Chapter One
Introduction
At the turn of the millennium, the Japanese economy remained mired
in a pattern of stagnation that had continued since the early 1990s. As
this disappointing condition dragged on, some in Japan called for systemic
reform as a central part of policies to restore economic health. Beginning in
1994, the government formally pursued an agenda of broad economic deregulation,
a specific package of deregulation measures for financial markets,
and administrative reform. The private sector, prompted by substantial
excess capacity in some industries, has also carried out some restructuring.
The casual outside observer might easily infer that substantial-and beneficial-systemic
change was well under way by 2001. Having recognized
their problems, the Japanese appeared on the surface to be charging forward
to embrace practical market-oriented solutions.
That appearance is deceiving. The central conclusion of this study is that
fundamental aspects of the economic system are not changing very much.
Like a person with arthritis, the existing Japanese economic system has lost
much of its nimbleness; its joints have become creaky and painful. Japan has
been taking aspirin for its arthritis-partially alleviating the pain temporarily.
Something more radical-like hip replacement-would restore
some mobility on a long-term basis, but so far this is not happening. As is
the case with arthritis, surgery and more powerful medicine will not return
Japan to its youth; Japan is a mature industrial economy with a diminishing
population of working age, so even reform will not restore the high growth
pattern of the past. Nevertheless, more radical treatment would produce
better economic performance than in the past decade.
To be sure, the formal policy of deregulation has been proceeding since
1994 and has increased competition in some markets. However, the nature
of corporate governance, corporate finance, labor markets, and the role of
government in the economy continue without much alteration. This conclusion
will elicit some protest among readers. As reform was getting under
way in 1997, Wall Street Journal editor Paul Gigot opined that the Japanese
economic system had failed, proving that the American style of capitalism
is superior and that Japan would now reform to be more like the United
States. Then-prime minister Keizo Obuchi published an op-ed in the New
York Times in 1999 stating that his nation recognized the need for extensive
reform and was pushing boldly ahead. Even some outside observers believe
that radical changes are under way that will propel the economy back on to
a stronger growth path. Careful analysis, however, leads to the conclusion
that such views are incorrect and provide misleading expectations for American
businesses and policy makers.
This conclusion has important implications. The economic stagnation of
the 1990s was largely macroeconomic in origin, stemming from the rise and
collapse of real estate and stock prices. Such asset bubbles can occur-and
have-in any economy. However, the macroeconomic origin of the problems
obscures the fact that structural flaws in the existing system contributed
to the creation of the asset bubble. Furthermore, the failure to reform
through most of the 1990s complicated and delayed the recovery of the
economy. Therefore, robust economic recovery depends on further systemic
reform and not just macroeconomic fixes. Cyclical macroeconomic developments
and simple downsizing in the corporate sector should produce an
upturn in growth over the next few years. However, Japan's moving to a sustained
higher growth path and avoiding renewed recession or financial crisis
over the next decade requires more substantial reform. Given the nation's
grim demographics-decreasing population and a rapid increase of retirees
relative to workers-acceleration of economic and productivity growth is
crucial. Without reform, the economy will not achieve this acceleration.
Failure to change will result in a stumbling economy bedeviled by recession
and financial crisis, a scenario that would be worrisome for Japanese
society, the rest of the region, and the United States. Should the economy
sink into recession and crisis-a distinct possibility-Japanese households
will obviously suffer. In a larger perspective, Japan will not contribute much
to global growth by sucking in more imports and investment. Furthermore,
the politics of a disgruntled population could easily lead toward a more
nationalistic stance in foreign policy.
None of this need happen. More extensive reforms that enhance reliance
on freely operating and transparent markets for goods, services, and finance,
with a concomitant decline in interference by the government, would underwrite
a brighter future. Economic growth under the best of circumstances
will not be high, given the decline in the working age population and the
financial burden of handling the exploding share of retirees. A more vibrant
economy is crucial to surviving these problems without incurring a decline
in standards of living. With reform Japan might manage a growth rate of two
to two-and-a-half percent annually in the next decade; without reform
annual growth of one percent or less will be Japan's fate.
The record of the past 130 years in Japan since modernization began is
one of a pragmatic people who dramatically and successfully transformed
their nation into one of the leading industrial nations of the world. That
record does not guarantee success this time. The obstacles to reform have
been formidable, and success itself may have made society less flexible.
Background
All across the globe nations have been getting government out of the
market place over the past quarter century. The United States began a
process of deregulation during the Carter administration in the 1970s, and
the process continues today. In Britain, Prime Minister Margaret Thatcher
presided over the privatization of nationalized industries during the 1980s.
China has permitted private corporations and markets to operate. Experiments
with communism, socialism, and regulation, undertaken in many
countries in the name of fairness and promotion of economic growth, failed
to meet expectations, leading to this massive reversal in policy. Behind the
reversal lay a strong intellectual movement based on theory and on empirical
research concerning the inefficiency and failures of government when it
meddles excessively with markets.
On the surface, Japan would appear to conform to this broad global
trend, as deregulation, administrative reform, and industrial restructuring
have been the hot topics of discussion for most of the past decade. The 1990s
were certainly a troubling decade for Japanese society. After a half century
of rapid economic growth and successful transformation to an advanced
industrial nation, the economy stagnated and a mountain of bad debt
weighed down the financial sector. Economic growth in the eight years from
1992 (when the slowdown began in earnest) through 1999 averaged a relatively
weak annual rate of 1.0 percent. The general stagnation was accompanied
by the first real recessions since 1974, with negative growth in calendar
1998 and in two consecutive negative quarters in the second half of
1999. This economic performance was hardly the disaster that it might have
seemed from the exaggerated adjectives used to describe it in the media;
Japan remains one of the most affluent nations of the world, and unemployment
remains modest. Nevertheless, after such a long period of unusually
successful economic performance, stagnation and bad debts left many
Japanese dismayed and bewildered by their problems.
The proximate cause of this poor economic performance lay in the speculative
asset price bubble in the stock market and real estate market during
the second half of the 1980s. In five years both equity prices and urban real
estate tripled in value. When a worried government finally raised interest
rates to constrain this situation, the party came to an end. The collapse of
asset prices from the beginning of the 1990s, wiping out all the price gains
since 1985, had a serious negative effect on the economy, as it would on any
economy. Banks were also left with massive amounts of non-performing
loans, secured by real estate collateral that was shrinking in value. Both poor
macroeconomic performance and the bad debt problem were exacerbated
by poor decisions within the Japanese government. Fiscal stimulus was an
on-again, off-again affair for much of the 1990s, while the bad debt problem
was allowed to fester unchecked until near the end of the decade.
Arguably, any market economy could encounter the problems Japan
experienced in the 1990s. Speculative bubbles, driven by excessively positive
expectations about the future, can occur anywhere. Collapse of asset prices
of the magnitude experienced in Japan would have a negative macroeconomic
effect in any economy and would produce massive amounts of bad
debt in the banking sector. The record of policy on the nonperforming loans
of the savings and loan industry in the United States during the 1980s amply
demonstrates that poor policymaking is certainly not unique to Japan.
Even though the problems of the 1990s can be traced directly to the rise
and fall of asset prices, the problems lay deeper. Why did the speculative
bubble occur? Why did the bad debt problem fester so long without any
serious effort at resolution? Why did low interest rates in the 1990s fail to
encourage new business investment? Answers to these questions lay in structural
flaws in the organization and operation of the economy rather than in
just an unfortunate but understandable speculative mistake in asset markets.
The existing Japanese economic system is a modification of capitalism
involving, among other things, a strong indirect government intervention in
markets that may have been well suited to the needs of a rapidly industrializing
nation. The problems of the 1990s, however, demonstrated that this
model did not suit the needs of an advanced industrial nation.
Poor economic performance in the 1990s, therefore, sparked a vigorous
domestic debate over the need for government administrative reform, economic
deregulation, new accounting rules, and other changes to spur more
efficient corporate behavior. Beginning in 1993, all of these topics gained
serious attention in government and the private sector. Over the course of
the rest of the decade, government moved forward with a plan for general
economic deregulation, a "big bang" deregulation of the financial sector,
and government administrative reform. Corporations also began to cope
with their own problems-bad debts, excess labor, and excess facilities-by
late in the decade. By 2001, talk of change was very much in the air.
Is Japan really forging ahead with major economic restructuring, institutional
reform, and deregulation? This study argues that the surface image of
change is misleading. That "something" is changing cannot be denied, and the
pace of change has clearly increased from the stasis of the preceding two
decades. Nevertheless, a number of important and interrelated factors
impede the reform process, and the result will be an economy that continues
to differ in organization and behavior from that of the United States and
most other industrial nations. The government will remain more intrusive in
the economy than is the case in the United States or some other nations that
have been deregulating. Mistrust of markets will continue, leading to constraints
on the scope of their function. Corporate governance will not change
to put shareholders in the driver's seat, and corporations will temper their
drive for efficiency by other social considerations. Corporations might succeed
in raising their return on investment relative to the dismal performance
of the 1990s, but remain less profitable than their western counterparts.
All economies change over time. Economic institutions, the laws enabling
those institutions, and regulations affecting economic behavior are all artificial
constructs created by political systems and can be changed at any time.
New technologies, experience gained concerning the success or failure of
existing institutions and rules, shifts in macroeconomic variables (such as
private-sector savings and investment), as well as shifts among growing and
shrinking sectors all produce changes in laws, regulations, institutions, and
economic behavior. In this basic sense, Japan is no different from other
countries. Many changes have occurred in the past fifty years; new industries
have been created, and some sectors have been deregulated.
What other kinds of changes have occurred? In just the past decade the
number of franchise outlets (an American corporate organizational innovation
of the 1950s) has increased four-fold, with convenience stores and fast
food outlets popping up everywhere. Franchised convenience stores have
morphed into a distinctly Japanese format, providing a set of goods and
services quite different from their American counterparts. Cellular telephones
have come into widespread use since substantial deregulation
occurred in 1994; the number of cellular telephone subscribers rose explosively
from 2.1 million to 60 million in the seven years from 1993 to 2000.
These rather dramatic changes in the context of a largely stagnant economy
certainly suggest that economic vitality was not entirely lost. However,
such examples do not offset the harsh reality of a stagnant economy and the
need for broader reform. The fact is, Japan does not have enough examples
of such successes to drive the economy back to health and needs further
systemic change to provide a more receptive environment for them.
The Japanese are well aware of the trends in the rest of the world. They
have been deeply interested in deregulation in the United States and in
changes in other countries that have reduced the role of government in the
economy. Much of the call for change at home has been driven by knowledge
of these trends abroad. The continuing revolution in information technology
and its explosive deployment in the United States have attracted particular
attention. In many aspects of information technology the Japanese economy
lags behind that of the United States, but it is moving forward quite rapidly
(and leads in some areas, such as wireless communication). Japanese society
is rich in technical expertise and generally has a pragmatic approach to new
industries and technologies that will enable the economy to adjust reasonably
quickly to the information revolution. Concern over lagging behind the
Americans provides a powerful incentive to both corporations and government
to push development of this sector of the economy.
However, this technical strength and the ability to respond to foreign
trends should be kept in perspective.
Continues...
Excerpted from Arthritic Japan
by Edward J. Lincoln
Copyright © 2001
by Brookings Institution Press
Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Copyright © 2001
Brookings Institution Press
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