(Reprinted from HKCER Letters, Vol.54, January 1999)
Blessing or Curse: Characteristics of
the Japanese Economy
Japan and East, as Seen by West
Several hundred years ago, the contact between East and West started with a few occidental missionaries and merchants-cum-adventurers bringing back home goods, as well as stories of exotic people and societies. Religions had crossed the continents and the oceans long before then, but individual apostles of new teachings did not travel great distances, and information moved slowly. Later, in the 16th and the 17th centuries, advancement in navigation technologies helped the Dutch and the British come into contact with the world outside Europe at a much larger scale then ever before. The West occasionally seemed to be at a loss how to understand the alien and seemingly complex East. Even at the height of Pax Britannica years, Rudyard Kipling mused: "Oh, East is East, and West is West, and never the twain shall meet." And, on a more acerbic note, "Asia is not going to be civilised after the methods of the West. There is too much Asia and she is too old." The Japan Gazette at the end of the last century printed, "Wealthy we do not think it [i.e. Japan] will ever become: the advantages conferred by Nature, with the exception of the climate, and the love of indolence and pleasure of the people themselves forbid it."
Institutions such as banks and national governments did exist in Asia before the arrival of Westerners. However, their modernization started in the West, where they adapted so that they could effectively serve modern capitalism. Consequently, these Western forms were imported by Asian countries, including Japan, as a part of their efforts to update their socio-economic systems. Westerners were quite perplexed to see many of their social institutions modified, often beyond recognition, in order to suit the Eastern rulers of the time. According to the Japan Gazette, "The national banking system of Japan is but another example of the futility of trying to transfer Western growth to an Oriental habitat. In this part of the world principles, established and recognized in the West, appear to lose whatever virtue and vitality they originally possessed and to tend fatally towards weediness and corruption."
People fare poorly in comprehending phenomena outside the realm of previous knowledge and experience. This limitation prevents such phenomena from securing a firm place in people's mind, and that seems to be the reason why the West's evaluation of the East, in particular Japan, goes from one extreme to another.
When it could no longer be denied that the modified institutions of Japan worked in favor of economic growth, the modifications themselves started to draw praise. By the 1980s, the economic achievement of Japan was so great that the US was feeling rather threatened. Written in the late 1980s and early 1990s by American authors, books such as In the Shadow of the Rising Sun, Yen! Japan's New Financial Empire and Its Threat to America, and Pearl Harbor Ghosts, prophesied a gloomy future for the US. It would be conquered in one way or another by Japan. At the end of the Cold War, the scholar Chalmers Johnson declared, "The Cold War is over, and Japan won." Japan was not enjoying a mere upward blip in its history, but was traveling on a path that was different from that taken by the Western countries and guaranteed consistent high economic growth.
Currently, Japan is in a recession that started in the early 1990s, and that is the worst since World War II. Its seriousness is such that some US officials have blamed Japan for the volatility on Wall Street and the undesirable economic performance in Latin America and Russia. Moreover, Japan's institutions such as life-time employment and long-term relationships among firms and banks, once credited as the source of its remarkable growth, are now held responsible for the economic downturn.
Reasons for Swings in Evaluation
Of the many issues that played a role in the latest turnaround in the assessment of the Japanese economy, we list several here.
Humans typically equip themselves with criteria to evaluate quickly and accurately object and process within the scope of their experience and comprehension. When faced with the unfamiliar, they usually take one of two routes. First, despite apparent inadequacies, they may still apply their standard criteria, which tend to judge the unfamiliar unfavorably. Or they may abandon the process of careful assessment altogether, which leads to wholesale rejection or acceptance. Neither does the Japanese economy quite fit the model prescribed by the Anglo-Saxon tradition of free markets, nor does the Japanese society follow the ancient Greek tradition of democracy. Nonetheless, the country seemed to have been in unstoppable upward motion, and that puzzled most people trained in the above traditions. With the changing fortunes of Japan, their assessment swang from stupefied admiration to dismissive scorn.
No country is locked in time, but domestic and international dynamics relating to Japan are often overlooked. The efficiency-enhancing production methods which originated in the Japanese economy, e.g. the system of lean production and just-in-time deliveries, have been copied by many companies abroad, and only some of the original relative advantages remain today. Furthermore, after decades of rapid growth that attracted attention and praise from the US and Europe, the Japanese have grown complacent, which manifested itself as a bubble in the 1980s. Without their belief in the sustainability of sky-high prices of stock and real-estate, a bubble could not have started and grown.
In addition, some aspects of the society function well only under certain conditions, especially favorable economic conditions. Not giving priority to maximizing profits yielded profits nonetheless, because the economy was performing well. Life-time employment, for example, was sustainable without straining the firms' finances when the economy was on the fast track; a growing number of new recruits, by effectively deferring their wages, could support a smaller number of mid-career salaries and retirement packages. This remuneration scheme based on seniority was made possible because it was not necessary to search for strategies in order to cope with the quickly changing economic environment the economy could grow without such measures. Hence, there was no need for incentives that would encourage drawing up potentially risky plans which prescribed dramatic changes.
Conversely, flaws become more prominent when the overall economic performance falls. As late as in 1989, the Japanese financial system was considered sound and well qualified to take on the world financial leadership role.
Of the Two sides to Japan's Socioeconomic coin, only one side has been in the spotlight lately. For instance, life-time employment provides stability and job security, but does not yield specialists. This is because life-time employment requires workers in redundant departments to be transferred to others, and that usually involves applying different skills. However, sepcialists, and not generalists, are the type of workers that are deemed useful in service and high-tech sectors, which lately have been considered the most growth-enhancing sectors.
Another example involves the Japanese education. It had long been labeled superb, but the recent recession has prompted critics to emphasize its inability to nurture creativity. To function efficiently, all workers, be they medical doctors or auto-plant workers, need to have a solid basic education. That is what Japan has been providing, by holding back the gifted few so as not to discourage the ungifted many. The US educational system, on the other hand, excels in fostering creative thinkers and leaders, whom we need in order to advance the frontier of the economy. However, a US organization called the Council on Competitiveness has identified the education and skill levels of the workforce to be "the most serious competitiveness hurdle that the United States will face over the next decade." A successful society needs to raise the overall educational level of its workers and encourage its most creative minds to pursue their ideas and goals. Attaining both goals at a time is a challenging task.
Some of the assessments about the Japanese economy have been contradictory. They were accepted despite their contradictions because they were positive assessments, and Japan was growing. For example, export promotion strategies have been identified among the most successful government policies adopted by Asian countries, because they exposed their products to foreign competition, leading to improvements in both products and manufacturing. At the same time, the close relationship among firms, banks, and the government was the envy of the West as it was considered to protect firms from volatility introduced by shareholders and foreign competitors with short-term goals. In other words, policies and practices increasing or limiting exposure to foreign competition were both lauded.
There were some oversights to boot. The long-term relationships among firms, banks, and the government has been hailed as an effective barrier against short-term fluctuations that may distract the economy from aiming for long-term growth. However, long-term relationships can also turn into a breeding ground for corruption, inertia, and inefficiency, since the parties involved are often not held accountable towards one another or to the rest of the society. Indeed, in January 1998, high-ranking officials of the Japanese Finance Ministry were arrested on charges of having accepted bribes from the banks they were suppose to regulate. There were earlier indications of widespread corruption in the 1970s, such as the Lockheed case, which involved the Prime Minister at the time, Kakuei Tanaka. Nonetheless, the corruption-prone nature of long-term relationships was almost entirely neglected in the eulogy of the Japanese economy.
Finally, the evaluation of the Japanese economy is deeply related to what we are keen to know more about, but have found difficult to assess: what makes an economy grow. Until we obtain more knowledge about the necessary and sufficient conditions for economic growth, it remains a formidable task to conclude whether the Japanese economy grew because of or despite its characteristics.
The Latest Recession
Japan has suffered many setbacks in its modern history, including World War II and the OPEC oil shocks, only to emerge with more vitality. In which respect is the latest, prolonged recession different from them?
The current crisis is strongly marked by inflexibility of the Japanese economy. Lack of flexibility may have influenced many facets of society, but the Japanese used to adopt flexibility at critical crossroads. The persistence of inflexibility, which at least partly resulted from complacency, may be considered one of the biggest differences that divide the current crisis from past ones. Having seen their country grow at an almost unprecedented speed under the envious eyes of the world, the Japanese have come to believe that their unique institutions have been responsible for its economic success. Such belief was strengthened by the comparably fast growth in countries similar to Japan, such as Korea and Taiwan. This high level of confidence, never before achieved in modern history, collapsed to an unknown low after the bubble burst. Unfortunately, loss of confidence has so far not transformed itself into a spring for change. Low consumer confidence is one of the factors that are holding the economy back from rebounding.
The complacency has further been exacerbated by deregulation. In the 1980s, when the country was becoming narcissist, some deregulation took place in the financial sector, which created a situation very similar to that before the savings-and-loans (S&L) crisis in the US. In both cases, deregulation led to reckless lending. Even after the bubble burst, bank-lending did not abate, encouraged by low interest rates, expensive yen, and the unquestioned faith in the growth potential among producers. The results were overcapacity in production at home, as well as massive investments in Asia. In addition, banks did not act on bad debts run up during the bubble period. One of the differences between the S&L crisis and the current banking crisis in Japan is per-capita magnitude. Japan's bad loans, estimated to be at least US$600 billion at the time of writing, are six times larger than that created by the S&L organizations in the US, relative to the size of the economy. Another difference is that the US could make use of the Mexican market for their exports to pull the economy out of the contraction caused by the crisis. But major exporting countries of Japan, which take up about 45% of the total Japanese exports, are in Asia, and are also in recession.
Serious policy blunders and political impasse are also to blame. The fiscal stimuli intended to revive the economy have so far consisted of projects that did not spur further growth (but provided jobs to construction companies). The consumption tax was raised prematurely from 3% to 5% in the spring of 1997, when confidence had not yet returned to consumers, and a sharp decline in demand followed. In April 1998, the last remnant of foreign-currency control was eliminated. But this did not improve the credibility of the Japanese financial system, because of the ill-maneuvered and indiscreet manipulation in the stock market by the government on the day before the deregulation. Moreover, the country's political establishment is virtually paralyzed by its wish to survive. The ruling Liberal Democratic Party seems unaware that its old ways are no longer acceptable to the Japanese taxpayers, nor to the outside world. They still attempt to pass vaguely worded reform plans that can favor the failing banks (which support the Party in turn), once the plans are legislated. Some rigidities also exist in the banking system, and their elimination requires changes of laws. To make matters worse, even if all the debt problems were solved, there would still remain the problem of pension funds, which need to be financed at an alarmingly increasing pace to serve the rapidly aging society.
What We Have Learned
We have come to recognize that the ingredients, which were once thought to let economies grow in almost any case, will do so only under restricted circumstances. We first need to separate because-of conditions for economic growth from despite ones. Once we do so, we will have to identify the conditional clauses which make because-of conditions encouraging factors of growth. These analyses are now more feasible, as the faltering economy makes the despite conditions more visible. In addition, it has become more than clear that the current Japanese political system is inadequate for solving crises of the present kind. The bureaucracy, once thought to be the backbone of the economy, may be required to make a drastic change as well.
Moreover, the desirability of unrestricted international flows of capital, which is in accordance with unadulterated free trade, has been questioned: a move that was unthinkable in the 1980s. Although swings in public opinion are unavoidable, we should try not to succumb to the desire to abandon one extreme, only to embrace another. In addition, some US critics have voiced their concern over the American government's attitude towards Japan, saying it has been rather condescending, and hence ineffective. Such criticism in public was also unthinkable around the turn of the century, indicating that we may have progressed in understanding different cultures, in addition to accepting the possibility of different paths to economic growth.
Junko Nakai is lecturer at the School of Economics and Finance, the University of Hong Kong. This article is based on the talk given at the meeting of the Japan Society of Hong Kong in October 1998.