Japan's Dual Industrial Structure as a Welfare System: "The Lexus and the Olive Tree"-And "The Vulture"
Ozawa, Seiji, Journal of Economic Issues
During the high-growth period of 1950-1973 (Golden Age of Capitalism) and its subsequent two decades, Japan came to be known for efficiency and perfectionism in manufacturing as exemplified by the low production costs and high quality of automobiles and electronics it produced. Japan's renowned manufacturing technology, flexible production with "just-in-time" parts delivery, is now in use throughout the advanced world. Yet, now that the Japanese economy has been mired in a prolonged slump over more than a decade since the bursting of the asset bubble in 1990, the world's perception of the Japanese economy has drastically changed from admiration to indifference even to pity.
What has brought Japan's juggernaut to its knees? Why can its government, once so much touted for effective industrial policies and administrative guidance, no longer cope with the current economic problems, especially bad bank loans, which stand at anywhere between $430 billion (official estimate) and $1.9 trillion (private estimate)? A litany of reform proposals have been put up in the recent past, but so far no decisive and effective implementation has taken place.
In order to explain the leitmotiv of this paper, I draw upon the title of a book, The Lexus and the Olive Tree, a recent best-seller written by Thomas Friedman (1999) of the New York Times, a twice-winner of the Pulitzer Prize. 'He used "the Lexus" as a symbol of an age-old human drive for material betterment and higher standards of living and "the olive tree" as a symbol of an equally age-old human quest for communal identity, stable sustenance, and social cohesion. The former represents technological efficiency and the latter the human attachment to, and concern of, livelihood security and cultural identity. And Friedman argued that a healthy balance between the Lexus and the olive tree, namely between efficiency and security, needs to be maintained, particularly in this age of globalization and a fast-changing world.
As will be explored below, Japan's current predicament stems essentially from the difficulty of keeping this socioeconomic balance. And what makes the Japanese quandary even more intractable is the existence of another age-old human trait, cupidity for power. Since Friedman did not mention this third, equally persistent and powerful, human drive, a drive for political/ideological dominance and greed, I am adding a third symbol, "the vulture."
Against this background, the themes of this paper can be summarized as follows:
1. In the course of Japan's rapid growth it has ended up creating a new industrial dualism consisting of a super-efficient "outer-focused (OF)" sector (symbolized by the Lexus) and an inefficient, but unemployment-alleviating and job-coddling, "inner-focused (IF)" sector (represented by the olive tree).
2. The real cause of Japan's economic imbroglio is the entrenchment of parochial political interests (vultures) in the zombie-haunted industries in the IF sector (in other words, the olive grove was taken over by vultures).
3. The current predicament is a path-dependent outcome of the immediate postwar policies of the Occupation authorities and Japan's subsequent catch-up growth and income distribution measures, an outcome that is much more strongly molded institutionally than anything else.
Dual industrial Structure
Japan was once successful in nurturing dynamic comparative advantages and climbing up the ladder of industrial upgrading, rung by rung from low-value-added to higher-value-added industries, under the Japanese-style infant-industry strategy in the post-World War II period (Ozawa 200la). Initially, all industries were heavily regulated and shielded from competition. Early postwar Japan started out as an exporter of labor-intensive goods (such as textiles and sundries) to earn precious foreign exchange, essentially repeating its prewar experience. In order for Japan not to remain for long an exporter of low-wage-based goods, however, selective industrial policies were then actively pursued to create comparative advantages. First the policies were used in capital-intensive industries (such as steel, shipbuilding, and heavy machinery)--which had previously been built in the prewar days but destroyed or left dilapidated during the course of the war-and then in more technology-based industries (such as cars, comput ers, and other electronics).
Yet the very success in building up new export-competitive industries necessarily made some existing--especially traditional--industries all the more comparatively disadvantaged. Thus the emergence of the "Lexus" sector led to that of the "olive grove sector. Many low-productivity, domestic market--focused industries continued to be heavily protected from both imports and inward foreign investment--protected if not by outright tariffs and quotas then by regulations and red tape and by the manner in which industries were organized under close-knit keiretsu networks. The upshot is the emergence of a new industrial dualism: a highly efficient outer-focused (OF) sector and a secluded import-averse (or nontradable) inner-focused (IF) sector, which caters to domestic markets. The OF sector is best represented by automobiles and electronics. The IF sector includes mostly the sheltered "inefficient" industries such as agriculture, distribution (wholesale and retailing), telecommunications, transportation, banking, finance, insurance, construction, real estate, and food and beverage (Ozawa 1996).
Legacy of the Occupation Policies
The origin of the IF sector, notably agriculture and food and beverage, harks back to the early postwar policy of the Allies' Occupation authorities, as well as to the income-redistribution policies adopted by the Japanese government during the high-growth era of 1950-1973. Initially, Japan as a defeated nation began its reconstruction and modernization under the aegis of the United States. Japan's socioeconomic political system was drastically overhauled so as to introduce democracy and to eliminate any feudalistic remnants of the prewar years. (Indeed, this U.S. effort would turn out to be one of the most successful cases of "nation building" in today's parlance.)
Agriculture in particular was forcefully "democratized" by a drastic land reform to emancipate peasants. Under this reform about 1.5 million landlords had lost their farmland (except about five hectares, or 12.4 acres, for their own use) by 1950, while 4 million peasant households acquired new land (Nakamura 1994). Consequently, the poor tenant farmers all but disappeared. Reportedly, General Douglas MacArthur observed no surer foundation would be found on which to construct a sound and moderate democracy, and no more trustworthy defense against the pressure 'of extreme ideologies" (Takahashi 1968, 129). MacArthur also converted the prewar and wartime hierarchy of agricultural associations into a democratic agricultural cooperative system. The United States was thus determined "to reserve [Japan] as far as possible from socialist encroachments" (Tsurul993, 39).
In short, MacArthur's farm reform did rectify the serious mal-distribution of farm incomes and created a vast "low-middle-income" group of farmers who would form an important source of domestic demand for household goods Japan's early postwar industry was about to produce-a market that would supplement export markets in enabling Japanese manufacturers to reap scale economies. Moreover, self-cultivating farmers like small landowners became all the more motivated to adopt new technology, such as insulated rice seed beds, insecticides, herbicides, and new fertilizers, all "pushing agricultural output to new heights" (Nakamura 1994, 145).
Takeover of "the Olive Grove" by "the Vulture"
Most important of all, however, once the communist threat emerged, with the strong backing of the United States a conservative political party, the Liberal Democratic Party (LDP), was established in November 1955. And Nobusuke Kishi (who became a prime minister in 1957), a war criminal as minister of munitions in Tojo's cabinet, was freed from war crime charges and released from prison, along with others. Many war-time economic planners, who once were engaged in the Greater East Asian Co-Prosperity Sphere scheme, were allowed to return to Japan's dirigiste bureaucracy. They initiated a series of industrial policies which would eventually lead to the recent role of Japan as the major integrator of East Asia economies through channels of trade and foreign direct investment, The Japanese government, once granted independence under the San Francisco Peace Treaty of 1951, also began a so-called sengo kaikaku (postwar reforms) to create a new set of institutional arrangements of their own, including the state-direc ted "main bank" system of finance and the formation of keiretsu by even relaxing the Occupation-imposed anti-monopoly law.
As might well have been expected, the agricultural regions, along with their surrounding semi-urban farm-linked areas (where farm-related economic activities such as dairy, food processing, farm supplies, and services are concentrated), became a major political base for the LDP. Early on (for instance, in 1955), agriculture was the major political support group for the LDP when that sector alone provided employment for as much as 39 percent of Japan's work force and yielded 21 per cent of GDP (Argy and Stein 1997). In fact, the farm districts came to be overrepresented for electoral voting, as the population began to continuously shift toward the urban industrial areas pari passu with postwar industrialization. In 1976, for example, the former, representing only around 20 percent of the national electorate, were able to decide about 30 percent of the seats in the Lower House of Parliament (Okimoto 1989). And the nationwide system of agricultural cooperative associations in the rural areas became a powerful vo te-securing organization for LDP candidates.
Protection and Subsidization
According to traditionalists, agriculture should be regarded as a "cultural industry" since rice cultivation and the rural communities based on such farming represent many centuries of unique Japanese history, culture, tradition, and mores--hence, the Japanese "soul" itself. Even though Japan now allows rice imports, its agriculture continues to be heavily subsidized (just as is the case with the European Union and the United States.). As much as 59-percent of farm incomes in Japan come from subsidies, in comparison with about 20 percent and 31 percent for the United States and Europe (OECD statistics as reported in "Farm Subsidies: A Blight on the Economy," Business Week, September 9, 2002, 50).
Japan's labyrinthine distribution industry used to be likewise romanticized and extolled as a neighborhood-community service provider, since the distribution system used to be full of small "mom and pop" shops whose owners knew their customers intimately as neighbors. Japanese housewives once shopped practically on a daily basis for fresh supplies of vegetables, fish, and meats, especially in the early postwar period when refrigerators were still out of reach for ordinary households. These small retail stores were once protected from competition from large, more efficient retailers such as department stores, discount stores, and supermarkets--all under the Large-Scale Store Law and the Department Store Law, which both restricted large stores from competing with small ones.
Indeed, agriculture and distribution have long served as a private welfare provider. It was the agriculture sector that was able to absorb millions of returnees from overseas, as nearly 6 million demobilized soldiers and repatriated civilians flooded back into Japan from its lost territories, and most of them settled in the rural areas with their families, relatives, and friends right after war's end. The distribution sector has similarly been labor absorbing, since small shops and jobbers are family owned and willing to employ their job-searching relatives and acquaintances in a communal fashion. In addition to agriculture and distribution, construction, small manufacturers, and other IF industries came to be equally regulated to avoid excessive competition (namely to give abnormal profits) and effectively subsidized so that job security would be maintained.
The interests of the construction industry, in particular, became entwined with the government policy to distribute the benefits of high growth promoted under the National Income-Doubling Plan of 1960 in such a way to eliminate the interregional and inter-sectorial income disparities, especially between the industrialized urban and the rural farm-based regions. Under the comprehensive National Development Plan of 1962, the government selected thirteen new industrial cities and six special areas for state-funded infrastructural development projects (Uchino 1983, 116). Ever since, a large sum of money has been poured into the rural areas each year, creating windfall public works for construction and real estate firms. The construction industry got a further boost from the Kakuhei Tanaka administration (1972-74). Tanaka's ambitious and best-selling book, A Plan for Rebuilding the Japanese Archipelago, became the basis for relocation of industries out of the congested Pacific belt. Fiscal spending for public work s to expand the bullet-train railways and highway systems across the nation zoomed. One consequence was the rise in the price of land. In fact, Japan experienced the first postwar bubble in land and stocks over 1972-73.
Throughout Japan, construction firms and their workers (estimated to be more than 6 million, approximately about 10 percent of Japan's labor force) have been staunch supporters of the LDP for good reasons. Many of these firms, especially large ones, hire senior officials from the central government (notably the Ministry of Construction) and from public corporations (such as Japan Highway Corporation) through the practice called amakudari (descent from heaven). William Tabb (1995) even called
Japan "a construction state," in the same breath as some countries maybe identified as a military-industrial state or a welfare state:
The circular flow is from taxpayers to construction companies for massive development projects, bridges and tunnels, highways, and airports. The money goes to favored construction companies, who provide kickbacks from these regional development projects, to the LDP politicians who keep the money flowing. (172-3)
Furthermore, the construction, real estate, and distribution industries developed close connections with, and dependence on, the banking industry in the course of the asset bubble of 1987-1990. Until only recently, Japan's banking and financial sector was long controlled and managed by the government. In fact, it was the very first industry whose ownership had until very recently been excluded from foreign interests. It was considered a strategic industry for economic development after the Meiji Restoration of 1868, when Japan embarked on its modernization program. In the post-World War II period, especially during the 1950-1973 high-growth era, Japan adopted a so-called "main bank" system under which state-directed bank loans were channeled to finance corporate investments in state-targeted industries. Capital (equity) markets were given only a supplementary role, the bond market in particular was not permitted to develop until the mid 1980s, and corporate bond issues and the development of a secondary mark et were discouraged (Patrick 1994). The state-directed banking system naturally produced a moral hazard, because high-risk investments were encouraged and the central bank always stood ready to bail out any main bank. Large city banks were strategically too important to fail, Small regional banks were in turn assisted by the large ones under a so-called "convoy" system.
Although this state-directed finance was quite instrumental in modernizing and building up capital-intensive heavy and chemical industries during Japan's high-growth period, it was no longer effective in controlling subsequently emerging growth industries such as electronics and cars. The latter increasingly turned to capital markets, both overseas and at home. Because of their high profitability they also quickly accumulated internal funds, thereby reducing their dependence on banks. Consequently, when the Bank of Japan pursued a loose monetary policy in order to counter a recession caused by a sharp appreciation of the yen after the Plaza accord of 1985 (under which a concerted effort was made to depreciate the U.S. dollar), the banks began to extend loans for speculative investments in stocks and real estate. These investments led to a construction boom in which many posh office buildings, recreational facilities, distribution outlets, and condominiums were built one after another. The upshot was the asse t bubble of 1987-1990, whose aftermath left the banks with mountains of bad loans.
Although many firms in these industries went bankrupt, still many others have been kept in business only by financial life support from their banks with which they have traditional long-term relations. Expectedly, the government, which is majority controlled by the LDP, has so far been unwilling to force the banks to use stricter asset appraisal in order to write off nonperforming loans for fear of causing massive bankruptcies--and massive layoffs. After all, banking, construction, real estate, and distribution, along with agriculture and other IF industries, are the political power base of the LDP. And it would be suicidal for the majority of LDP politicians to compel a cold-turkey treatment to the present banking ill.
In short, the protection and subsidization of the IF sector was thus initially motivated to solve income disparities and to create stable employment conditions in the face of fast growth. But it was soon made into a pork-barrel sector by the ruling party, the LDP. Through the power to spend public money, LDP politicians staked out their jurisdictional interests. Many of them are identified as a "farm tribe," a "road tribe," a "construction tribe," and so on. In other words, "the olive groves" are inhabited by the "vultures."
The growth of the dual industrial structure resulted in a lopsided trade surplus and equally unbalanced FDI flows, as the OF sector cultivated export competitiveness while the IF sector continued to block imports and inward FDI. These external imbalances inevitably invited severe criticism from the outside world and strong pressure for Japan to open up. In addition to multilateral negotiations sponsored by the GATT (and more recently by its successor, the WTO), the United States in particular employed a bilateral approach to force Japan to remove trade and investment barriers, as seen in the Market-Oriented Sector-Selective (MOSS) talks (1985-86) and the Structural Impediments Initiative (SII). The sharp increases in distressed businesses in the post-bubble period ironically all of a sudden necessitated rescues from foreign investors, especially in the form of mergers and acquisitions, mostly in the IF sector, which had long been restricted for inward FDI (Ozawa 2001b). Japan's willingness to host foreign mu ltinationals has abruptly risen in the space of a few years. (1) Some of the IF industries have thus been thrown open almost completely to the competitive forces of globalization. Telecommunications, insurance, banking, retailing, and food and beverage now eagerly host foreign multinational corporations as direct participants or joint partners.
The initial protection of the IF sector did serve as a growth-sharing mechanism providing a cushion for social cohesion and employment stability, albeit at the huge cost of inefficiency for which Japanese consumers had to pay high prices. (2) But such a structural welfare arrangement declined in importance as the national pension system developed in the course of Japan's catch-up growth. The National Social Insurance and Pension Programs initiated in 1961 became a fairly effective social safety net, assuring decent economic security for retirement. Yet, politically sensitive areas, such as agriculture, banking, construction, and distribution, still remain controlled by the LDP factions, and zombie firms are still kept "revived" by vultures.
Given the weakness of opposition parties, a "regime change" (again in today's parlance) is out of the question--at least for the foreseeable future. The only solution lies in self-cleansing by the LDP itself. The present Koizumi administration's avowed intention is right on target (i.e., compelling banks to get rid of bad loans even at the short-run cost of worsening the current slump), but its pronouncement still sounds hollow.
(1.) Inward FDI in 1998 ($10.47 billion) nearly doubled over the previous year ($5.53 billion). And it further rose to $21.5 billion in 1999 and $28.3 billion in 2000. The first half of 2001 recorded $17.7 billion, indicating another record level (estimated to be over $34 billion) for the entire year (JETRO 2002).
(2.) Market capitalism is a second-best solution to wealth creation as compared with socialism, communism, and totalitarianism, which may be third-or lower-ranked solutions. There is no perfect system that can attain the highest possible efficiency without any accompanying cost. The Japanese approach may be considered, a case of second-best optimization in which the marginal gains from maximizing efficiency are equated to the marginal coat of by-product distortions--that is, efficiency attainment is somewhat sacrificed to moderate the accompanying social losses.
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The author is Professor of Economics, Colorado State University, Fort Collins, Colorado, USA, and Research Associate at the Center on Japanese Economy and Business, Columbia Business School, Columbia University, New York, N.Y. This paper was presented at an Association for Evolutionary Economics session, Economic Growth and Inequality in Asia (D3), at the Allied Social Science Association meetings in Washington, D.C., January 3, 2003. The author wishes to thank Robert Schlock of Carthage College and Peter Gray of Rutgers for their constructive comments.…
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Publication information: Article title: Japan's Dual Industrial Structure as a Welfare System: "The Lexus and the Olive Tree"-And "The Vulture". Contributors: Ozawa, Seiji - Author. Journal title: Journal of Economic Issues. Volume: 37. Issue: 2 Publication date: June 2003. Page number: 519+. © 1999 Association for Evolutionary Economics. COPYRIGHT 2003 Gale Group.
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