The Weight of the Yen.

Mainstream academics and journalists like to tell us that one of the few points on which all economists agree is the value of free trade. Until very recently, however, no one bothered to pass this wisdom on to the Japanese. And despite their ignorance, their economy has become the world's strongest and most productive.

R. Taggart Murphy's The Weight of the Yen is a very readable--often even gripping--account of the rise of Japanese economic power. Unlike other recent celebrations of Japan, Murphy's analysis highlights major flaws not only in classical free trade but also in Japan's nationalistic industrial policy.

In the years following the Second World War, leading Japanese bureaucrats decided that Japan must focus on economic security. Murphy characterizes their major corporate structures as "alliances for mutual protection in a world in which nothing is certain." Consequently, this corporate leadership decided that the capital to finance economic expansion would be raised exclusively from domestic sources.

In pursuing these ends, two Japanese ministries played a vital role. The Ministry of International Trade and Industry did extensive market and technical research, targeting areas in which Japan could use its talents and resources to gain a market niche. It then ensured that the whole process could be integrated to foster speed and efficiency in production of the final product. Selective tariffs and other policies cementing supportive relations between manufacturers and suppliers were key elements in early success. The Ministry of Finance then allocated capital on a preferential basis to those firms that played crucial strategic roles in strengthening the Japanese economy.

How did Japan generate the savings and the capital it needed? Japan is a high-wage society. But land, housing costs, and most ordinary retail goods are very expensive as well. These high costs are not an accident. The Japanese are big savers, a virture we are frequently told American lack. Yet this virtue grows out of the singular mindset of the Japanese economic elites that run the country. Government planners keep land off the market and discourage use of credit. Basic public education is free, but slots for elite education are scarce and require much commitment of time and money. Bureaucrats have thus managed to make saving a necessity.

By squeezing their own people and targeting their investments, Japan achieved continuous improvements in productivity. Cheaper and better goods allowed markets to grow and costs to dip. Even in the face of periodic revaluations of its currency, making its goods more costly in dollar terms, the Japanese simply accepted sharp reductions in profits in order to keep their share of the market expanding.

The Japanese economy is a miracle. Tokyo itself now produces 5 percent of the world's GNP. This miracle, however, has exhausted its people and disrupted the foundations of the world economy. When one economic super-power runs ever larger balances of trade against other major economies, it in effect cripples its own prosperity. Simply put, the many U.S. firms driven out of business by Japanese competition can no longer produce the goods and services U.S. citizens must produce if they are to earn enough to buy more goods from Japan.

For nearly a decade these consequences could be ignored because the Japanese were willing to dispose of their own surpluses by loaning them back to the U.S. by buying our Treasury bonds. Nonetheless, as U.S. trade and government debt continued to grow, the very stability of the dollar came into question. These instabilities threatened not only the world economy but even the many Japanese institutions holding U.S. dollars.

The world economy in the last two decades has been driven increasingly by the debt and consumption of one nation, the United States, and the production of another, Japan. This ponzi scheme is unsustainable. However, simply to cut off the deficit spigot with no further changes in domestic or international economies is only a different road to depression.

R. Taggart Murphy, an investment banker and journalist, argues that the United States must practice more fiscal prudence and employ firm but sensitive negotiation with Japan on trade. His analysis is prescient but his prescriptions less precise. Part of an adequate policy agenda would lie in getting the Japanese to consume a little more, so that total world consumption would more closely approximate world production and U.S. governmental and trade deficits could be reduced. Japan could thus play a broader role in sustaining the world economy. Prudence in the U.S. must also include a better effort to employ all our citizens and give them greater voice in the way our scarce capital is deployed.

Similarly, one of the great strengths of Murphy's book lies in his recognition that if economic policy in Japan is to change, the power of its bureaucracy must be challenged. There are, in fact, many signs of political unrest in Japan. If fair trade practices were required of all trading partners and if they were designed to help working-class citizens in Japan and other nations, these initiatives might occasion less nationalistic backlash.

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Shortly before his death, John Maynard Keynes recognized that a world of increasingly free trade could be destroyed by beggar-thy-neighbor trade policies. He advocated negotiation of an international economic framework that would stimulate a high-wage, high-growth form of trade. Exchange rates would be pegged within narrow bands, and any nation persistently in surplus to the whole trading system would face automatic, internationally imposed tariffs. Such a system would provide financial stimulus for those healthy economies to expand consumption and stimulate worldwide growth. In today's world--at least the most industrialized segments of it--one might also argue that trade agreements should foster more growth in the form of shorter working hours and more family and leisure time.

One virtue of Keynes's model is that trade responsibilities are defined through broadly negotiated treaties. Trade surpluses are also measured against a whole system, not in the context of periodic attacks by one power on another. Trade and development issues can no longer be resolved simply through actions by any one government, however large. Nonetheless, world government is clearly neither possible nor desirable. The only prospect for peace and development lies in the open, democratic negotiation of new trade frameworks that allow some domestic industrial policies but also recognize each nation's obligation to the whole system. Such an approach to trade could strengthen and in turn be aided by democratic reform movements in the major industrial nations. Without such movements, we will have little more than sterile debate between advocates of "free trade" and those embracing the most xenophobic alternatives.