How to Get Rich with Structural Holes

 

        

Ronald Burt, the greatest social network theorist on the planet, developed a theory about how people get rich. His theory can be found in a book called Structural Holes: Social Structure of Competition. (1995, Harvard). And yes, the secret of getting rich really does involve structural holes. Ronald Burt used the theory to explain how executive compensation and how corporations get rich. Speaking as a development sociologist, I can tell you that the theory also tells you how countries economically develop.

    

Here is the basic idea.

    

A structural hole exists where there are two networks of people who want to interact with each other – but can’t. There are no interpersonal connections between individuals in the two groups. A strategically minded and very wise person then plants him or herself right between the two groups so that he or she can negotiate with both groups while the individual groups have limited capacity to communicate with each other. According to Ronald Burt, that individual is exploiting a structural hole.

Structural%20hole_edited.jpg

Why is being in a structural hole advantageous?

A. If the two parties want to do business with each other – they have to deal with the bridge agent. There is no alternative. The bridge agent finds him or herself indispensable.

B. The bridge agent can completely shape the knowledge that each side has about the other. That information can be tailored to maximize the advantages accruing to the broker personally.

Simple example from an early historical period:

    

Nowadays, China has excellent connections to Silicon Valley; it can do business with any company it wants. Likewise, computer hardware and software companies themselves have connections all over China.

    

But things were not always this way. Once upon a time, China was a strange and mysterious post-communist place. Western computer techies did not speak the language and knew nothing about the politics or the culture. They knew doing business in China would be advantageous, but they did not know who to talk to, where they should locate, or how to negotiate the political or legal environment. Someone who spoke Chinese and could explain the political and organizational complexities of doing business on the Mainland would have been very valuable.

   

At the same time, right after the opening to capitalism, China was technologically backward. Chinese leaders knew they wanted high tech companies to be locating in China and doing collaborative deals with Chinese firms. But they did not know which companies were good or not so good, and they did not know how to negotiate Silicon Valley culture. Someone who spoke both Chinese and English and who was familiar with the ways of the California high technology world would have been priceless to the Chinese. A Chinese Stanford computer science graduate from a well-connected political family in the Pearl River Delta had opportunities to make a fortune.

    

Ronald Burt’s book showed that these principles explained the compensation of executives and the profitability of corporations. Executives who had connections in multiple industries that became wealthier when the industry that employed them had few routine business dealings with those other industries. An executive with experience in the media industry would be particularly well paid when he worked in an industry that had no history of buying from or selling to the media industry. His expertise created options to do new business with media. His experience also allowed the introduction of new and exciting policies from media companies which would be unfamiliar to executives with a more limited provincial background.

    

Corporations that deal with multiple industries also tend to be far more profitable when those industries do not deal with the same other industries the corporation does. On any project involving a third type of industry, the corporation can leverage its superior knowledge and connections.

    

How does this relate to economic development?

    

It is highly advantageous to be a country trading with a wealthy pariah nation, when most of the world won’t trade with it. Your country can fill the structural hole and benefit from its strategic position. Consider the examples of Hong Kong, Finland and Switzerland.

    

Hong Kong has a per capita GDP greater than that of Japan, and nearly equal to that of Australia. It was poorer than Egypt in 1913. A substantial proportion of its economic growth came from it being a gateway for trade with Communist China. In the 1950’s, trade between China and the outside world was limited. Whatever small amount of trade existed was between China and Russia. The United States had a legal ban on Chinese trade. As the world opened up to China, there were two primary portals. There was trade with Japan – which was primarily for the Japanese market – and trade with Hong Kong – which was for the rest of the world. Chinese currency was not convertible into any other major world currency. When China needed imports from the rest of the world, it used banks incorporated in Hong Kong but owned by the Chinese Government, which could legally hold foreign currency and buy the outside supplies China needed. The result was the tremendous expansion of both banking and commerce that comprises the foundation of the Hong Kong economy today.

    

Finland’s prosperity was heavily based on its trade with Russia. During the tsarist era, Finland was remote from the rest of Europe. Finland was a part of Russia and convenient to Saint Petersburg and the rest of the European Russian market. Finland was industrially weak, but had a good paper industry, with Russia buying most of the output. Finland became independent from Russia in 1917 – which cut Finland off from its primary market just as the world would go into global recession in the 1920’s and 1930’s. The Finnish economy stagnated badly.

    

After World War II, relationships with the Soviet Union warmed up. As was the case with China, Russian currency was non-convertible. As Russia’s trade with the world increased, it was increasingly dependent on Finland to serve as an entrepot to get the foreign currencies needed. Finland’s economic growth, which had been mediocre between independence in 1917 and the reopening of trade with Russia in 1947, exploded after 1947. Its rapid rate of postwar growth led to the prosperous Finland we know today.

    

Switzerland had many other advantages besides working in a structural hole that promoted its economic growth. It had

a.  an excellent educational system,

b.  low levels of social inequality,

c.  high levels of religious tolerance – which promoted the in-migration of Protestant and Jewish skilled artisans       who were being persecuted elsewhere,

d.  a dominant position in the eighteenth century in making braided ornaments for European military uniforms, a thriving export dairy market based around Swiss cheese,

e. an extension of dairy importing to chocolate manufacture (think of chocolate as a stabilizer for milk allowing        it made into bars for shipping long distances),

f. a dominant position in global markets for watches and clocks and

g. its political neutrality and abstention from war promoted its position in global banking.

    

However, Switzerland profited enormously from its trade with the Nazis during World War II. Hitler actually self-isolated Germany from trade with most of the West during the 1930’s, out of concern for its deteriorating balance of trade. Nazi trade was concentrated with German speaking countries, the Balkans, Sweden and Spain. The onset of the war definitively closed further trade with the West. The two channels for exports for German industries and imports from the outside world into the Third Reich became Switzerland and Sweden. Switzerland was a primary provider of machinery to the Nazis, and also shipped substantial quantities of chemicals and textiles. They were a major backup provider of electricity to the Germans. Although the Swiss were technically neutral, and were under pressure from the Allies to do business with the Allied block and to avoid sales to Axis nations – de facto most of Swiss trade during the war was with Germany or its Central European Allies. The Swiss were an even more important source of finance and services to the Germans. The Swiss provided substantial liquidity to the Third Reich through the use of Swiss bank accounts. A fairly large quantity of Nazi gold was deposited in Swiss banks and used to finance a variety of international transactions. That capital stayed within Swiss banks after the end of World War II. It became part of the financial base for the substantial expansion of Swiss banking in the postwar era.

 

*  *  *

    

Is exploiting structural holes the primary determinant of economic growth? No. Economic growth continues to be determined by such objective factors as population growth rates, education levels, government provision of infrastructure, the development of consumer markets through income support and the development of viable export agricultural and manufacturing sectors. Furthermore, countries cannot voluntarily choose to become brokers in structural holes. There is a huge amount of luck involved in just happening to be located next to a wealthy trading partner who is kept from effectively trading with other partners. No one can place themselves into a structural hole at will.  Being in a structural hole is not sufficient to produce growth, nor can one place oneself in a structural hole at will.

Being in a structural hole is much like winning the lottery. But winning that lottery comes with some moral cost. Many Swiss have had deep regrets about their role in collaborating with Nazis in World War II. Anti-Communists would have had misgivings about Finland’s friendliness with Post World War II Soviets or Hong Kong’s enabling of Mao-tse-Tung.

Countries that are isolated are often pariahs. They may be pariahs for good reason. 

    

I personally don’t think the Hong Kong bankers of the late twentieth century needed to lose a lot of sleep about working with Communist China. Trade with Nazi Germany would have been an entirely different matter.

   

But then many strategies of economic growth include elements of brutality. The economies of the Americas grew by seizing land from aborigines. Settlers in the Americas also created plantations that were worked by slaves.

   

Poverty is terrible. Prosperity is wonderful. The movement from poverty to prosperity can involve a lot of unsavory elements.  

For More Information

On the general theory of structural holes, see Ronald Burt’s book.

For a review of Hong Kong economic history with a focus on Chinese relations, see Cindy Yik-Yi Chu. 2010. Chinese Communists and Hong Kong Capitalist 1937-1997. (Palgrave Macmillan).

On the economic history of Finland, see Jari Ojala’s 2006 Road to Prosperity: Economic History of Finland. (Suomalaisen Kirjaalsuuden Seura).

On the economic history of Switzerland, there is no good general English language source. My favorite French language source is Jean-Francois Bergier. 1983. Histoire de l’Economie Suisse. (Payot).

 

On World War II, and Switzerland’s relationship with the belligerents, there is an excellent doctoral dissertation thesis by Eric Golson. 2011. Economics of Neutrality: Spain, Sweden and Switzerland in the Second World War. London School of Economics, Department of Economic History.