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Guest Article GUEST ARTICLE Japan's Economy Needs Structural Change TAKATOSHIITO features of the Japanese economy are fre- makes workers versatile and prepares them Japan's economic miracle quently cited as contributing to this rapid for higher positions, is common. This growth. investment in firm-specific human capital appears to be waning. Struc- Lifetime employment. The conven- helps to increase worker productivity in the tural changes are needed to tional wisdom highlights the importance long run. for growth of the long-term relationship It is often said that productivity increases put the economy on a reason- between Japanese firms and their workers: in Japan were due mainly to a combination ably high growth path once regular workers are virtually guaranteed a of innovations in the manufacturing pro- again. job for life. As a result, involuntary job cess and better communication between changes are rare and the unemployment employees at all levels in the firm. This was rate has been low—around 1-2 percent in made possible by teams of versatile work- the 1950s and 1960s, and between 2 and 3 ers who went through on-the-job training N THE four years from 1992 to 1995, percent since the mid-1970s. Although together. In addition, competition in the Japan's growth rate was around employment is to some degree guaranteed, domestic labor market and a system of 1 percent or lower, the lowest among job assignments, work hours, and rates of "deferred" payments—characterized by a the G-7 countries. Although the reces- pay are quite flexible. Given that workers steep age-earnings profile and substantial Ision touched bottom in October 1993, the are unlikely to quit, a firm can afford to pro- severance pay upon retirement linked to recovery has been extremely weak; the vide often costly on-the-job training. length of service and final salary—deters growth rate did not pick up again until Rotation through different job skills, which workers from shirking work or quitting 1996, when it is thought to have risen above 3 percent. The appreciation of the yen during most of this period and the neg- Prices and growth in Japan ative effect on wealth of the collapse of the (percent change 1980s' share and land price bubble have been singled out as immediate causes of the recession. However, the slowness of the recovery suggests that other factors must have been at work as well. Specifically, fea- tures of the Japanese system that were once considered its strengths may now be holding back growth. The Japanese system Japan's growth record, especially from the 1950s to 1990, was certainly re- spectable for an economy without major resources (see chart). Several institutional Source: IMF, International Financial Statistics Yearbook, various issues. Takatoshi Ito, a Japanese national, is a Professor at the Institute of Economic Research, Hitotsubashi University. He was a Senior Advisor in the IMF's Research Department when this article was written. 16 Finance & Development /June 1997 ©International Monetary Fund. Not for Redistribution altogether. Thus, lifetime employment is takeovers. Management can therefore con- economy grew and firms gained experience supported by a system of implicit contracts. centrate on long-term investment projects, in production, the successful ones were able Moreover, it is self-sustaining: lifetime rather than on dressing up quarterly earn- to expand. Increasing returns to scale employment contributes to the growth of a ings reports. Conversely, if the management brought down production costs, and firm, and growth makes it possible for the of a company has failed, the group firms returns to scale were further enhanced firm to maintain lifetime employment. can collectively decide to replace those who when these firms started to export and The system works especially well in an are responsible. became more competitive in the world mar- expansionary environment, since the rela- Industrial policy. Despite the popular ket. When the sector reached this stage, tively large pool of "underpaid" younger image of interventionist government, public restrictions on imports were liberalized. workers makes possible more "deferred" expenditure as a percentage of GDP in This strategy was most visible in the steel payments to retiring workers. When the Japan has been relatively small compared and shipbuilding industries. organizational hierarchy of a corporation with other industrial countries. Never- In fact, this kind of targeting was almost grows, more management positions are cre- theless, public policy has been used to inevitable in the 1950s because the yen was ated, and therefore "deferred" payments promote growth in a variety of ways. overvalued and import restrictions (includ- increase. Thus, lifetime employment can During the 1950s and 1960s, the govern- ing quotas, tariffs, and foreign currency allo- also be seen as a type of pay-as-you-go ment targeted certain industries as sunrise cations) were necessary to maintain the company pension scheme. exchange rate. The Ministry of The main bank system. Strong International Trade and Industry long-term relationships between (MITI) and the Ministry of Finance banks and firms are often cited as a effectively "promoted" particular in- source of strength in the Japanese dustries simply by allowing them to economy. Typically, a firm develops a use foreign currency allocations to relationship with a particular bank buy raw materials. and relies on its financial support over Opponents of this view point to the long term. The bank not only pro- failures in the government's attempt vides loans to, but also holds shares to identify prospective sunrise in- in, the firm. In return, the firm uses dustries: coal, petrochemicals, oil the bank for major transactions from refining, and aluminum are exam- which the bank earns profits. A bank ples. In fact, some studies suggest that has this type of primary relation- that if productivity increases are ship with a firm is called a main bank. related to loans from the Japanese The main bank acts as an agent for Development Bank at the industry investors and lenders to the firm, level, the relationship is negative. examining the viability of investment Consumer electronics, probably one projects and monitoring the perfor- of the most successful export indus- mance of management. Individual tries, never was on MITI's list. The stockholders do not monitor manage- automobile industry is another inter- ment efforts, and Japanese institu- esting case. In the early 1960s, MITI tional investors have not exercised the attempted to merge several automo- kind of monitoring power, such as Takatoshi Ito bile manufacturers into two groups pressing for higher dividends, that of firms, arguing that there were too investors have in the United States, for many automobile manufacturers in example. Because a main bank takes a Japan. The firms fought back and long-term view, a firm's management industries, providing them with various maintained their independence. If is able to embark on long-term investment advantages to stimulate their expansion. MITI had succeeded in reducing their num- projects with committed funding. They were given low-interest loans through ber, domestic competition would have been Keiretsu. In addition to the strong rela- government financial institutions and stifled and Japanese automobiles might not tionship between banks and firms, the received hard-to-obtain foreign exchange have dominated the world market in the Japanese economy is characterized by long- allocations. The government also restricted 1980s. term relationships between businesses in entry to markets that were considered There is a broader consensus on the ben- the form of keiretsu, or enterprise groups. important and crowded, and some markets eficial effects of the government's com- There are horizontal keiretsu (across were segmented to limit competition. mitment to exports in general. Pushing different industries) and vertical keiretsu One influential but controversial inter- exports was certainly an important aspect (between a manufacturer and its suppliers, pretation of the industrial policy of this of industrial policy in the 1950s and 1960s, or its wholesale distributors, dealers, and period goes as follows. When a chosen sun- but it too was largely a necessary response retailers). rise industry was in its infancy, the gov- to the overvalued currency. The evidence Conventional wisdom on the significance ernment protected the domestic market suggests that the phenomenal success of of the keiretsu to the Japanese economy is through quotas and high tariffs, but Japanese exports reflects a variety of fac- similar to that for the main banks; they allowed domestic firms to compete within tors, including the rapid response of private monitor the performance of management. the captive market. Japanese firms either firms to changing market opportunities. Since group firms hold each other's shares, licensed foreign technology or reverse engi- Indeed, the composition of Japanese they are effectively safe from hostile neered foreign products to catch up. As the exports changed quite rapidly during the Finance & Development /June 1997 17 ©International Monetary Fund. Not for Redistribution 1 decade, it is quite likely that workers who Productivity growth has been slowing are now in their forties will retire to find that their age-earning profiles have not 1960-71 1971-81 1981-92 been as steep as those of the previous Tradable generation—a subtle breach of implied Total 10.22 5.677 4.599 contract. The recent increase in the unem- Agriculture 4.644 3.18 2.79 Manufacturing 10.16 5.318 3.999 ployment rate foreshadows this prospect, although firms, concerned to maintain their Nontradable reputations in the eyes of prospective Total 6.83 2.533 1.900 3 recruits, have so far honored their implicit Energy and transportation 8.08 1.955 2.822 Construction 5.818 0.277 1.99 contractual obligation not to lay off Distribution and finance 8.755 4.799 2.868 workers.
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