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International perspective: trading with Japan: why the U.S. loses - even on a level playing field.

Unlike U.S. firms, Japanese firms do not

seek to maximize profits, either short or long

run. Instead, Japanese firms seek to

maximize growth, maximize market share,

maximize employee welfare, or promote

company prestige. Consequently, Japanese

firms will sell more goods at lower prices,

reduce marginal costs faster in

technologically progressive industries, decouple

production and price decisions from production

costs, act as if they had a lower cost of

capital, and overpay for assets. The

implications of such behavior are not good for U.S.

and European companies.

IT'S HARD TO PICK up a business magazine these days without finding some story about U.S.-Japan trade. Our bilateral trade deficit is sometimes attributed to Japanese protectionism or other "unfair trade practices." These charges may be true. But I want to argue that there is a deeper source -- a source that explains why we would lose out even on a fully level playing field.

My hypothesis is that large Japanese firms engaged in international trade do not seek to maximize profits. Rather, their drive for growth leads them systematically to produce and sell more than the conventional theory of profit maximization dictates. And I want to argue that this gives them a severe -- but not necessarily unfair -- advantage in international trade. I hasten to say the hypothesis does not originate with me. Rather it is commonly believed in Japan. To the extent I have anything original to add, it is to point out the implications of this hypothesis for international trade. In particular, the non-profit-maximizing hypothesis, if true, helps explain: (1) Why Japanese businesses often outcompete their foreign rivals; (2) why Japanese exporters sometimes seem to swallow cost increases; and (3) why trade negotiations between the U.S. and Japan consistently produce such meager results.

The argument can be presented in three steps:

1. Evidence (against the standard assumption of

profit-maximization for Japanese firms). The

evidence is largely and admittedly anecdotal,

but there is a fair amount of it. And, as George

Stigler once quipped, data are the plural of


2. Implications (for international competition

and trade). Suppose Western and Japanese

firms face identical cost and demand

conditions, but Western firms maximize profits

while Japanese firms systematically produce

more. Then Japanese companies will sell their

wares at lower prices and take markets away

from their Western rivals. From the European

or American perspective, this behavior may

look like predatory pricing. But to the

Japanese it will simply be normal business

practice, which is one reason why the two sides

often talk past each other.

3. The Darwinian argument (for profit

maximization). According to conventional economic

theory, firms that fail to maximize profits will

be driven out of business by the forces of

competitive capitalism. The usual argument is that

non-profit-maximizing firms will fail to attract

new capital and will therefore wither and die.

I will conclude by offering several conjectures

about why this argument might not apply in



Sometimes it is said that American firms maximize "short-run profits" while Japanese firms maximize "long-run profits." That is not my hypothesis. Why? The stock market is supposed to capitalize long-run profits into share prices. If the market values companies correctly, American managers striving to maximize stock-market value will be induced to maximize long-run profits. If they fail to do so, either they or the stock market must be making mistakes. My claim goes deeper and is more basic. It is that there is a systematic difference between the goals of Japanese and Western firms. Managers of large Japanese enterprises are willing to sacrifice some of their firms' potential profits indefinitely for the sake of greater size.

The behavior of Japanese firms looks puzzling when viewed through the prism of profit maximization. In particular, many people have observed that Japanese companies appear to be much more interested in growing fast and gaining market share than at generating profits. According to Clyde Prestowitz, "The Japanese are not averse to making money; all things being equal, they'd like to make more. But if the choice is between growth and profit, it will be growth every time."(1)

Abegglen and Stalk write of "the strong bias toward growth of the successful kaisha."(2) They quote a survey that revealed American companies believe return on investments is their principal objective. There was no serious competition; stock-market price was a distant second and market share finished third.(3) By contrast, Japanese companies listed (1) market share, (2) return on investment, and (3) introducing new products. Very few even listed stockmarket price among their top ten objectives.(4)

In Business Week's latest list of the largest companies in the world, by sales all of the top five and six of the top ten firms were Japanese, but by profits only one of the top ten companies was Japanese.

I don't think that's because the Japanese maximize long-run rather than short-run profits. Giants like Toyota and Mitsubishi are old enough so that they should now be realizing their long-run profit potential.

A former NEC executive told Prestowitz that Japanese managers, who typically come from engineering backgrounds, do not worry about capital costs. The executive claimed that he had never seen a discounted cash flow analysis in all his years at NEC.(5) Can such a firm be maximizing profits?

Sony's Akio Morita once told a prominent American CEO that Sony simply had to be at the technological frontier at all times.(6) When the American related this story (approvingly) to me, the neoclassical economist in me almost blurted out: "But that can't be profit maximizing behavior!" It is probably not; but that is precisely the point. Morita wrote in his autobiography that Japanese "companies will go after an increase in share of market by cutting prices to the bone, sometimes to the point where there is no chance of anybody making a profit" (p. 225).

As a second type of evidence, most students of the Japanese system believe that the kaisha do not maximize profits. As I have noted, Abegglen and Stalk emphasize growth. Ryutaro Komiya, a leading academic economist now associated with MITI, believes that Japanese firms maximize the welfare of their employees.(7) Hiroyuki Itami, calls the Japanese system "peoplism" instead of "capitalism." Masahiko Aoki, perhaps the premier theorist of the Japanese system, modifies this somewhat to argue that Japanese managers mediate between workers and shareholders by maximizing a weighted average of profits and employee welfare.(8) Journalist Karel van Wolferen writes that: "Whereas in the west . . . economic factors such as profitability determine a company's success, in Japan success is measured more by political indicators: the company's size and market share." Douglas Kenrick, a New Zealander who has run his own business in Japan for more than fourty years, writes that the "feeling that the place-of-work, the corporation, exists for the employees and to give a service to its customers, not the shareholders, is taken for granted."(9) Many of the Japanese businessmen, government officials and economists I interviewed this summer thought that employee welfare motivates the Japanese firm more then profits. Morita called the Japanese corporation "A social welfare organization."

These are all impressions, to be sure. But there seems to be no evidence at all on the other side of the debate, just faith in the postulates of neoclassical economic theory.

If not profit maximization, then what are the goals of the Japanese corporations?

1. Maximizing growth: Abegglen and Stalk and many others emphasize growth in sales -- an hypothesis first advanced (for large American firms!) by William Baumol more than thirty years ago.(10)

2. Maximizing market share: This goal differs from the first only under unusual circumstances. For the most part, growing and increasing market share amount to the same thing.

3. Maximizing employee welfare: Komiya's hypothesis that the kaisha are run for the benefit of their employees seems at first to be quite different from growth maximization. But the two goals closely coincide under the Japanese lifetime employment system.

4. "Collecting trophies": For example, see the Japanese penchant for acquiring prominent properties like Rockefeller Center or the Pebble Beach golf club. Mitsui Real Estate's man in New York told writer Michael Lewis that no Japanese investor has yet made money in the New York real estate market. What, then, motivated all those purchases? According to Lewis, it was the drive for status back in Japan. When Mitsubishi Estates outbid Mitsui for a 51 percent interest in Rockefeller Center, "It wasn't a normal American-style corporate rivalry. It has nothing to do with who made the most money. It had to do with the prestige of the company, with being the biggest."(11)

Which goal? It doesn't matter, because all lead to the same conclusion: The Japanese firm produces beyond the profit-maximizing level. Hence, I will be deliberately vague in referring to "size maximization" as the goal of the Japanese firm.


Suppose, then, that Japanese firms maximize size rather than profits. What are the implications for international trade and competition?

1. The kaisha will be eager to sell more goods at lower prices than their profit-maximizing rivals. Therefore, Japanese firms will enter markets that Western firms are exiting due to low profitability. This difference gives the Japanese a natural edge in head-to-head competition. They can succeed by their criterion (that is, grow larger) while Western firms are failing by theirs (that is, not earning a competitive rate of return). Beleaguered Western firms will naturally view such competition as unfair. The Japanese are, after all, selling below full cost -- including an appropriate return on capital. The Japanese will find the charge perplexing; they are just practicing business as usual.

2. Size maximizers have an even sharper advantage in technologically progressive industries with important learning curves, precisely the areas in which Japanese industry has succeeded so well of late. The Japanese firm will ride down its learning curve faster. Hence, even if it starts the competitive race with no cost advantage, it will soon acquire one. The Japanese firm not only produces more at any given level of marginal cost, but also reduces its marginal cost faster. So the profit-maximizing tortoise never catches the size-maximizing hare.

3. This point applies when market conditions are favorable enough to let Japanese firms, at the margin, ignore profits entirely. For example, if the Japanese firm maximizes revenue subject to a minimum-profit constraint that is not binding, it becomes a pure revenue maximizer and its production and price decisions are entirely decoupled from production costs. If costs increase, say, because of OPEC or currency realignment, a pure revenue maximizer will sacrifice profit rather than scale back its operations. A profit maximizer will contract.

4. A size maximizer will act as if it has a lower cost of capital than its profit-maximizing rivals because it appraises investment opportunities by their contributions to, say, the firm's growth, not their contributions to profit. Japan's cost of capital advantage has received much attention of late in academia and in the business press.(12) But a simple fact seems to have been lost in the debate. From the time of its postwar "take-off" in the mid-1950s until sometime in the early 1970s, Japan had no capital-cost advantage over the United States. Yet that is precisely when the Japanese formulated and carried out their high-investment strategy. Thus there are two competing theories: (1) the cost of capital is lower in Japan, and (2) Japanese firms value size per se. Normally, these two theories yield identical predictions about investment behavior. But current events may provide an unusually decisive test, because the cost of capital is now approximately equal.

5. A firm that is more concerned with size than profits will systematically "overpay" for assets, if these assets are valued according to the discounted present value calculations relevant to profit maximization. This seems to be precisely how American business people characterize Japanese purchases. Whether it is Hawaiian hotels, New York skyscrapers, or interests in investment firms, American observers always seem to claim that the Japanese overpay for the assets they buy. That is, of course, why the Americans sell so eagerly.


The notion that firms do not maximize profits surfaces regularly in the economic literature, where it is normally dismissed with a Darwinian argument. Firms that fail to maximize profits will generate smaller returns for the capitalists who own them. Their stock market values will fall, making them vulnerable to takeovers and/or will be unable to raise funds in a competitive capital market. Eventually, they will perish or be swallowed up by profit maximizers.

Why does this argument not hold in Japan? Three speculative hypotheses are offered:

1. The Japanese stock market does not discipline non-profit-maximizing managers the way the U.S. stock market does. Equity is locked up in cross-holdings, which reduces selling pressure and all but immunizes non-profit-maximizing managers from takeover bids.

But this is not a sufficient explanation, for the docile behavior of arms-length investors still needs to be explained. Stock prices are, after all, determined at the margin. Why do profit-driven investors not punish managers with low share prices the way we do. Japanese managers can ignore stock market values in a way that U.S. managers cannot. Arms-length shareholders in Japan are essentially rentiers with little or no influence on corporate behavior. To quote a former bank executive, "Shareholders are almost nonexistent in the mind of the president of any big Japanese company." I asked the head of a large service conglomerate if the stock market would ever influence his business decisions: "Never!"

2. There is a possible shortcoming of standard economic thought. Neoclassical micro theory assumes that firms hire labor and other inputs, put them to work, and get the output specified by the production function. But suppose workers need to be properly motivated to put forth their best efforts, as assumed in some versions of the efficiency wage theory. Conventional profit maximization, which assigns all marginal returns to the capitalists, gives workers only weak incentives to perform up to their abilities. A system that features higher wages, greater job security, more employee involvement and gives workers a real stake in their jobs may provide much stronger incentives. If so, the production function of a firm following "Japanese" practices might be superior to that of a conventional profit maximizer. In that case, the Darwinian struggle might not eliminate the size maximizers.

But is it really true? There is intriguing evidence that profit sharing, which helps align the interests of capital and labor, raises labor productivity.(13) And there are also dramatic examples, like the NUMMI plant in Fremont, California, where Japanese management techniques have led to drastic improvements in output from almost the same capital and labor inputs.

3. This relative efficiency argument may be much more powerful when we move from statistics to dynamics, because it is at least possible that size-maximizing behavior may actually increase the rate of growth, not just the level, of productivity. Why? Haruo Shimada and other Japanese labor economists argue that Japanese management practices encourage workers to kaizen, or continuously improve the manufacturing process.

". . . the American system . . . places a ceiling on

the performance gains that can be achieved by

improving human resource effectiveness -- ceiling

not in place in the Japanese system. Japanese

companies emphasize human resource effectiveness

because it is a technological imperative to achieve

continued gains in performance.(14) (emphasis


If Shimada is right, then a firm that maximizes sales or employee welfare rather than profits might enjoy a faster pace of technological improvement than a conventional profit maximizer. Once again, Darwinian forces will work in its favor rather than against it.


A substantial amount of anecdotal evidence suggests that large Japanese firms systematically produce and sell more than the standard theory of profit maximization dictates. If this hypothesis is true, several key implications for trade follow:

1. Japanese firms have a natural competitive advantage over Western rivals who maximize profits. They can flourish (by their own standards) even in markets that will not support a competitive rate of return. This edge grows progressively larger in industries on the cutting edge of technology, where learning curves are important.

2. Cost increases may not induce Japanese firms to retrench.

3. Japanese firms will behave as if they have a cost of capital advantage even if they do not.

But why does the Darwinian process not eliminate firms that fail to maximize profits? Here the argument is on shakier grounds, but I offer three speculative explanations.

1. The Japanese stock market does not discipline non-profit-maximizing managers the way the American stock market does.

2. Size-maximizing firms get more and better work effort from their employees.

3. Technical change proceeds faster in a size-maximizing environment with employee participation.

The aforementioned arguments cannot apply to the entire Japanese economy. Resource constraints mean that if some Japanese industries are bigger than they would be under profit maximization, then other industries must be smaller. Extreme export success in some industries will raise the value of the yen, thereby handicapping other export (and import-competing) industries.

Where, then, does the model apply? Clearly not to small firms nor perhaps even to large firms controlled by owner-managers. Rather, the model applies mainly to large firms in which management enjoys considerable autonomy, especially in technologically progressive industries with steep learning curves. Here, the model predicts, is where Japan will be most competitive on world markets.

The implications are not very good for the United States and Europe. If major Japanese companies are willing systematically to sacrifice profits for growth, they will outlast their Western rivals in head-to-head competition -- as has happened in semiconductors. If the ultimate "structural impediment" is not overt trade barriers but the differing goals of the two groups of firms, then market-opening initiatives can only delay the inevitable triumph of the Japanese. If normal Japanese business practices are perceived as unfair competition in the West, then trade negotiations are doomed to failure. After all, what right do Americans have to demand that Japan change its eminently successful ways?

There is, however, one possibly cheerful resolution. If the Japanese practices that I have characterized as size-maximization really amount to a more sophisticated way to maximize profits, then Western firms may be expected to catch on. That is one reason why more Western understanding of the Japanese system is so important.


(1)Clyde V. Prestowitz, Jr., Trading Places, (New York: Basic Books), 1989, p. 311. (2)James C. Abegglen and George Stalk, Jr., Kaisha: The Japanese Corporation (New York: Basic Books), 1985, p. 6. (3)I interpret return on investment and stock market value as more or less the same thing, and both as connoting profit-maximizing behavior. (4)Cited in Abegglen and Stalk, op. cit., p. 177. (5)Ibid., p. 311. (6)I subsequently verified this directly with Morita. (7)Ryutaro Komiya, "Japanese Firms, Chinese Firms: Problems for Economic Reform in China, I, Journal of the Japanese and International Economies, March 1987, pp. 31-61. (8)Masahiko Aoki, Information, Incentives, and Bargaining in the Japanese Economy (Cambridge, U.K.: Cambridge University Press), 1988, p. 165. (9)Douglas Moore Kenrick, The Success of Competitive-Communism in Japan (London: Macmillan), 1988, p. 8. In fairness, it should be mentioned that, somewhat contradictorily, Kenrick emphasizes the Japanese firm's drive for profits. (10)William J. Baumol, Business Behavior, Value and Growth, (New York: Macmillan), 1959. (11)Michael Lewis, Pacific Rift, (Whittle Direct Books, 1991), pp. 67, 75. The quotation comes from a real estate specialist. (12)For a recent survey, see James Poterba, "Comparing the Cost of Capital in the United States and Japan: A Survey of Methods," Federal Reserve Bank of New York Quarterly Review, Vol. 15, No. 3-4, Winter 1991, pp. 20-32. (13)Alan S. Blinder (ed.), Paying for Productivity: A Look at the Evidence (Washington, D.C.: Brookings), 1990. (14)H. Shimada, "Japanese Management of Auto Production in the United States: An Overview of |Humanwear Technology'," in K. Yamamura (ed.), Japanese Investment in the United States: Should We Be Concerned?, Society for Japanese Studies, 1989, p. 193.

Alan S. Blinder is Rentschler Professor of Economics, Princeton University, Princeton, NJ.
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Author:Blinder, Alan S.
Publication:Business Economics
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Date:Jan 1, 1992
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