Is China the next Japan?

• Author: Smith, Roy C.

Twenty-five years after a major financial crisis, Japan's powerful export-based economy has become a mere shadow of its earlier status as a financial superpower. Though different in many ways, China has followed Japan's economic development model and may now too be facing a financial crisis like Japan's that it may not be able to control and that could diminish its ability to become the next Asian superpower.

In 1970, American futurologist Herman Kahn published The Emerging Japanese Superstate, which summed up informed opinion on Japan twenty-five years after World War II. The war had been a disaster for Japan, but it purified the country of all of its bushido-driven prewar notions to allow a new Japan to emerge. The seven-year U.S. occupation forced a constitution and other democratic institutions on the new government that were accepted with little understanding or complaint. But beyond the American influence, the struggling new Japanese government understood that it had to create an economy that could grow the country out of the extreme poverty and hardship into which it had been plunged. After a relatively slow initial recovery, Japan's economy picked up during the Korean War (1950-53) when United Nations military forces were supplied from Japan (Dower 1999, 536-40).

After the war, Japan would create a protected market economy dominated by a collective triumvirate of industry, banks, and powerful government ministries, soon called "Japan Inc." by foreign observers. The mission of Japan Inc. was to create the maximum amount of growth the economy could achieve by manufacturing for export. The exports were initially low-technology goods manufactured in great quantity at low cost. The system worked extremely well. The Ministry of International Trade and Industry (MITI, reorganized as the Ministry of Economy, Trade, and Industry in 2001) would determine what the industrial focus would be. The Keidanren (Federation of Economic Organizations, or council of big business organizations) would cooperate to carry out MITI's guidelines. Labor unions would agree to accept an annual Shunto, or Spring Offensive, to set wages for all. The Ministry of Finance would ensure that banks, closely supervised but highly leveraged, made funds available to the large manufacturers, which were reconstituted from the powerful prewar zaibatsus into mutually supportive keiretsus (successor affinity groups, such as Mitsubishi or Sumitomo), to expand production capacity. "Trading companies" within keiretsus would acquire the goods and sell them aggressively in overseas markets.

All of this was intended to maximize employment and create cash flow sufficient to restore a normal society in Japan. Though the system Japan installed was essentially a capitalist one, not unlike its prewar industrialized predecessor, there was very little private capital left after the war, profits were modest, and social claims on them were considerable. Capital for investment had to be generated from a high household-savings rate.

The new economic and financial system, launched under close American supervision, had some socialist characteristics, but only some. There was concern about Communist ideology spreading to Japan, as it had in the immediate postwar years in Europe, and the concern resulted in land reforms and other measures to provide government support for the common man, but the emphasis was always on creating a highly functional, democratic, free-market system that lifted everyone up.

A key condition of the Japan Inc. arrangement was that fair wages had to flow to workers and corporate distributions had to take a backseat to reinvestment for growth. The bureaucrats were smart and efficient, but they were also part of a new democratic political system that needed and received unquestioned public support.

A Miracle Economy

By 1970, Japan Inc. was an unqualified success. Japan's economic growth rate averaged 9.6 percent from 1946 to 1970 (Maddison 2003), and a stable middle class had emerged. It was a staunch, if passive, ally of the United States, with no territorial aspirations. The Japanese stock market, reestablished early on, soared for years, enriching many foreign as well as Japanese investors. The export-led Japan Inc. development model was a modern economic miracle that was carefully studied by South Korea, Taiwan, and other Asian emerging market countries.

Kahn greatly admired Japan's economic progress, but his book (Kahn 1970) anticipated problems of a "second" appearance of a Japanese "superstate" in the Pacific region. Among these problems were other Asian states' resentment of the reconstruction of the Greater East Asian Co-prosperity Sphere by other means, Japan's insatiable need to invest abroad to secure raw materials for its industry, and a growing expectation of Japanese resistance to its subordinate relationship to the United States.

Kahn needn't have worried. Three years later the "oil shock" precipitated by Arab oil-producing countries in 1973 in response to the Yom Kippur War in Israel nearly brought Japanese industry to its knees. A fourfold increase in the price of crude oil, almost all of which Japan had to import, brought about a global recession (and lack of demand for its exports) as well as a crushing increase in Japanese industrial operating costs.

But Japan Inc. rallied. It found ways to conserve energy, and it moved its exports up the technology curve from items such as textiles and steel to electronics, automobiles, and semiconductors. For the next decade, although Japan's growth rate was halved, to about 4 percent (Maddison 2003), much of this decrease was inevitable as Japan moved from competing on the basis of low wages to competing on the basis of more sophisticated products.

At the same time, however, Japan developed an increasing amount of conflict with the United States and other trading partners. These conflicts were twofold. First was the charge by U.S. industry groups and labor unions that Japan was unfairly "dumping" low-cost goods on the American market. (1) The second was that Japan deliberately blocked access to its home market by U.S. and other foreign companies seeking to compete there. Disputes over these issues lasted two decades or more, with concessions demanded of the Japanese, to which, periodically but as slowly as possible, they would agree.

Becoming Number One

In 1979, Ezra Vogel, a Harvard social scientist and professor of Asian studies, published Japan as Number One: Lessons for America. Japan had already surpassed Germany to become the world's second-largest economy, and Vogel, recognizing the inflation-ridden angst into which the U.S. economy had fallen in the 1970s, foresaw a future in which Japan, because of its cohesive cultural and organizational characteristics, would surpass the United States as well.

By 1979, the training wheels of the Japan Inc. control system had been taken off: the government had withdrawn from routine supervision of investment decisions, and business matters were left to individual companies to decide on the basis of market factors. The lessons Vogel (1979) had in mind, however, related to the collegial, cooperative, employee-friendly management and organizational methods used by Japanese companies to achieve steady growth and to add to broad social prosperity, despite having to adapt to unexpected changes in the world economy. These methods included lifetime employment obligations, company unions, worker participation in factory management, and various programs to inculcate company loyalty. Most of these "cultural" factors, however, had been adopted in the postwar period only because of the necessities of the times.

There was a great deal of support for Vogel's views. Japan was widely regarded as an economic superpower, even if it had become, in some critics' views, a society of hyperenergetic economic animals with little regard for activities or responsibilities beyond its corporate or national borders.

Indeed, Kahn and Vogel had underscored the uniqueness of Japanese economic success to such a degree that some considered it threatening. Chalmers Johnson (1982) suggested that the United States needed to take steps to "contain" the threat, much as communism had been contained during the Cold War, and this view gained support by unions and Congress.

The 1980s, however, brought in the babaru keizai, or "bubble economy," in which Japan's superpower status was destroyed by its own riches. As Japan became a more normal economy, its growth slowed to world averages. As this slowing occurred, Japanese officials sought to counter the trend with low interest rates and large amounts of easy money. The ensuing "excess liquidity" (the growth in money supply minus the inflation rate), which reached 5.5 percent of gross domestic product (GDP) in 1986 and 1987, did not pass into goods and services as inflation but into financial assets--mainly stocks and real estate--as value increases.

Both corporations and households bought these assets, very often with borrowed money, because of their belief in the limitless sustainability of Japanese economic success. The Nikkei stock-market index rose sixfold in the 1980s, compared to a threefold increase in the United States under the effects of Reaganomics. At the end of 1989, the market capitalization of all Japanese stocks was $4.4 trillion, reflecting an average price-earnings ratio of 70.6 (by comparison, the U.S. equities market was valued then at $3.5 trillion, with a price-earnings ratio of 14.1). The Nikkei reached its all-time high of 38,916 on December 29, 1989 (R. Smith 1993, 243-49).

An Economic Tsunami

Then the bubble burst, slowly at first, but it accelerated. The Nikkei index lost two-thirds of its value by August 1992. The market decline spread the panic into the real estate and banking sectors and jolted the real economy. The crash became systemic as margin loans were called, creditors were squeezed, and...