Exploring the Effects of Business Association
Guilt by Association?
Exploring the Effects of Business Association
Activity on Economic Growth
Gabriel Mattera
Faculty Advisor: Professor Sami Alpanda
Submitted to the Department of Economics at AmherstCollege in partial fulfillment of the requirements for the degree of Bachelor of Arts with Distinction
April 22, 2005
Acknowledgments
First and foremost among those to whom I owe a great debt is my advisor, Professor Sami Alpanda. As fellow neophytes, he to the process of thesis advising, I to the process of thesis writing, I like to think that we both had something to teach the other. Unfortunately, I know that this is simply not true. The theoretical insights, econometric understanding and general guidance he bestowed upon me vastly outweigh anything I could hope to offer in return. I wish to thank him especially for his patience across many weekly meetings, and for his tolerance of my proclivity towards independent action. The greatest teachers, I like to think, are those that lead their students to discover things on their own.
I would also like to sincerely thank Ashfaq Qadri for his honest and straightforward comments on early drafts of the manuscript. It is truly a noble friend who willingly offers to take time out of his busy day to read tens of pages of dry undergraduate economics.
Zeina Nasr deserves special mention. Without her anxious reminders of the impending April deadline, I would never have become nervous enough to do the intense work necessary to finish this project in a timely manner.
Thanks goes also to Ngoc Trang, whose conversation and joking in the Economics Computer Laboratory was a burst of fresh air during the writing process.
Finally, I must acknowledge both of my parents. Throughout my life they have constantly stressed the value of a full education and the pleasures of a curious mind. Without their influence and support I would not be at AmherstCollege.
1
INTRODUCTION
Business associations are a natural phenomenon in modern, democratic states. In so far as firms and individuals can benefit from sharing professional experience with each other, or from uniting to pursue a common economic aim, it stands to reason that businesses will always have an interest in joining together. The issue, though, is how this activity affects overall social welfare.
Many other private interest organizations pose a similar question. What partly distinguishes businessassociationsfrom these others is that they are a fluid and varied category, representing a range of groups including, but not limited to, local professional clubs, national business federations, and on a grander scale the lobbying wingsof multinational corporations. In part because of this, while interest groups as a whole have been examined at length, there have been few attempts to isolate the effects of business associationsfrom the greater aggregation of private organizations. The goal of this paper is precisely to do that. More specifically, it seeks to find whether or not business associations can have a positive influence on social welfare.
A key hypothesis tested in the study is what is here termed the “information effect”, the idea that business associations channel information to government about industry and economic trends that it does not otherwise have access to. This information should in turn improve the efficacy of government economic policymaking and so lead to higher growth.
Building onthe analysis of Stephen Knack (2003), the current study uses an econometric model to test the relationship between associations and economic growth. Membership in professional organizations forms the key explanatory variable. Also incorporated, however, are interaction terms that highlight the relationship between this variable and gross, public and private investment rates. The idea is to see whether business associations affect different types of investment. Of specific interest is public investment. Government capital expenditures are key component of economic policy. If the information effect is true, then business associations should have a positive effect on public investment.
Regression results prove somewhat surprising. Membership alone appears to have a negative effect on economic growth. Turning to the interaction terms,membership has a positive and significant influence on the efficacy of total and private investment, and does not seem to be significantly correlated with public investment. These findings suggest a new perspective on the role of business associations in economic affairs.
The layout of the paper is as follows. The first section is a brief survey of the ongoing academic debate about interest groups on social welfare. It focuses in particular on the activity of business associations. Section two describes the principle data set used in the empirical analysis. The third section outlinesthestatistical model used here to examine the relationship between association activity and economic growth. Section four gives the regression results and their interpretation.The fifth sectionis a case study of Japan. The idea of incorporating such a study is to provide a concrete instance of a country considered to have a high degree of interaction between business associations and government. A major point of this section is to draw connections betweenthe Japanese example and the results of the empirical analysis.
2 BACKGROUND
Before discussing business associations directly it is critical to consider their position against the greater backdrop of existing private organizations. Political scientists have offered differing judgments on private interest groups. Mancur Olson (1982) argues that interest group activity creates inefficiencies because of collective action problems. Small groups find it relatively easy to organize and achieve their aims—benefits are focused in few hands, and it is easier to impose constraints to keep members in line. Bigger groups, on the other hand, have many members, and as such each individual obtains little reward from any effort he or she alone puts forth in advancing the group’s cause.
Observed in a social context, the problem becomes clear. Consider the example of a small manufacturing industry that succeeds in lobbying the government for tariff protection. Managers and laborers in the industry wouldseea great reduction in wages or even layoffs if theyhad to face foreign competition. On the other hand, the loss each domestic consumer faces as a result of the tariff is a relatively minor price increase. As such, private individuals do not have a strong impetus to counter the lobbying industry. This holds true even though such a price increase, when multiplied across the entire consumer population, translates into a major loss bigger than that faced by those in industry. Thus, total social welfare is reduced because of the collective action problem inherent in trying to unite all consumers together.
Heckleman’s (2000) study is one of few empirical investigations to use data associated with business activity to test Olson’s predictions. Hebases his data oninformationgathered from Murrell (1984) on the concentration of trade associations in a sample of OECD and non-OECD countries. In his study the number of these associations in each countryserves as a proxy of overall interest group strength. Regressing a ten-year average of per capita income growth against this variable and a host of control indicators, his results reveal moderate evidence to support Olson’s idea that interest groups are a drag on economic growth.
There are opposing views to Olson, however. Robert Putnam (1993)believes that private associations with horizontal, non-hierarchical structures can actually work to increase social productivity by instilling a spirit of trust and cooperation between members within a group. Such groups may also have a hand in overcoming collective action issues by bringing together diverse individuals who might not meet under ordinary circumstances because of differences in language, culture, or socio-economic status.
Local neighborhood crime-awareness associationsmay be seen as an instance of this type of activity. They serve to unite people of all backgrounds in a given communitywho may not normally have much significant interaction with each other. Through the association, the community achieves a common good, namely crime prevention, that would not have been realized otherwise.
Literature looking at the Putnam hypothesis in the context of business associations has been largely theoretical, using mathematical modeling to represent association behavioron a macroeconomic level. Most of this work, though sharing Putnam’s premise that interest groups have a positive influence on welfare, incorporates a different logic from that used by him to explain why this might be the case. For instance,one argument made is that lobbying on the part of associations can have positive “spillover effects”. These effects may arise when gains are incurred not only by the lobbying parties but by outside individuals as well (Mohtadi and Roe, 1998). Aninstance of this phenomenon is found in the example of construction firms that lobby for increased government expenditure on road works. Though the firms themselves are directly rewarded through contracts for new roads, in fact all automobile users gain because they can use these new roadsfor their own transportation needs.
Other models posit that business associations may have a role to play in augmenting government economic policymaking. This idea might be termed the “information effect”. Associations are a channel of communication between private and public sectors, and can help state officials learnabout, among other things, certain market failures that are impeding private investment in productive sectors. Banning business associations or their affiliated lobbieswould deprive government of what might be a decision-enhancing dialogue (Ball, 1995).
Interest in the role of information in economic development has been strengthened by a spate of recent literature on the topic of industrial policy. A key reference in much of this writing is Peter Evans (1995). His concept of “embedded autonomy” describes a situation in which policymakers “are embedded in a concrete set of social ties that binds the state to society and provides institutionalized channels for the continual negotiation and renegotiation of goals and policies” (Evans, 1995, p.12). In other words, the state is closely connected to, though not co-opted by, the private sphere. A major case study for Evans isJapan, where he argues that it was just this sort of strong relationship between government and industry that led to that country’s spectacular growth following the Second World War. The example of Japanis discussed at length in section five.
According to Rodrik (2004) and Rodrik and Hausmann (2003), business associations and other organizations that bridge the gap between government and the private sector can do more than just help existing industries. They may also serve to promote growth in new industries that were previously locked out because of the kind of collective action problems highlighted earlier. This activity might be seen as a different form of the information effect.
Without state support of some kind, entrepreneurs active in the process of investing in new business ideas would have to bear the full brunt of the costs of discovery. Discovery is a hit or miss process, and investors must often spend a great deal of capital on unproductive projects before hitting upon a viable business idea. Without external regulation, competitors could simply wait around for entrepreneurs to find a productive opportunity and then co-opt this opportunity for themselves, thereby eliminating the lucrative profits entrepreneurs had hoped to achieve as the result of their investments.
Patent and copyright laws are one method of curbingthe problems arising from this information externality. Business associations may be another, allowing entrepreneurs to “tip off” public officials to productive opportunities, which government can then support through subsidies, licenses, and other policies that reward capital outlays and research aimed at the discovery process.
The information effect lies at the core of thecurrent paper. As noted above, much of the economic literature on the topic of interest groups has displayed mixed results. Quantitative studies have looked very broadly at the subject as a whole, and those authors who have honed in on business have done so largely from a theoretical perspective.
This study is an empirical analysisthat looks directly at the correlation between business associations, investment and growth. Data and methodology follow Knack (2003). Using cross-country data from the World Values Surveys (WVS), Knack examines a broad range of social organizations, separating these into what he calls “Olson” and “Putnam” groups. “Professional Associations” are placed into the Olson group. Thirty-eight countries are sampled, and levels of participation in each of the two groups form the core explanatory variable. Eighteen-year averages of per-capita income growthand domestic investment serve asthe dependent variables. Ultimately, Knack is unable to support either the Olson or Putnam hypothesis conclusively, as he finds neither category of group to be significantly correlated with his measures of economic performance.
2 DATA
Like Knack (2003), the World Values Surveys (WVS) serve as the source of the most critical datahere. Coordinated by Professor Ronald Inglehart of the University of Michigan and a host of other social researchers, the WVS were designed with the intent to be “a worldwide investigation of socio-cultural and political change” (WVS website).
The WVSare public opinion polls with queries on a number of topics ranging from religion to politics and economics. Participating populations represent a variety of communities across the globe, including those defined by clear country boundaries (“Japan”), as well as some defined by regional affiliation (“Basque”). Though the surveys are centrally coordinated, in each case the actual polling is managed at a local level, with researchers in each population funding and conducting their own studies. Standardization is maintained as much as possible, though in some countries costs and geographical obstacles prohibit a perfect random-sampling. Questionnaires are extremely similaracross each population, differing only on a few topics that speak to social particularities (for example, questions regarding affiliation with ethnic identities found in the “home” society but not anywhere else). Country sample sizes range from500 to 4000 individuals, though most are approximately 1000.
Of the four total surveys that have taken place, three are currently available to the wider public. These are for 1981, 1990, and 1995-1998. All three are used in the present study. Moreover all populations found are included, with the single exception of those that are not defined by country borders. The reason for omitting these is that standard data on economic indicators such as life expectancy and education exist only for internationally recognized states.
The portion of the WVS usedhere is the subsection relating to membership in voluntary organizations. This study is concerned with gauging the effect of business association activity on the economy. As a result, unlike Knack, only the item on “professional associations” within the greater set of voluntary organizations is used. Although Knack incorporates this one in his own study, he does so in aggregation with a host of other organizations that includes labor unions, recreational associations and environmental groups. Rather than testing the effect of each of these group types individually, he clusters them together in a single membership index. As a result of this itis impossible to separate out the unique effect of professional associations.
In the WVS participants are asked to give a response about the degree of their membership in professional associations. This membership is defined differently between survey waves. In the 1990 questionnaireparticipants were asked to list whether or not they belonged to professional associations, and additionally whether or not they did voluntary work for these groups. In contrast, in the 1995-1998 questionnaireparticipants had to list whether they were active members, inactive members, or not members of professional associations. Active membership refers to individuals who take an active role in the association, and inactive membershipto individualswho belong but do not actively participate. Though no questionnaire is available for the 1981 survey, it seems that the format of the subsection of this survey on voluntary organizations was very similar to that of the 1990 survey. Copies of the voluntary organizations subsection of both available questionnaires appear in Appendix 2.A at the end of this paper.
Interestingly, there is a disjunction between the way the membership categories are listed in the questionnaires and the way that they appear in the online WVS database found at the University of Michigan’s university library website. In that database, membership data for all three surveys appears under “active”, “inactive” and “not member” categories. In effect, it is as if the 1981 and 1990 surveys had been subsumed under the format of the 1995-1998survey. Here again, brief communication withProfessor Inglehart served to clarify the issue (personal communication, April 2005). It appears that the 1981 and 1990 data was transferred into the WVS database as follows; participants who merely belonged to professional associations were placed in the “inactive” category, and those who belonged and did voluntary work were placed into the “active” category. All others went into the “not member” category. Thus, though the database seems inconsistent at face levelits measurements are in fact reliable and can be used in analysis.