Nippon self-reinvention. (Last Word).

A graph showing listings of new firms on the Tokyo Stock Exchange over time looks like the profile of an alpine mountain: It rises from a low level in the 1870's to a sharp peak after World War II and then descends back to the lowlands. (The recent addition of NASDAQ-like exchanges has not much altered this overall pattern.)

A survey by the Financial Times shows that with a few exceptions its major high tech companies were established before World War II. There are few counterparts to Sun, Cisco, Microsoft, or SAP, relatively new, large firms. It is not that Japanese ones lack ideas. Japan led in growth in absolute numbers of patents from 1992-99 and was near the top in information technology (IT) patents. However, despite its strengths in computer games and the success of its creative wireless firm, DoCoMo, overall, Japanese companies were not key innovators in the major IT developments over the past twenty years: the PC revolution, networking, software, and the Internet.

Before the 1990's, after several decades of excellent performance by Japanese industry, any observer noting that it had few, new, high tech companies would probably have met with the response that success spoke for itself. Now, after a decade of economic stagnation, questions about the near absence of startups have become increasingly salient.

An important function of new firms is reallocating resources, human and physical, from old sectors to new. A competitive market causes the shrinkage and disappearance of existing firms and the creation and growth of new ones. Of course, established companies can reinvent themselves, a mechanism that has been much used in Japan. But, the ability to start afresh arguably hastens the redeployment of assets.

Another function of startups is to speed the entry of new technologies to the market. While large firms remain the main wellsprings of technological advance, they are often faced with more opportunities than they can exploit. Since their managements often focus on meeting the needs of current customers, a role for startups is to exploit these large firms' unexploited ideas, often by people leaving to build new firms. Because there is always uncertainty about which ideas will be winners, an efficient way to select them is for many firms to be started and allow the market to pick the winners and weed out the losers.

A third function of new firms is motivational. It gives people with entrepreneurial abilities an opportunity for them to demonstrate their skills as well as the opportunity to get rich.

Structural changes in the computer industry since the early 1980's gave an advantage to firms able to move fast. This shift centered on the move from proprietary to open standards. It was followed closely by the transformation of network computing into the Internet. Japan's IT industry accommodated slowly to these radical changes. Many had keiretsu interlocking relationships among suppliers, manufacturers, distributors, and financiers; such relationships are fairly rigid and many Japanese firms were caught off guard by the rapid advance in computer technology. Now, they are making a transition to relationships that are more fluid and weaker in order to become more adaptable in technically dynamic sectors.

By the late 1990's, MITI (now called METI, the Ministry of the Economy, Trade and Industry) recognized the problem and began to change the rules affecting incentives for creating new firms. They focused on four aims: 1) increasing labor mobility; 2) deregulating capital markets; 3) facilitating corporate restructuring; and 4) improving university-industry linkages. To mention only a few of many changes, private "headhunters" can now operate; a plan for portable (defined contribution) pensions is being designed; pension funds can now invest in venture capital projects; it is easier for firms to create spin offs; and the Education Ministry has made it easier for faculty members to take a leave to start a business.

Some observers argue that there remain deep cultural obstacles, such as that towards failure. It is regarded not as a valuable learning experience but as a sign of ineptitude or moral turpitude with family members being ostracized and credit ratings ruined. However, those holding such an opinion should ask why it was that Japan created so many new firms after World War II? The answer is clear: The society had to rebuild itself and entrepreneurship was essential to that process.

Japan today needs to invent itself again and METI, at least, has a program for doing just that.

Henry S. Rowen is a Senior Fellow at the Hoover Institution. This article is based on a paper by Mr. Rowen and his colleague, A. Maria Toyoda.