Industrial Organization and Entrepreneurship in the Developing Countries: The Economic

Groups
Author(s): Nathaniel H. Leff
Source: Economic Development and Cultural Change, Vol. 26, No. 4 (Jul., 1978), pp. 661-675
Published by: The University of Chicago Press
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in the
IndustrialOrganizationand Entrepreneurship
DevelopingCountries:The EconomicGroups

Nathaniel H. Leff*
Columbia University
I. Introduction
The subject of industrial organization has not received much attention in
the analysis of postwar economic development. This neglect has occurred
despite the importance of industrial organization for such questions as
efficiency in production and investment and, especially, for transmitting
the external economies which are believed to play a central role in the
development process.' By contrast, the topic of entrepreneurshipin lessdeveloped economies has been discussed extensively, if not always in
satisfactory theoretical terms.2 As William Baumol expressed it a decade
ago, despite the entrepreneur's "acknowledged

importance . . . [he is]

one of the most elusive characters in the cast that constitutes the subject
of economic

analysis . . . [and has] virtually disappeared

from the

theoretical literature."3This conceptual elusiveness is especially unfortunate for the analysis of the developing economies, in which entrepreneurship is likely to be more necessary for output expansion and structural
change than in the more developed countries.
* I am grateful to Tuvia Blumenthal, Neil Chamberlain, Frank Edwards,
Ronald Findlay, David Felix, Harvey Leibenstein, Richard Porter, Frederic Pryor,
Kazuo Sato, and Julian Simon for helpful comments on an earlier version of this
paper. I also thank the Faculty Research Program of the Columbia Business School
for financial support; and the Department of Developing Countries of Tel-Aviv
University, where the first draft of the paper was written, for the use of its research
facilities. I bear sole responsibility for any deficiencies in the paper.
1 Paul N. Rosenstein-Rodan, "Problems of the Industrializationof Eastern
and South Eastern Europe," Economic Journal 53 (June 1943): 202-11.
2 For an indication of the large volume of
professional literature addressed
to the subject of entrepreneurshipand economic development, see the bibliography
in Flavia Derossi, The Mexican Entrepreneur(Paris: OECD Development Centre,
1972), pp. 409-28.
3 William Baumol, "Entrepreneurshipin Economic Theory," American Economic Review 58 (May 1968): 61-71; quote from p. 64.
? 1978 by The University of Chicago. 0013-0079/78/2604-0001$01.30

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Economic Development and Cultural Change

Industrial organization and entrepreneurship are of course related.4
Accordingly, this paper attempts to make some analytical progress by
considering these two subjects together. We will proceed by drawing
attention to and analyzing a pattern of industrial organization in the
developing countries which has important effects on the functioning of
these economies, particularly on the conditions which affect investment
and production decisions. This pattern of industrial organization, which
I shall call "the group," is distinct from other forms of capitalist organization in the less developed countries which have been more widely
noted and discussed; for example, the public sector corporation, the
broadly held public company, the family owned company, and the multinational corporation. Despite its existence as a phenomenon which appears in many developing countries and despite its pervasive economic
effects, which we shall discuss below, the group has received surprisingly
little generalized analysis. Some aspects of the group phenomenon have
been noted before, usually in observations for individual less developed
countries. Also, most observers have focused on one or two features of
the groups, such as their monopoly power or their political connections.
However, relatively little effort has been directed to conceptualizing
the groups in more general analytical terms, and analyzing the implications for economic development, industrial organization, and entrepreneurship.5
II. The Economic Groups
In many of the less developed countries a significant part of the domestic
and privately owned industrial sector, and particularly the activities
which use relatively modern and capital-intensive techniques, is organized
in a special institutional pattern. Following the Latin American term,
we may call this structure the "group," although this pattern of economic
organization is also common, with different names, in Asia and Africa.
Documentation on the structure and scale of group activities in many
less developed countries is sparse. This is not surprising, for collection
of data on a phenomenon usually requires that its existence first be noted
in the professional literature and a conceptual framework be developed
to analyze it. Such a general framework has previously not been
developed for the groups. Nevertheless, on the basis of presently available materials, the following generalizations can be advanced.6
4 Cf. the comment by W. A. Lewis: "We have no good theory of entrepreneurship because we have no good theory of monopoly," cited by Baumol, p. 68.
5 The present paper concentrates on the causes of the group structure and
on its positive effects on the functioning of the less developed economies. Pernicious
effects and their policy implications are discussed in my "Monopoly Capitalism
and Public Policy in the Less-developed Economies," mimeographed (1978; available from the author).
6 For some published sources which discuss aspects of the groups (often in

different terms), see, e.g., W. Dean, The Industrialization of Sao Paulo (Austin:

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Nathaniel H. Leff
The group is a multicompany firm which transacts in different
markets but which does so under common entrepreneurial and financial
control. More generally, this pattern of industrial organization has two
essential features. First, the group draws its capital and its high-level
managers from sources which transcend a single family. The capital and
the managers may come from a number of wealthy families, but they
remain within the group as a single economic unit. The group's ownermanagers typically include some (but by no means all) members of the
family within which the group's activity originated. However, what
distinguishes this institution from the family firm and what gives it the
resources for greater scope is the fact that owner-managers from other
families also participate. Participants are people linked by relations of
interpersonal trust, on the basis of a similar personal, ethnic, or communal background.7
Second, somewhat like the zaibatsu in pre-World War II Japan,
the groups invest and produce in several product markets rather than
University of Texas Press, 1969), pt. 1; A. Lauterbach, "ManagementAims and
Development Needs in Latin America," Business History Review 42 (Winter
1968): 558-59; Derossi, esp. pp. 97-115 and 158-93; Frangois Bourricaud,"Structure and Function of the Peruvian Oligarchy,"Studies in ComparativeInternational
Development 2 (1966): 1-15; Robert T. Aubey, "EntrepreneurialFormation in El
Salvador,"Explorationsin EntrepreneurialHistory, vol. 6 (November 1969), esp. pp.
272-76; D. W. Stammer, "FinancialDevelopment and Economic Growth in Underdeveloped Countries: Comment," Economic Development and Cultural Change
20 (January 1972): 318-25; Andrew J. Brimmer, "The Setting of Entrepreneurship in India," Quarterly Journal of Economics 69 (1955): 553-76; G. Rosen,
Some Aspects of Industrial Finance in India (Glencoe, Ill.: Free Press, 1962),
chap. 1; E. K. Hazari, The Corporate Private Sector (Bombay, 1966); Gustav
Papanek, Pakistan's Development (Cambridge, Mass.: Harvard University Press,
1967), pp. 67-68; Thomas A. Timberg, "IndustrialEntrepreneurshipamong the
Trading Communities of India," Harvard University Economic Development
Report no. 136, mimeographed (Cambridge, Mass.: Harvard University, July
1969), pp. 1-126; Hannah Papanek, "Pakistan's Big Businessmen," Economic
Development and Cultural Change 21 (October 1972): 1-32, esp. 17-32; Lawrence
J. White, Industrial Concentration and Economic Power in Pakistan (Princeton,
N.J.: Princeton University Press, 1974); and Harry Strachan, The Role of Family
and Other Groups in Economic Development: The Case of Nicaragua (New York:
Praeger Publishers, 1976). (The page references cited below to Strachan's work
refer to his D.B.A. thesis, Harvard University, 1972.) I have also been informed
by Steven Resnick, K. S. Lee, and Jose Buera that a similar pattern exists in the
Philippines, South Korea, and the Dominican Republic, respectively. Also, on the
basis of his field experience in Asia and Africa, Richard Porter has written to me
that the groups are common in other countries of Asia and Africa. These materials,
as well as my own interviews conducted in the course of fieldworkin less developed
countries, constitute the basis for the statements advanced in the text.
7 The groups I am discussing are, for reasons of their comparativeadvantage
and private returns, largely in the "modern"sector of the economy. Another type
of group, often purely ethnic and without capabilities in modern technology, sometimes operates as an informal financial intermediaryin activities where "organized"
sources of finance are scarce in less developed countries (see, e.g., William Baldwin,
"The Thai Rice Trade as a Vertical Market Network," Economic Development
and Cultural Change 22 [January 1974]: 179-99).

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EconomicDevelopmentand CulturalChange
in a single productline. These productmarketsmay be quite diverse,
ranging, for example, from consumer durables to chemicals to steel
rolling. These activitieshave sometimesbeen selected on the basis of
forwardor backwardintegration.In other cases, new investmentshave
been made in product markets which are unrelatedbut in activities
where the group'stechnicaland managerialcapabilitiesare applicable
as inputs.8Largegroupshave also establishedbanks and other financial
intermediaries
to tap capitalfromsourcesoutsidethe immediatemembers
of the group.9Finally,the groupsusuallyexercisea considerabledegree
of marketpowerin the activitieswheretheyoperate.
In some respectsthe groups'diversifiedactivitiesobviouslyresemble the Americanconglomerates.However, for microeconomicreasons
discussedbelow, they developedindigenouslyand independentlyin the
less developedcountries.1'It is also importantto note that in many less
developed countriesthe assets of the larger individualgroups run to
tens of millions of dollars. Taken together, they comprise a significant perecentageof the modern industrialsector, particularlyof that
portionwhich is not owned by public sector firms or by multinational
corporations.
Reliable documentationon the extent of group activities is not
availablefor many countries;and in developingcountrieswith a substantial stock of direct investmentsby multinationalcorporationsit
wouldbe easy to underestimatethe groups'quantitativeimportance.This
is because their investmentstrategyinvolves portfoliobalance through
diversificationin differentactivities;consequently,they do not concentrate their investmentsin a single industry.By contrast,foreign-based
multinationalcorporationscan also diversify their portfolios interna8

For a similar pattern in more developed countries, see Edith T. Penrose,

The Theory of the Growth of the Firm (New York: Basil Blackwell, 1959), chaps.

5 and 7. Cf. also with G. B. Richardson's distinction between expansion into

activities which are "complementary"to or "similar"to a firm's initial activities (see
his paper, "The Organizationof Industry,"Economic Journal 82 [September1972]:
887-92).
9 In some cases, the reverse sequence has occurred: from a group's establishing a bank to entry into nonfinancial activities. Derossi (p. 178, n.) remarks
that in addition to the banks which belong to industrial groups in Mexico the
same can be said of 41 of the country's 44 financieras (investment banks).
10In some respects these reasons are similar. Thus the groups' pattern of
diversifying to utilize slack resources is similar to the expansion path documented
by Alfred D. Chandler for American firms (see, e.g., his Strategy and Structure:
Chapters in the History of Industrial Enterprise [Cambridge, Mass.: M.I.T. Press,

1962], pp. 102-3, 432, 448). By contrast, the emergence of the groups in the less
developed countries owes less to the conditions of tax and capital-marketlegislation,
which were importantin the United States. On the latter, see Jon Didrichsen, "The
Development of Diversified and Conglomerate Firms in the United States, 192070," Business History Review 46 (Summer 1972): 202-19. Didrichsen has also
emphasized the importance of economies of scale to imperfectly marketed skills
(see the discussion in Sec. III below).

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NathanielH. Leff
tionally." Because of the groups' interactivitydiversification,multinational corporationsare often the largestfirmswithin specificindustries.
The foreigners'positionas the dominantfirmwithinindividualindustries
may divert attentionfrom the groups' large overall assets within the
industrialsector as a whole.
Despitedata limitations,some figuresconvey an idea of the groups'
scope. In Nicaragua,Strachanreportsthatin the early 1970s four groups
accountedfor 35% of all loans and investmentsof the total financial
sector and a much largershare of loans and investmentsin the private
financialsector.12In Pakistanin 1968, 10 groupscontrolled33% of all
firmsin the modernmanufacturing
assetsof private,Pakistani-controlled
sector; and 30 groups controlled 52%.13These assets were held in a
wide rangeof diversifiedactivities.14Similarly,in India the largestfour
groupsheld 17% of the assets of public and privatecompaniesin 1958
and the largest 20 groups, 28%.'5 As regardsdiversification,data for
37 of the largestIndiandomesticallyowned groupsshow an averageof
five activitiesper group.16Excludingthe two largest groups (Tata and
Birla), the averagewas still four activitiesper group.
A more detailedpictureof the size and diversificationof groupsin
a developingeconomyis availablefrom a 1962 study in Brazil." These
data on the assets and diversificationof Braziliangroups in 1962 are
presentedin table 1. Althoughthese data convey an idea of the size of
groups in Brazil, for a numberof reasons table 1 tends to understate
the importanceof the groups.First,the studyconsideredonly the groups'
own capital, excluding external resourceswhich they could mobilize.
The balance-sheetdata utilizedmay also underreporttrue asset values,
both to reduce tax payments and because of accountinglags during
inflation.The study was also confined to the four most industrialized
statesof Brazil'ssouth,therebyomittinggroupslocatedelsewherein the
economy. Finally, the data of table 1 relate to 1962, before the large
economic expansionwhich began after 1967. An update of these data
11In some cases where multinational corporations operating in developing
countries have generated cash flow in excess of profit-remissionconstraints, they
have also followed a pattern of interactivity investment within the local economy.
This behavior reflects the same causes as those affecting the groups (see Sec. III
below).
12 Strachan, pp. 80-81.
13 White, p. 65.

14Letter from Gustav Papanek, May 6, 1969.

15 Hazari, chap. 2, as cited in White, p. 71.
16These figures on group participation in different activities were computed
from data presented in Timberg, pp. 88-104.
17 Mauricio Vinhas de Queiroz, "Os grupos multibilionarios," Revista do
instituto de ciencias sociais (Rio de Janeiro) 2, no. 1 (January 1965): 47-77;
Luciano Martins, "Os grupos bilionarios nacionais,"ibid., pp. 79-115. I am grateful
to Marcio Teixeira for bringing this data source to my attention.

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Economic Development and Cultural Change

TABLE 1
OWN ASSETS AND DIVERSIFICATIONOF PRIVATE,LOCALLY OWNED GROUPS
IN FOUR STATESOF BRAZIL, 1962

ASSETCLASS($ MILLION)

Groups (N)...................

Averagecompaniesper group(N)

2.5-10

>10

144

24

8*

21

> 25
5

N.A.

SOURCES.-Mauricio
Vinhasde Queiroz,"Os grupos multibilionarios,"Revistado institutode cidnciassocials(Rio de Janeiro)2, no. 1
(January1965):47, 50, 64; LucianoMartins,"Os gruposbilionarios
nacionais,"
ibid.,p. 86.
NOTE.-The
assetfiguresarein 1962dollars,converted
fromcruzeiros
at an exchangerateof 400cruzeirosperdollar.N.A. = not available.
* Sampleestimate.
would undoubtedly show a much larger scale for the assets of groups in
Brazil.
Bearing in mind the size and diversity of groups and their importance in the private, domestically owned modern sector of the economy,
we will consider and discuss below the effects this feature of industrial
organization has on the functioning of the developing economies. First,
however, let us analyze the causes of the group structure.
III. Causes of the GroupPattern of IndustrialOrganization
The group pattern of industrial organization is readily understood as a
microeconomic response to well-known conditions of market failure in
the less developed countries. In fact, the emergence of the group as an
institutional mode might well have been predicted on the basis of familiar
theory and a knowledge of the environment in these countries.
The group can be conceptualized as an organizational structure for
appropriating quasi rents which accrue from access to scarce and imperfectly marketed inputs. Some of these inputs, such as capital, might be
marketed more efficiently, but in the conditions of the less developed
countries they are not. Some of these inputs are inherently difficult to
market efficiently; for example, honesty and trustworthy competence
on the part of high-level managers.18 Finally, substantial private gains
can accrue from not marketing some inputs, for example, information
generated in one group activity which is relevant for (actual or potential)
investment and production decisions elsewhere in the economy.
The absence of markets for risk and uncertainty also helps explain
another feature of the groups' pattern of expansion-their entry in diversified product lines. This pattern may appear to be due exclusively to
the relatively small size of the domestic market for many manufactured
18Harvey Leibenstein, "Entrepreneurshipand Development,"American Eco-

nomic Review 58 (May 1968): 72-83.

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Nathaniel H. Leff
products in the less developed countries. More important, however, for
reasons of portfolio balance, diversification has an obvious appeal in
economies subject to the risks and uncertainties of instability and rapid
structural change. The groups' practice of choosing new investments on
the basis of backward and forward linkages also stems in part from an
effort to alleviate risk and uncertainty. Vertical integration has been
sought to avoid being dependent on a monopolist or oligopolist for materials inputs, or on an oligopsonist for the group's output. In conditions
where both parties must make specific and long-lived investments, bilateral oligopoly involves serious risks and uncertainties concerning future quantities, qualities, and prices for inputs and for outputs. In addition, vertical integration can avoid the transactions (bargaining and
enforcing) costs which intricate arm's-length negotiations would entail.19
These conditions which lead to gains from vertical integration are
well known from the more developed countries.20 They are likely to be
more severe, however, in the less developed countries. The probability
of having to confront strong market power is greater in these economies
whose domestic markets are often too small to accommodate more than
a few sellers and buyers for many intermediate products.21Also, in relatively large and open economies such as those of the more developed
countries random fluctuations in the components of overall market demand for specific intermediate products may be offsetting. The less developed economies, however, are too small and often too closed to enable
the law of large numbers to have this smoothing effect, and make more
predictable the total market demand for individual intermediate products.
The institution of the group is thus an intrafirm mechanism for
dealing with deficiencies in the markets for primary factors, risk, and
intermediate products in the developing countries. In this perspective,
the group pattern of industrial organization fits closely into the theory of
entrepreneurship and development formulated by Harvey Leibenstein.22
Leibenstein has suggested that entrepreneurship in less developed
countries involves the opening of channels for input supply and for marketing of output in situations where a routinized market mechanism does
not exist. In the absence of such "intermarket operators" some input
and/or output quantities, qualities, and costs would be so beclouded by
risk and uncertainty that investment and production in these activities
19 Oliver E. Williamson, "The Vertical Integration of Production: Market
Failure Considerations,"American Economic Review 61 (May 1971): 112-23.
20 George J. Stigler, "The Division of Labor Is Limited by the Extent of the
Market,"reprinted in his The Organizationof Industry (Homewood, Ill.: Richard
D. Irwin, Inc., 1968), pp. 136-38.
21 Reliance on international trade to complement the domestic market might
be another possibility. However, in addition to problems often posed by overvalued
exchange rates, foreign trade often involves--or is perceived to involve-substantial
risks and uncertainties of its own in the less developed countries.
22 See n. 18 above.

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Economic Development and Cultural Change

would not take place. With their access to nonmarketed inputs and with
their pattern of vertical integration, however, the groups create a channel
both for mobilizing and for allocating such inputs and outputs. In fact,
the group can perhaps best be understood as an institutional innovation
for internalizing the returns which accrue from interactivity operations
in the imperfect market conditions of the less developed countries. What
has happened in effect is that the groups have appropriated as gains the
quasi rents of the output which Leibenstein envisaged would otherwise
be foregone due to imperfect factor markets and insufficient entrepreneurship.
Not only does the group pattern of industrial organization provide
the "real life" correspondence to Leibenstein's theory of entrepreneurship, but it also suggests some analytical extensions. First, the group
constitutes a pattern of industrial organization which permits structure
rather than gifted individuals to perform the key interactivity function of
entrepreneurship.Another departure from earlier theoretical expectations
is that with the institution of the group some factors and products flow
within the firm rather than through the market.
IV. Other Explanations
The preceding discussion has explained the group pattern of industrial
organization largely as an institutional innovation for overcoming-and
reaping the benefits from-imperfect markets in the less developed countries. We must also consider some other interpretations of this phenomenon.
Thus it has been suggested that the group structure arises mainly
because of political connections which permit special access to government dispensations of, for example, import licenses.23 Groups undoubtedly do benefit from government largesse in the form of import licenses,
bank charters, and tax and investment credits; but this is hardly an "alternative" explanation. For one thing, the groups' entrepreneurship and the
externalities which they internalize (see below) help explain why particular government favors may have higher present value for groups than
for other firms and, consequently, why the groups can outbid others in
acquiring political favors and connections.24 More generally, I do not
believe that political influence per se is a sufficient reason for the emergence of the group pattern of industrial organization.25 If the reader
23
24

See, e.g., White, p. 17.

For a more general framework on this topic, see my "Corruptionand

Economic

8-14.

Development,"

American

Behavioral

Scientist 3 (December

1964):

25Cf. Hannah Papanek's comment: "Although political influence obviously

played an important role in the development of the Big Houses, it was not in itself
sufficient for large-scale growth of the enterprises"(p. 17).

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Nathaniel H. Leff
judges otherwise, however, political connections can readily be conceptualized as an imperfectly marketed input.
It may also be suggested that the group structure is due to no more
than imperfect access to capital and that the highly skewed distribution of
wealth common in less developed countries simply means that the very
rich take a pervasive role in industrialization. I find this explanation
insufficient on a number of grounds. First, it fails to explain why only a
small percentage of individuals and families in the traditional wealthy
class establish groups. Also, some groups have been founded by individuals who were initially not in the high-wealth brackets.26
The emphasis I have placed on the importance of conditions other
than preferential access to capital alone as an explanation for the groups27
is supported by other features of their structure.28The groups do not
operate simply as financial trusts or holding companies; rather, they
maintain active entrepreneurial participation in their manifold activities.
The existence of structures similar to groups in the public sector of some
less developed countries provides further evidence that more than imperfect access to capital underlies the group pattern of industrial organization. Public sector companies in the less developed countries generally face less stringent conditions of capital supply than do private firms.
Nevertheless, where legislation has permitted, some public sector companies have also operated with diversified investment and production
activities similar to those of private groups.29
V. The Groups and Entrepreneurship
The existence of large-scale, diversified firms is a familiar phenomenon
in advanced capitalist economies. What have we gained from noting that
a similar phenomenon, in the special form of the groups, is also present
in the developing countries?
First, the group pattern of industrial organization has helped relax
entrepreneurial constraint which, in the first postwar decade, many observers expected would limit the pace of economic development in the
26 Hannah Papanek (ibid.) has also noted the "modest antecedents of some
of the big businessmen in Pakistan today."
27 Cf. George Stigler's comment that the phrase "imperfectionsin the capital
market"has too often been employed as a substitute for analysis of other relevant
conditions (see his "Imperfections in the Capital Market," Journal of Political
Economy 75 [June 19671: 287-92, reprintedin The Organizationof Industry).
28 Strachan (p. 111) reports that in the Nicaraguan groups people who can
contribute only capital but not special management skills to group activities are
gradually excluded from participation. He has also noted another piece of information which reduces the importanceof preferentialaccess to capital as a sufficient
condition for the group structure.He points out that Costa Rica, where the banking
system has been nationalized since the late 1940s, has groups which operate in
modes similar to those of Nicaragua, with its privately owned banking system.
29 An example is the Pertamina company in Indonesia.

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Economic Development and Cultural Change

underdeveloped countries. Thus, this institution has permitted "pure"
Schumpeterian entrepreneurship to become effective. This is because the
group provides the capital and the technical and managerial resources
which are necessary to transform "innovativeness and alertness to opportunities"30into actual investment and production decisions. The institution of the group also facilitates economies in the use of scarce entrepreneurial resources. Economies of scale to entrepreneurship can be appropriated as able individuals are utilized to their full potential in the group's
large and diversified activities. In addition to such "central office" effects,
the groups increase entrepreneurial mobility, for they can deploy entrepreneurial resources to specific intragroup companies as opportunities
arise.
Perhaps even more importantly, the group structure itself reduces
the amount of enterepreneurial capacity which is required per unit of
innovative decision making. Thus the groups' partcipation in many different activities increases information flows and reduces uncertainty surrounding investment and production decisions.31 More generally, the
groups embody in their structure and expansion path a number of suggestions which have been advanced on theoretical grounds for economizing on entrepreneurship in developing countries. As noted earlier, the
group performs the Leibenstein entrepreneurial function of overcoming
deficiencies in important factor and product markets. In addition, as we
have seen, the groups expand along a path of backward and forward
linkages, with investment decisions taken in function of economic and
technological complementarities. Thus the groups have in effect implemented at the micro level the development pattern which Albert Hirschman proposed as an optimizing macro strategy for economies where
entrepreneurship is scarce.32
Note finally a subjective, motivational feature which also increases
the groups' orientation toward the investment and economic expansion
aspects of entrepreneurship. The groups' top managers are often aggressive "empire builders." However, these managers lack some standard
criteria for evaluating their performance, either for purposes of their own
self-assessment or, perhaps even more important subjectively, for com30 For a discussion of these aspects of entrepreneurship,see I. M. Kirzner,
Competition and Entrepreneurship (Chicago: University of Chicago Press, 1973),

pp. 39-57.
31 In terms of John Harris's decision-theory conceptualization of entrepreneurship, the reduced uncertaintycaused by the group pattern of industrialorganization leads to a shift of the action set toward the origin and a rise in the probability that a given profitable investment will be implemented. For Harris's model
of entrepreneurship,see his paper, "Entrepreneurshipand Economic Development,"
in Business Enterprise and Economic

Change: Essays in Honor of Harold F.

Williamson, ed. Louis Cain and Paul Uselding (Kent, Ohio: Kent State University
Press, 1973).
32 Albert O. Hirschman,

The Strategy of Economic

Haven, Conn.: Yale University Press, 1958), pp. 42-43.

Development

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(New

NathanielH. Leff
parisonwith rival groups.Thus, the deficienciesof formal capital markets in the developingcountriesprevent the use of share-pricesin the
stock marketas an evaluativemechanism.And problemsof accounting
in these inflationaryenvironmentsalso preclude utilizing the group's
overallrate of returnon capital as a yardstick.In this context, two figures which are more readilyavailabletake on a special appealas a performancemeasure:the size of a group'sturnoverand, relatedly,the rate
of sales growthover time. This approachleads to a bias toward sales
maximization,subject to a profit constraint,in the group'soperations.
The inefficienciesassociatedwith such a managementorientationare well
known.33In the presentcontext,however,this orientationalso reinforces
a group'spropensityfor entrepreneurial
expansionism.
VI. OtherBeneficialEffectson the DevelopingEconomies
In additionto entrepreneurship,
the group patternof industrialorganization also makes a differencein terms of other positive effects on the
functioningof the developingeconomies.Not only does the group provide an institutionfor mobilizingcapitalfrom a pool which extendsbeyond the resourcesof a single family,but it performsa similarfunction
for higher-management
personnelas well. Such an enlargementof the
base fromwhichhumanresourcescan be recruitedis especiallyimportant
in the less developedcountries.This is becausemobilizationand utilization of these humanresourcesis in any case severelylimited,due to the
fact that top managementis often selectedonly from withinthe circle of
people who have at least some participationin ownership.The separation of ownershipfrom controlhas not occurredon a large scale in the
indigenousprivatesectorof these economies.34
Furthermore,the group's internal relations of interpersonaltrust
permitthe formationof largertop managementteams than would otherwise be possible.35 This facilitateseffectivecommunicationand delegation of authorityand enablesfirmsto overcomeorganizationalconstraints
33William J. Baumol, Business Behavior, Value and Growth (New York:
Harcourt, Brace & World, 1959), pp. 49-50.
34 As discussed below, the groups' activities may suffer from some forms of
inefficiency. It would be easy to attribute this to nepotism and to the lack of
separation of ownership from control. Many of the groups' top managers are,
however, professionally trained. In addition, the keener motivation and vested
interest of owner-managersmay increase the pressures for superior performance.
In the United States, there is some evidence of better performance in firms which
are owner controlled rather than management controlled (see R. J. Monsen, J. S.
Chiu, and D. E. Cooley, "The Effect of Separation of Ownership and Control on
the Performance of the Large Firm," QuarterlyJournal of Economics 82 [August
1968]: 435-51; and Harvey Leibenstein, "Organization or Frictional Equilibria,
X-Efficiency, and The Rate of Innovation," Quarterly Journal of Economics 83
[November 1969]: 614-15).
35 Interpersonal trust among the top owner-managers of the group is so
important in these environments that Strachan (pp. 4, 22-25) considers it one of
the central features of this pattern of industrial organization.

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Economic Development and Cultural Change

on size and efficiency.36As a result, group firms can achieve economies
of scale which might otherwise be foregone and can attain output levels
and rates of growth within individual activities which would be beyond
the scope of family-owned firms."3
The group pattern of industrial organization also affects rates of
return to capital and the rate of capital formation in the less developed
countries. The groups' capacity to marshall the managerial and technical
resources necessary for entry into new activities mitigates downward
pressures on rates of return to capital which would otherwise occur if
firms were restricted to their existing activities. The groups' power in
product markets probably also leads to a higher rate of return.38In addition, the diversification in the groups' activities reduces portfolio risk.
Both individually and a fortiori, in interaction, these risk and rate-ofreturn conditions caused by the group pattern of industrial organization
probably lead to a higher rate of investment than would otherwise prevail.
Further, investments made along lines of vertical integration permit
the group to internalize economies which would otherwise be external to
the firm and its individual activity. Thus, in addition to increasing the
volume of capital formation, the group pattern also leads in this respect
to a (socially) more optimal allocation of investment."9With their interactivity investment allocations, the groups provide a previously unsuspected mechanism for capital mobility between activities. In fact, to some
extent the groups approximate the functioning of a capital market in
the less developed countries.40 The pattern of investment and production
36

See Penrose, pp. 28-29. On the special aspects of this managerial problem

in developing countries, see Peter Kilby, Entrepreneurship and Economic Develop-

ment (New York: Free Press, 1971), pp. 26-29.

37 This has also been noted by White (p. 33). His data for Pakistan (pp.
150-51) indicate that group firms there experienced faster growth than nongroup
firms. This result obtained even when the size of original equity investment, which
was also larger for group firms, is held constant.
38 Studies with U.S. data, for example, have indicated a strong positive
relation between a firm's rate of return and its market power, as measured by its
market share within an industry (see, e.g., W. G. Shephard, "The Elements of
Market Structure," Review of Economics and Statistics 54 [February 1972]: 25-37.

This relation holds even when barriers to entry are low [p. 31]). For a less developed country, Pakistan, White (pp. 145-46) has presented evidence showing a
positive relation between industry concentrationratios and industryrates of return.
William J. House reports similar results for Kenya (see his paper, "MarketStructure and Industry Performance: The Case of Kenya," Oxford Economic Papers 25
[November 1973]: 405-19).
39 In discussing their investment decisions, group firms usually express themselves in terms of the need to provide input and output quantities for complementary group activities rather than in terms of prices and rates of return. This
need not be as irrational as might first appear. In effect, such decisions involve
using the primal rather than the dual solution of an implicit linear programming
optimizing model.
40 White (p. 33) has also noted aspects of the groups' capital market activities. An extended analysis is presented in my "Capital Markets in the Lessdeveloped Countries: The Group Principle,"in Money and Finance in Economic

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Nathaniel H. Leff
decisions taken in cognizance of backward and forward linkage effects
helps explain the speed of the adjustment process with which interrelated
investment opportunities have been taken up in less developed countries.41Finally, the coordination of investment and production decisions
by the groups has both reduced the need for, and lessened the burden on,
government planning of the modern sector in developing countries.
The preceding discussion has noted some of the ways in which the
group pattern of industrial organization improves the efficiency of the
less developed economies. However, the groups also create some serious
distortions. These involve inefficiency within the group, interfirm and
intersectoral distortions, and finally, political-economic effects on overall
development patterns. In effect, the groups have taken factor-market imperfections in the less developed countries and transmuted them into
product-marketimperfections. In the process, rapid industrial growth has
often occurred, but the groups have also created a special form of monopoly capitalism in the less developed countries. The associated distortions raise important problems for public policy in the less developed
countries. However, that subject is so large that it requires another
paper.42

VII. Conclusions
This paper has drawn attention to and analyzed a neglected feature of
industrial organization which has far-reaching effects on the economies
of many less developed countries, the group. As noted, the groups have
their origin in well-known market imperfections of the less developed
countries. Mobilizing imperfectly marketed inputs, and reducing uncertainty and risk with their diversified and vertically integrated activities,
the groups in fact constitute the "intermarket operators" on which Leibenstein's theory of entrepreneurship has focused. Further, in addition
to its effects on entrepreneurship, the group pattern of industrial organization also permits less developed economies to relax institutional constraints in the allocation of capital and of managerial resources. Consequently, domestic, privately owned firms can enter and can attain efficient
scale in activities which might be beyond the scope of a private, locally
owned firm. And because of the groups, the modern sector in many less
developed countries is far less "fragmented"-both in a static and a dynamic sense-than might be expected from accounts which have not been
Growth and Development, ed. Ronald I. McKinnon (New York: Marcel Dekker,
Inc., 1976).
41This has also been noted, in different terms, by Albert Hirschman, "The
Political Economy of Import-substituting Industrialization in Latin America,"
Quarterly Journal of Economics 82 (February 1968): 1-32.

2 See my "Monopoly Capitalism and Public Policy in the Less-developed

Countries."

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Economic Development and Cultural Change

aware of this pattern of industrial organization.43Having described the
costs of factor-market imperfections in the less developed countries,
economists should hardly be surprised that an institution like the group
emerged to appropriate the gains to overcoming these distortions.
This paper has also provided an example of the now well-documented point that economic theory can be relevant beyond the more
advanced countries where it was first developed. Thus, standard microeconomic concepts help explain the emergence of the group institutional
pattern, a phenomenon which might easily be attributed exclusively to
sociocultural or political conditions. Understanding the economic basis
of the group is not equivalent to justifying the institution, however, and
indeed is a necessary step for reforming it. Our focus in this paper on the
groups' effects in mitigating factor-market imperfections should not divert
attention from the product-market distortions and serious problems for
public policy which this pattern of industrial organization also creates.
The group institutional form clearly resembles some features of industrial and corporate organization in the more developed countries.
The similarities to the conglomerate and to the large-scale multidivisional
company are evident. Moreover, some of the causes of the group pattern
also overlap with those which Oliver Williamson has discussed in his
work on the theory of the firm in the more advanced economies.44 Further, as we have seen, some aspects of the microeconomic and managerial
reality in the advanced sector of the less developed economies are fairly
similar to those of the more developed economies. Consequently, if
adapted to recognize differences such as the absence of a formal capital
market, the economics of the modern firm may be more applicable to
the advanced sector of the developing countries than might have been
assumed. And because of the similarity in patterns of industrial organization, oligopoly theory can clearly be helpful in modeling some features
of price, output, and capacity decisions in the modern sector of the developing economies.
Finally, although we have discussed some aspects of the groups in
the developing countries, many important questions obviously remain
unanswered. One wonders, for example, why groups or a similar pattern
of industrial organization has not emerged with equal frequency in all
development contexts, both contemporary and historical. Similarly, it
43See, for example, Ronald McKinnon's description of "the fragmented

economy," in chap. 2 of his Money and Capital in Economic Development

ington, D.C.: Brookings Institution, 1972).

(Wash-

44 See Oliver E. Williamson, Markets and Hierarchies: Analysis and Antitrust

Implications (New York: Free Press, 1975), and particularlyhis emphasis on the
importance of small numbers, bounded rationality (uncertainty), informational
asymmetry, and opportunism (and hence the need for trust).

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NathanielH. Leff
wouldbe usefulto have muchmore quantitativeinformationon the scale
and diversificationof group activities and on the size distributionof
groups in individualcountries and its change over time. These may
clearly be relatedto particularphases of developmentand government
developmentstrategies.Provisionof answersto these questionsand filling in our picture of the groups must await the collection of detailed
statisticaldata. As noted earlier, however, collection of data requires
that attentionbe drawnto a phenomenonand that a conceptualframework be elaboratedto analyzeit. Hopefully,the presentpaper will help
serve this priorneed.

LAND

ECONOMICS

CONTENTS, Land Economics, Volume 54, No. 3, August 1978

ARTICLES
Spatially Differentiated Air Pollutant Emission Charges: Economic
and Legal Analysis
T.H. Tietenberg
Some Evidence on the Distribution of Air Quality
P. Asch, I.]. Seneca
Externalities from Urban Growth: Increased Storm Runoff and
j.R. Barnard
Flooding
Allocation of U.S. Coal Production to Meet Future Energy Needs
M.R. LeBlanc, R.]. Kalter, R.N. Boisvert
Federal Price Regulation and the Supply of Natural Gas in a
H.G. Huntington
Segmented Field Market
Alternative Cost-of-Capital Concepts in Regulation
B.L. Copeland Jr.
Estimating Impacts of a Property Tax Reform
j. Cuddington

REVIEWS
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Editor: Daniel W. Bromley

SHORT PAPERS
Alternative Measures of School Desegregation: A Methodological
C.T. Clotfelter
Note

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