Putting the Pieces in Place for Japan's Economic Recovery

By Ozawa, Terutomo | Asia - Pacific Issues, December 2001 | Go to article overview

Putting the Pieces in Place for Japan's Economic Recovery


Ozawa, Terutomo, Asia - Pacific Issues


Japan is at a critical juncture of dramatic economic change: it must deregulate and open up more fully to global business opportunities and capital inflows. Although progress is slow, the country is in fact changing. That this process of economic transformation has been referred to as the "third opening of Japan" is an indicator of its significance. It follows two other major transformations, the Meiji opening of 1868 and the postwar opening of 1945. These past openings were driven by external pressures, and the current third opening continues this pattern. But the difference is that this new movement toward economic liberalization has been fundamentally compelled by market forces rather than led by the government.

Two key market imperatives have been forcing Japan to bring itself more in line with the norms of the global economy. The first is corporate Japan's pressing need to dispose of excess capacities and distressed businesses while acquiring new managerial skills and expertise in business restructuring. Such skills and expertise can be acquired most effectively through mergers and acquisitions with foreign investors as controlling shareholders. The information technology (IT) revolution has created the second market imperative: deregulation and a more marketoriented business milieu, where entrepreneurship, with its free-spirited ideas, can flourish. Hence Japan's telecommunications industry, once monopolized by Nippon Telegraph and Telephone, has been gradually privatized, and its substantially reduced connection fees have created key access to the Web. Furthermore, Japan's underdeveloped capital markets are being modernized to meet the needs of Net-related ventures.

The government has recently stepped up its campaign to accelerate the third economic opening of Japan. However, the economic logic of the market, driven by global capitalism and the demands of modern information technology, is proving to be far more effective in facilitating reforms than political action has been.

Past Policy

Japan's modern economic history has been one of continuous emulation of, and cautious integration with, the industrialized nations in the West. U.S. industry showed Japan the image of its future. But while Japan absorbed advanced industrial knowledge from the West, it kept foreign companies at arm's length-foreign multinational corporations were not welcomed to run domestic industries. In enlarging and modernizing its own industry, Japan employed a dynamic "infant industry" strategy-substituting domestically produced goods for imports and quickly promoting its own exports. This process entailed government protection and promotion of domestic industries.

Japan's self-directed approach to industrial upgrading seemed flawless and was admired worldwide. Thus Japan caught up with the West and even surpassed it in some industrial technologies. Yet its economy is now in shambles. What went wrong?

The carefully state-orchestrated process that engendered Japan's impressive industrial transformation also rendered its existing economic institutions obsolete. Every economy has its own set of institutions, the arrangement of which largely determines its overall performance during a particular period. But as time goes by, the arrangement becomes dated. This is Japan's current predicament, and two characteristics of Japan's economic institutional setup have been most directly responsible for it.

State-directed, bank-based finance. To pursue its catch-up strategy, Japan maximized bank-based financing instead of financing industrial development through capital markets (equities and bonds). In addition, the government initially repressed capital markets, especially the bond market. Governmentfostered dependence on bank loans became the critical mechanism for keeping the price of capital low for corporate Japan, controlling market competition through entry regulations and channeling capital to policy-targeted sectors and projects. …

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