The Microfoundations of the Developmental State and the Asian Economic Crisis

Contrary to the dominant view that the developmental state evolved to reduce transaction costs (such as moral hazard), it is argued that it represented, first and foremost, a policy compromise between business and government over redistribution and market competitiveness. This compromise was possible because of favorable political conditions: a long shadow of the future, a favorable payoff structure, and an unequal distribution of power (in favor of the government). The long shadow of the future, in particular, was decisive in allowing the government and business to commit to and enforce their agreement. In some East Asian countries, however, political changes shortened the time horizon of state and business elites, weakening their policy cooperation and increasing the vulnerability of the economy to a crisis. This theory is tested against the cases of nine East Asian countries, using the stability of the party system as a proxy for the length of the time horizon and thus, the ability of actors to make a credible commitment. Consistent with theory, it is found that the more fragmented or divided a country's party system (i.e. the shorter the time horizon) had become before the outbreak of the crisis, the more severe and costly the economic crisis has been in that country.