Varieties of Capitalism and Institutional Complementarities in the Macroeconomy An Empirical Analysis

MPIfG Discussion Paper 04/5

Varieties of Capitalism and Institutional
Complementarities in the Macroeconomy
An Empirical Analysis

Peter A. Hall and Daniel W. Gingerich
Peter A. Hall is Krupp Foundation Professor of European Studies and the Director
of the Minda de Gunzburg Center for European Studies at Harvard University.
Daniel W. Gingerich is a Graduate Associate of the Weatherhead Center for
International Affairs and a Ph. D. candidate in the Department of Government
at Harvard University.
Peter A. Hall
phall@fas.harvard.edu
Daniel W. Gingerich
gingeric@fas.harvard.edu

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Peter A. Hall and Daniel W. Gingerich
Varieties of Capitalism and Institutional Complementarities in the Macroeconomy:
An Empirical Analysis

MPIfG Discussion Paper 04 / 5
Max-Planck-Institut für Gesellschaftsforschung Köln
Max Planck Institute for the Study of Societies Cologne
September 2004

© 2004 by the author(s)
MPIfG Discussion Paper | ISSN 0944-2073

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Abstract
Using aggregate analysis, this paper examines the core contentions of the “varieties of
capitalism” perspective on comparative capitalism. We construct a coordination index
to assess whether the institutional features of liberal and coordinated market econo-
mies conform to the predictions of the theory. We test the contention that institu-
tional complementarities occur across sub-spheres of the macroeconomy by examin-
ing the correspondence of institutions across sub-spheres and estimating the impact
of complementarities in labor relations and corporate governance on rates of growth.
To assess the stability of the institutional features central to the theory, we assess the
dynamics of institutional change in recent years. The evidence suggests that there are
powerful interaction effects among institutions across sub-spheres of the political
economy that must be considered if the economic impact of institutional change in
any one sphere is to be accurately assessed.

Zusammenfassung
Mit Hilfe von Aggregatdaten analysiert dieses Papier Kernaussagen des „Varieties-of-
Capitalism“-Ansatzes. Um beurteilen zu können, ob die Aussagen der Theorie mit den
institutionellen Begebenheiten liberaler und koordinierter Ökonomien übereinstim-
men, konstruieren wir einen ländervergleichenden Index der ökonomischen Koordi-
nation. Wir überprüfen die These von der institutionellen Komplementarität zwi-
schen den verschiedenen Sphären politischer Ökonomien, indem wir das Zusammen-
wirken von Institutionen analysieren und den Einfluss komplementärer Institutionen
der Arbeitsbeziehungen und der Unternehmenskontrolle auf die Höhe von Wachs-
tumsraten untersuchen. Wir diskutieren darüber hinaus, wie stabil die institutionellen
Begebenheiten in den vergangenen Jahren waren. Im Ergebnis zeigen sich starke In-
teraktionseffekte zwischen den Sphären politischer Ökonomien, die berücksichtigt
werden müssen, um die wirtschaftlichen Wirkungen institutionellen Wandels in ein-
zelnen Sphären zu verstehen.

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MPIfG Discussion Paper 04 / 5
Contents
1
The varieties of capitalism approach
7
2
Establishing coordination as a crucial dimension
10
3
Locating political economies relative to one another
13
4 Congruence
across
spheres
of the political economy
17
5
The effect of institutional complementarities on economic growth
22
6
Political and economic adjustment paths
30
7 Conclusion
37
References 39

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Hall/Gingerich: Varieties of Capitalism and Institutional Complementarities
5
How do national variations in the institutions of the political economy affect eco-
nomic performance? This question has been central to comparative political economy
for many years. However, most answers to it focus on institutions in a single sphere of
the political economy. In economics, there are large but separate literatures on labor
and financial markets. One explores the impact of labor regulations, social regimes,
and trade unions on growth or unemployment (Nickell 1997; OECD 1994; Calmfors/
Driffil 1988). The other considers the effects of accounting standards, the legal stand-
ing of owners or creditors, ownership patterns, and equity or bank-based finance on
levels of investment or growth (Carlin/Mayer 1999a, 1999b; LaPorta et al. 1998a;
Huang/Xu 1999; Mayer 1996). A similar separation is evident in political science.
Although neocorporatism can be defined in broad terms (cf. Katzenstein 1985;
Schmitter/Lehmbruch 1978), analyses of its economic impact usually focus on the
organization of the trade union movement, considering its interaction mainly with
the partisanship of governance (Cameron 1984; Alvarez et al. 1991; Garrett 1999).1 An
entirely different literature examines the structure of financial systems (Verdier 2000;
Cox 1986; Zysman 1984).2
However, there are good reasons to expect interaction effects among institutions
across spheres of the political economy. In recent years, significant interaction effects
have been found between monetary institutions and those governing wage coordina-
tion (Franzese 2002; Cukierman/Lippi 1999; Soskice/Iversen 2000; Iversen et al. 2000;
Iversen 1998; Hall/Franzese 1998). But investigation of such effects among other in-
stitutions has barely begun (cf. Amable 2000; Amable et al. 2001; Ernst 2002; Fehn/
Meier 2000; Caballero/Hamour 1998; Nicoletti et al. 2000).
The problem can be described as one of identifying institutional complementarities in
the macroeconomy. Economists have identified complementarities among the activi-
ties of firms: marketing strategies based on product customization, for instance, can
be complementary to computer-controlled machines on the production line (cf. Jai-

We are grateful to Alexander Kuo for research assistance and to the John D. and Catherine T.
MacArthur Foundation for a grant to Hall for research and writing. For helpful comments, we
thank James Alt, Bruno Amable, Moreno Bertoldi, Robert Boyer, Colin Crouch, Eckhard Ernst,
Peter Gourevitch, Torben Iversen, Bruce Kogut, Martin Höpner, Marino Regini, and Wolfgang
Streeck. An earlier version of this paper was presented to the American Political Science Associa-
tion, August 2001. A shorter version has been published in German: Peter A. Hall and Daniel W.
Gingerich, “Spielarten des Kapitalismus” und institutionelle Komplementaritäten in der Makro-
ökonomie – Eine empirische Analyse, in: Berliner Journal für Soziologie 14, 2004, 5–32.
1
Hicks and Kenworthy (1998; cf. Kenworthy 1995) are a notable exception. They examine the
impact of neocorporatism construed as a broad system of cooperation; and a few other studies
do so as well, without, however, examining interaction effects among spheres of the economy
directly.
2
Less relevant to this paper but of equal importance is a literature on the economic impact of
variation in the institutions responsible for economic policy (cf. Drazen 2000; Persson / Ta-
belini 1994).

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MPIfG Discussion Paper 04 / 5
kumar 1986; Milgrom/Roberts 1990, 1995). It is plausible to posit analogous com-
plementarities among the institutions structuring relations in the political economy
(Amable 2000). One set of institutions is complementary to another when its presence
raises the returns available from the other. Here, we refer to the returns to the actors
involved in the relevant activities that feed into national economic performance.3
The requirement for any investigation of this issue, however, is a theory specifying
why two or more institutions might be complementary to each other, and where such
complementarities are located in the political economy. Aoki (1994) offers important
observations about the issue but focuses only on the case of Japan. An important lit-
erature on comparative capitalism suggests that political economies contain such
complementarities (Crouch/Streeck 1997; Whitley 1999; Hollingsworth/Boyer 1997;
Albert 1993), but most contributions to it address a limited number of countries and
do not specify the complementarities in readily generalizable terms.4
In this context, a new body of work on ‘varieties of capitalism’ is important (cf. Hall/
Soskice 2001b).5 Its formulations contain a theory about the nature of the institu-
tional complementarities found in the political economies of the developed world.
Applying the new economics of organization to the macroeconomy, this literature
distinguishes among capitalist economies by reference to the means firms and other
actors use to coordinate their endeavors. It suggests that nations cluster into identifi-
able groups based on the extent to which firms rely on market or strategic modes of
coordination and that important complementarities can exist between the institutions
in different spheres of the political economy. From this follow many important con-
tentions about variations in economic performance, comparative institutional advan-
tage, national responses to globalization, and comparative public policy, which are
grounded in a rich set of comparative case studies (see the references in Hall/Soskice
2001b).6
However, the core postulates of the varieties of capitalism approach have not yet been
subjected to empirical tests based on aggregate analysis of a large number of cases. As
yet, we do not even have good measures for the character of coordination, the concept

3
Obviously, this leaves aside the question of how these returns are distributed, a matter that
may also be conditioned by the character of the institutions.
4
For important recent exceptions, see Amable (2000); Amable et al. (2001); Ernst (2002); Boyer
(1989).
5
This approach originates in early formulations by Soskice (1990a, 1990b) that build on the
literature about neocorporatism and regulation (cf. Katzenstein 1985; Boyer 1989) but add to
it a fuller appreciation for the role that employer networks play in the economy. It has subse-
quently been developed by Soskice and a number of other scholars, many of whom are con-
tributors to Hall and Soskice (2001b).
6
Aggregate analysis has been applied to a few of the relatively specific propositions generated
by this approach (cf. Franzese 2001; Estevez et al. 2001; Iversen / Soskice 2000, 2001).

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Hall/Gingerich: Varieties of Capitalism and Institutional Complementarities
7
at the heart of the analysis. This poses many problems. Case studies have been used to
classify nations into general categories, but reliance on such broad classifications has
meant that a theory designed to offer insights about all the developed nations is some-
times misinterpreted to be one that speaks only to a few ideal types, and the position
of many nations within these categories remains ambiguous.
The object of this paper is to address these problems, by devising indicators for some
of the central concepts of the varieties of capitalism approach and subjecting some of
its core contentions to aggregate empirical tests. We begin by developing indices to
measure the character of coordination in key spheres of the political economy. We use
them and other measures to assess the plausibility of the account given by the varieties
of capitalism perspective about how behavior across the sub-spheres of the political
economy interlocks and how national political economies differ. We then examine the
core postulates of the theory about the presence of institutional complementarities in
the macroeconomy. Finally, we examine patterns of political adjustment and institu-
tional change in order to assess the durability of the national distinctions identified by
this approach. Before considering specific propositions, we open with an overview of
the varieties of capitalism perspective.7
1
The varieties of capitalism approach
In contrast to the large literature focused on national labor movements, varieties of
capitalism analyses assume that firms are the central actors in the economy whose
behavior aggregates into national economic performance. In order to prosper, firms
must engage with others in multiple spheres of the political economy: to raise finance
(on financial markets), to regulate wages and working conditions (industrial rela-
tions), to ensure workers have the requisite skills (education and training), to secure
access to inputs and technology (via interfirm relations), to compete for customers (in
product markets), and to secure the cooperation of their workforce (firm–employee
relations). Adopting a relational view of the firm, this perspective assumes that the key
to success in each of these endeavors is efficient coordination with other actors. The
central problems facing firms are, therefore, coordination problems involving other
actors in the economy.
The varieties of capitalism approach draws a distinction between two modes of coor-
dination. In one, firms coordinate with other actors primarily through competitive
markets, characterized by arms-length relations and formal contracting. Here, equi-

7
This approach originates in the early work of David Soskice (1990a, b), and the account given
of it here draws extensively on joint work with him (Hall / Soskice 2001a).

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MPIfG Discussion Paper 04 / 5
librium outcomes are dictated primarily by relative prices, market signals, and famil-
iar marginalist considerations. In the other modality, firms coordinate with other
actors through processes of strategic interaction of the kind typically modeled by
game theory. Here, equilibrium outcomes depend on the institutional support avail-
able for the formation of credible commitments, including support for effective in-
formation-sharing, monitoring, sanctioning, and deliberation.8
Although instances of market and strategic coordination occur in all capitalist
economies, this approach contends that, in the spheres central to firm endeavor, the
balance between these two types of coordination varies across political economies. At
one end of the spectrum stand liberal market economies (LMEs) where relations be-
tween firms and other actors are coordinated primarily by competitive markets. At the
other end are coordinated market economies (CMEs) where firms typically engage in
more strategic interaction with trade unions, suppliers of finance, and other actors.9
Whether a firm coordinates its endeavors through market relations or strategic inter-
action is said to depend on the institutional setting. Where markets are imperfect and
there is substantial institutional support for the formation of credible commitments,
firms can be expected to rely more extensively on strategic coordination. Where mar-
kets are fluid and there is little support for such commitments, firms will rely more
heavily on market coordination. Accordingly there should be a correspondence be-
tween the institutional configuration of each sphere of the economy and the character
of coordination there.10
The distinction will be clearer if we describe a liberal and coordinated market econ-
omy. Market coordination is a familiar concept in neoclassical economics, and the
United States is a typical liberal market economy. Here, firms face large equity mar-
kets marked by high levels of transparency and dispersed shareholding, where firms’
access to external finance depends heavily on publicly assessable criteria such as mar-
ket valuation. Regulatory regimes allow hostile takeovers that depend on share price,
rendering managers sensitive to current profitability. Because trade unions are rela-

8
This list of the institutional correlates of effective strategic coordination is a familiar one that
draws on the conventional literature (cf. Ostrom 1990) but also includes the presence of a ca-
pacity for deliberation whose importance is outlined in Hall / Soskice (2001a).
9
The approach concentrates on cross-national variation because it examines spheres were na-
tional regulations and nationally specific institutions are especially important, but it acknowl-
edges there can be additional variation across specific regions or sectors (cf. Campbell et al.
1991; Herrigel 1996).
10 Of course, the distinction between institutions and coordination is a narrow one, especially if
coordination is construed as rule-patterned behavior (cf. Calvert 1995). Here, institutions are
construed as rules and practices, more or less formal, that actors take into account when mak-
ing decisions about what actions to undertake. These include the institutions generated by the
organizational setting (cf. Hall / Soskice 2001a: 9).

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Hall/Gingerich: Varieties of Capitalism and Institutional Complementarities
9
tively weak and employment protection low, labor markets are fluid and wage-setting
primarily a matter of contract between workers and individual employers. Because
labor markets are fluid, workers have incentives to invest in general skills that can be
taken to other jobs, and, because industry associations are weak, firms lack the capac-
ity to mount the collaborative training programs that confer industry-specific skills.
Technology transfer is accomplished primarily by licensing or taking on expert per-
sonnel, and standards are usually set by market races. Top managers enjoy substantial
authority over all aspects of firm strategy, including layoffs. In such settings, many of
the relationships firms form with other actors are mediated by competitive markets.
Although there are variations among them, the United Kingdom, Ireland, Canada,
Australia and New Zealand are also generally identified by this approach as liberal
market economies.
Germany provides a good example of a coordinated market economy. Its firms are
closely connected by dense networks of cross-shareholding and membership in influ-
ential employers associations. These networks provide for substantial exchanges of
private information, allowing firms to develop reputations that permit them some
access to capital on terms that depend more heavily on reputation than share value.
Accordingly, managers are less sensitive to current profitability. In the presence of
strong trade unions, powerful works councils, and high levels of employment protec-
tion, labor markets are less fluid and job tenures longer. In most industries, wage-
setting is coordinated by trade unions and employers associations that also supervise
collaborative training schemes, providing workers with industry-specific skills and
assurances of available positions if they invest in them. Industry associations play a
major role in standard-setting with legal endorsement, and substantial amounts of
technology transfer take place through interfirm collaboration. Hemmed in by power-
ful workforce representatives and business networks, top managers have less scope for
unilateral action, and firms typically adhere to more consensual styles of decision-
making.
It should be apparent that, in order to perform their core functions, firms in coordi-
nated market economies like that of Germany must engage in strategic interaction in
multiple spheres, although the institutions on which they rely and the quality of the
outcomes may vary from one to another. Austria, Japan, South Korea, Sweden, Nor-
way, Finland, Denmark, Belgium, the Netherlands, and Switzerland are usually also
identified by those who adopt this approach as coordinated market economies.

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MPIfG Discussion Paper 04 / 5
2
Establishing coordination as a crucial dimension
We begin our analysis by examining the core contention of the varieties of capitalism
approach that the developed economies differ systematically from one another ac-
cording to the extent to which firms depend on market or strategic coordination to
accomplish their endeavors. Of course, the character of coordination is difficult to
measure directly. However, as Hall and Soskice (2001a) point out, the nature of the
coordination present in any sphere of the economy depends on the type of institu-
tions available to support it there. Accordingly, a factor analysis designed to identify
commonalities that may be unobservable in themselves but that correlate with a range
of observable variables provides an appropriate technique for identifying the character
of coordination (Harman 1976). By performing a factor analysis on a set of institu-
tional measures that are commonly associated with one type of coordination or an-
other, we can assess whether the dimensions of market and strategic coordination
posited by varieties of capitalism theory exist and where they are present. Varieties of
capitalism theory generates two hypotheses that can be tested using such an analysis:
H1: The character of coordination constitutes a key dimension stretching across spheres of
the political economy.
If this is correct, a factor analysis of variables representing the institutional conditions
associated with different types of coordination in various spheres of the political
economy should identify a single principal component loading on the relevant vari-
ables across spheres of the political economy.
H2: This dimension reflects variation along a spectrum running from market coordina-
tion to strategic coordination.
If this is correct, the underlying factor identified in the analysis should be positively
correlated with indicators for institutional support for strategic coordination and
negatively correlated with indicators for institutional support for market coordina-
tion.
The central obstacle to such an analysis is the paucity of relevant indicators available
for more than a few countries. The measurement of coordination poses special diffi-
culties. In principle, types of coordination are observable, but intense observation is
required. Only one sphere has been the object of such observation, namely that of
wage bargaining. Accordingly, we employ two independent assessments of coordina-
tion in wage bargaining. The other variables used in the factor analysis are all indica-
tors of institutional features of the political economy that can reasonably be said to
provide support for or to reflect the operation of one type of coordination or the
other. We have deliberately identified variables that extend across two important
spheres of the political economy, those pertinent to labor relations and corporate gov-

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