The conglomerate way to growth

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The conglomerate way to growth

CAMBRIDGE ? Countries do not become rich by making more of the same thing. They do so by changing what they produce and how they produce it. They grow by doing things that are new to them; in short, they innovate.

Many countries have been altering their growth strategies to reflect this insight. But they are being distracted by some of the greatest - but atypical - examples of success.

We all have heard of Steve Jobs, Bill Gates, and Mark Zuckerberg - twenty-something college dropouts who built billion-dollar companies at the cutting edge of global innovation. We have heard of the many start-ups that they and others acquired for hundreds of millions of dollars - Instagram, Skype, YouTube, Tumblr, and, most recently, Waze. So why not emulate these successes?

The key problem is that these examples are peculiar to the software industry, which provides a woefully insufficient blueprint for the rest of the economy.

The software industry is unique, because it has unusually low barriers to entry and ready access to a huge market through the Internet. A start-up is typically just a group of kids with a good idea and programming skills. All they need is time to write the code. Incubators provide them with space, legal advice, and contacts with potential clients and investors.

But consider a steel, automobile, or fertilizer plant - or a tourist resort, a hospital, or a bank. These are much more complex organizations that must start at a much larger scale, require much more upfront investment, and need to assemble a more heterogeneous team of skilled professionals. This is not something at which a young college dropout is bound to excel because he lacks the experience, the organization, and the access to capital that these ventures require.

And, compared to software development, these activities also require more infrastructure, logistics, regulation, certifications, supply chains, and a host of other business services - all of which demand coordination with public and private entities. Most important, these activities are most likely to be central to economic growth in developing and emerging countries. So, how will companies in these sectors arise, and what can be done to stimulate their formation?

Many developing-country governments are ignoring that question. For example, Chile’s government, obsessed with so-called “horizontal” policies that do not tilt the playing field in favor of any industry, recently implemented Start-Up Chile, a program with standardized rules to encourage new ventures. Although the rules were designed for all industries, the scheme attracts almost exclusively software ventures - the only ones that can be formed with the low level of support that the program provides.

Other industries face more daunting chicken-and-egg problems: countries lack the capabilities that growth industries demand, yet it is impossible to develop these capabilities unless the industries that require them are present. One way to solve this coordination problem is through vertical integration - firms that can solve internally the coordination of the supply and demand for any new capability.

That is why national business groups - conglomerates - often play a key role in transforming an economy and its exports. This is especially true in developing counties, where many markets are missing and the business environment is often extremely challenging.

Conglomerates can use their knowledge, managerial skills, and financial capital to venture into new industries. They can start things at a scale that would be impossible for a start-up. They can make credible commitments to future suppliers and influence the business ecosystem to make new industries feasible.

Consider South Korea. In 1963, the country exported goods worth less than $600 million at today’s prices, mostly primary products such as seafood and silk. Fifty years later, it exports goods worth almost $600 billion, mostly electronics, machinery, transportation equipment, and chemical products.

This transformation was not achieved through independent start-ups. It was done through conglomerates, or chaebol in Korean. For example, Samsung started as a trading company, moved to food processing, textiles, insurance, and retail, and then on to electronics, shipbuilding, engineering, construction, and aerospace, just to name a few activities. South Korea’s transformation was reflected in the transformation of its leading companies.

But, in many developing countries, conglomerates have not played an equivalent role. They have focused on non-tradable goods and services - those that cannot be imported or exported - and have eschewed international competition. They have focused on banking, construction, distribution, retail, and television broadcasting.

Once these companies dominate one market, they move to another that is equally sheltered from competition and devoid of export opportunities, often using their size and political influence to keep out would-be competitors. Instead of becoming agents of change, they often prevent change. (Indeed, the big economic debate in South Korea nowadays concerns whether the chaebol are stifling innovation by preventing start-up competitors from challenging them.)

The productive transformation that developing countries need is much easier to achieve with the support, rather than the obstruction, of their conglomerates. But ensuring such support requires policies that nudge (or even shove) conglomerates toward export industries that can grow beyond the limits of the domestic market - industries in which competition will encourage the discipline that they lack as a result of dominating local markets.

To succeed, conglomerates need the support of government and the acceptance of society. They must earn it through their contribution to the growth of employment, exports, and tax revenues, and to the country’s technological transformation. That is what General Park Chung Hee (South Korea’s longtime ruler, and father of current President Park Geun-hye) pressured the chaebol to do in the early 1960’s. And it is what governments and civil societies in developing countries today should demand of their conglomerates. Copyright: Project Syndicate, 2013.

*The author, a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank, is a professor of economics at Harvard University, where he is also Director of the Center for International Development.

by Ricardo Hausmann
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