The Japanese economy has experienced an unprecedented period of macroeconomic turbulence over recent years. (1) Even before the 1997 Asian crisis, this had led to a sharp rise in the number of financial institutions experiencing bankruptcy, including a number of large regional banks and an international stockbroking firm.
The question we seek to address is, What effect has this economic turbulence since 1985 had on the four institutional foundations of post-World War II Japanese industrial success? (2) First, we examine the Japanese "main bank" system whereby a "main" bank is involved in a special type of long-term relationship with the non-financial firms that it lends to. (3) Second, we review the Japanese employment system characterized by lifetime employment, a seniority wage system, and enterprise unionism. (4) Third, we look at the inter-corporate relationships between main firms and their suppliers. (5) And, fourth, we consider the nature of Japanese industrial policy, the interventionist role of the Ministry of International Trade and Industry (MITI), and the relatively weak role of Japanese competition policy under the authority of the Japan Fair Trade Commission (JFTC). (6) In each case we present evidence that suggests that these institutional foundations of the Japanese "economic success story" have been weakened over the period we look at. Before turning to the institutions, we sketch the wider macroeconomic, political, and supply side situation of the Japanese economy.
The Japanese Economic System
Morishima asked the question "Why has Japan 'succeeded'?" in 1982. The answer that he gave suggested that there was a distinctive set of institutional characteristics present in Japan that significantly contributed to Japanese economic success. The interesting thing for Morishima was that although many of the elements of the Japanese system were present elsewhere, it was only in Japan that they were combined in the particular way that fueled the rapid growth of the post-war Japanese economy. In this paper we have picked out four of the most obvious institutions that were part of this Japanese economic system.
The Japanese main bank system successfully recycled domestic savings into manufacturing investment at a time when the stock market was underdeveloped. The keiretsu relationships between main firms and their suppliers in the manufacturing sector provided a combination of knowledge sharing, quality control, and flexibility for export-oriented firms. The lifetime employment system for workers in exporting firms reduced competition for scarce skilled labor while motivating workers with the threat being fired and losing future earnings.
These first three institutional arrangements fostered highly co-operative, non-confrontational relationships between related groups in society at a time when economic policy was focused on the stated goal of catching up with western levels of productivity. These private sector aspects of the economic system were supported by the co-operative environment which the Japanese government promoted via MITI. MITI bureaucrats sought to guide the private sector's efforts to catch up with the West. They did this by subjugating competition policy (under the control of the Japan Fair Trade Commission) to their own industrial policy. Under this arrangement there was legislative underpinning for domestic cartels, aimed at supporting international competitiveness, and government-supported co-ordination of domestic private sector investment activity.
The system successfully managed to promote co-operation in a way which reduced the transactions costs of competition while maintaining its incentive properties. Masahiko Aoki pointed out that this co-operation and its underlying incentive structures were consistent with rational profit-maximizing behavior (1988).
As in the nature of successful systems, all the elements of this system are consistent with one another, lf one or more of them were to be undermined, it is not at all clear that the other elements would have a rationale and could survive. For instance, if firms were to start competing for all employees on the basis of salary alone, rather than a job for life, this could undermine the keiretsu structure. Firms would be unwilling to send employees in to help supplier firms if the latter might be tempted to make them a competitive job offer on the basis of current pay. Higher worker mobility, which is a feature of a more competitive labor market, discourages firm co-operation of this type.
Recent Trends in the Japanese Economy
The beginning of this recent period of macroeconomic instability can be dated from the September 1985 Plaza Accord, when the United States and Japan reached an agreement aimed at reducing the value of the dollar-yen exchange rate. The Plaza Accord began a period of rapid yen appreciation (40 percent increase in real value in two years). This appreciation was accompanied by only a small reduction in the volume of Japanese exports and was not offset by increasing volumes of imports. The result was a substantial increase in the dollar value of the current account surplus. Following the 1987 stock market crash, looser monetary policy worldwide saw the Japanese discount rate fall to a period low of 2.5 percent in June 1989. Low interest rates prompted a stock and land market boom as lending to financial and property companies rose rapidly in the so-called bubble economy. (7) Rising interest rates from June 1989 led to sharp falls in asset prices in 1990. This put pressure on the financial system as the value of assets used as collateral for bank lending declined, leaving a large number of major financial institutions technically bankrupt. Declining financial wealth contributed to falls in consumption and a recession from 1991 to 1993. From November 1993 to 1997 there was a modest economic recovery.
In tandem with the financial instability initiated by the Plaza Accord, there developed growing political pressure on Japan from the United States at the industry level. The appreciation of the dollar in the early 1980s had sharply worsened the U.S. trade deficit with Japan. Not only did the United States seek and get agreement on macroeconomic policy to reduce the value of the dollar and improve the competitiveness of U.S. exports but it also fought for industry-level agreements aimed at restricting Japanese exports to the United States and at increasing the sales of U.S. components to Japanese firms. Under the Structural Impediments Initiative (SII), beginning in 1987, Japan agreed to maintain and promote competition in its domestic markets with transparent administrative guidance which did not discriminate between domestic and non-domestic firms. It also agreed to deregulate its distribution sector and to make more effective use of land. By 1996, continuing rounds of negotiations involved pressure to liberate insurance markets which were closed to foreign insurance firms.
These policies contributed to the trend toward a significant internationalization of the Japanese economy as import volumes rose and Japanese manufacturing firms shifted lower technology production off-shore and improved the productivity of high technology production. (8) Japanese firms have invested heavily in manufacturing plants overseas. The production of these plants has often substituted directly for exports from Japan. It is calculated that by 2000 Japanese manufacturing firms had the equivalent of around 20 percent of their domestic employees overseas, up from 5 percent in 1985. (9)
The other major trend affecting the Japanese economy was the aging of the workforce. The birth rate in Japan is 1.4 children per family unit. However, the life expectancy of the average Japanese has increased to 80.1 years. This implies that the dependency ratio has been increasing and is now one of the highest in the world. The implications of this trend are wide ranging. There are implications for the mix of consumption, the tax burden posed by public pensions, and the strain that this puts on company pension schemes and age-related promotion structures. Highly skilled young workers are at a premium, whereas there is a relative abundance of senior employees.
Recent Japanese Political Economy
Japanese macro-economic policy has had little impact on the underlying rate of economic growth. This is due to the stop-go nature of the government's fiscal stance against a background of deteriorating revenues. A large stimulus package was adopted in 1994, but the reductions were reversed and taxes increased in 1996. In 1998, another attempt was made to stimulate the economy, but this was reversed in 2001. The policy of low interest rates did not stimulate investment or an increase in the money supply. Banks were unwilling to increase their loans to already financially embarrassed companies and instead absorbed government attempts to increase the money supply by buying government bonds.
In parallel with the economic turbulence that Japan was experiencing, there was considerable political upheaval. A series of corporate scandals involving agreements between politicians and firms were exposed along with the worsening financial situation of companies. In one, the chief of the LDP-the political party that had governed Japan since 1955--was arrested. This gave rise to widespread public support for reform, leading to a vote of no confidence in the cabinet, a general election, and the return of a coalition government without the LDP in i993. The new administration was, however, short-lived, and a new coalition involving the LDP took power in 1994. In 1996, a reformed LDP regained majority control and took sole power again but with a mandate to carry out further political reforms.
Bureaucrats, too, came under public scrutiny for their perceived role in neglecting to monitor failing banks. This culminated in the arrest of officials from the Ministry of Finance and...