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Evolution of the Economic System in Japan.

Evolution of the Economic System in Japan Juro Teranishi. Cheltenham: Edward Elgar, 2005, 360pp.


One of the popular myths about the Japanese economy is that its systemic characteristics are old. Industrial paternalism and the close government-business relationship, for example, are sometimes taken as offshoots of Japan's pre-modern socio-economic order and institutions. Actually, as demonstrated in Teranishi's book about Japan's economic systems since 1868, contemporary Japanese economic institutions are modern in their origins. There was a discontinuity in the Japanese economic system around WWII. The preceding system was, in fact characterized by high labour mobility and a non-interventionist government--closer to Anglo-Saxon classical capitalism.

An economic system, defined by Teranishi as a set of rules that constrain the behaviour and interactions of economic agents, has three subsystems: (a) the division of labour between the government and the private sector, (b) the private sector institutions whose core is the employment, financial, production, and corporate governance systems, and (c) the mode of the government-private sector interaction and its impact on income distribution. An economic system's coherence depends on the complementarity across and within these subsystems. Insofar as economic agents accept and abide by the rules, the incumbent economic system lasts. If old rules become obsolete in the face of an environmental change, a system declines and is replaced by another.

Teranishi identifies the two systems as the 'Meiji-Taisho' and 'high-growth-period' economic systems. The Meiji-Taisho capitalist system (1868 to 1926) emerged around 1900 after the government laid the institutional foundation, and new transportation and communications networks and modern legal and currency systems integrated the national economy. By then Japan's modern sector was expanding but still relatively small, agriculture was the economy's mainstay, and industrialization proceeded from light industry. The Meiji-Taisho system enabled Japan to tap the entrepreneurship and accumulated wealth of local elites, landlords and merchants, who became the shareholders of large modern companies and borrowers from banks to invest in small businesses. This earlier economic system was decidedly more market-based than the high-growth-period system.

In terms of Teranishi's three subsystems, the government's role in the Meiji-Taisho system was largely confined to public goods provision centred on infrastructure investment and national defence, and government's intervention in private business activities was kept to a minimum. An overwhelming majority of workers were low-skilled, the firm's labour turnover was high, and Japan's income distribution was highly skewed. Large shareholders controlled modern firms, share ownership was concentrated, and the traditional sector relied on bank financing. As the modern sector was small, landlords and merchants as local elites took up the role of representing the private business interests in the parliamentary system. Distributive conflicts mainly appeared between geographical regions in the form of competition to win higher government spending on infrastructure investment and education for promoting regional economic development. It has been known that late Tokugawa Japan and pre-Industrial Revolution Western Europe shared a number of economic and institutional characteristics that served as the preconditions for modern economic growth. Teranishi shows that the Meiji-Taisho system resembled the early capitalist British economy. This suggests that this economic historical parallel continued to the early phase of Japan's capitalist development.

The Meiji-Taisho system's decline began in the late 1920s as the modern sector's continuous expansion and agricultural depression weakened the relative position of landlords and merchants. These local elites could no longer play a pivotal role in the system. Also, the rapidly expanding heavy industry required more capital, skilled labour, and active government support, than the Meiji-Taisho system could easily meet. Hastily introduced wartime economic planning and direct control measures put an end to the market-based Meiji-Taisho system by 1940.

Instead of reverting to a liberal system after World War II, Japan's economic system evolved to more interventionism. The high-growth-period economic system from the early 1950s to 1973 saw the government exercising broader discretionary power over private business. Post-war reconstruction and reform had greatly weakened the bargaining power of the private business sector. Hyperinflation, the dissolution of the zaibatsu, and land reform during the Allied occupation (1945-1952), wiped out the wealth and power of pre-WWII large shareholders. Government bureaucrats gained the upper hand and managed to maintain various wartime control measures in modified forms. Government bureaucrats mobilized funds through a tightly regulated banking system and guided private sector investment via industrial policy in order to build a comprehensive and modern industrial sector. The wartime manager bank, which headed a loan consortium for each key firm, was transformed in the 1950s into the main bank, which served creditors as a monitor over the borrowing firm.

During the interwar period some firms in heavy industry had adopted the lifetime employment and seniority wage systems as a means to train skilled workers in-house and retain them. Almost all large firms embraced these two employment practices during the rapid-growth period. Firms conducting continuous business transactions among themselves also entered cross-shareholding arrangements, which relieved pressures from the share markets and allowed corporate managers to pursue long-term firm goals. Long-term relationships in the private business sector, associated relation-specific investments by firms, and investment in firm-specific skills by workers constituted the foremost merit of the system according to Teranishi. The rise in modern industries and drop in labour mobility along with active government intervention at the industrial level changed the nature of distributive conflicts. Rather than only geographical regions, now industries competed for favourable treatment by the government.

The high-growth-period system's decline began in the 1980s once Japan had closed the industrial sector's technological gap with the West. Japanese-style indicative planning via industrial policy had its dark side. As is familiar to the students of former centrally planned economies, inefficiency, waste, and corruption associated with the planning scheme grew over time as the structure of the Japanese economy became more complex and international trade and capital flows increased their roles. Maintaining plan coherence for an extended period under democracy became impossible, since discrimination subjects the government to pressures from those in non-priority sectors demanding compensatory favours. Japanese indicative planning, which outlasted the French type, appears to have degenerated into a system dispensing subsidies, loans, and public works broadly by the 1990s. The discriminatory nature of industrial policy from the 1970s has been attenuated. The main bank system largely lost its role as strong firms began to rely on liberalized capital markets for external funding, and the banking crisis of the late 1990s reduced banks' ability to bear loan risks. Facing the decade-long economic slump from the mid-1990s, large firms began to unwind cross-shareholding positions to raise cash and to substitute temporary for regular workers.

Teranishi thinks Japan's outdated economic system in a changing environment was an important factor behind the economy's malaise of the past decade. Although some aspects of the post-WWII private sector institutions will certainly survive, we may expect a new economic system to appear in due course. As dirigisme has run its course, the Japanese system may revert to its liberal beginning after a long interlude since 1940.

Hiroyuki Imai

Lock Haven University of Pennsylvania, Lock Haven, Pennsylvania, USA

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Author:Imai, Hiroyuki
Publication:Comparative Economic Studies
Article Type:Book review
Date:Jun 1, 2007
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