers to the norm of commitment to collective interests and goals of the lineag e group. Lineage remains the focus of collective action and normative control in co ntemporary China. St rong ties provide the bonds and obligations; cultural id entity generalizes bilateral bonds and obligations into group loyalty, and density help to mobili ze resources into collective action. Informal integration is very strong in East Asia, especially in China, compared to Latin America. Chinas economy is characteri zed by the lack of coherent business laws
40 and strong governmental contrast over limited resources (Marshall, 2006). Developing close relationships is a necessa ry step to succeed in China. By developing personal relationships, firms can enhance their mark eting effectiveness and efficiency. The Chinese use the guanxi networks, which are c onnections, accepted as a matter of course in China (Wesdenbaum & Hughes, 1996). In Ch ina, guanxi networks fulfill a significant function in a society that lacks a legitimate legal system. As Tsui & Farh explain it, a guanxi is the interpersonal relationships base d on specific criteria or ties (Tsui & Farh, 1997). A guanxi is a personalized and close busin ess relationship that is often considered a necessary condition to start a new business in China. Davies better defines guanxi as a set of personal connections th at secures resources or adva ntages when doing business or in the course of social life (Davies, 1995) Guanxi is an enormous force supporting the way in which the Chinese conduct themselves and do business. Guanxi makes up for the weak legal syst em in China. People establish and maintain guanxi through informal interactions Consequently, people tend to engage in guanxi activities privatel y, outside the official domain (Redding, 1991). Guanxi is a personal relationship and a fr amework in which people relate to one another as individuals rather than role occupants. It ta kes personal inte ractions and sentiment to initiate and maintain guanxi (King, 1991). In the economic realm, this means that transactions depend critically on personal rather than organization trust and relationship. It is also a reciprocal relationship through which peopl e exchange favors. The favors exchanged range from scarce resources necessary in daily life to professional opportunities and political suppor t. The exchange does not have to be immediate or
41 direct; indeed the return of a favor is structurally uncer tain (Yang, 1994). But, guanxi generally involves repayment of a favor in one way or another. Trust is an important foundation of gua nxi. Since guanxi is an informal relationship of reciprocity, it ca nnot rely on formal institutions guarantee of enforcement. Parties of a guanxi relationship can only rely on their confidence in each others desire and capabilities to fulfill their respective ob ligations. According to Wang, Guanxi makes up for the weak legal system in China in two ways (Wang, 1997). First, it has been used to complement law, classifying legal ambiguity and providing access to legal mechanisms of contract enforcement. S econdly, it has been used to secure business opportunities with high profit pot ential, compensating for the high risks of investing in China. Personal connections are impacted by the Chinese culture in a number of ways. The Confucian legacy is very central to personal connections. In Confucianism the individual is perceived as a re lational being, in other words, it is the focus of how well an individual gets along with another. Relationships among strangers are also very important. It is expected that the relations hip persists and that people know that other members of the network will be making judgments on their behavior. In this relationship, Confucian principles require the participants to do favors for each other, help those in need, and reciprocate favors received. As I mentioned above, the Chinese culture is based on relationships. Although the guanxi is based on networking, it is not to be mistaken as palanca or connections as they call it in Latin America. It is wr ong to make the assumption that guanxi is the theory who you know matters more than wh at you know. Bell writes that the guanxi
42 network has a valuation that surpasses connections. So ultimately, not everyone pertains to a network within which gua nxi operates (Bell, 2000). Because of the Open-door policy, the majority of foreign capital coming into China is provided by overseas Chinese, fo reign firms and joint ventures. The ethnic Chinese business networks are beneficial because information, capital and other resources are easily transferred across national borders. Informal networks, like that of the ECBNs also makes it easier for Chinese businesses to obtain valuable information necessary for their business activities. The use of networks is very important for the future development of the economy. The ECBN is a type of informal integrat ion that promotes regional integration in the absence of a free trade agreement. It is very important that attention be placed on the impact of informal factors that are playi ng a major role in the Chinese economy. The center of the ECBNs are concentrat ed along kinship and lineage. In the Chinese culture, the family is the primary ba sis. These EBNs have their origins in Confucianism, which places a great deal of emphasis on human relations. Trust is the major basis for ties among the ethnic Chinese. The basic conditions to build these ties are the common culture and norms. Ot her common bases for good ties among the Chinese include kinship coming from the sa me region and speaking the same language (Peng, 233). For the business networks to f unction there has to be mutual trust among individuals and firms and Chines e rely on these more than lega l contracts. The advantage of having a strong ECBN is that all the capital made by Overs eas Chinese goes straight to China to establish new production bases.
43 In Asia, China has the longest history a nd also the strongest influence on social and economic developments because a rela tively high proportion of the Asian population is of Chinese ancestry. For many years, these people have been called overseas Chinese, reputed for their aggressive, vibr ant and influential roles in Asia-Pacific profiles. Distinctive charact eristics include being hard-w orking, pioneering, progressive and acquisitive. The overseas Chinese as a group keep thei r cultural identities and they also develop their businesses along family lines A major difference between overseas Chinese and overseas Latin Americans is that the Chinese do not have any formal organization that coordinates their activities. The overseas Chines e do not belong to any political unity, as opposed to overseas Latin Americans who strive to develop into a political community (Duckett, 2001). Latin Am erica has always been easily influenced by Western ways. Although Latin America still has a reliance on family lineage, as the Chinese do, formal economic integration is dom inating that region. Formal integration refers to economic integration through regi onal institutions or comprehensive free trade agreements, such as the EU and NAFTA. In contrast, informal integration refers to integration through non-institutional means ba sed on factors such as ethnic ties and industrial linkages. It is through this informal integrat ion the reason why the Chinese economy is more developed. The operation of the ECBNs is informal and its commercial power is very strong. The networks make up the small scale of the overseas Chinese economy relative to the huge Western firms. The most important re ason for the overseas Chinese capital to go
44 straight to China is to esta blish new production bases. They take advantage of the cheap labor for their labor-intensi ve manufacturing firms. There are many advantages that come w ith ethnic business networks. Ethnic Chinese are skillful in deali ng with the governments in various countries and Chinese businessmen are well-known for having close tie s with various governments at all levels. In Chinas case, the ethnic Chinese have a far better understanding of the special characteristics of Chinese society that is taken into consideration when conducting business in China. As I mentioned earlier, trust is very esse ntial in Chinese econo my. The distrust that Chinese hold towards outsiders is reflecte d in their preference for highly centralized control of their firms. Only people w ho are known very well and trusted within a Chinese-owned company are invited to be sharehol ders and directors in the firm. It is the informal, personal ties rather than that be tween incumbents of office that is more important. For the Chinese, emotional trust is more important than cognitive trust, and is based on sentiment-based ties between individua ls, which may also be extended to others through the relationship ne twork (Duckett, 2001). Chinese businessmen believe that interper sonal trust minimizes fraud to ensure certainty and order. They maintain that by having guanxi, formal legal sanctions are not necessary to induce performance exchange. This can be settled informally with guanxi. Xinyong is also very important in Chines e business networks. Xinyong refers to the integrity, credibilit y, trustworthiness, or the reputation and character of a person. The initial trust is more of a pr esumption of trust of a social category. There is a higher
45 presumption of trust in relatives than in non-kin. However, after several business dealings, a non-kin can acquire Xiny ong through the quality of his work. Chinese business practices emphasize personal trust. Xinyongs underlying principals grants those who apply to it a hi gher sense of moral supe riority because it is based upon the honesty and integrity of individuals Since the use of verbal agreement is dependent on Xinyong, the non-use of written contracts symbolizes the extent of mutual trust between them. Sometimes this is compromised. An example of this is in dealing with a new client. For someone new, there may be written contracts involved. As time passes and the new client is known better, there are no written contracts. A possible source of challenge to the in formal business network comes from the use of the modern state. For example, st ress from credentialism and the emphasis on the objectiveness of science and technology may challenge the endurance of personalism. Mandatory requirements regarding formalized transactions may be demanded by the state (Marshall, 2007). However, overtime, thes e demands will create new standards as to what is appropriate and necessary. China is regarded as a country in which economic relations are strongly dependent on trust, while, at the same time, trust is difficult to build there. Chinese culture is often noted for its particular ism and insistence on building up trust through cultivating personal relationships into which it is difficult for foreigners to enter (Hickson and Pugh, 2001). Some identify the root cause of the issue in China as the underdevelopment of its instit utions compared to most ot her industrial countries, which permits corruption. This explains why the Ch inese do not extend trust easily outside their
46 familiar social circles and why foreigners find it hard to trust the Chinese on general principals. In China, private entrepreneurs set up and run non-farm operations such as single households or multiple households in part nerships, including both self-employed individuals and owners of private enterp rises (Marshall, 2007). Because legal enforcement of private property rights has b een ineffective, private entrepreneurs depend on informal norms for security. Chinese peasants do understand the difference between collective vs. private property. However, mo ral justice can be manipulated and is pale without the support of a social circle in solidarity. Enforceable trust reduces costs in social exchanges such as interpersonal loans and pooling of funds. In Chinas reform pro cess, private entrepreneurs have found it very hard to obtain bank loans due to political discrimination. Thus, informal financial institutions similar to rotary credit associ ations have been important channels for providing start-up capital or emergency cash for small-scale private businesses (Tsai, 2002). Studies have shown that the Overseas Ch inese have created informal associations to which co ethnic businessp eople from both the host countri es and the mother country have access. These networks facilitate trade across polities by building trust when contract enforcement is weak to nonexistent. The work of Greif ha s established the idea that co-ethnic networks can promote in ternational trade by providing community enforcement of sanctions that deter violations of contracts in a weak international legal environment (Greif, 1989; 1993).
47 If a business owner violates an agreement then he is blacklisted. For overseas Chinese, this is worse than being sued, becau se the Chinese networks will stay away from doing business with the guilty part y (Weidenbaum and Hughes, 1996). While trying to cope with local change s influenced by Western legal forms and concepts, China is enjoying rapidly increas ing foreign investment. Again, I place emphasis on the guanxi as it provides one of the most dramatic examples of an entrenched cultural norm under pressure fr om international business trends. During the past two decades, China has become a major player in world trade and has attracted substantial foreign investme nt (Knight and Song, 2001). With Chinas cautious integration into the world economy, important changes have taken place in the domestic business environment. These ch anges include increased privatization of business firms, a movement toward more emph asis on the rule of law, changes in forms of business operation, and increased competition (Liang, 2002). I felt it important to demonstrate that there are some scholars who believe that China is moving away from its established tradit ions. The significance of this is to show how necessary a component guanxi is to the Ch inese society. As Eakele y put it, China is showing an interest in the rule of law (Eakeley, 1997). Alth ough there is a growing interest in law, there are still problems of federalism and administration and corruption plague (Nikkel, 1995). When legal remedies are not effective e nough, shareholders rely on mediation or guanxi, which is the most common route. There are scholars who disagree on the deba te of whether China is moving toward a Westernized emphasis on the rule of law. Guthrie believes shifts in the economy have led China to redesign the legal system in a wa y that it would favor efficiency and produce
48 disincentives for guanxi-based transactions (Guthrie, 1998). He goe s on to explain how increases in the monitoring of industrial or ganizations decrease the reliance on guanxi. Others, such as Garten, disagr ee arguing that the structure of Chinas government will not be as important to business as the official s who are in charge (Garten, 1998). Besides Garten, there are others who agree that gua nxi will gain importance in international transactions because it provides a more eff ective means of conveying trust than formal legal contracts (Lovett, 1999). Privately-owned firms continue to emer ge, along with hybrid forms in which a governmental entity owns the majority of the sh ares and private investors own an interest. The Chinese government encourages privatiza tion as a means of increasing efficient decision-making and also tapping the flexibi lity of global capital markets. Although privatization encountered difficulties in the late 1990s, according to Dunfee and Warren, it is expected to accelerate especially when China is finally admitted to the World Trade Organization (Dunfee and Warren, 2001). In an attempt to sustain economic gr owth, China offers increasingly more attractive opportunities for fore ign investment. These opportun ities coincide with major changes in the legal and political environment such as the legalization of wholly foreignowned enterprises. Such ownership opportuni ties continue to attract foreign investors who do not want to bother with local bus inesses. Tung and Worms research on European firms conducting business in China co nfirm the assertion th at foreign investors desire a sole ownership in their Chinese business (Tung & Worm, 1997). Their research explains how these managerial preferences stem from the fact that they want to attempt to lessen the influence of the large cultural distance between Europe and China.
49 The growth of wholly-owned foreign ente rprises threatens to disrupt traditional Chinese practices the most, despite the fact th at any type of forei gn investment poses a threat to the Chinese business culture. Most importantly, these foreign-owned organizations may present competitive forces that conflict with guanxi traditions and thereby impact the effectiveness of an or ganization that relies heavily on guanxi. Dunfee and Warren explain the curren t debate of guanxi. They address managerial perceptions of gua nxi, guanxi ownership, and business uses of guanxi. They indicate that many argue that guanxi is deeply tied to the Confucian heritage of the Chinese people and entrenched in the Ch inese way of life (Yeung and Tung, 1996). If guanxi is deeply rooted in traditional Chinese culture, then economic forces alone should not be sufficient to bring about major cha nges in the practice. If guanxi is more artifactual, then it may change quickly in th e face of evolving background institutions and business conditions. To know how current Chinese view guanxi, Guthrie did a survey of Chinese managers. In that survey he found that so me view guanxi as increasing in importance while others believe that it is of less importance in the emerging Chinese legal framework. Guthrie summarized the view as stating that guanxi is diminishing in importance due to both increasing competition an d legalism. Those managers in higher institutions already have access to the bureau crats who facilitate bus iness transactions and therefore do not need to rely on guanxi as much as those managers in lower institutions (Guthrie, 1998). Dunfee and Warren do believe that ther e is an impact of guanxi on economic performance. There are certain macro c onsiderations supporting the claim that the
50 impact of guanxi is positive (Dunfee and Warre n, 1999). Guanxi serves as a means for signaling trust and credibility in a society in which such ch aracteristics are not supported by incentives embedded in strong background institutions (Lovett, 1999). It also constitutes an informal network allowing the by passing of the inefficiencies inherent in a communist bureaucracy. In this sense, guanxi is seen as a substitute for the rule of law. Xin and Pearce reported that pr ivate managers were more lik ely to rely on guanxi as a defensive measure (Xin & Pearce, 1996). Emphasis on personal power promotes the practice of guanxi, since an i ndividual defines what is permi ssible in a given context at a particular time (Yeung and Tung, 1996). The Chinese businessmen who have legitimate claims over resources are governed by the moral precepts of rightfulne ss, fairness, and equitability. The key question is to what extent moral justice is enforceable. Without the backing of legal sanctioning, the effectiveness of informal property rights depends crucially on the sanctioning capacity of social networks. The thru st of my argument is that kin solidarity and kin trust help to enforce the informal norms of property rights. For the Chinese businessmen, kinship networks help protect th em from predatory cadres, and thus reduce the uncertainty and high transa ction costs associated with insecure property rights and fledging markets. Ultimately, upon reviewing Chinas conti nued success over Latin America, it is inevitable to attribute the overseas Chines e economic success in China to guanxi and kinship. As noted by the American Cham ber of Commerce in Hong Kong, overseas Chinese receive better returns on their investme nts in China because they rely on family
51 members and friends who already possess guanx i to assist in business establishments (1997). The importance of guanxi in business deali ngs is accepted as virtually a truism in certain areas of Asia. Many have argued that understanding and practicing guanxi is essential for successful market entry and sustained success in China. As already described, guanxi is used to better facilitate efficient exchange. The ability to develop trust to create tightly linked connections between business parties is seen as a comparative advantage for firms. Gift-giving and entertainment used as a foundation for future business relationships ar e common in many cultures. This is very true in the United States wh ere a large industry supports business entertaining. These practices are based on the idea that humans are social creatures and that social relationships underpin many other types of interactions. A different use of guanxi is to apply it to overriding government rules and regulations. It may be the equivalent to coarse public sector bribery where payments are made to avoid environmental or safety regulations. Another reason why guanxi is an important component to the Chinese economy is because it is used as a facilita tor of business transactions in China. The need for a networked society is root ed in the insecurity that emerged in a close-to-subsistence level soci ety and lack of trust in the forces of modernization. Despite the fact that Chinas communist hi story of nationalist production has meant that people in China have had a different experi ence of business than people in the Chinese diaspora, it is regarded that the practice of networking is comparable given the shared Confucian history of ethnic Chinese throughout the world.
52 Luo suggests that the reason why guanxi differs from inter-firm networking in Latin America is that it is ubiquitous in pl aying a fundamental role in daily life (Luo, 2000). Latin Americans fight for rights and th e Chinese curry favor through guanxi ties. The Chinese focus on relationships created over long periods of time that are built on frequent exchanges. In China, interactions with others are viewed as part of a whole relationship, as opposed to the West, where bus iness and social posi tions are separate. Overseas Chinese Since Chinese civilization reaches back fo r more than four thousand years, the Chinese had the opportunity to migrate to a ll areas of the world. The overseas Chinese are widely distributed around the world and liv e in almost every c ountry. Finally, the overseas Chinese have had important social, economic and cultural influences in many of their host countries; moreover, th ey have also made important contribution to their home country of China. When referring to overseas Chinese, I used the definition employed by others: all Chinese living abroad (outside of mainland Ch ina and Taiwan). This definition includes all persons with any Chinese ancestry. The influence of the culture of overs eas Chinese on business is very well recognized. Firms owned by Overseas Chines e often belong to loosely interconnected networks of firms that prefer to conduct busin ess with one another. Confucian traditions, such as the primacy of relationships influe nce decision making in firms in ethnic Chinese communities. There is widespread acceptance th at the shared culture of overseas Chinese produces some common behaviors th at differ from the West.
53 As a group, Overseas Chinese businesses are a major economic force around East Asia. Chinese-owned businesses dominate i ndustries anywhere from food production to property developments. In 1997, the estimated economic output by the Overseas Chinese was about U.S. $500 billion (Zutshi, 1997). The overseas Chinese maintain a culture th at is not found in the West. Hofstede and Bond grouped these cultura l characteristics u nder Confucian dynamism. (Hofstede & Bond, 1988). Key differences include the link of the family to the business, the role of guanxi in doing business, and th e financing of the firm. In the Latin American society, the role of the family diminishes as the firms grow. As a small family-owned business grows larg er, they raise money in the public equity market. Even if the family remains a principal shareholder, the financial markets require that the firm be managed in such a manner that is consistent with othe r public firms. The Overseas Chinese firms function as family bus inesses whether or not the firms are traded publicly. Pressure from equity markets in Asia is le ss than that in the West. This is so because the levels of family ownership limit the degree of outside influence over poorly performing firms. This allows the top mana gement to govern the firm with less input from the outside. The primacy of the family in Overseas Chinese firms is further insured by the strong family control over key aspects of the firm even if it is traded publicly. There is a recognized tendency for thrift in the Chinese culture. This tendency has developed as a means to deal with the fr equent political and so cial turmoil that has negatively impacted various Chinese commun ities around East Asia. One consequence
54 of this is that Overseas Chinese firms rely more heavily on numerous lines of credit and short-term loans than similar fi rms in Latin America (Liu, 1998). Guanxi is one of the pillars that differentiate firms in ethnic Chinese communities (FECCs) from Latin American businesses. Thes e networks initially arose in response to the absence of strong legal traditions. W ithout legal support, th e relationships and connections provided a means to enforce, or sanction violators of contracts (Peng and Luo, 2000). Another differentiation between FECCs and Latin America is the central role of the owner-manager. In Chinese culture, the he ad of the family is the father and this individual is given respect. The owner of an FECC holds the position of Board Chair and has control of the firm and its decisions. In Latin America, an owner-manager can play a similar role in closely held family-owned fi rms; however, in FECCs, this role is common to organizations of all sizes. Therefore, in FECCs this owner-manager would hold the title of Chairman of the Board and will make all major decisions of the firm with little supervision from the outside. In Chinese culture, there is a tendency not to discuss negatives such as illness because it is believed to bring bad luck. This also holds true in business not only due to the potential for bad luck but also because it may cause a loss of face or respect among peers of the business person. Chinese family businesses (CFBs) use an informal and unstructured approach to FDI. They tend to send family members overs eas to be in charge of key management positions. According to Kao, many of the CF Bs ownership and managerial control are concentrated with in a single family Ka o, 1993). Some CFBs have become MNCs.
55 Competition has increasingly spread across na tional borders because of rapidly merging world markets. According to a study done by E.W.K Tsang, it was found that CFBs and nonCFBs have different approach es to attracting FDI. He did this study by observing 10 Singapore companies (Tsang, 1998). At the beginning stage of evaluating an FDI project, CFBs tend to have a less formal and structured way of collecting information and conducting analysis than non-CFBs. The negot iating team of a CFB consists of the boss/head of family and his immediate family. Non-CFBs is often la rger and consists of various functional managers. CFBs tend to assi gn family members to be in charge of key positions and they rely heavily on their boss visits to these headquarters and overseas operations. Strategic experience is maintained within the family of a CFB because of its highly centralized mangement control and stra tegic decision-making. Some CFBs have become sprawling MNCs. Examples incl ude the Hutchison Whampoa of Hong Kong and the Salim Group of Indonesia. To surv ive competition by foreign competitors a company should leverage its strength overseas (Peng, 2000). In a CFB, managerial ideology is shaped by Chinese cultural values such as clear hierarchy, reciprocal vertical obligation, and benevolent auto cracy. The internal system of coordination and control is highly personal. Tight control is exerted on financial and production management. In dealing with the external environment, CFBs make use of extensive networking an d relational contracting. These ne tworking activitie s also enable a CFB to transcend its own limitation of scale through obtaining access to resources owned by other network members (Powell, 1990). There are three main features of CFBs
56 that distinguish them from other family fi rms. The first two are Chinese managerial ideology and extensive networki ng behavior. The third feat ure is the way of business succession. Out of the 10 companies that were studied in Singapore, only three are CFBs. Singapore is a latecomer to the China investme nt arena. They had three main objectives to investing in China. Firs tly, the huge domestic market a ttracted them. Secondly, they wanted to establish a busine ss presence and gain strategi c positions. The third motive was to take advantage of the lo wer labor cost in China. When a foreign investor sets up an operati on in China, it has to negotiate with the government bodies concerned. There are inst ances where Chinese negotiators may use tactics that catch their West ern counterparts off guard. Th is is why foreign investors need to send their skillful negotiators to China in or der to achieve good bargains. Networking in Latin America As in China, the family is of fundament al importance throughout Latin America. Family ties are the basis of identity and orie ntation to the greater society and political system (Vanden and Provost, 2006). However, Latin America is quickly becoming more urbanized and as urbanization takes place, financial pressures have begun to reduce family size, but not family unit. In Latin Am erica it is the male that has a great deal of power. Effective political action is associated with the strong ruling style that most Latin American patriarchs display. It is tradit ionally expected that the Latin American politician exhibit characteris tics identified with the str ong dominant male, otherwise
57 known as machismo. Machismo is very much incorporated into the Latin American culture. In Latin America, classism and elitism exists and mobility and entrance to social circles or employment opportunitie s are still often defined by who one is and the circle in which ones family travels than by ones ac complishments and abilities. However, as Latin America becomes more urban and e ducated, the Latin American society will continue to change, and many of the old barriers will be challenged. From a historical and legal perspective, th e family in Latin America is represented consistently as the fundamental unit of society, and as an in stitution that is essentially patriarchal, based on a system of monogam ous marriage, and focused on reproduction. This vision is retained from the 16th and 20th century in spite of the remarkable diversity in family and household forms that existed in Latin America over time. The family as constructed through laws can be seen as the codification of an elite world vision, concerned with the legality of family ties, with the legal definition of marital and paternal power, the legitimacy of offspring, and the regulation of family wealth. The family as an institution in Latin Ameri ca has always been vital. Children in Latin America continue to utilize kinship a nd family relations in creative and adaptive ways even as they interact ever mo re strongly with the globalized economy. Globalization in Latin America also includes neoliberalism and free trade, which as exacerbated an already unequal distribution of income. One important characteristic of that distribution is that kinship relations have increasingly become segregated within particular socio-economic groups, as was the case historically until the 20th century (Bulmer-Thomas, 2003).
58 Oscar Lewis was one of the first to obse rve that aggregate data concealed the importance of the family as a building unit between the individual and society (Lewis, 1950). Charles Wagley similarly concluded th at there is a growing body of evidence that kinship relations and awar eness of kinship need not di sappear with industrialization and urbanization (Wagley, 1964) There is every reason to believe that kinship will continue to play an important ro le in ordering so cial relations. Antonio Gramscis idea of contradictory consciousness can be easily applied to the attitudes of working-class Mexicans to changes in gender relations and family structure in Mexico. Gramsci defines this as those who simultaneously hold uncritically to ideas and practices inherited from the pa st while they also develop new ways of thinking based on the practical transformations of the real world in which they are constantly engaged (Gramsci, 1971). This is a good description of how much most Latin America adheres to traditional ideas about the family, even as they are forced by circumstances to adapt family structure a nd roles to increasingly difficult economic circumstances and changing ideologies of the family. This, however, does not mean that to maintain kinship and family relations along with committing to the family has evaporated. In Latin America, both political and econom ic powers reinforce each other. One has to understand the politics of the region to understand the economy in Latin America. It has been seen that the Latin Amer ican governance is breaking down, as new movements strive to challenge traditiona l political leadership, traditional political institutions are losing legitimacy. Recently, th ere has been a growing discontent with the return of democracy. Many people feel th at they have been left economically
59 marginalized by the globalization process. It is acknowledged that the recent growth of democratic political forms and economic restru cturing have done very little to remove social inequalities. Neo-liberalism and the globalization process have had a considerable affect on the Latin American economies. There was a reductio n of inflation in most of Latin America, including Brazil and Argentina. There was al so economic growth in the early and mid1990s. Some of the wealthiest people in the world are generated from Mexico. This took place in the 1980s, when the larger economic groups were temporarily weakened by the economic crisis and the 1982 bank natio nalization (Vanden, Prevost, 2006). As a result, these large economic groups succeeded in reconstituting themselves with significant help from the government. New groups formed and both old and new benefited from the reprivatization of the banks. Despite this success, there is still the inequitable di stribution of wealth and income. The IMF conditionality and austerity measures that have become part of structural adjustments have crated a burd en on the poor, and many in the middle class (Thomson, 2007). Inequality and continued marginality for the masses have spawned major leftist parties that ha ve won many local and congressi onal elections. A growing number of workers have been forced to go into the informal sector to survive. According to the ILO, the informal sector arose as a res ponse to the inability of the modern sector to provide sufficient jobs (Franko, 2007). Low productivity in the informal sector drags the rest of the economy down. On the other hand, productivity levels in the formal sector have been advancing. Though there is a rising trend In the informal sector, Chile is the
60 exception. This is due to the fact that ther e has been a rapid growth in the economy and other factors such as the introductio n of private retirement accounts. Mexicos performance is an example of the cost and benefits of globalization. Mexico was quick to liberalize its curren t and capital accounts and to integrate its economy into the North American econom y. When the United States economy performed well, Mexico benefited. Grow th was export-led. The economy became less dependent on oil and manufactured exports became less dependent on the assembly industry. However, Mexico went into re cession as soon as the United States economy slowed down. The large size of these family owned busin esses presents a two-fold dilemma. On the one hand, their magnitude allows for ec onomies of scale that increase their productive capacity, efficiency, and immun ity to the economic hazards that characterize the Latin American environment. On the other hand, size augments their vulnerability to political controls and interventions. The structure of second and third generation of these businesses is also affected in important ways by entrepreneurial ventures of individual family members. In economies in which there are only limited investment oppor tunities, individuals create ventures in order to put their money to work. While owned by a single-family member, these ventures often become dependent on the larger family business as a s ource of clients and customers (WEF, 2007). For example, a sec ond-generation president of a large banking group started a private travel agency to provi de travel arrangements for the executives in the family businesses. The executives felt obliged to use the agency regardless of whether or not it offered the best services in the market. When several members of a
61 given family replicate this kind of activity, it becomes a form of moonlighting that can create conflicts of interest a nd dilute the overall focus and st ructure of the enterprise. As Woehrer puts it, loyalty to the family is paramount (Woehrer, 1988). There is enmeshment in these families because of the constant presence of a hostile environment in which there are vast differences between rich and poor. Wea lth, high visibility, stature, and influence make these families the targets of terrorism and crime. The Chinese, on the other hand have these type s of corruptions, but again, due the guanxibased networks, the corruption is not mu ch of a factor affecting its economy. The impact of the Latin American e nvironment on the inner working of the leading family enterprises can be examin ed by tracing the interaction between the economic, political, and sociocultural forces in the environment and the three basic domains: family, business, and ownership. Th ese domains constitute the family business systems as identified by Davis & Tagiuri (1986). Rapid growth also raises a number of ethical dilemmas that are unique to these societies. The Latin American economies ar e covered with micro enterprises providing goods and services of every variety. With th e entry of a commercial giant into a given sector of the economy, the existence of sma ll ventures is threat ened. In developed economies with multiple resources and options the high turnover of smaller businesses rarely threatens the to tal loss of livelihood and sustenance. In Latin America, the leading families vary significantly in their social va lues and political orie ntation. Therefore, families differ in the extent to which they are willing to handle the dilemma posed by unintended harm that may result from the growth of their business.
62 Family identity is powerful in Latin Amer ican societies as it is in China. In addition, family identity is inseparable from business identity for every family member (Tapia, 2004). In many families, selling a share in the company tends to augment the number of family shareholders who retain their stock ownership primarily for family rather than for economic reasons. This limits the effectiveness of a ttempts to consolidate the holding company stock of many family businesses (Hefferman, 2005). However, predominantly speaking in La tin America, the guanxi component that the Chinese have is missing. Family busine sses face the dilemma of long-term survival by not only overcoming difficultie s common to all economic activities, but also conflicts specifically arising from thei r family-business nature (Carlock and Ward, 2001). Often, family welfare and needs take priority with no consideration for the firms need for future growth. When the business is given priority, this usually occurs to the detriment of family communication. Research findings by Esteban Brenes and Kryssa Madrigal suggest that survival of generational transition or the family as a whole, re quire defining guidelines to anticipate conflict. These research findings indicated that family structure and agreements on issues concerning succession a nd business control all attempt to achieve family-business balance. However, all efforts targeted family preservation. According to Brenes and Madrigal, many families in Latin America rely on external members as a way to gaining objectiveness and to avoiding c onflict. Non-family members have proven important for family business development and communication. In Latin American family businesses, fam ily culture is strong. The role of the family in these societies is central to every facet of daily life. Family values, attitudes,
63 and behaviors are imported into the firm in a direct and forceful way, demanding loyalty and commitment from family and non-family members alike. Non-family employees are often treated like adopted memb ers of the family. Securi ty, caring, and inclusion are offered in exchange for performance and alle giance. Paternalism, which is the dominant management model, is the approach to the management of people that is protective and benevolent but also patronizing. Outsiders often misread the im portance of paternalism. There are a number of important factor s that contribute to the survival and proliferation of these organizations in Latin societies, but again, the Latin American society lacks the strong hold that China has. One reason is the lack of competition in Latin economies, coupled with the fact that many commercial niches are protected from foreign companies (Brenes and Madrigal, 2003). Another reason is that the social structure of Latin societies al so creates a climate in which members of the upper circles often support each others commercial activities (Fernandez-Kelly, 2006). In Latin America, popular capitalism exists and is created by the activities generally characterized as informal. These in formal activities, illegal but not criminal, take place in the absence of legal protecti on and guarantees. For example, the street vendor goals in Latin America are licit but must use illicit mean s non-compliant with legal regulations, non-compliant with labor la ws, and non-payment of taxes because there are no other alternatives. The street vendor cannot be incor porated in the formal economy because the formal economy imposes a heavy cost on Latin American societies as to make it impossible for people and entreprene urs with minimal income to enter it. Informality is a situation whereby people want to work legally, but cannot.
64 In Latin America, informal commerce and public transportation services are public and visible. There are two kinds of in formal industrialists in this region. One is the formal industrialist who informalizes part of the production as a result of the high cost of regulation of taxes. Even though he may conceal part of his pr oduction, he belongs to the community of established industrialists. In many cases the high cost of legality in Latin America has forced him to move part of his production to the informal sector. Therefore, he has to abandon the formal sector, or hide totally or part ially in the informal sector. That occurs every time inflation rises, which in turn, raises taxes. The other kind of informal industrialists is made up of artis ans and fully informal industrialists, who are employed illegally in the manufacturing sector. The origin of informality can be found in the inefficiency of the law. Activities are informal because of the cost of legality. In Latin America, the cost of the law is very high. Latin Americans measure the cost of the law when the cost of complying with it is greater than its benefits. Pe ople comply with the law when it is convenient. When it is not, they do not comply with it. From the law being so costly it distorts the market and excludes from it the leastfavored sectors of the population. There is informality in Latin America because people cannot work otherwise, given their small inco mes. They cannot comply with the law, cannot pay taxes, and cannot have access to formally built houses because they cannot afford it. In Latin America, there is a kind of capitalism where private property is not a right but a privilege and competition does not exist. The state takes it upon itself to create legal obstacles to mark et competition. This is where the difference between China and Latin America can also be noticed. Info rmal networks in China exist to motivate
65 economic development as a whole. In Latin America, informality is seen more as a means of survival (Thomson, 2007). In Latin America, the 1990s were a time of significant economic and political changes that altered the soci al landscape of the region, and promised to reduce the poverty that still afflicts the great majority of the population. It wa s the beginning of the privatization of state enterp rises and the opening of the economy to foreign goods and investment in countries where historically the government played a key role as promoter of development. Today, however, the situation could not be any worse, as evidence by the economic downturn that afflicts the region. Arge ntina has exemplified th e crisis, but it is by no means the only case: Brazil, Venezuela, Ecuador, Colombia and most nations of Central America also find themselves in a very delicat e situation. It is necessary to consider the impact of two cultural constructs on the success of any type of economic reform in Latin Ameri ca: 1) corruption and the ensuing lack of trust in social institutions, and 2) highly inadequate support for the creation of small businesses. According to Thomas Friedma n, the ability of an economy to withstand globalization depends on the quality of its legal system, financial system and economic management (Friedman, 2000). In Latin America, corruption has been a major problem, and in the context of a severe crisis, lack of confidence in public institutions can become a barrier to necessary reforms. Networks of reciprocal help abound in poor neighborhoods in Latin America. Enzo Mingione coined the term popular economy by which he means the combination of activities undertakes for dire ct subsistence and for low monetary income (Mingione,
66 1991). In small towns throughout Latin America, these activities incl ude raising animals, operating food stalls, undertak ing self-help repairs and buildings, and industrial homeworking in subcontracting chains. These activ ities have always been made possible by family and neighborhood networks to coagulate into a poor but socially protected way of life. Larissa Lomnitz showed in her study of a Mexican shanty town that social networks based on residence and kinship function as a surrogate system of social security for individual survival among the residents (Lomnitz, 1988). Proximate networks of reciprocity with neighbors and kins are well-studied elements in understanding how individuals confront the challenge of survival and the kinds of relations they establish in the process (Friedman, 2000). Reciprocal fa vors abound in the slum economies much as they do in other poor neighborhoods across the Americas. But with the escalation of unemployment and underemployment and the generalized reduction of income, these networks are being progressively emptied of their resources. The avenues that formerly linked the slum economy to outside wage work are now being disrupt ed. When rejection from the labor market ceases to be temporar y and income reduction affects every job that the unskilled residents of the poor neighborhoods can obtain, the soci al economy of the slum loses its traditional function as a buffe r that helps cushion the impacts of economic hardship. To fully understand the logic of clientel ist interaction, one must not only focus on the objective meaning of practices but also investigate the subject ive purposes of the actions of the actors involved (Colomer and Escatel, 2004). Once the empirical focus of the analysis is not only relati ons but also experiences, it can be seen that clientelist problem solving involves constructing pers onalized ties, an imagined solidaristic
67 community, and a protective and predictable network that buffers the harsh everyday reality of the slum. Relations of clientilist domination exist in practice as relations that are useful from the clients perspective for solving pr oblems, obtaining protection against the risks of everyday life, and making friends with someone who seems to really care. While much attention is being given to Latin Americas need to follow the steps of China, it is also true that a huge majority of Latin Americans are not even inserted into their own countries legal economies. More th an half of Latin Amer icans operate within the informal economy. While there are many Grameen-like banks now in Latin America, and growing numbers of established commercial banks ar e getting into the micro-lending businesses, many experts on poverty believe that the scope of these efforts are limited (Petras and Vieux, 1997). They do a great job helping the poorest of the poor, but they do not help the majority of the poor get access to larger loans that are necessary to start a small business, hire employees and become successful entrepreneurs. De Soto has argued that the best way to win the war over poverty is to give people legal property rights and a valid commercial identity that would bring them into the formal economy. That would allow millions of Latin America to use their homes as collateral to get bank loans to start a new business, or to convince others beyond their immediate family members to lend them mone y for commercial proj ects. As it is now only the Latin American elites have access to the tools to cr eate wealth. De Soto claims that there needs to be enabling rights in Latin America. There are many prohibitive rules,
68 but there are no enabling rules, that would allow most people to embark on commercial deals with strangers (De Soto, 1989).
69 Chapter Three Foreign Direct Investment in China and Latin America The purpose of attracting foreign direct inve stment (FDI) is beneficial to a region because it brings in capital, technology, and ma nagerial ability. It also brings a channel to access international markets. Policymake rs in less developed countries (LDCs) know that FDI is paramount in accelerating economic growth in the current global economic environment. The behavior of economic activities cannot be explained without reference to the role of social and cultural factors (Hav ey, 1988). FDI is produced through a complex historical process of embedding, in which th e cultural, social, political, and economic characteristics of the national home base pl ay a dominant part (Dicken, 1992). These arguments suggest that the importance of political and cultura l factors should be considered when analyzing FDI. In the competition for limited foreign capital, states adopt strategies to maximize the favorable impact of investments. States must compete with one and other for limited investment by pursuing outward-oriented econo mic and trade policies to attract inward FDI, while trying to ensure that the lo cal firms benefit from such investments (Ramamurti, 1999). According to Ramamurti, developing countries ha ve not privatized faster because bureaucratic in terests, institutional constr aints, and economic rigidities have slowed the pace.
70 Latin America and China both have different patterns in developing FDI. China has the dual-track approach, which is both import-substituting industries and exportoriented industries (network-forming indus tries). Latin Americas incoming FDI has remained of the import-substitution-type, and the development of international production/distribution networks has yet to be seen. According to Kimura and Ando, there are three lines of thought that must be interpreted to explain the m echanics of international pr oduction/distribution networks (Ando and Kimura, 2003). The first line of thought is fragmentation theory. In China, location patterns are determined at the produc tion process level, and the fragmentation theory best explains the logic behind this. This thought is useful to analyze the patterns of FDI going to developing countries to formulate cross-border production sharing systems. Secondly, the agglomeration theory incorporates external economies of scale by introducing the concept of space from city plan ning. Finally, the third line of thought is the internalization theory of corporate firm s. Firms set limits to upstream operations by purchasing raw materials from other firms a nd sets limits to downstream operations by selling products to other firms. Ando and Kimura did a study on the proporti on of machinery in total exports and imports of major countries in the world fo r the year 2000. The study demonstrated that the share of machinery in Chinas total e xports and imports was large. This study suggested that there is an existence of activ e back-and-forth transactions of intermediate goods in international production/distribution networks of machiner y industries (Ando and Kimura, 2003).
71 It was also suggested by this study that countries in Latin America had a lower share of machinery exports than China. This is an indication that Latin America still has not yet formed networks in the machinery se ctor. In addition, the share of machinery imports was greater than expor ts; therefore, this indicates that the Latin American manufacturing production ac tivities still have the import-substituting type. In China, there is an abundance of hu man resources and stable macroeconomic fundamentals. Adding to these factors, there is the importance of de velopment strategies applied by East Asian countries. This is ca lled the network-forming-type FDI. This triggered the formation of international pr oduction/distribu tion networks by hosting FDI, extensive FDI facilitation, tariff reduction for semiconductor-related parts, and the duty drawback system. Ando and Kimura also demonstrated in another study that the Japanese commitment to Latin America in terms of FDI has been very low when compared to Japanese commitment to China. It was f ound that in China, manufacturing firms own over 60 percent of the affiliates in the regi on (Ando and Kimura, 2004). However, in Latin America the share affiliates with manufacturing firms are only 35 percent. This indicates that manufacturing activities in Latin America by Japanese firms are much smaller than in China. FDI in Latin America It is evident that Latin America is one of the fast est-growing economies in the global market. The region is replete with natural resources and emerging service industries, which make it globally competitive. FDI into Latin American countries
72 almost doubled from 1985 to 1998 (Characteris tics, 1999). More U.S. FDI flows into Latin America than to the Middle East, Asia -Pacific or Africa (U.S. Department of Commerce, 2003). FDI in Latin Americ a reached a record $126 Billion in 2007 according to the UN conference on trade and development (UNCTAD). The strong FDI growth was driven by new investment and e xpansions. The pattern was the result of strong regional economic growth and elevat ed corporate profits on the back of high commodity prices (Latin Business Chronicl e, 2008). Howeve r, the one cultural distinction that appears to conform to expecta tion is the fact that greater collectivism in China attract more investment then in Latin America. There have been success stories from La tin America that we can attribute to market, such as Brazil. The Brazilian econom y is the eleventh largest in the world and the largest in Latin America. Former Pr esident Fernando Collor de Mello replaced Brazils import-substitution strategy with an open-market economy and began a process of privatization of the stat e-owned industries (Vanden and Provost, 2006). The lowering of tariffs on imports reduced the barriers that protected Braz ilian industry from international competition. This embarked Brazil on a new economic course, sloughing off decades of state-led gr owth and protectionism. Another former president Fernando Henri que Cardosa believed that dependent economies could develop in association w ith the industrialized world. During his presidency, inflation was defeated in Brazil. Currently, Brazil has been able to control inflation and fiscal austerit y. New programs such as Fome Zero (No Hunger), which guarantees sufficient food to Brazils poorest regions, have proved successful (Vanden
73 and Provost, 2006). The constitution has been amended, bringing social security and tax reforms. Brazil can be regarded as one of the wo rlds great emerging markets. Transition to democratic rule was successful, role of military in domestic politics is reduced and corruption is less acceptable (Woods, 2007). Al so, new social programs have been put into place for education and public health. Despite these advances, there are still soci al problems that not only affect Brazil, but also the rest of Latin America. These include poverty and inequa lity. Unemployment still dominates and there is a high rate of infant mortality. Redistributing income and achieving government expenditures in health, education, and land reform can stretch the budget even further and trigger inflation (P ayne, Zovatto, Carril lo, and Zavala, 2002). Brazil has consistently failed to achieve it s potential. Greater fiscal and monetary responsibility and low inflati on have not yet enabled Brazil to shift to a higher long-run sustainable growth rate. Ther e are numerous obstacles to faster growth in Brazil. The rate of investment is held back by low dome stic savings, as in so many parts of Latin America and unlike in China. High real interest rates discourage borrowing by the private sector for productive purposes. Its inco me inequality is one of the worst in the world (Payne, Zovatto, Carrillo, and Zavala, 200 2). Brazil does not enjoy the benefits such as high savings rates that are suppos ed to accompany an unequal distribution of income. Argentina has been a case study in the dange rs of inconsistent policies. In the 1990s, Argentina was the most neo-liberal eco nomy in Latin America with widespread privatization, complete capital account liber alization, and a large measure of trade
74 liberalization, and a large measure of trade liberal ization (Auyero, 2000). Economic growth stopped after 1998, and authorities had no instrument s at their disposal with which to stimulate the economy. The Cuban health system under the Castro regime has been lauded as one of the major achievements of the revolution. I ndeed, the Cuban revolution has attracted appreciable and worldwide attention because of these purported successes in health care access, infant mortality and life expectancy. In Cuba, health care is successful because half of all the currency earn ed in the country goes toward the health-care system. Cutting expenditures for the health care system is not an option. Despite the abundance of natural resour ces not one republic has achieved the status of a developed country. Unable to br eak into the circle of advanced capitalist countries, Latin America has remained a peri pheral region in which external influence has been preeminent (Bulmer, Thomas, 2003). There are several major urban areas in La tin America where laws and polity have changed to encourage foreign investments. This can be seen in Argentina and Costa Rica. Although there are changes, the benef its of economic growth are slowly coming to many rural areas including a lack of entrep reneurial development. This is due to entrenched elitists and po or governance including a lack of indigenous input. Latin American economic development falls into three phases. The first is traditional export-led growth based on primary products. This began slow and reached its height in the first decade of the twentieth century, only to fa de away in the wake of the Great Depression. The second phase is the in ward-looking development. This was based on import-substitution and peaked in the quarter century after World War II. The third
75 phase which is globalization, became dominant af ter the debt crisis of the 1980s (Lindert, Skoufias, and Shapiro, 2005). Argentinas success with exporting cattle showed that export -led growth could work well in the Latin American context. Most peripheral countries at the beginning of the twentieth century regarded Argentina as a legitimate model, envying its wealth of commodity export and diversified markets. During the inward-looking phase, the Argentine economy declined significantly (Lin dert, Skoufias, and Shapiro, 2005). It was the agricultural protectionism in the deve loped countries and the accumulation of policy errors during the inward-looking phase that led to the decline of the economy. The inward-looking phase was a legitimate response to the problems in international markets after 1913. The problem was that the phase began too slowly and did not become the paradigm for the regi on until world trade ha d started to expand rapidly after World War II. Eventually, the cost of the inward-looking model became too high, however at the beginning the benefits were substantial (Lindert, Skoufias, and Shapiro, 2005). For example, at the annual rate of growth increased for all republics. Ensuring the development of the economy has always been difficult in Latin America (Morley, 2005). In the presence of barriers, such as physical, economic, and financial, the initial stimulus has often withered away be fore reaching low-productivity activities in distant regions. Public polic y has rightly been seen as crucial in the destruction of these barriers. Sectoral policies have a long and often succe ssful history in Latin America. Meat in Argentina, coffee in Guatemala, and oil in Venezuela are all commodities for which the policy framework was an important ingred ient in the emergence of a dynamic sector
76 in the first phase of post independence deve lopment. However, inadequate fiscal resources and antiquated tax structures have usually prevented Latin American governments from making the expenditures need ed to increase the flexibility of the economic system (Morley, 2001). Potentiall y productive regions remained trapped by the lack of communications, unable to devel op an agricultural surp lus, and provide a market for industrial goods. In Latin America, it is difficult to find many manufacturing affiliates in industries different from their manufacturing parent firm as opposed to China, where it is easy (Morley, 2001). This means that switching in dustries within the manufacturing sector is rare in Latin America. Instead, almost all a ffiliates in industries different from that of their manufacturing parent firm are found in the wholesale trade sector. This point suggests that Japanese manufactur ing parents establish affiliat es in Latin America to sell products to local markets, sometimes with si mple local processing, rather than building dense production networks. From the study mentioned above, we see the difference in the development of international production networks between Chin a and Latin America. The contrast is generated by economic initial conditions a nd policy environment for incoming FDI. Annually, the Japan Bank for Interna tional Cooperation (JBIC) surveys the Japanese MNEs. One of the key questions asks for a list of countries that they think are potential destinations for their FDI in the short and longrun. In 2001 and 2002, China was the most important destination for fo rthcoming FDI. Latin America lagged way behind. Despite the size of La tin Americas market, there ha s been a barrier preventing Japanese firms from investing in Latin America.
77 The conditions that were important for attracting FDI to China were market potential and inexpensive la bor (Marugami, 2003). Intern ational producti on/distribution networks in China are being developed utilizing new economic login such as fragmentation, agglomeration, and optimal in ternalization. Conversely, Latin America has yet to succeed in developing such networks. With differences in economic background, regional trade arrangements would have completely different effects. With the formation of the FTAA, potentia l investors outside the region are likely to watch the formation process with optimism and concern. The concern includes that of a possibility of discriminatory treatment against non-regional investors. Most of the FDI in Latin America still have the import-substitu ting-type with trade protection. According to Ando and Kimura, if tariffs are removed by FTAA, incumbent investors will face more competition and be forced to reorganize th eir activities in frameworks beyond their national borders (Ando and Kimura, 2004). The pos itive side is that inefficient firms will exit the market while competitive firms will expand their operations. Ando and Kimura also state the MNEs from outside the re gion would face serious disadvantages in competing with intra-regional MNEs because MNEs must often import some of their key parts and components from their home count ry. This is due in part because local supporting industries in LDCs are typical ly immature (Ando and Kimura, 2004). Secondly, Latin American countries s hould construct and implement policy packages to stimulate the formation of in ternational production/di stribution networks. Also essential are policy measures to reduce service link costs and to encourage the creation of a critical mass of agglomerati on. With these points, Latin America can possibly learn from the Chinese experience.
78 Since 1995, three Spanish banks -Banco Santander, Banco Bilbao Vizcaya, and Banco Central Hispano-have become the largest foreign banks in Latin America (Maudos, 1997). These Spanish banks saw La tin America as a great region to expand internationally for many reasons: the comm onality of the Spanish language has made Latin America comfortable for the Spanish and permits easy communication; also, the Spanish banks already had some familiarity with the region. Although the timing and sequence of ec onomic and political opening differ by country, the logical historical reference point is the Latin American debt and banking crisis of 1982. Since then, and as the Latin American lost decade lingered on, democratically elected presidents came to power across the region. These governments, with the support of broad coal itions of the middle class a nd business interests, managed to introduce market-oriented reforms of the financial system incl uding liberalization of foreign entry. As Gross pointed out, fr om 1971-1987, the Andean pact countries barred foreign banks from owning more than 20 per cent of local banks (Gross, 1997). Thus, only recently have these count ries banking sectors become ripe for foreign investment. The Spanish banks were not the only ones to respond to the developing opportunity. Following the start of the Spanish push in 1995, a number of foreign banks also started to buy banks in Latin America. The two with the widest geographic scope were Bank of Nova Scotia and Hongkong and Shanghai Banking Corporation (Wang and Hu, 1999). There are three sets of explanations for the Sp anish banks rise to Latin American investment. The first is asset s eeking. The Spanish banks have been seeking to enter markets that permit them faster grow th and higher margins th an they are able to achieve at home. Latin America differs from the Chinese emerging market and the
79 advanced markets in terms of the developmen t of the banking sector (The Gazette, 2007, March 30). The ratio of money supply GDP is lower than elsewhere. Also, expenses in Latin America and interest margins are hi gher than elsewhere (World Bank, World Development Indicators, 1998). The second set is asset exploring. Th e Spanish banks are not just passive acquirers of assets. The Spanish banks believe that they have something to offer. That is, they believe that they can improve cas h flows in their acquisitions. The Spanish Banks have transferred knowledge from Spain to Latin America. One obvious parent contribution has been the introduction of an aggressive posture built on the introduction of new products. Wherever local regulations have permitted it, the Spanish banks have introduced the lottery-linked deposit accounts th ey offer in Spain (Guillen and Tschoegl, 1998). The banks also have improved the issuin g, pricing and term of mortgages relative to all the banks targeting the mass market of bank branches. Now that these countries are recovering from the lost-decade, the situation is one in which the opportunities for growth may not depend solely on taking market share away from others. In addition to asset seeking and explor ing, the whole expansion of the Spanish banks represent a case of o ligopolistic reaction. In the o ligopolistic reaction pattern that Flowers first identified, a firm matches th e location choices of a rival in a pattern of move-countermove (Flowers, 1976). In the ca se of the Spanish banks, a leapfrogging of leadership occurs so that at some point one can no longer unambiguously describe one firm or the other as the overall leader. Spanish banking FDI in Latin America requires understanding the shifting competitive environment of banking over the last decade. Financial deregulation and
80 privatization in Latin America have opened up new horizons, and have enhanced competition via product differentiation and eff ective leverage of new information and telecommunications and technologies. FDI in China China, up until recently, used to be a country with high barriers to foreign investment. Foreign investment is a recent phenomenon in China. Chinas regulatory framework for FDI has improved gradually ove r time since opening up to international trade. China, currently, is one the most attractive locations for FDI in the world (Benjamin and Brandt, 1997). The success of China in attracting FDI has been attributed to a variety of factors includi ng market size, a low cost of labor, liberalized FDI policy, political stability and improved infrastructu re. Much of the FDI in China can be contributed to its cultural and geographic proximity to major Asian sources, among which are Japan and the newly industrialized economies. Most of the ethnic Chinese companies are family-owned. Although in recent years some of them have been listed as publ ic companies, they remain under the effective control of the founding families. In addition to making investment in China themselves, ethnic Chinese outside China have also played a major role in facili tating FDI from other foreign companies. Foreign companies seeking to invest in China realize the advantages of ethnic Chinese in adapting to Chinas inst itutional environment. Many of them have used Chinese employees or middlemen to f acilitate their negotiations and operations, including Chinese students both returning to China and remaining abroad (Rubin, 1995).
81 In China there are still many overlap ping responsibilities between local government agencies and central government sectoral ministries and departments. Efficient public interest regulation is an e ssential part of devel oping and maintaining a policy environment conducive to private sector growth and investment. Unfortunately, according to Henley, Kirkpatrick, and W ilde, China has a poor reputation for transparency and bureaucracy (1999). Because China does not yet publish its rules and regulations, applicable laws are difficult to de termine. Property right s and contract laws are still weak. Moreover, language and cultural barriers, corruption and legal uncertainties also present difficulties to foreign investors. The existence of internal rules and regulations, which are unavailable to foreig ners, has long been a source of contention and uncertainty for investors. However, the above-mentioned problems can give the overseas Chinese an edge. Some overseas Chinese firms have managed to turn these problems to their advantage through informal channels such as personal contact and family connections. Through these networks, trade and investment inform ation is passed along and deals are done. Much of Chinas inward FDI comes fro m countries or regions with a large presence of Chinese or ethnic Chinese. Other factors besides ethnicity and common language have contributed to large FDI flow s from Hong Kong and Taiwan into China. These factors include geographic proximity, labor costs, and market potential. As Taiwan and Hong Kong are more technologically advanced a nd experience increases in labor costs, it is natural for businesses in thes e two regions to turn to China. China offers an unlimited supply of cheap labor and a potentially large market.
82 In 1995, there were about 55 million ethnic Chinese living outside mainland China (Yeung and Olds, 2000). The recent rise of East and Southeast Asia in the world economy has encouraged renewed interest in ov erseas Chinese networks. It is evident that ethnic Chinese networks do display flexibil ity and efficiency in certain settings and have been successful in Southeast Asia where market institutions are weak. Ethnic Chinese networks have been streng thened by the forma tion of large-scale formal overseas Chinese associations. Exampl es to demonstrate is since the 1960s about one hundred world conventions of overseas Chin ese associations have been held. Some associations enjoy strong financial support from ethnic Chinese business leaders and political backing from their local communities. China experienced tremendous growth in inward FDI during the last two decades or so. Prior to 1978 when the economic refo rms started, FDI was prohibited in China. Since then, FDI in China has grown to $45.3 billion by 1997 annually and total cumulative FDI has reached $220 billion. A ccording to UNCTAD China is the larges FDI recipient in the developi ng world (UNCTAD, 1996). In much of the 1980s, foreign invested firms were required to export a major portion of their output. Restri ctions on foreign exchange al so forced foreign invested companies to sell output outside China to earn hard currency in order to pay for imported inputs. Many domestic markets were clos ed to these firms. As a result, until 1991, almost all-industrial output by foreign invested firms was exported (Naughton, 1996). Given the limited access to Chinas domestic market, low labor costs should be an important factor explaining FDI in China.
83 By the 1990s, China became the second larg est FDI recipient in the world. There is a great disparity of FDI among regions in terms of geographical distribution. The open door policy started with the creation of the Special Economic Zones (SEZs) in the southern zones. The opening of other SEZs in coastal cities in the 80s followed this. FDI started to spread to other provinces when the authorities adopted more economic reforms in the 90s. The increasing openness of China to the outsi de world is seen in the fast growth of its foreign trade. Because China exempt s many goods from import duties, actual tariff collection has been lower. The collection rate has a very low percentage rate in China. When explaining FDI in China, two de terminants are considered: domesticmarket FDI is produced by size and growth of the host country (China Daily, 2003, Nov. 14). Export-oriented FDI mainly looks for cost competitiveness. To explain what impacts FDI in China, there are three factor s to consider. Thes e factors are economic structure, liberalization and pr eferential policies, and cultura l and legal environment. The strong market potential that China ha s to offer has attracted FDI. Many European and American multinationals have set up factories in China with the purpose to produce for the domestic market. Low wage co sts appear to have played an important role in attracting FDI to China. It has also been proven that provinces where the infrastructure is more developed have rece ived more FDI (China Daily, 2003, Nov. 14). Once a province has attracted a critical mass of FDI, it is easier for them to attract more FDI as foreign investors percei ve the presence of other fore ign investors. In addition, it is more efficient for foreign multinationals to locate in the same area. This allows them to share information and facilities. Th e coastal provinces of Guangdong and Fujian,
84 which are close to Hong Kong, have been the la rgest recipients of FDI and have acquired a significant advantage attracting FDI than the inland provinces (Sun, 1999). There are many theories of FDI that de monstrate the causes of FDI in China (Zhang, 2001). The location advantage of Ch ina possesses a large pool of unskilled workers. Growing countries or regions such as Taiwan and Hong Kong invest heavily in China to take advantage of low labor costs. However, much FDI in China is still unskilled labor-intensive production aiming at the export markets in the developing world. There were other reasons e xplaining why foreign firms set up production facilities in China. By 1994, foreign invested firms were able to sell half of th eir output in Chinas domestic markets. Even before Chinas year s of reform, many companies ventured into China realizing its large market potential. FDI tends to be more likely to promote economic growth when host countries adopt liberalized trade regime, improve edu cation, and human capital conditions. The growing interest in China as a host to FD I is a reflection of favorable economic performance and prospects, and policy regime s that are open to both international trade and capital flows. In comparison, Latin Am erica is lacking in both economic and policy attributes that stimulate FDI. There is an economic instability and political uncertainty dominating the region. In another study conducted by Jona thon Doh using a database of telecommunication projects in emerging mark ets around the world, they investigated how differences in the economic and cultural characteristics of Latin America and China affect private infrastructure investment. He found that in genera l, attracting private
85 participation telecommunications infrastructure investment is more diverse along cultural dimensions in China than in Latin Ameri ca countries (Doh, 2000). Chinese attracting investment are more individualistic, have hi gh power distance and have less uncertainty avoidance than Latin American countries attr acting private particip ation investors. By studying the telecommunications infr astructure, Doh also found that Latin American countries attracting pr ivate participation investors ha ve agreed to more telecom liberalization commitments, tend to allo w more competition and, therefore, less monopoly protection, and have lower tariff le vels than China (Doh, 2000). The Chinese attracting private participation investors are more diverse th an Latin American countries in terms of tariffs. In China, variations in institutional change across regions play a critical role in attracting foreign investment to a region. Gi ven the homogeneous and stable institutions settings across region s in the West, local regions comp ete only through various industrial incentive systems, such as local taxe s, to attract foreign investment. Chinas interior region is known for its poor physical infrastr ucture, inadequacy of human resources, lack of business philos ophy, and ailing environment (Sims, Schiff, and James, 2000). It is less attractive to fore ign investors than the coastal belt, however, the interior has received a signi ficant amount of FDI. In terms of the actual value, it was the recipient of 12% of all FDI in Chin a between 1978-2001 (MOFTEC, 2002). This is a small proportion in relative terms, but in ab solute terms, it its large. By 2001, 32, 993 foreign enterprises were established in inte rior areas with an investment value of $2 billion (SSB, 2002).
86 The relationship among FDI/foreign pa rent firms, personal networks, and institutional involvement have a hierarchical structure: the larg er the foreign parent firms, the more institutional involvement, while the smaller the foreign parent firms, the more personal networks are involved (Qui, 2004). It is argued that the embeddedness of FD I in personal networks and institutional involvement is perhaps best observed in periphe ral regions, such as Chinas interior. The economic conditions and policy environment in China vary substantially among regions, and there are major structural differences betw een the coastal and interior provinces. In the coastal region, economic reforms and an open door policy were introduced early, and as a consequence, the economy has become highly liberalized and has shifted from the traditional centrally planned system to a market economy (Sun, 1999). Because of their proximity to foreign countries and regions, the coastal area are more commercially advanced then is the rest of the country (Tsai, 2002). For example, certain economic innovations such as the encouragement of priv ate business and informal financing at the ground level appeared in places like Zhejia ng and Fujian (two coastal provinces) well before they were officially acknowledged by the central government (Tsai, 2002). Int contrast, the interior region experienced the preponderance of sociolist construction and heavy investment in central planning dur ing the pre-1978 period which has left it with a more conservative reputation than the coastal provinces. The interior appears to have a greater stake in preserving its old st ate-subsidized positions and exhibits more resistance to marketization processes. Furthermore, economic reforms and the opendoor were not introduced in the region until the beginning of the 1990s, a decade later than in the coastal areas (Sun, 1999). Thus, its institutional infrastructure is problematic
87 and less attractive to foreign investors. As a result, business and risk are greater in the interior than on the coast a nd provide the breeding ground for the existence of personal networks and institutional involvemen t to facilitate FDI activities. An understanding of Chinas processes of integration into the global economy will be enhanced if the interior is included in the analysis. The interior is important to the Chinese economy. It has always played a big role as an economic powerhouse for Chinas economic development and supplies Ch ina with a significant proportion of the raw materials that are required to create manufactured products. The rapid economic growth of the coastal belt over the past 20 years has depended heavily on the investors energy and minerals supplies (Chen, 2000). Recent Chinese regional policy has paid pa rticular attention to the interior. Throughout the 1980s coastal-interi or regional disparities ac celerated; the annual growth rate of the real percapita gross domestic product in the coastal areas was three percent faster than that in the inte rior (Wang and Hu, 1999). To attack these problems, since the early 1990s, the central state has proposed channeling more investment into the interior. In 1999, the Great Western Development Strate gy, was launched with the aim of steering state investment, outside expertise, forei gn investment, outside expertise, foreign investment, and private capital into the parts of China that are most in need of and the least likely to attract aid on their own. FDI has been playing a more important role in the economic development of the interior and the integration of the interior into the world economy. FDI has been one of the most significant features of Chinas ec onomic reform and opening up to the outside world since 1978 (UNCTAD, 2003). Throughout the 1980s because of Chinas
88 adoption of a coastal-biased re gional policy, the majority of FDI went into the coastal region. FDI has contributed significantly to the opening-up and catch ing-up processes of some of the interior provinces. It is predicted that the role played by FDI in the economic development of the interior will be greater (Lane, 1998). Foreign investors have become more familiar with the market and intend gradually to increase their participation in less-developed areas, where land and labor are cheaper than in the coastal areas and the market potentials have been largely unexplored. A case study of Shaanxi province done by Ying Qui highlights the importance of personal networks and institutional involvement in determining the locational choices of FDI. Shaanxi is located in the middle of Chin a. Political institutions have a particularly strong influence on Shaanxis economy because the province has close linkages with the central state. In the pre-reform era, Sh aanxi was described as a transfusion economy, since its economic growth and development re lied heavily on constant transfusions of capital, subsidies, and grants from the central government (Lane, 1998). This had a great impact on its present economic structure. T oday, Shaanxi is the most important location in China in terms of the total number of military enterprises and its strength and breadth in science and technology rank third na tionwide (Liang, 2002). Shaanxis close relationship with the central government of fered the province new opportunities when the central government readjusted its regional policie s gradually to favor the interior from the early 1990s onward. The downside to the close relationshi p between the central government and Shaanxi is the political decentralization a nd transformation from a planned economy to a
89 market economy in the province has been slow compared to those in the coastal provinces. This factor increases the difficulty and uncertainty of investment and provide the breeding ground for personal networks and institutions involvement that consequently exert an important influence on FDI activities. There is enormous heterogeneity in the interior, and Shaanxi has some features that make it unique in the region. Shaanxi was chosen as a case study because it provides insights into some of the impor tant processes that shape FDI flows into Chinas interior. According to this study, economic consideratio ns are embedded in cu ltural and political considerations, which include personal networks, and institu tional involvement. This survey showed that the linkage between pers onal networks and inst itutional involvement is networks, which are prevalent in the everyda y life of Chinese society (Xin and Pearce, 1996). This survey also showed that the use of networks is not confin ed to individuals; it also operates it at the institutional level. Th e popularity of networks at the institutional level can be regarded as the use of persona l networks by groups of individuals. Qui clearly points out that the Shaanxi su rvey is not representative of Chinas interior as a whole. This st udy was done to just shed light on some important features of the embeddedness of FDI, in informal and fo rmal institutions, which contribute to an understanding of FDI flows into peripheral re gions. Economic activities, such as FDI flows, are socially, politica lly, and culturally embedded in time-space contexts. Many unsuccessful regions do not possess the advant ages enjoyed by successful regions, such as easy access to international markets. In this regard, formal and informal institutions can provide the basis for localized social and economic networks and contracts.
90 Chapter Four Labor Markets in China and Latin America The labor market is the medium through which labor moves from rural to urban areas. Scholars have not been able to come to an agreemen t as to how well labor markets have been functioning during the past two decad es in China. Some researchers believe that significant barriers still exist in Ch inas economy, and that the absence of wellfunctioning rural labor markets has delayed gr owth (Benjamin and Brandt, 1997). Others show that labor markets are used in a ssigning jobs and wages (Meng, 1995). Cook, Knight and Song all contend that healthy rural labor markets have emerged and are continuing to evolve in a positive directi on in China (Cook, 1999; Knight & Song, 2001). In analyzing the relationship between e ducation and the labor market, I found that in rural China, students returning to school are very low. According to a study done by Mincer, China stands out as having one of the lowest rates of return in the world. This would explain why labor markets in China ha ve not been functioning well. In other studies, it has been found that th e rates of return to human cap ital in recent years may be higher for labor market participants that are more like those in other developing countries. This would go along with the hypot hesis that better functioning labor markets in recent years are being reflected by rising returns to human capital. By researching other studies the one explan ation I found to be more consistent is that human capital has continued to be in creasingly rewarded in rural Chinas labor
91 markets. As de Brauw found, this is proof th at the labor market is improving (de Brauw, 2002). Increasing educational availability in rural areas would be a good policy instrument for increasing rural incomes. If rural education was ma de a top priority by Chinas government, then there would be an increase in rural incomes. Economically speaking, foreign investment s not only contribute to the overall output of China but also to the employment of a large proportion of the labor force. It is well-known that MNCs operating in less deve loped countries could have a positive or negative impact on the developm ent and welfare of the host country. Critics such as De George claim that MNCs exploit the less de veloped countries thr ough cheap labor, lower the cost of resources, and impoverish the less developed countries (De George, 1999). Advocates of MNCs agree that multinationals are less hostile than their local competitors to demands such as safe working environmen t and promotion opportunities in the interest of boosting productivity. In China, there are four major forms of enterprise ownership: the state-owned enterprises (SOEs), the collectives, the forei gn-investment enterprises, and other private enterprises. Kit-Chun Lam evaluated the ethi cal performance of the foreign-investment enterprises and compared them to local ente rprises with different forms of ownership. The difference between the behavior of foreign-investment enterprises and the other types of ownerships is th at the foreign-investment enterprise is allowed to compete in the market and is given more flexibility in their pricing and empl oyment decisions than the local socialistic enterprises. It also ha s a different business culture from that of the indigenous enterprises.
92 A direct contribution of fo reign-investment enterprise s to the welfare of the Chinese workers and the country as a w hole is job and income creation. This contribution is notable in China where the economy is far from full employment and plenty of useful labor res ources are available. Wit hout the foreign-investment enterprises, employment opportunities in China would have been much less. Furthermore, the foreign-investment enterp rises can also contribute to the earnings potential of the workers by increasing th eir labor productivity through the use of relatively more advanced technologies. Critics of MNCs argue that MNCs ar e drawing skilled workers away from indigenous enterprises, caus ing under-development of the indigenous enterprises. Chun Lam postulates that this argument does not appl y to China. The average education level of workers in foreign-investment enterprises is in fact slightly lower than that in stateowned enterprises, and is slightly higher than th at in other private enterprises. The reality is that foreign-investment enterprises do pr ovide employment to both low-skilled workers in China. Even if the foreign-investment enterprises employ more skilled workers in the future, it will only be good for the deve lopment of economy that human capital investment is stimulated by the presence of job opportunities for the hi gh-skilled workers. Foreign-investment enterprises are ethically good for China to the extent that they bring about desirable consequences of employment and income creation as they increase the growth potential of the economy and impr ove the welfare of the workers. A study done by Chun Lam resulted in explai ning that higher average wage in foreign-investment enterprises is consistent with the argument that foreign-investment enterprises are more efficient in the use of resources, more productive and therefore able
93 to pay higher wages to their workers. Chun Lam argues that if this were the case, the diffusion of technology and management skills fr om the foreign-investment enterprises to the rest of the economy is expected to genera te important positive external effects on the Chinese economy. In analyzing the study provided by Chun Lam, I observed that ethical performance of foreign-investment enterprise s is good compared with other local firms, and many common accusations against multinational corporations do not apply to foreign-investment enterprises in China. Foreign-investment enterprises have been morally good in creating employment and inco me, and offering wages higher than that in other local firms. They also promote th e growth of the economy by bringing in new technologies and raise labor productivity a nd income. In China where there is considerable unemployment and unutilized resources, the contribution of foreigninvestment enterprises in promoting welfar e through employment and income creation is important. The shift toward liberalization and econom ic restructuring in Latin America has provoked debate about reforming labor laws (Ffrench-Davis, 2005). The debate has raised a number of intriguing questions about current labor laws and institutions creating obstacles to structural adju stment. Another question brought to mind is if reforms are necessary, then what kinds of ch anges should governments adopt? In Reforming the Labor Market in a Liberalized Economy, Gustavo Marques writes that many labor laws in Latin America un dermine the capacity of firms to adjust to changing market conditions. While intende d to provide job security and limit competition, labor regulations impose costly restrictions on hiring and firing, sanction
94 practices that result in low productivity, and create incentive st ructures that result in high job turnover. Researchers who believe this theory argue that the governments role in bargaining should be limited to enforcing la bor contracts, and labor agreements should encourage work rules that improve efficienc y. At the same time, labor laws should aim to reduce strikes and conflict and establis h minimum standards for remuneration and occupational safety. Writing from a similar perspective, wr iters such as John Pencavel examined unions and labor movements in Latin America. He suggested that although unions can help promote democratization and raise pr oductivity, they often increase members wages and unemployment for unskilled workers. Gains made currently by unions may also reduce investment, which in turn, leads to less economic growth and lower employment in the future. Carola Pessino notes that despite structural reforms adopted in Argentina, employment growth has been slow while unemployment and wage differentials have grown. A number of factors may have led to high unemployment, but she believes that labor regulations also played some role. High payroll taxes, expensive severance payments, and rigid collective bargaining agre ements have reduced demand for labor and also created obstacles to labor mobility and wage flexibility in Argentina. Since Chiles labor laws and institutions were transformed during the period of military rule, they often figure prominently in discussions about the impact of labor reform in Latin America (Lear and Collins, 1995). Since the resumption of democracy, unions have fared better, although collective bargaining remains decentralized and the rate of unionization fell between 1991 and 1996. However, the government has taken
95 steps to promote talks between employers and unions, and these discussions have resulted in important policy changes. Scholars cast doubt on the claim that st rong labor standards have affected employment negatively. While labor-law re forms in the early 1990s increased employer severance payments for layoffs, job creati on remained strong throughout the decade. These scholars argue that macroeconomic stability has been far more important in job creation than institutional factors (Fernandez-Kelly and Shefner, 2006). Since the early 1980s, labor-market conditi ons have worsened throughout most of Latin America. Some researchers, such as Petras and Vieux, have focused on the IMF and other international organi zations linked to the U.S. government in explaining the spread of adjustment programs throughout Latin America. They suggest that the U.S. companies pursued structural adjustment because these policies guaranteed U.S. companies greater opportunities in Latin Amer ica, while debt-service payment helped shore up a weak U.S. economy (Petras and Vieux, 1997). Petras and Vieuxs analysis of the polit ical responses to neoliberal reform is considered by some to be unsatisfactory on se veral different levels. The authors fail to note that the impact and strength of political movements against neoliberalism vary from country to country. They provide little evidence to support th eir assertion that widespread protest against lib eralization is spre ading throughout Latin America (Petras and Vieux, 1997). The authors also fail to pa y attention to organi zed labors activities during the last two decades. If they included more information on labor movements, they might have noted that some unions have suppor ted reform in exchange for certain wage and employment concessions.
96 Although Latin American countries attracti ng investment are higher in terms of uncertainty avoidance than their Chinese counter parts, project sizes are larger and tend to be more diverse, and there is greater privat e participation. This disallows the insurance of sovereignty and security over critical in frastructure. These projects tend to have relatively smaller shares of investments by ot her nationsstate-owned enterprises, which is pro sovereignty. This coul d relate to collectivism considerations. But more work would need to be done to defend that. As Doh has suggested, there are learni ng effects among countries in regions so that countries may follow patterns set by others in their regions (Doh, 2000). His conclusions suggest that initial appro aches and investments in a newly open infrastructure market set a pattern not just for subsequent practices in that market, but also throughout the region. An additional factor is that the same principal foreign investors tend to participate in multiple proj ects within a given region. For example, as Dohs study suggest, companies such as Telefo nia and France Telecom have been active investors in Latin America and have partic ipated in multiple projects in the same countries (Doh, 2000). Hence, there are various results that have derived from regional homogeneity: early investments that set a pa ttern followed by later project transactions within a specific country, the participation of a limited number of investors in multiple projects who adopt similar pract ices in the range of projects in which they participate, and cultural homogeneity in th e region would tend to increase the potential relevance of learning within one market and the region for valid transference with in the region, despite evidence of greater project di versity in Latin America.
97 Latin American labor codes favor full-time indefinite employment over part-time, fixed-term, or temporary contracts. These t ypes of contracts differ not only in the length of the employment relationship, but also in the conditions for termination. Latin American countries severely re strict the termination of a c ontract. Labor codes mandate a minimum period for notifying workers prior to termination, determine which causes are considered just of unjust causes for dismissa l, and establish compensation to be awarded to workers for each possible cause of termination (Marquez, 1998). Most Latin American nations retain strict labor regulati ons that make it difficult to dismiss employees. Hiring has become cumberso me. As a result of this, Latin American employers find it difficult to adapt to quick ly changing economies and business demands. Employers in Latin America today are ha mstrung by protectionist measures. In Nicaragua, it is insufficient grounds to di smiss an employee when somebody else does his work. Even in some countries where re dundancy is a justific ation for dismissal, employers must notify and seek the approval fro m third parties, such as labor unions or labor ministries, before they fire someone. The cost of firing an employee can be pr ohibitive. In Brazil, the combination of advance notice requirements, severance packag es and penalties is the equivalent of paying three years of the fired workers salary. Hiring has also become costly. As soon as someone is hired, the employer has to pay payroll taxes and make social secur ity payments to cover everything from a retirement fund to health and unemployment in surance. This is typical, even in the developed countries but, in the Latin Am erican economy, economic development is
98 highly impacted. Today, such payments ar e two to three times higher in Argentina, Brazil and Colombia than in the Un ited States or Norway (OECD, 1999). According to World Bank data, Latin Amer ica suffers from the greatest imbalance by keeping strict regulations to protect those already employed and making it more expensive for employers to hire new worker s (World Bank, 2006). Therefore, piecemeal jobs are created. Today, an estimated 23 million people in Latin America are jobless and 103 million work in an informal job sector that includes people selling goods on the street as well as day laborers. In some Latin American countries, this informal sector makes up to 60 percent of the labor force. This labor crisis explains why in opinion polls, Latin Americans want jobs over anything else, including pers onal safety, and would even consider a system different from de mocracy if it gave them jobs.
99 Chapter Five Business Funding in China and Latin America A survey of private firms conducted in 1999 by the International Finance Corporation (IFC), the private sector arm of the World Bank Group, revealed that about 80 percent of businesses in China considered their lack of access to finance to be a serious constraint. They reli ed heavily on self-financing for both start-up and expansion. In the case of post-start-up investments, th e sample firms continued to overwhelmingly depend on internal sources (World Bank, 2002). Among external funding sources, informal channels, credit unions, and commercia l banks were about e qually represented. Outside equity, including public equity, and publ ic debt markets played an insignificant role. As it is pointed out from the survey, internal sources tend to become less important as firms grow larger. External sources for the smallest firms are mainly informal channels and Chinese firms rely more on external sour ces of financing. The state owned commercial banks in China control about 70 percent of bank deposits and make about 70 percent of loan s (Mellor, 2004). SOEs account for 80 percent of outstanding loans while producing just one third of output (The Economist, 2004). There have been extensive reforms that have been instituted in recent years to address many of the problems in the financial system. An example is the new regulatory
100 regime for bank lending, a shift from a funds constraint to what is viewed as a capital constraint. This has encouraged the deve lopment of a large-s cale deposit gathering networks. While an earlier rise over 1994-1997 reflected FDI inflows, there was a decline in the rate of increase up to 2000 following the As ian crisis. The recent incline reflects continuing FDI flows (Ryan, 2004). While Chin as exports have been growing strongly, so have its imports. About half of China s imports are employed in further processing and over 40 percent of Chinas expo rts embody imports (Prasad, 2004). Theory proposes that international fi nancial capital flows should provide for a more efficient allocation of capital, including a greater diversificati on of asset holding for investors. Inflows should encourage improved economic growth performance by augmenting domestic savings, lowering the cost of capital, and facilitating the development of local institutions (Prasad and Wei, 2005). For achieving the benefits from capital liberalization, it is critical to have prudential controls and regulations, a stable macro economy and a supportive institutio nal environment. Chinas access to FDI has allowed more of the upside benefits wh ile compensating for the poorly performing domestic finance sector and problems with SOEs (Huang, 2003). Enforceable trust reduces costs in social exchanges such as interpersonal loans and pooling of funds. In Chinas reform pro cess, private entrepreneurs have found it very hard to obtain bank loans due to political discrimination. Thus, informal financial institutions similar to rotary credit associations (such as biaohui ) have been very important channels for providing start-up cap ital or emergency cash for small-scale private businesses (Tsai, 2002). The fledgling market system implies that formal and
101 impersonal channels of information flow ar e sluggish. Thus, social networks are essential in channeling market information. In sum, kinship networks confer all thr ee types of social capital benefits for private entrepreneurs. These three are the following: protecting private property rights, reducing uncertainty and tran saction costs, and building better bridges to market information and entrepreneuria l opportunity. Kinship networks lower the entry barriers and raise the survival and success ra tes of private entrepreneurs. Another reason why the Latin American info rmal networks are not as efficient as Chinas is because of the absence of opportuni ties for large segments of the population. The exclusion of some groups on the basis of their gender, ethni c origin, or social status explains why the Latin American economy is not as organized as Chinas. Instead of the informal networks stimulating growth in Latin America, it increases social exclusion. Narrow bands of trust preset small bu sinesses with hard choices. Low-trust societies are at a disadvantage in a global market place. The reason is because foreigners cannot be trusted in those so cieties. Growth only occurs sometimes when extended family members could be brought into the mana gerial ranks of organi zation expansion. Low-trust economies not only have limited oppor tunities for growth within their own intra-organizational networks, the narrowness of relational activity negatively impacts opportunities and well being of others in thos e communities. Most modern liberalized democracies are not hindered by cultural, bureau cratic, elitist, reli gious restraints. Latin America is a region with serious problem of poverty and lack of equity, which affect vast sectors of the population. As a result of this situation, it has been considered the continent with greatest levels of inequality. The mobilization of culture
102 can be a very valuable factor in the fight against poverty. The poor lack material wealth, but they do store an immense amount of cultu re that goes back for hundreds of years. Respect for their culture will help create fa vorable conditions for making use in social programs of their accumulated knowledge and traditions. Latin America is growing at a pace above its historical average, within the context of a strong global economy. Despite this grow th, there are important divergences when it comes to evaluating the economies as a whole. The high growth that has occurred in recent years is concentrated in those countries that faced a very serious crisis at the beginning of this decade, including Argentina and Uruguay, which faced serious problems from 1999-2002 (Montiel, 2003). Ve nezuela confronted another economic crisis of a similar character in 2002 and 2003 (Economist, 2004). The IMF warns that in the absence of more reforms, growth will slow down in the future. The IMF warns that Latin America is falling behind other emerging regions such as those in Asia, specifically China. The great challenge facing Latin American economies is to carry out reforms that not only prolong the curre nt buoyant conditions, but also reduce obstacles to future growth. There are three areas where Latin Ameri can countries need to commit to making reforms. They have to modify their tax a nd customs policy, since tax collections are at a very low level, and that leads to low budgets which are tied to the problem of rigidity, which does not allow them to apply appropria te spending policy. In Latin America, the allocation of revenues toward specific goals a nd the obligatory nature of certain expenses jointly absorb a substantial propor tion of the public deficit.
103 In addition, some governmental reforms ar e necessary in order to achieve more stable and less corrupt political systems. The IMF believes that growth in many Latin American countries will continue to be lim ited by the weaknesses of the State. The consequences of this weakness include deficien t public services; a fragile judicial system; high rates of crime and corruption; tax evasion, and a sizable informal economy. It is necessary for Latin American economies to undertake reforms aimed at achieving financial institutions that are stable and solvent, both in the public and private sectors. The most serious problem in Latin America continues to be the poor distribution of wealth. When it comes to poverty, the situa tion is not positive. Poverty rates remain extremely high. The data about the regions contribution to global GDP are clear, and other emerging regions. In 2003, Latin Ameri cans contribution to gl obal wealth fell to 4.3%, while Chinas grew to 3.9% (World Bank, 2006).
104 Chapter Six Latin American and Chinese Economic Situation These last couple of years has been good for Latin Americas financial markets. Currencies in Brazil, Chile and Mexico gained against the dollar on sp eculation that local yields will maintain their attractiveness in antic ipation of the US Federal Reserves halt as interest rates increases. A diversity of deals are con tinuing apace, from Colombias $1.13 billion buyback of dollars led by Gold man Sachs and Merrill Lynch to Mexican household goods manufacturer Controladora Ma bes sale of $200 million in privately placed notes (Economist, 2004). Despite the deals being made, these accomp lishments are products of the regions financial performance, not its competitiven ess. Unless Latin America becomes more competitive, it will become irrelevant in the global economy. The regions remarkable growth trajectory is unimpressive when one considers the decline at the beginning of the decade (Montiel, 2003). Also, Latin Amer ica is growing economically almost exclusively because of external factors, especially a growing world economy and high commodity prices. The Latin American economy has grown at a five percent rate for the past five years, but Chinas has been growing at a 10% rate for nearly three decades (Hill, 2007). In terms of poverty reduction, th e context is even st arker. China cut poverty from 50% of
105 its population in 1970 to 19% presently. La tin America reduced poverty only from 43% of its population to 36% over th e same period (Hill, 2007). The Chinese, along with other Asian countries are guided by pragmatism and obsessed with the future, while many Latin American countries are guided by ideology and obsessed with the past. In an article written for the Washington Post, Oppenheimer relates the times he visited China and Venezuel a. Upon arriving in China, he learned that top government officials had recently welcom ed the entire board of directors of McDonalds. A few weeks earlier while traveling in South Am erica, he learned that the Chavez government had announced a three-day suspension of all McDonalds restaurants in Venezuela to teach multinationals a le sson. Ironically, while communist-ruled China is going out of its way to at tract foreign investors, several nominally capitalist Latin American countries seen to be trying to keep investors away (Oppenheimer, 2008). Latin Americas most troubling trend is its stagnation in education, science and technology. While the Chinese are creating incr easingly highly skille d labor forces, most Latin American countries have barely modifi ed their outdated educational systems (Hill, 2007). An example that Oppenheimer provides in Cuentos Chinos about the difference in education is that in China, children in all public schools begin English-language classes in third grade, fours hours a week. In Mexico, public-school students start studying English in the seventh grade tw o hours a week (Oppenheimer, 2005). Latin Americas global economic comp etitiveness ranks low and it is clearly eroding according to the latest rankings of both the World Economic Yearbook and the World Economic Forums Global Competitiveness Report. The highest-ranking Latin American nation, Chile, comes in at 23rd in the latter report, w ith the next two places
106 occupied by Mexico at 55th and Brazil at 65th (WEF, 2007), China ranks 11th (Marshall, 2006). Regrettably, Latin America has no t yet built a sustainable culture of competitiveness. The regions historical deve lopment, the institutions it has created and the leaders it has produced for the most part, have impeded the establishment of healthy, thriving societies where self-reliance, good governance, social justice, democratic capitalism and effective and transparent instit utions prevail, and institutions matter a great deal (North, 1993). It is recognized that Latin America ha s made significant progress during the last two decades in a number of areas that relate to economic competitiveness. These areas include prudent fiscal and mone tary policies, privatizations economic liberalizations and primary school enrollment. However, as Eduardo Fernandez-Arias and Peter Montiel found in their study Reform and Growth in La tin America: All Pain, No Gain, there has been insufficient depth and breadth of macroec onomic reform and a lack of structural and institutional second generation reforms (Fernandez-Arias & Montiel, 2001). If Latin America is to develop and sustai n a culture of competitiveness, which is a necessity not a choice, in todays global economy, it needs to undertake a number of measures. First measure would be to expedite and intensify economic liberalization. It is important to ensure continued, deeper e fforts to achieve macroeconomic reforms, including in areas where there has been slippa ge in recent years, such as public sector financial management and energy privatizati on. The second measure would be to adopt and implement second generation reforms. Prudent fiscal and monetary policies are necessary, but conditions are insufficient to achieve prosperity to all. Non-economic
107 measures to improve education, health care, housing, social services and infrastructure are essential. Another measure would be to institute comprehensive microeconomic reforms. Microeconomic issues are the ones that are felt most directly by business, workers and consumers (The Gazette, 2007, March 30). Fo remost among the microeconomic issues in need of reform are: regulations, taxation, ad ministration of justice, labor, research and development and financial services. In th e World Banks Doing Business in 2006, for business regulations in 14 countries, Latin Americas poor performance is nearly as miserable as that of Africa. In Brazil it takes 152 different steps and five months to start a business versus less than two nights in China (World Bank, 2006). Regulatory burdens are most harmful to small business and startups, the largest private employers in Latin America. Most tax systems in the region are char acterized by high rates and low collection. Also, corporate tax rates are hi gher than those in China. This is why tax evasion and capital flight are rampant. Latin American labor rules raise costs, create barriers to entry and introduce rigidities in the employment structure. These include the restrictive regulation on hiring and firing practices as well as burdensome soci al insurance schemes. While salaries may be low by industrialized nation standards, non-salary costs such as benefits, labor production taxes and severance can double the co st of labor. Hiring a worker is easy. Firing a worker is lengthy and costly. Despite some progress, Latin Ameri cas banking industry is inadequate, conservative, complicated and cumbersome. For the most part, bank activity is
108 dominated by trading government paper. Th e financing that is provided is often in syndicate for large preferred bor rowers. If it was not for the proliferation of credit cards and retailers providing credit to customers, such as Elecrtas Banco Azteca in Mexico, the working class would have even less access to consumer goods (Thompson, 2007). Latin America is becoming increasingly uncompetitive in a competitive world. In Cuentos Chinos a book by Miami Herald columnist Andres Oppenheimer, Argentine education minister Daniel Filmus writes, for the past 30 years, Argentina has not had a culture of excellence, nor a cultu re of effort, nor a culture of hard work. Our culture has rather been one of cutting corners and tryi ng to pass the grade rather than seeking excellence through effort, hard work and research (Oppenheimer, 2005). In historical context, th e regions descent is even more revealing. Between 1880 to 1930, Argentina was one of the worlds te n wealthiest nations. Before 1959, Cubas economic and social indicators ranked among th e highest in the world. While the world spread adoption of neoliberal reforms be gun in the 1980s has been laudable and highly significant, it has not been enough to create global competitiveness. Meanwhile, China has extended, deepened and quickened thei r economic reforms during the past decade (Tyler, 2006).
109 Chapter Seven Conclusion This thesis has suggested that culture clearl y matters for economic development. Culture is a dynamic process in and through whic h people define who they are, what they desire, and how they seek to realize thei r goals. From casual experience to formal analysis, it is evident that culture exerts real and effects on development outcomes and development projects. Ignoring culture has measurable consequences. Taking culture into account requires integrating informati on about culture into development economic analyses in an informed way. The values of a culture have a decisive weight in economic development. Throughout this paper, it can be seen that there has been de bate on the types of values, which have helped countries to attain sustained growth a nd significant social achievements. If the dominant values are concentrated on individualism, indifference to the fate of others, lack of co llective responsibility, lack of interest in the general good, the pursuit of personal enrichment as the central value, consumerism, and similar goals, the consequent forms of conduct may be expected to cause serious harm to the fabric of society and to lead to all kinds of regr essive effects, ranging from severe economic inequity. This gives rise to serious hindrances to sustai ned economic development. Research affirms the importance of cu ltural understanding to the development of partnership with international constituents (Baldauf, Cravens, and Wagner, 2000). I hope
110 to have accomplished my reasoning as to w hy China has passed Latin America in the economic aspect by using economic culture. Ch ina has strong cultura l ties with three of the industrialized economies (Hong Kong, Taiwan, and Sing apore). These ties go beyond sharing a common language, sinc e the majority of people in these source regions are ethnic Chinese. In review, the success of Ch ina in attracting FDI has been attributed to a variety of factors including market size, low costs of labor, liberalized FDI policy, political stability and improved infrastructure. While these factors do to some extent facilitate large inflows of FDI, less emphasized are China natural sources. Although policy measures that improve political and macr oeconomic stability as well as business environment are always at the disposal of policy makers, many natural advantages are country specific. The part of FDI in China that is due to natural advantages such as culture is not likely to be reproduced by other countries through economic policy (Marshall, 2006). Latin America is a major player in the world economy. Although there are numerous national distinctions, the countries can be thought of as distinct region, sharing significant cultural, linguistic, political and economic characteristics. However, the region is typified as developing. The region is characterized by deep-seated difficulties in creating locally owned, i nnovative industries based on sc ientific and technological knowledge. Enterprises in Latin America seem to have a culture that limits their ability to cooperate, especially when trying to make new innovations. Unfortunately, the state tends not to send clear long-te rm signals favoring the need for innovation and sponsoring
111 the elements that make it happen. Latin America tends to have a culture where information is hoarded, not shared. This results in a duplication of efforts, underutilization of available resources and a mismatch between supply and demand. Industrial innovation in Latin America faces si gnificant and deep-seated difficulties. In Latin America, the concept of the in formal sector was re adily adopted by the ILOs Regional Employment program, know n by its Spanish acronym PREALC. The economic goal of informal enterprise is to ensu re the survival of the individual and his or her immediate family in contrast to the goal of capitalist enterprise, which is to generate and accumulate profits (PREALC, 1981). Th is view was negatively looked on because informal enterprises were depicted as a simple survival mechanism. An alternative theory of informality was attributed by Hernando de Soto. He attributed the origins of informality to ex cess regulation of the economy. According to this view, the mercantilist Latin American stat e survives by granting the privilege of legal participation in the economy to a narrow elit e. De Soto argued that popular disregard for legal restrictions leads to de facto deregulation of the economy. More than a survival mechanism in response to insufficient job creation, informality also represents the irruption of real market forces in an economy straight jacket ed by mercantilist regulation. The role of personal networks and institutio nal involvement as facilitators of FDI should not be overstated. The prevalence of personal networks and institutional involvement would probably discourage foreign investors who lack th e appropriate links from entering the regions, which would ha mper the creation of a fair investment environment in the long term. However, my point in this thesis is that the use of personal networks and institutional involvement can pr ovide an alternative way to solve some of
112 the problems that underdeveloped regions face. For a transitional economy, this could be a practical and feasible solution to current regional problems. It is still too simplistic to attribute the different economic performance between China and Latin America solely to cultural di fferences. In other words, Confucianism cannot be the only answer to Chinas past success and for Latin America, the IberoCatholic culture is not the single cause of its relatively bad economic performance. However, the cultural approach has op ened a door for us to see why economic performance is different among regions and count ries. As Alvin Y. So and Stephen W.K. Chiu point out, the cultural a pproach is not aimed at redu cing economic development to a set of cultural traits (So, and Chiu, 1995). Rather, it relates development policy options and institutional choices to certain cultural antecedents that make the reason for such elections easier to be und erstood. In other words, cu ltural perspective provides researchers with a frame of reference within which they can see how values, attitudes, practices or behaviors have influenced economic development in China and Latin America. This can be seen in the differences between family businesses in China and Latin America. For example, as suggested by Brenes and Madrigal, in Latin America, if family members strengthen their focus on the business philosophi cal area and family integration, difficulties commonl y found in family businesses would not be expected to lead to family conflict and disr uption (Brenes and Madrigal, 2003). Culture plays an important role in econo mic performance, as it can affect peoples behaviors and attitudes towards savings, educa tion, work ethic, and so on. Of all the factors determining economic performance, economic factors always stand on top.
113 Each culture has its own unique positive or negative components, but the positive ones cannot automatically create better econom ic performance in the absence of other necessary conditions like sound economic policie s, effective institutions, favorable world economic situations, and political stability. In other words, only in a favored economic and political environment can culture trigge r economic growth. This point might help explain why China made remarkable economic achievements during the past decades of economic reform.
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Role of culture in economic development :
b case study of China and Latin America
h [electronic resource] /
by Amira Fellner.
[Tampa, Fla] :
University of South Florida,
Title from PDF of title page.
Document formatted into pages; contains 127 pages.
Thesis (M.A.)--University of South Florida, 2008.
Includes bibliographical references.
Text (Electronic thesis) in PDF format.
ABSTRACT: The purpose of my thesis is to demonstrate the economic development of China and Latin America. My reason for choosing these two regions for my study is because they are both Third World Nations. My intention on writing this thesis is to prove that culture and the informal business networks of China are the major forces of what is driving the Chinese economy ahead of Latin America. I will explain how the definition of culture ties in with the economic society of both regions. In writing about culture, I will attempt to explain if there really is a difference between trust in each society. To better interpret this thesis, I came up with several variables of economy that will help explain each region's development. These variables are federal direct investment (FDI), labor, and funding of businesses in each region. In my study, I present the different approaches that are taken by each region to attract FDI. In addition, I will explain how and if informal networking is beneficial to the work force and the funding of businesses in each region. The majority of my research for this thesis consisted on reviewing past articles of scholarly journals. From these journals I drew conclusions of my own and compared them to other scholars' work. I also analyzed such websites like the International Monetary Fund (IMF) and the World Bank and various others to be able to come up with my own findings necessary to complete my thesis. To anticipate the conclusion, this thesis notes how important it is for each region to find its own unique way to attract FDI and how culture can impact the development of an economy. In my thesis, I am including the importance of trust in the society and the significance of the informal business networks on the Chinese economy.
Mode of access: World Wide Web.
System requirements: World Wide Web browser and PDF reader.
Advisor: Dajin Peng, Ph.D.
Foreign direct investment
Ethnic Chinese business networks
x Political Science
t USF Electronic Theses and Dissertations.