Does Varieties of Capitalism Theory condemn Britain to inequality?

Jeremy Cliffe made some interesting points on twitter over the weekend about the relevance of Varieties of Capitalism (VoC) theory to Britain today. Cliffe’s own BBC documentary provides a good introduction to the theory, but here is the general idea.  VoC suggests that successful modern economies can take one of two forms: they can be ‘liberal market economies’, like the UK or US; or ‘coordinated market economies’ like Germany or Japan. The table below, taken from wikipedia, offers a good overview of the key differences between the two:

One of the key concepts of VoC theory is institutional complementarity: the idea that the distinctive features of liberal or coordinated market economies reinforce one another. The key virtue of liberal economies is flexibility – consequently, the education system emphasises general skills so that workers can quickly move jobs, relaxed labour laws allow easy hiring and firing and fast-moving stock markets move investment rapidly between firms as they identify new opportunities. By contrast, coordinated economies value stability, which encourages greater mutual commitment and long-term planning between firms, workers and investors. The result is greater use of apprenticeships, so that workers can develop employer-specific skills, higher levels of unionisation and ‘patient capital’, whereby investors are more willing to support long term investments without expectation of large, quick profits.

Institutional complementarity suggests that the features of a liberal or coordinated economy must be taken as a package, not picked a la carte. As Cliffe points out, if that’s the choice, many British social democrats are likely to favour the coordinated economy, particularly attracted by the lower levels of inequality. This was certainly the case for  Ed Miliband, whose thinking was clearly influenced by the VoC theory. In his 2014 documentary, however, Cliffe concluded that this was unlikely to succeed: Britain’s culture was too individualistic to become a coordinated economy. Now, though, he says he is unsure: Jeremy Corbyn’s electoral success makes him wonder whether that is really the case, and whether the country may be open to a more collectivist system.

Yet culture is only one of a number of obstacles that a country must overcome in order to shift from a liberal to a coordinated economy. Another important factor is comparative institutional advantage: the idea that liberal economies are suited to certain types of industry and coordinated economies to others. The flexibility of liberal economies means that they better support dynamic, fast-moving industries like IT and finance; the skilled workers and patient investors of coordinated economies fit well into high end manufacturing. Thus a full shift to a coordinated economy would therefore involve a shift in the sorts of industries that the UK sustains – it would, essentially, involve taking on the coordinated economies at their own game.

An interesting question to ask is what happens if the UK attempts to move in the direction of the coordinated economy but does not fully succeed. Given the scale of the change proposed, that seems the most probable scenario. One possibility is that the changes are so minor that they do not register at the level of classification – the UK remains fundamentally a liberal economy. VoC theory is a theoretical simplification – of course, the UK already has apprenticeships, unions, patient investors and industries like manufacturing – just less of these than Germany. The government could simply make these slightly more common, nudging without radically overhauling the country’s economic model.

This could be beneficial for the economy within the VoC framework – it is possible that the UK has had ‘too much of a good thing’ and become too liberal even for a successful liberal economy. For example, it might be the case that excessive inequality is undermining the equality of opportunity on which a liberal economy depends for its innovation. Conversely, it might be bad for the economy, but nevertheless be seen as a price worth paying – for example, stricter labour regulations might raise unemployment but reduce inequality.

Most intriguing – and risky –  is the possibility that economic reforms create a hybrid system, with some coordinated and some liberal features. There is some debate in the literature about whether hybrid systems can be successful. The orthodox theory suggests they should perform worse than ‘purer’ models. Yet it has been argued that Denmark, for example, represents a successful hybrid – with relatively flexible labour markets, decentralisation and market competition in vocational training, combined with significant centralised coordination and unionisation.

What this hybrid system would look like in the UK – how you could successfully import the features of coordinated economies to complement those of a liberal one – is a question for someone with more time, expertise and imagination than me. One indication, perhaps, lies in the idea of a lifelong national education service, whereby the state would fund retraining and skills development throughout working age people’s careers, possibly in coordination with employers. Such a system would allow workers to invest in specialised knowledge while retaining the flexibility to shift course. If funded by taxes on firms, it would allow them to pool the risk of paying to train workers before losing them to competitors.

The varieties of capitalism theory is a useful framework for thinking about political economy. Yet while it gives us reason for caution when it comes to upsetting existing economic models, I suspect it may be less deterministic than it appears. Britain’s hands are not entirely bound.

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