House of the setting sun, part 1
What happened to the Japanese economy?
The three grand imperatives of imperial geostrategy are to prevent collusion and maintain security dependence among the vassals, to keep tributaries pliant and protected, and to keep the barbarians from coming together.
—Zbigniew Brzeziński
Japan was the undisputed king of growth for most of the second half of the twentieth century. In 1959, their economy grew seventeen percent in real terms. They have won twenty-nine Nobel prizes, but none for economics. How did their economic system come into being, how did it work, and why did it eventually fail? In order to understand modern Japan, it is necessary for us to explain their economic journey, all the way from the Meiji Restoration to the present. The first part of this two-part series will take us to the 1980s, just as the infamous bubble economy began to get going.
From laissez-faire to militarism, c.1854-1931
In 1854, Commodore Perry of the United States Navy effectively forced open Japan after centuries of self-imposed isolation from the world, sakoku, during which a small number of Dutch traders were the only foreigners allowed in the country (and even then only at Dejima, a small artificial island off of Nagasaki). Perry had unknowingly set in motion the historical forces behind the Meiji Restoration of 1868, a reactionary-turned-modernising nationalist revolution which would consolidate political power under the Emperor Meiji (under the preceding Tokugawa Shogunate, the Emperor had been a mere figurehead). The revolutionaries would set about reforming the country with a new constitution, new army, and new economic policies.
The European powers were in the process of colonising much of the undeveloped world, and in order to remain sovereign, it was obvious that Japan desperately needed not just to strengthen itself militarily, but also to develop a native industrialism. This native Japanese industrialism would centre upon vertically-integrated family-owned conglomerates which owned their own banks, such as Mitsubishi. These became known as the zaibatsu. The zaibatsu grew in influence after the surprise Japanese victory in the Russo-Japanese War (1904-5); as a consequence of this victory, Russia evacuated Manchuria with immediate effect, and Korea was annexed in 1910, with all the economic opportunities that this entailed. However, during this period, despite the imperial expansion, Japanese economic policy was still relatively laissez-faire. In fact, Japanese industry had already found some success, including in export markets, albeit only in light industry for now — above all, in textiles.
In 1915, the Japanese Army commissioned a study of the doctrines and policies of the European nations and empires at war. The study highlighted the Japanese shortages in materiel, troops, and the need for more comprehensive resource mobilisation. In 1917, Colonel Koiso Kuniaki produced a top secret, but highly influential, report entitled Resources for the Defence of the Empire. This report laid out the requirements for total war, and introduced the concepts of ‘national general mobilisation’ and ‘national economic self sufficiency’ to promote exports, curtail imports, preserve domestic resources, stockpile war materials, convert civilian industries to munitions production, and maintain close contact with the Asian continent. Technological progress and the rise of mass society shaped this vision of total war. The Japanese Army concluded from the German experience that modern wars were ultimately battles of organisational ability.
The Great War had a significant effect on the Japanese economy. It shifted trade relations in Japan’s favour, as European export capacity was diminished, and vast overseas export markets were opened up to Japanese goods. Domestically, imports of chemicals, steel, and fertiliser were curtailed. The entrepreneurs who took advantage of these opportunities created a new generation of zaibatsu — the so-called ‘New Zaibatsu’ (shinko zaibatsu), the most famous of these being Yoshisuke Aikawa’s Nissan. These zaibatsu were, as a general rule, more closely connected to the Japanese government, and in particular the Japanese military (often benefiting from military and/or colonial contracts and ventures), and were generally more capital-intensive and focused upon heavy industry than their predecessors. They shared the Japanese military’s technological and scientific vision for the future of Japan, and often came into conflict with the interwar Japanese business and political establishment.
The Great Depression hit Japan hard: unemployment skyrocketed, and some of the urban proletariat starved. Countries across the world engaged in a tit-for-tat of competitive devaluations and tariff increases, which threatened any country that had become reliant on trade. In Japan, young bureaucrats and the military turned to both Nazi Germany and the Soviet Union for inspiration in escaping the economic and social rut that the country found itself in.
In 1931, the Empire of Japan’s Kwantung Army invaded the resource-rich Chinese territory of Manchuria. In 1932, it established the puppet state of Manchukuo. The Army sought to turn it into an industrial powerhouse in support of the Empire. Economic development in Manchukuo was therefore focused entirely on heavy industry relevant to the needs of total war, such as steel and cement. The Army enlisted the help of a group of young, ultra-nationalist bureaucrats, known as the ‘Reform Bureaucrats’, to help implement their vision of a ‘national defence state’ in Manchuria.
Nobusuke Kishi, who would later become Japanese Prime Minister after the Second World War, was the most important of the ‘reform bureaucrats’. It was he who persuaded the army to allow in the Nissan zaibatsu. The Reform Bureaucrats were responsible for developing economic plans which the Army’s chosen zaibatsu had to carry out. The public-private Manchuria Industrial Development Company had investment of around double the annual budget of the Japanese government, making it by far the largest capital project in the Japanese Empire. Manchukuo’s steel production exceeded that of Japan by the end of the 1930s. By 1941, the puppet state had a population of some 50,000,000, as well as its own railways, banks, and currency. Hideki Tojo, one of the more ‘moderate’ senior Army figures in Manchukuo, would later become Japanese Prime Minister (1941-44), and Kishi himself would serve as Commerce Minister and Vice Minister of Munitions in the Tojo Cabinet (1941-43). Manchukuo, then, served as a testing ground for a new economic system that would later be implemented on the Japanese home islands. Arguably, it served as the testing ground for the economic system under which much of East Asia as a whole would industrialise.
The Reform Bureaucrats and the military were generally hostile to laissez-faire. They were sympathetic to the view that it was both immoral and inefficient for shareholders to seek to maximise profits at a time of high unemployment. Between 1934 and 1936, bank borrowing in Japan accounted for an average of just under one-fifth of a firm’s liabilities; equity finance, by contrast, accounted for four-fifths. This financial structure meant that firms were squeezed for dividends; managers had little left over to reinvest and were unable to plan for the long term. Many believed that major shareholders often engaged in speculation and financial manipulation, driving up share prices and then dumping them for short-term gains. The Reform Bureaucrats and the military thought all of this unacceptable: they wanted Japan to mobilise all of the nation’s resources, all of its strength. This was obviously incompatible with persistent high unemployment. They did not want to wait for the ‘invisible hand’ to restore employment and growth to Japan — this would be too slow. They wanted to push ahead by reforming the incentive structures that were at play.
From militarism to the war economy, c.1931-45
In 1937, hostilities with China would escalate into a full-scale war. Under the cover of emergency legislation, the military pushed through major reforms which would enable bureaucrats to more extensively intervene in the economy in order to achieve full resource mobilisation. Managers and workers would work together to maximise industrial output, not short-term profits.
In 1932, Japan introduced foreign exchange control laws to restrict imports of raw materials. These were introduced after a speculative boom because of anticipated war demand. The Emergency Capital Allocation Law controlled the establishment of companies, capital increases, dividend payouts, bond flotations, and the borrowing of funds. It was used to channel credit into the munitions industry. In 1938, the sweeping National General Mobilisation Law was put before the Diet. This law was pushed through by the Prime Minister, Fumimaro Konoe, against vigorous resistance from establishment politicians and business leaders, who immediately recognised that it would give a carte blanche for bureaucratic control of the economy. The law gave the bureaucracy the power to control the production, distribution, consumption, movement of goods, and foreign trade through new agencies.
In 1940, as the outbreak of war with the United States approached, the Konoe Cabinet proclaimed a ‘new economic order’. The aim, once again, was to introduce an institutional framework that altered incentives to prioritise maximising industrial production, not profits. The Government believed that economic expansion would be achieved primarily via increased savings and investment — that is to say, capital accumulation. Firms face the decision whether to save and reinvest their profits, or instead to pay them out to the shareholders as dividends. The smaller the dividends, the more that is saved and the more that is invested, and, in the view of the Japanese government, the faster the company will grow. As a consequence, to create an economy that grows rapidly, economic institutions must be shaped such that individuals will save, firms will plow back their profits, and managers will have sufficient incentive to retain earnings and reinvest.
In the view of the Reform Bureaucrats, there were three interest groups involved in the organisation of firms: owners, managers, and employees. (Some owners are also managers, and some managers acquire significant shareholdings, but this becomes increasingly rare as a firm grows in size.) Each group has different interests which are not necessarily always aligned with the others; nor, at least in the case of owners and employees, with the overarching goal of national industrial expansion. Shareholders, for instance, seek to maximise profits. While this can sometimes drive efficiency, it can also starve a firm of funds and investment, leading to slower growth. When profits are not plowed back into the company, are often spent unproductively on prodigious conspicuous consumption; income inequality rises, and the production of wasteful goods increases. And the self-interest of employees, too, is also not necessarily aligned with maximising industrial expansion, as they seek instead to maximise their wages, which can dampen profits and thus lower investment.
As a result, the Reform Bureaucrats concluded that giving too much power to shareholders or the workers was bad for growth. But for managers, matters were thought to be different. Managers receive not only higher pay, but greater prestige and more power over resources if they move up the corporate hierarchy. Since all hierarchies are structured as a pyramid, with far fewer people at the top than at the bottom, the firm must grow for more managers to rise up through the ranks. As such, the pursuit of their own self-interest will lead managers to strive for faster growth of the firm, rather than higher profits per se. So while the self-interest of shareholders and workers are not necessarily conducive to high retained profits, high investment, and high growth, the same was not believed to be true of managers.
The aim of the new system was to set the firm free from the control of shareholders and workers. This would, in the view of the Reform Bureaucrats, boost growth; managers thus became the main allies of the economic planners, and shareholders and unruly unionised workers their main enemies. That said, the reform bureaucrats believed that the workers could also be won over if treated the right way. To curb discontent and communist agitation, workers were encouraged to identify closely with their firm; for instance, through having a greater say in company matters, and through indoctrination with the notion of the ‘firm as family’.
Shareholder interests were rather more difficult to reconcile with the overarching national goal of industrial expansion. As such, the reform bureaucrats concluded, irony of ironies, that capitalism would work better without capitalists; instead, it needed powerful managers. To some extent, this came naturally to the Reform Bureaucrats. After all, their most direct equivalents in the private sector were the managers, not the owners.
The doctrine of the firm as an ‘organic organisation’ that bound employers and employees together, serving the public benefit, was officially enshrined in 1938 with the establishment of ‘industrial patriotic societies’ in all firms. At the same time, trade unions were abolished. This ensured that concessions to workers would not become too large, lest they endanger the fast growth of the firm.
Meanwhile, shareholders were cut down to size. In 1940, it was officially proclaimed that the firm was not the property of the shareholders, but a communal organisation composed of those who worked there. The bureaucrats argued that it was necessary that shareholders should become more like the owners of interest-bearing securities. New laws set limits on dividends: anything above ten percent required special permission, which made investing in the stock market less attractive.
However, by 1943, the Reform Bureaucrats and military felt that the profit orientation of firms was still too dominant, and orientation towards the growth of industrial production insufficient. They found that managers were still afraid of shareholders. Although dividends had been reduced, shareholders could still threaten managers at general meetings. In response, they further reduced the shareholder’s influence over the firm’s management. They designated one manager as the person responsible for production in every firm. He was given the power to run the firm as he saw fit to achieve the twin goals of quantity and quality. He could not be sacked by shareholders, and did not have to obtain their permission for his actions. He was only to be held accountable by the planning bureaucracy for the fulfilment of quantitative production objectives. In March 1944, the annual share dividend was cut from ten percent to five percent. Shareholders had been reduced to fixed income investors. The bulk of profits were divided between reinvestment, salaries for managers and employees, and special bonuses for meeting production targets.
Since managers had acquired such great power, it was felt that there was a need to prevent them from boosting their own bonuses excessively. As such, both managers and employees received salaries according to the number of years that they had served — that is to say, seniority pay. If a firm grew fast, even the less able manager could be promoted; in exchange, employees and managers had to vow loyalty to the firm. They were, in effect, prevented from quitting, because other firms were organised on the same principles of seniority and lifetime employment, and thus would not hire them.
To sweeten the deal, welfare schemes for both managers and employees were introduced. The National Health Insurance Law of 1938 and the Personal Health Insurance Law of 1939 provided virtually complete health coverage for employees. The Workmen’s Annuity and Insurance Law for the first time required the payment of annuities in the case of old age, disability, or death. In 1944, it was broadened to include other personnel and women.
Japan’s savings rate had to be increased to prevent inflation since so much credit was flowing towards military producers. These producers made claims on scarce resources, which meant that fewer goods were available for private consumption. In 1938, a national savings promotion campaign was launched, aiming to boost saving to thirty percent of GNP. Most of these savings took the form of deposits in the postal system or banks. This resulted in a transfer of purchasing power from the household sector to the corporate sector.
In Japan’s new economic order, the changes implemented between 1937 and 1945 directed resources from top-down through quantitive output targets which were then divided between the firms in the various industries and passed onto the control organisations that had been created in each industry. Through this, the private sector could do the job of implementing, dividing the tasks, and monitoring them. To organise industry more efficiently, firms and factories were amalgamated in the hopes of reaping the benefits of economies of scale.
As such, by the end of the War, the laissez-faire of the nineteenth century had been substituted by a system of ‘planning’ and ‘government guidance’ that nonetheless made use of competition and self-interest as incentives. Import penetration was successfully reduced. Resources shifted from ‘nonessential’ industries to the heavy machinery and manufacturing industries that were crucial for munitions: the share of output of textiles fell from 29.3% of total industrial production in 1937 to 14.7% in 1941; meanwhile, the share of output of machinery more than doubled, increasing from 14.4% to 30.2%. Private sector savings rose from 9.1% in the 1920s to 54.8% of GNP from 1941 to 1944. Real GDP grew twenty-five percent during the war years; munitions production grew by 197% between 1941 and 1944. Labour had been fully mobilised. Japan was now irreversibly industrialised, and unemployment had been all but eliminated. It would be fair to conclude that the Reform Bureaucrats and the Army had, on the whole, achieved their aims, despite their eventual defeat. This was the political and economic system that General MacArthur confronted upon the Japanese surrender in 1945.
From a war economy in war to a war economy in peace, c.1945-1980
General MacArthur was given orders to democratise, de-concentrate, demilitarise, and liberalise Japan. Firstly, wartime laws (such as the National General Mobilisation Law) were repealed, and the military and the military bureaucracy was disbanded. The Ministry of Munitions was broken up, and so too was the powerful Home Ministry with its extensive police apparatus. War criminals were brought to trial. Secondly, Japan was given a new constitution, which enshrined liberal-democratic political principles: freedom of speech, freedom of religion, female suffrage, free and fair elections, et cetera. Thirdly, MacArthur sought to dismantle the war economy: through the breakup of the zaibatsu and the dispersal of the assets of the families who owned them; through land reform and the liquidation of the rural landlord class; and through the promotion of trade unionism, which had previously been banned.
On the surface, then, it seemed as if Japan had become a liberal, capitalist, and democratic state, with a tinge of post-war social democracy. However, when the US occupation ended in 1952, it was clear to all that the war economy remained deeply entrenched. What happened?
Concerned about the spread of communism, the US State Department pushed for far milder occupation policies than those in West Germany. They were careful to leave Emperor Hirohito in place as a figurehead and symbol of continuity, and made sure that he was excluded from the war crimes trials. Ultimately, the United States came to the conclusion that the ‘visible hand’ of government should indeed be used to accelerate growth, and by 1947 MacArthur’s original policies had already been severely undermined, if not completely replaced.
The Ministry of Munitions had been split into the Ministry of International Trade and Industry (MITI) and the Economic Planning Agency (EPA). The wartime ‘control associations’ soon resurfaced as private sector ‘business associations’, such as the Japan Automobiles Manufacturers Association. Certain wartime legislation was reintroduced very soon after the war, especially by MITI and the still-powerful Ministry of Finance. Economic controls continued, with foreign currency rationing and materials supply and demand planning replacing wartime materials mobilisation planning. The wartime Temporary Funds Adjustment Law (1937) and the Ordinance on Funds Operation of Banks (1940) remained effective; so too did the Bank of Japan Law (1942), which was altered only in 1998. The Foreign Exchange and Foreign Trade Control Law (1949) was simply a continuation of the Capital Flight Prevention Law (1932), one of the first of the series of laws that gradually established the war economy. Even the close relationship between companies and banks that had flourished before the end of the War was quickly reestablished when the US occupation ended, now in the form of powerful keiretsu business groups, which had replaced the old family-owned zaibatsu. Even the tax system with the the Enterprise Rationalisation Promotion Law (1952), which established very high rates of depreciation for important machinery (in order to accelerate capital investment), can find its origins in the Price Compensation System (1943).
It was not only the institutions of the wartime system that survived intact. Perhaps more importantly, there was virtually complete continuity of personnel. MacArthur favoured indirect rule through the Japanese bureaucracy, unlike the more direct rule in Germany. With the Army and Home Ministry disbanded, the power of the economic bureaucracy was increased. Another (albeit lesser) rival, the Foreign Ministry, was diminished in stature, as foreign policy was now made in Washington. Moreover, political parties remained relatively weak, politicians were generally easy for the bureaucracy to control, and much of the old economic elite had been ruined by both the war economy and the occupation. As such, so long as they could agree with the goals of MacArthur, the economic bureaucrats at the Ministry of Finance, MITI, and the Bank of Japan became the de facto rulers of Japan, filling the power vacuum that had emerged.
The bureaucrats and managers who had demonstrated excellence in Manchuria or Japan received rapid promotions. Hardly any of the economic planners were purged: just forty-two from the Ministry of Munitions, and almost none from the Bank of Japan. Moreover, as soon as the US occupation forces left, even the few non-military men who were purged were mostly rehabilitated. The elite Manchurian wartime planners did not just move back to modest positions. Suspected Class A war criminals took centre stage in the 1960s and 1970s: while Germany’s chief wartime economic planner Albert Speer was incarcerated in Spandau Prison, his Japanese counterpart, Nobosuke Kishi, became Prime Minister (1957-60), as did his brother Eisako Sato (1964-72). Indeed, Japan’s longest serving Prime Minister, Shinzo Abe (2006-07, 2012-20), was Kishi’s grandson.
Furthermore, the circumstances of the occupation meant that two of the policies that the Reform Bureaucrats had been hitherto unable to implement were achieved under the occupation. Firstly, as already mentioned, the zaibatsu were liquidated, with the consequence that their main rivals, the old economic elite, were permanently reduced in stature. This would help ensure an even greater orientation of the Japanese economy towards growth rather than profits. And, secondly, the occupation implemented land reform, which the Reform Bureaucrats favoured both for political and economic reasons, believing that it would subdue discontent in the countryside and improve agricultural productivity. Before the occupation, land reform had faced resistance from incumbent elites, not least because it was heavily associated with communism (an ideology with which the Reform Bureaucrats themselves had a complex relationship). During the War, the Reform Bureaucrats had opted for rendering the rural landowners de facto irrelevant by buying rice at a high price directly from farmers while paying landowners low rents for their land, thus severing the tie between tenants and land owners and reducing them to becoming receivers of a fixed income. The post-war land reform went further, and almost completely wiped out the landowners as a social class.
General McArthur volunteered to implement these policies, employing all the force of an occupying power. He implemented the aforementioned land reform. He purged the capitalist class; officially, this was because they had allegedly been instrumental in setting up the militarist regime, not that this made much sense given that most of the bureaucracy remained unpunished. In 1946 they held around two-fifths of all stock. They were forced to sell this to the public, and holding companies were banned entirely until 1998. An ‘Anti-monopoly Law’ and a ‘Law for the Elimination of Excessive Concentration of Economic Power’ were both enacted in 1947. But despite the rhetorical tenor of these laws, whilst the families who owned the zaibatsu disappeared, the large conglomerates that they had built up remained largely intact. Of the more than three-hundred firms scheduled for dismantling in 1948, only eighteen were actually split up. By 1953, the ‘Anti-monopoly Law’ had already been watered down. Restrictions on stock retention, interlocking directorships, and mergers were relaxed; depression and rationalisation cartels were now once again permitted. In the 1950s and 1960s, thirty laws were passed that provided further exemptions to many industries from the ‘Anti-monopoly Law’ as well as the ‘Export-Import Law’. The number of official cartels swelled from 162 in 1955 to 1079 in 1966. The proposed breakup of the five largest banks was abandoned, leaving the financial system effectively unchanged from wartime.
The companies regrouped as so-called ‘keiretsu’ business groups. Instead of being centred upon centralised holding companies, the keiretsu tied themselves together by issuing more shares and swapping them, rapidly expanding cross-shareholdings. The full flowering of the Japanese system of a ‘capitalism without capitalists’ meant that they were now even more independent from shareholder influence than even in wartime. Cross-shareholding meant that they could control two-thirds of shares, resulting in bank-centred business groups identical to the prewar conglomerates, only now in effect wholly controlled by managers. In this managerial capitalism, it was the banks and the bureaucrats who had the real say over resource allocation in the national economy.
The US occupation also initially pushed for the democratisation of the labour market, introducing new labour legislation and a nationwide labour union movement. The share of unionised labour rose from zero in 1945 to almost sixty percent in 1949. However, in July 1948, with growing fears of communism across the globe, the right to form unions on the basis of trade was once again restricted, and the right of civil servants to strike was abolished altogether; the wartime company labour unions and the ‘Industrial Patriotic Associations’ were revived. Other wartime practices — lifetime employment, bonus payments, seniority pay, and generous social security provision — were, if anything, reinforced.
Thanks to the US occupation, then, the war economy system was nearly complete — except for one important aspect. Although concentration was greatly increased to take advantage of economies of scale, the planners made sure that enough firms remained in each industry to ensure some degree of competition, as managers battled over ranking. After all, being in a firm with more output and more market share brought more prestige, not to say higher pay and benefits. However, without wartime production quotas, and with the profit motive greatly diminished, how could the bureaucrats prevent firms going deeply into the red simply to increase their market share — a phenomenon that became known in Japan as ‘excess competition’? If left to their own devices, these practices would ultimately produce bankruptcies, high unemployment, and, eventually, excessive concentration in each sector.
The solution in Japan was the formation of explicit or implicit cartels, usually administered by industry associations. A ranking system was established which ensured that, by and large, the rankings were left unaltered. All firms continued to compete, but only enough to maintain their rank. Instead, they were encouraged to compete on price and quality, rather than over market share. However despite the advance of cartelisation, the competition between firms remained fierce; contrary to the expectations of many of those unfamiliar with Japanese capitalism, excess (rather than a lack of) competition was perhaps the biggest systemic vulnerability in Japan’s peacetime war economy. Japanese firms, as a rule, produced too much, invested too much, competed too much, and grew too much.
The relationships that had been forged in war between banks and companies, large firms and their small suppliers, bureaucrats and the industry associations, provided the framework for postwar success. In the 1960s, more than forty percent of the parts suppliers to Toyota had began this relationship as wartime subcontractors. There are cases of machine gun factories switching to sewing machines; optical weapons factories to cameras and binoculars. Suppliers of hardware such as tanks, trucks, planes, and ships became postwar shipping, automobile, and heavy industry giants. Upstart firms championed by the military during the war would become world leaders in the postwar period.
Consumers and households were encouraged to save in order to give firms the funds to invest in the designated priority sectors. And now, instead of munitions, the priority industries were export-orientated manufacturers. In the early postwar period, domestic demand growth through the enfranchisement of workers and rapid (albeit below productivity) wage growth was important, but by the early 1960s, it became apparent that, given persistently high domestic savings (as was intended), new markets had to be found overseas if production in Japan was to further expand.
In the Japanese peacetime war economy, managers were the officers; workers and salarymen the soldiers; the bureaucracies of the Ministry of Finance, MITI, and the Bank of Japan the general staff. Exports were the bullets flying out, hitting world markets; imports were hits taken, and were to be minimised. The wartime rationing system revived after the war meant that imports required licences. These licenses were only granted to ‘priority industries’, above all exporters. This system was used to impose extreme import restrictions on automobiles while the infant domestic car industry was getting into gear. A trade surplus meant victory; a trade deficit meant defeat. While domestically, the bureaucrats and industry associations ensured that companies would be protected against kamikaze market share expansion behaviour, the rest of the world was not so lucky, finding the expansion of Japanese production dumped upon them at seemingly impossibly low prices.
As the United States pushed Western countries to welcome Japanese exports, the full force of the war economy was at last unleashed. Japanese exports soon dominated steel and shipbuilding markets in the 1960s. European and American firms aiming for profitability were soon driven out of business. The onslaught of the Japanese carmakers followed: subsidised by deliberate and systematic domestic underconsumption, they began to conquer world markets. In 1971 OECD countries had an overall trade surplus of $7.4bn, but of this, $5.8bn was accounted for by Japan alone. In the 1970s and 1980s, the American consumer electronics industry was wiped out. Partly as a consequence of Japan’s dominance in the export markets, and increasing penetration of the Western home markets, American and European unemployment rose. Western economists were left puzzled by the fact that monopolisation of markets by Japanese companies did not eventually lead to price rises in order to make bigger profits.
Before Japan could gain access to these markets, Japan had to join GATT (the predecessor of the WTO) and the OECD, which it had been pushing for membership of since the 1950s. The membership rules stated that only countries with market-orientated economies and ‘open markets’ could join; there were also rules against ‘dumping’ — selling excess home production abroad at lower margins or even at a loss. However, with the Cold War raging, the United States prioritised sound politics, not sound economics, and against the wishes of European countries (especially France), used its dominant position to push through their GATT membership in 1955. In response to GATT, Japan, which was classified as a developing country, giving it more leeway on tariffs, strengthened its tariff barriers.
However, they realised that they could not maintain exemptions forever, and longed to join the OECD, which would force them to forgo many of their GATT exemptions. There was one rule that they knew they would have to adhere to: the free movement of capital between OECD members. As a result of these rules, United States had been able to buy up many European assets; Japan desperately wanted to defend against this risk.
In 1955, they used the tried and tested method: cross-shareholding. Modifying Article 280 of the Commercial Law, which made shareholder expropriation illegal, they allowed the dilution of shareholders without having to obtain formal approval from the current stockholders. Slowly but surely, companies issued new stock and swapped it amongst themselves; this accelerated in the early 1960s, as Japan received indications it would be allowed to join the OECD (which happened in 1964). In 1949, about 70% of all shares traded on the Tokyo Stock Exchange were held by individuals, but by the late 1980s, this had dropped to a mere 19.9%.
Japan, then, had built up an invisible defence against foreign investment. The foreigners, now, could come or go as they wished — it did not matter. They had no way to influence policy, assert their rights, or to influence management. Japanese capitalism could continue expanding, continue invading foreign markets with their manufactures, continue resisting foreign influence. In sum, all seemed well in Japan, Inc.
In this article, we have shown how the Japanese bureaucracy had learned during the war to not ‘pick winners’, but rather to treat worthy competitors equally. For so long as they met certain standards of ‘rationalisation’, and operated in certain favoured sectors, they would receive equal government support. In Japanese economic policy, there was state direction, but incentives still mattered: competition, of a certain type, was used to give firms and their employees the maximum incentive to work hard towards state-determined goals, and when subsidies were on offer, they had to compete strenuously to obtain them. The Japanese bureaucracy, in sum, always used conscious organisational design to shape incentive structures towards their own desired outcomes in industrial structure and development.
In Part 2, we will further examine the role of credit and banking in the Japanese economy, and consider how the Japanese economic system began to fall apart as the 1980s wore on, culminating in the inflating and then bursting of the world’s greatest bubble, followed by the famous three decades of ‘lost’ economic growth.
To be continued…
Fascinating article!