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System still sour?

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In his 1998 book, “Japan: the system that soured”, Richard Katz concluded that “In all likelihood, Japan will not reform within five years; within twenty, it almost certainly will”.  Let’s hope that we don’t have to wait much longer than that.  Japan’s system remains decidedly sour some 12 years later.


Katz argues that Japan’s economic system was very effective for its catchup process with the West.  But the system has been a spectacular failure for a mature economy.  The strategy was essentially based on a nationalistic economic ideology.  The drive for autonomy emerged from centuries of isolation.  The state welcomed foreign technology and advisors, but not capital.  The state took the lead because business was so weak.  

As Japan developed, a new business class emerged.  This created a pattern of industrial organization, government-business relations, and attitudes that remain powerful to this day.  The relationship between industry and government became difficult to change. Thus, industrial policy continues, becoming nothing more than protectionism, and hampering the development of a competitive environment in the economy as a whole.  Japan is neither a true market economy nor bureaucratic authoritarian developmental state.  Rather, it is a highly politicised economy, with major decisions being determined by negotiations and lobbying with business, banks and government.

It’s easy to forget, but Japan was really the first emerging economy.  It had many industries with the capacity to catchup, like motor vehicles, televisions, electronics, semiconductors and so on.  Government protection like import quotas, massive subsidies and tolerance of cartels, gave them a jump start.  They could then achieve economies of scale.  They could also do lots of “learning by doing” as they copied Western technology and lifted product standards to Western levels.  Ripples were felt all down the line, as the steel industry and many others got a great boost.

Sure, Japan also assisted some losers like aviation and chemicals.  But, overall, it backed enough winners for the strategy to work.  While not every industry that received aid went to become a competitive exporter, most industries that did become export superstars received critical protection and promotion during their initial stages.  Without such a strategy, Japan may have achieved development, but not nearly as quickly.

This type of strategy worked while the economy was still in catchup mode.  But when catchup was achieved, it was time to switch plans.  As the economy matured, it ran out of infant industries. And a dual economy had been created.  The export sector was strong.  But the domestic sector was weak and uncompetitive (in areas like transportation, telecommunications, finance, energy, distribution, food processing and textiles).  It was living off the efficiency of the export sector.  Dualism is typical of developing countries.  But in Japan, dualism increased after the first oil shock.

It was then time to remove the import protection and deregulate the economy, and lay the foundation for innovation, and a services oriented economy -- especially when a rising yen in the 1980s led to outsourcing of much of Japan’s manufacturing sector to emerging Asia.  But Japan never did that.  Japan went from promoting winners to protecting losers in the face of the 1970s oil shocks.  And following the bursting of the bubble 20 years ago, government-financed infrastructure became the life-support of the economy. 

Why could Japan not change?  Psychologically, it is hard for anyone to recognize that a strategy that once worked, now works no longer.  Mental habits just stick.  While the protection that helped takeoff was beneficial to the economy, it created lots of vested interests – people with their noses in the trough, who are difficult to wean off assistance.  Moreover, in Japan it is not just a question of policy reform, but of systemic reform – that is, reforming a system which is a complex, interconnected puzzle.

But lastly and perhaps most importantly, in a homogeneous society, whose citizens are taught to be obedient, there is little scope for new ideas to rise to the surface.  Last year’s election of the Democratic Party of Japan, ousting the Liberal Democratic Party which had been in power for basically 60 years, was historic.  But the DPJ is cut from the same cloth as the LDP, many of its members are LDP defectors.  And Prime Minister Yukio Hatoyama does not bring fresh blood like US President Barack Obama.

A well-functioning democracy requires a competition of ideas and philosophies.  Japan does not yet have that, despite having recently achieved some competition between political parties.  There are few serious research institutes and think tanks.  Japan studies is in decline overseas – everyone now studies China.  Less and less Japanese now study overseas.

It is difficult to see what could unleash major reform, except for a crisis.  What crisis could that be?


“Japan: the system that soured” by Richard Katz.  An East Gate Book.  1998.