Explaining the Japanese economic miracle

Japan and the World Economy 13 (2001) 303±319

Explaining the Japanese economic miracle Donald W. Katzner* Department of Economics, University of Massachusetts, Amherst, MA 01003, USA

Abstract This paper argues that, contrary to popular opinion, the Japanese economy was not, by western notions and standards, highly ef®cient during the period in which the so-called economic miracle took place. Rather, the rapid economic growth of that period, which actually occurred in the face of substantial inef®ciencies, was made possible in part by signi®cant offsetting effects. # 2001 Elsevier Science B.V. All rights reserved. JEL classification: O53; P52; Z10 Keywords: Japan; Miracle; Inef®ciency

1. Introduction The performance of the Japanese economy since the Meiji restoration in 1868 has been quite extraordinary. Japan emerged from the intense isolation imposed by the Tokugawa as an economic backwater, lagging far behind the west. But by the end of the 20th century, her economy had become the second most powerful in the world. And this was accomplished in spite of the vast devastation that she suffered as a consequence of her defeat in World War II. Although the sustained growth of the Japanese economy from 1868 to 1989 was remarkable by itself, the 18 year period between 1955 and 1973 was especially noteworthy. For over the latter span the average annual growth rate of the Japanese economy measured in terms of real GNP rose to almost 10%. The singular nature of this achievement is captured in the phrase ``Japanese economic miracle'' which has come to be used to describe the phenomenon. As a consequence of the successful development of the Japanese economy in general, and the miracle in particular, Western economies began to take notice of Japan. The view that there was much to be learned by studying the Japanese approach became widespread. Western companies and governments began to emulate components (e.g. the kanban or *

Tel.: ‡1-413-545-6350; fax: ‡1-413-545-2921.

0922-1425/01/$ ± see front matter # 2001 Elsevier Science B.V. All rights reserved. PII: S 0 9 2 2 - 1 4 2 5 ( 0 1 ) 0 0 0 5 6 - 1

304

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

just-in-time inventory system, worker participation in directing production, and, in some countries, governmental bureaucratic direction of the allocation of resources) that appeared to be signi®cant in contributing to the Japanese accomplishment. By the 1980s, interest in Japan had intensi®ed considerably and even turned, in some quarters, to worry. Japan, it seemed, had rede®ned the notions of competition, the organization of production, and economic progress and development. Moreover, Japan Inc. had become so ef®cient that it was taking over the world, and the only way to compete with the Japanese was to join the bandwagon and adopt their methods. Then, in 1990, the speculative bubble in Japanese land prices burst and the Japanese economy began its decade-long slide through lower growth rates into recession. Suddenly the tables were turned. Instead of being admired and emulated everywhere, the Japanese came to be seen as bumblers who threatened global prosperity. Companies formerly thought of as the most ef®cient in the world were now perceived of as having costs that were much too high. The government bureaucracy that previously had been seen as one of the main engines driving Japanese economic success since World War II was now regarded as inept and rudderless. The regulatory structures that earlier were given credit for fostering large-scale industry growth, such as the protection of ``infant'' industries from foreign competition and the provision of low cost loans and foreign exchange to certain favored companies, became a tangle of barriers to competition and another of the primary reasons for Japan's economic troubles. Now perceptions, of course, do not always, no matter how widespread, re¯ect reality. Still, it is possible to claim that the popular perceptions of the Japanese economy before and after 1990 as previously described are both accurate, and that the change in perception around 1990 came about because the characteristics of the real economic world had modi®ed. What worked before 1990 did not work afterwards. The Japanese economic system, while uniquely suited to spur rapid economic growth during the miracle period, did not mesh with the changed economic realities that had emerged and become established by the last decade of the 20th century.1 It is also possible to assert, however, and this is the perspective taken in the present paper, that not only is the above perception of the Japanese economy since 1990 accurate for the decade of the 1990s, but that a similar perception actually re¯ects Japanese economic realities back through the miracle period and possibly even earlier. That is, the recent perception of Japanese inef®ciency (as that concept is de®ned in western economics) is closer to the mark for the entire post-war period than the previous perception that Japan (before 1990) was leading the way to a new kind of economic system that, by dint of its enhanced ef®ciency and, hence, competitive edge, would dominate the world during the 21st century. Moreover, the development of the Japanese economy since World War II, and especially the Japanese economic miracle, are even more striking because they occurred in the face of rather signi®cant inef®ciencies that would ordinarily have caused western economies to stumble badly and stagnate. If this view is correct, it raises many questions, including the following: If Japanese ®rms were so inef®cient, how were they able to sell their products for almost 40 years at prices comparable to, and sometimes substantially lower than, those of considerably more 1

Katz (1998, pp. 3, 4, 109±111), for example, has argued that this change in realities was a consequence of the economic growth of the Japanese economy itself.

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

305

ef®cient western ®rms and not be driven out of world markets by the competition? And even if they survived, as they surely did quite well until 1990, how, in the light of such inef®ciencies were they also able to prosper and lead the Japanese economy to and through the economic miracle? The purpose of this paper is to propose some preliminary answers to these questions. The basic argument that there were signi®cant offsetting effects is given in the next two sections; some suggestive empirical support for it is provided in Section 4; and the paper ends with a few implications drawn from it in Section 5. 2. Concepts of efficiency and inefficiency There are a number of well-known reasons that have been proposed to explain the cause and maintenance for almost 20 years of the Japanese economic miracle. In summary form these include: (A) low foreign prices of the raw materials and agricultural products that Japan needed to import; (B) sound government monetary and ®scal policies; (C) a high savings rate that provided large quantities of funds for investment; (D) Government forecasts of business activity that, though optimistic, repeatedly turned out to be low, thereby making it possible for investors to realize returns on their investments that were over and over again greater than expected. This gave investors con®dence throughout the period that future investments would be pro®table; (E) successful identi®cation and targeting by the Ministry of International Trade and Industry (MITI) of sunrise industries that, once so designated, became eligible for favorable allocations of foreign currency and subsidized government loans; and (F) the technology needed for advancement was readily available from abroad and did not require large expenditures of resources to secure and adapt for Japanese purposes and to Japanese production conditions. By the end of the miracle period in 1973, foreign prices were no longer so low,2 forecasts were more accurate and did not portray as optimistic an outlook, MITI's successes were mostly in the past, and Japan had caught up to western technology to such an extent that there was little left to import. With respect to the last of these items, further Japanese technological advancement required the assignment of much more signi®cant quantities of resources to research and development. Nevertheless, Japanese real GNP was still able to grow at a respectable rate (on average, about 4% per year) until 1991. Though certainly contributing factors, none of reasons (A) through (F) speaks directly to the issues raised above of the survival and prosperity of Japanese ®rms in the face of what would be called severe inef®ciencies in western economics textbooks. To address them requires identi®cation of the source or sources of inef®ciency, the manner in which the inef®ciencies that emerged manifested themselves in relation to Japanese ®rms, and the compensating effects that mitigated their severity and even turned them into advantages. However, the notions of ef®ciency and inef®ciency are abstract and, as such, can only be characterized and their manifestations described with respect to a suitable model of the ®rm. It is also necessary that appropriately related models, with variations that permit distinctions between the two cases, be employed as the basis for understanding and 2

The first wave of sharp increases in the prices of oil and petroleum products began in 1973 with the first OPEC oil embargo.

306

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

explaining the behavior of both Japanese and western ®rms. For otherwise, ef®ciency and inef®ciency concepts would have different meanings for the two kinds of ®rms, and Japanese ef®ciency or the absence thereof (i.e. inef®ciency) could not be compared to that in the west. Thus, it is assumed below that the operation of western ®rms is reasonably captured by the traditional, static model of ``pro®t maximization'' under perfectly competitive conditions.3 That model, of course, can appear in a variety of forms, short run or long run, involving alternative objective functions that are maximized or minimized, with or without constraint, and under conditions of certainty or uncertainty. Regardless, such a ®rm is, henceforth, referred to as a pure capitalist ®rm, and the perfectly competitive economy in which it is embedded is said to be a pure capitalist economy. Although this model, in all of its forms, is somewhat removed from the reality in which actual western ®rms make decisions and take action, it is invoked in present argument not only because of its convenience and simplicity, but also because of the fact that it gives expression to the most common perceptions of western ef®ciency both within the ®rm itself and with respect to the economy at large. The latter ef®ciency, which often goes under the name of Pareto optimality or allocative ef®ciency, needs no further attention at this point. But the former requires some clari®cation. There are three kinds of ef®ciency present in a pure capitalist ®rm that focuses on the maximization of pro®t in the form of the spread between revenue and costs: (i) technological ef®ciency in that the maximum output is obtained from each input combination; (ii) input-mix ef®ciency that results from the use of those input combinations that produce output quantities at minimum input cost; and (iii) output-level ef®ciency achieved by producing that level of output that maximizes pro®t.4 Typically, (ii) arises in the presence of (i), and (iii) arises in the presence of both (i) and (ii). It is, of course, possible for technological and input-mix ef®ciency to hold up in the face of a lack of output-level ef®ciency. All that is required is that the ®rm produce a non-pro®t maximizing level of output. But if technological ef®ciency is in place and input-mix ef®ciency is not, then the ®rm cannot be maximizing its pro®t since an appropriate, alternative input-mix applied to producing the same level of output would increase that pro®t. This does not mean, however, that the ®rm is necessarily producing an output-level different from that which would maximize its pro®t with the ef®cient input-mix. Similarly, without technological ef®ciency, the ®rm can be neither minimizing production cost nor maximizing pro®t. But it could still, by accident, be using the optimal input-mix and producing the optimal outputlevel that would obtain were all three types of ef®ciency present. Now it has been suggested elsewhere that, for cultural reasons, the model of the pure capitalist ®rm is not suitable for explaining the behavior of Japanese ®rms because, at a minimum, the assumption of pro®t maximization in any of its forms is not appropriate.5 Unfortunately, space will not permit repetition of the argument in detail here. Suf®ce it to 3 This, clearly, is a general statement. It is not intended to imply that all western firms always select the profit maximizing course of action in all situations. 4 The efficiency relating to the financing of the firm's investment undertakings is also relevant but, for present purposes, will be ignored. 5 Katzner (1999). Like the previous assumption that western firms are profit maximizers, this, too, is a generalization. It does not mean that no Japanese firm ever chooses a profit maximizing option. Recall Footnote 3.

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

307

say that, re¯ecting a cultural tradition quite different from that of the west, input quantities would not ordinarily be chosen to minimize cost at each level of output, output would not necessarily be produced to maximize pro®t, and investments would not generally be undertaken so as to maximize their expected rate of return for a given degree of risk. Such motivations as the ful®llment of social and economic obligations, the furtherance of intra®rm harmony and unity, loyalty to employees and others with whom the ®rm has business dealings, and the preservation of the ®rm's social status are more important in the making of employment, production, investment, marketing, and ®nancial decisions.6 Indeed, the primary purpose of the Japanese ®rm is to provide service to society and bene®t to employees,7 and this is best achieved through steady, long-term growth. Thus, input and output quantities may be determined on the basis of long-term targets emerging from, say, plans to expand into certain markets, where both the quantities and targets have little to do with short-run or long-run pro®tability considerations; parts may be purchased from suppliers with whom the ®rm has a long-term relationship rather than from sources offering the lowest price; investments might be made so as to maintain the ®rm's social status by providing a product line similar to that of competitors; and so on. To introduce these alternative motivations by modifying the model of the pure capitalist ®rm, and then to analyze their effects in that context, are not straight-forward tasks. For, in addition to the absence of the input-mix and output-level ef®ciencies described above, loyalty to employees, say, might imply that the ®rm is prepared to ``overhire'' or hoard labor. Although, from the point of view of the pure capitalist ®rm, such excessive hiring of labor would imply the absence of technological ef®ciency, it would still be possible to de®ne a production function for the Japanese ®rm with respect to which that same ``excessive'' quantity of labor would appear to be technologically ef®cient. But in that case, the model of the pure capitalist ®rm and that of the Japanese ®rm, each with its own distinct production function, would have become so disparate that it would not be possible to compare ef®ciency and inef®ciency, in any of the above senses, across them. The approach below avoids this dif®culty by ignoring those characteristics of the Japanese ®rm and its employees that are not describable with respect to a western-capitalist or purecapitalist style production function. In particular, since it has been indicated above that pro®t maximization is generally not relevant to Japanese decision making, all of the elements of the pure capitalist model will be retained except that decisions will be made by some other means. Present purposes do not require that a precise alternative decision criterion be speci®ed; it only matters that all forms of pro®t maximization, including cost minimization, be excluded. This will mean, in the argument that follows, that varying assumptions will be made regarding the absence of pro®t maximization and, hence, the extent of similarity between the pure capitalist and Japanese ®rms. Regardless, since the models of the Japanese and western ®rm employed here are identical except for the respective lack and presence of pro®t maximization in decision making, the notions of technological, input-mix, and output-level ef®ciency are comparable across cases, and only western ®rms will, in general, be ef®cient with respect to all three. That is, Japanese ®rms, due to the lack of pro®t maximization in them, will typically be, by de®nition, less 6 7

Benedict (1946, Chapters 5±8) and Nakane (1970, pp. 82±82, 89±91). Clark (1979, p. 137).

308

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

ef®cient than their western counterparts. Such ®rms will be called quasi-capitalist, and the economy surrounding them, in which the behavior of all ®rms is not generally derived from pro®t maximization, a quasi-capitalist economy. It might be thought that, from a theoretical perspective, the Japanese focus on longterm growth may be interpreted as a way of maximizing the present value of expected future income streams. In this sense, then, the Japanese ®rm would be maximizing a form of pro®t just like any pure capitalist ®rm. But the act of merely pursuing growth carries, by itself, no logical implication either way of whether that growth is optimal, or whether the ®rm is maximizing anything at all. And, as suggested above, cultural traditions point to the use of criteria other than maximization in the making of decisions, even in the long run. 3. Japanese inefficiencies and offsets Two manifestations of the absence of pro®t maximization in Japanese ®rms are explored here: the hiring and keeping of ``too many'' employees, and the ``misallocation'' of resources in the economy at large, and among investment opportunities in particular. Consider the hiring and keeping of employees ®rst. Japanese ®rms, especially those who offer ``life-time'' employment, have been known for their enthusiastic and even ``excessive'' hiring of new employees (especially university graduates) in good times, and their reluctance to ®re them when business activity sours.8 This will be understood in the quasicapitalist model to mean that Japanese ®rms employ more individuals than they would if they were making hiring decisions on the basis of pro®t maximization. And it signals the absence of one or more of technological ef®ciency, input-mix ef®ciency, and output-level ef®ciency. Now if such a ®rm were to try to sell its output in highly competitive (e.g. world) markets, it would ®nd, according to the theory of the pure capitalist economy, that its costs were too high to survive, and it would be driven out of those markets by lower-cost ®rms that make decisions in compliance with pro®t maximization. But in the Japanese case there are at least two mitigating factors. On the one hand, it is well-known that Japanese employees tend to work very long hours, more hours than they are compensated for by western standards of work time in relation to compensation.9 This fact may be introduced into the quasi-capitalist model of the Japanese ®rm in several ways. One method, consistent with the present requirement of maintaining 8

Abegglen and Stalk (1985, pp. 6, 199±203). This statement applies mostly to the medium size and large Japanese manufacturing firms (i.e. enterprises with 100 or more employees) which, between 1955 and 1990, employed roughly 45% of the manufacturing labor force and accounted for approximately 63% of value added in Japanese manufacturing (according to the Census of Manufacturers conducted by the Japanese Ministry of International Trade and Industry). These firms constituted the sector of the Japanese economy that, during the miracle period and up to 1990, was thought to be the most efficient in the world, and that was both emulated and feared almost everywhere. 9 The ``salaryman'' usually works into the evening and many of these hours would be considered unpaid or non-salaried hours in the west. Even when evening hours are spent with colleagues at restaurants and Geisha houses, they are often thought by the Japanese to be work since work related matters frequently are discussed and sometimes work-decisions are made. Higa and Lupardus (1998, p. 92) estimate that, in 1994, the typical male worker in Japan was paid for only 82% of the hours he actually worked.

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

309

identical production functions in the pure-capitalist and quasi-capitalist ®rm, is as follows: In both pure-capitalist and quasi-capitalist cases, let labor be measured in hours, each unit of which carries the same quality. Let the argument in the production function representing labor denote only those labor hours for which the ®rm actually pays, and let the output of that production function be the output of the paid labor only. Given market conditions, taken to be the same in both cases, let the ®rm determine the quantities of inputs it hires and output it produces according to whatever decision criteria it uses. Assume that the quasicapitalist Japanese ®rm is producing that level of output speci®ed by the production function in relation to actually paid labor so that it is technologically ef®cient. But, as described in the preceding paragraph, that cannot mean that that ®rm is hiring labor and producing output in quantities that both minimize cost and maximize pro®t. For the Japanese ®rm is necessarily less ef®cient and has higher costs than the pure-capitalist ®rm. Now, with respect to the former, keep the quantities of non-labor inputs ®xed and add in the presence of unpaid labor together with the extra output derived from it. Then, although the quasi-capitalist ®rm's total cost remains unchanged, its effective unit cost falls. Thus, the increase in output provided by unpaid labor offsets at least some of the extra cost of hiring too much labor. On the other hand, Japanese ®rms pay their employees according to a bonus system10 which allows the ®rms to effectively lower wages and salaries generally, and reduce bonus payments during hard economic times. Whereas a pure capitalist, pro®t maximizing ®rm would always pay an employee the value of his marginal product, since approximately one-third of the Japanese worker's income from employment has, in the post-war period, come as a bonus, the Japanese ®rm could be thought of as paying the employee two-thirds of what it would ``normally'' pay to meet its labor requirements, were it operating as a pure capitalist ®rm. Additions to the latter employee's income would come from pro®t, when the ®rm is pro®table enough.11 Obviously this results in total labor costs that are one-third below what they would be if bonuses were not separated out from wages and salaries and paid out of pro®ts, and if the same quantity of labor were hired in each situation. In the last assertion, ``quantity of labor'' is meant to refer to total labor hours, including, in the language of the previous paragraph, both ``paid'' and ``unpaid'' labor, and the statement itself is intended to carry no implication with respect to pro®t maximization or ef®ciency in any form. Should the ®rm not do well, it reduces or eliminates the bonus rather than letting employees go. Thus, when total labor hired (including the unpaid component) is considered, and when the total production cost associated with it is in view, the overhiring of employees by Japanese ®rms need not necessarily lead to cost disadvantages when competing in world markets against ®rms that, in theory, maximize pro®ts. These general considerations suggest reasons why the labor-hiring and wage-remuneration practices and production decisions of the quasi-capitalist Japanese ®rm enable it to offset the lower pro®t level resulting from the inef®ciencies that have been attributed to an absence of cost minimization or pro®t maximization. To examine the matter further, 10

Abegglen and Stalk (1985, pp. 196±197). The fact that there may be a minimum bonus that is always paid regardless of economic conditions is ignored. 11

310

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

attention turns, for a moment, to the following comparative example. Focus on a production function of the form p x ˆ y; where x indicates quantities of output and y denotes quantities of total labor input (the latter is comprised, in the case of the Japanese firm, of both paid and unpaid labor). To keep matters simple, assume that no other inputs are employed. Suppose that this same production function arises in both the quasi-capitalist (Japanese) and pure-capitalist firm, that labor is homogeneous across these firms, and that the Japanese firm is technologically efficient. Since there is only one input, the issue of whether there is input-mix efficiency does not arise. Represent the wage per unit of labor (averaged over paid and unpaid components) by w. Taking the output price to be p, profit p is given by p p ˆ p y wy: (1) With w and p fixed, choosing y so as to maximize p yields the input demand function yˆ

p2 : 4w2

(2)

Were the Japanese firm to determine its employment level like a pure capitalist firm, it would decide on the quantity of labor it would hire on the basis of profit maximization. Then, in that case, it would follow that if that firm's employees were paid two-thirds of the full capitalist wage w, that is, if (2/3)w were substituted in place of w in Eq. (2), then the Japanese firm would hire 9/4 or more than twice the number of employees than the pure capitalist firm would hire at wage w. In addition, substituting Eq. (2) into Eq. (1) and differentiating the result with respect to w leads to the inequality @p < 0; for all w > 0: @w

(3)

Thus, assuming p and w are given, if the Japanese firm were to pursue the objective of profit maximization, it would hire more labor at the wage (2/3)w than it would if it hired at w and, by Inequality (3), its profit would be larger. But recalling previous observations regarding overhiring by the Japanese firm, an alternative scenario might be envisaged. Consider, for that purpose, what has just been described as the firm's profit maximizing demand for labor at the wage (2/3)w. If the firm were to hire that same quantity of labor at wage w, it would clearly fail to realize maximum profit. In that case, however, profit maximization would, of course, be restored by paying labor (2/3)w, and the firm would not face what has been contemplated as a survival problem.12 But the implicit hypothetical comparison between the pure capitalist and Japanese ®rm in what has just been discussed does not fully describe the condition of the quasi-capitalist Japanese ®rm and its decision making complex. For the quasi-capitalist ®rm, it has been 12 Of course, since the Japanese firm would then pay a bonus on top of (2/3)w, the allocation of resources that results would be unlikely to achieve the Paretian efficiency of pure capitalist systems. This latter manifestation of inefficiency is taken up shortly.

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

311

Fig. 1. Profitability at various wages and employments in the Japanese firm.

assumed, does not appeal to pro®t maximization to determine its employment. Furthermore, overhiring by that ®rm means that, as previously indicated, it actually hires more labor than that which would equate the value of its marginal product to w. Thus, if VMP(y) represents the value of the marginal product of labor at y, if w0 is the given capitalist wage and y0 satis®es the equation VMP(y† ˆ w0 from which Eq. (2) is derived when w is variable,13 and if y0 is the quantity of labor that is hired by the ®rm, then as shown in Fig. 1, y0 > y0 and VMP…y0 † < VMP(y0 ). In addition, the actual wage paid by the Japanese ®rm is (2/3)w0 , not w0 . Thus, as speci®ed above, if y00 is the value of y that solves VMP…y† ˆ …2=3†w0, then y0 < y00 (refer again to Fig. 1), where y00 ˆ …9=4†y0 . Hence, as long as the Japanese ®rm does not hire more than 9/4 the labor it would hire if it were a pure capitalist ®rm, that is as long as y0 < y00 , the value of the employee's marginal product is larger than the wage, (2/3)w0 , he is paid. Moreover, since VMP(y0 †5…2=3†w0 for y0 4y0 4y00 , Inequality (3) implies that, with wage (2/3)w0 and a ®xed value for p, before-bonus payment pro®t at each such y0 is higher than the pure capitalist pro®t at y0 with wage w0 . And because, as is also implied by Inequality (3) when bonus payments are ignored, pro®t at y00 is greater than that at y0, that larger pro®t could be preserved to some degree were the ®rm to hire a little beyond y00 at a wage of (2/3)w0 . Once again, the loss from overhiring at wage w0 is more than offset (before-bonus-disbursement) by paying employees (2/3)w0 . But once the payment of the bonus is taken into account, the offsets to the consequences of overhiring described here are reduced by the total of all bonus disbursements. Returning to Fig. 1, if, at wage w0 , the ®rm hires y0 instead of the pro®t maximizing y0, its revenues rise by area ABCD. Since it actually pays a wage of only (2/3)w0 , its labor costs increase by 13

That is, y0 satisfies VMP…y† ˆ p= 2

p
y ˆ w0.

312

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

EFCD rather than by AGCD for a pre-bonus offset savings of AGFE. Its pre-bonus pro®t rises by ABFE. That pro®t increase, however, will be eaten away depending on the size of the bonus paid. For example, suppose that, while the Japanese ®rm pays a nominal wage of (2/3)w0 , the effective wage payment is actually somewhere between w0 and (2/3)w0 by virtue of the additional bonus to be subsequently provided. That would mean that the payment of the bonus would absorb some, all, or possibly even more than all, of the additional pro®t achievable by employing y0 labor at nominal wage (2/3)w0 . In general, the degree to which that absorbtion takes place depends on the elasticity of production with respect to labor input implicit in the production function. The latter point, however, need not be pursued further here. Regardless, to the extent that Japanese ®rms are in fact prepared to accept a smaller pro®t than that which would accrue to the comparable pure capitalist ®rm (a willingness that, as argued below, is quite common in Japan), they could tolerate bonus payments associated with effective wages above, say, w0 in Fig. 1. In that illustration, were the ®rm return the full capitalist wage w0 to each employee, its after-bonus-payment pro®t would be reduced from the capitalist pro®t at A by area AGB. The second manifestation of inef®ciency in Japanese ®rms has to do with the implications for the misallocation of resources in the economy at large and among investment opportunities in particular, and the resulting higher costs that that entails. The misallocation comes about from such practices as overhiring and the use of criteria (like, for example, the preservation of the ®rm's social status) other than expected rate of return maximization (for a given risk) in making investment decisions. The compensating effect that offsets the inef®ciencies and higher costs here is the willing acceptance of less-thanmaximum pro®t by the ®rm's owners, managers, and bankers. That willingness comes about for several reasons.14 First, the members of the board of directors of a ®rm largely come from inside that ®rm. Any outsiders are usually representatives of other companies that have very close business relations with the ®rm. Thus, as a consequence, ®rms tend to be managed more for their employees than for their owners. This means that long-term growth, which often implies enlargement of market share by expansion in foreign markets, and which generally provides greater job security for employees, is, as suggested earlier, a much higher priority than pro®t maximization in any of its forms. Second, the owners of the ®rm, i.e. those who hold its equity, have little choice since, although they are entitled to dividends by dint of their ownership position, once those dividends are paid, they have little say in the management of the company's affairs. Moreover, a sizable portion of the ®rm's equity is held by those same ®rms that have close business relations with it and who, as indicated above, are more interested in long-term growth than either short-run or long-run pro®t maximization. Third, the Japanese banks are managed in much the same way with emphasis on long-term growth. A ®rm and bank that are tied together, in that the former is heavily in debt to the latter, will hold each other's equity. A bank representative may sit on the ®rm's board of directors. The bank feels obligated to underwrite portions of the ®rm's investments with low-cost loans, thereby decreasing the spread between its lending and 14 Abegglen and Stalk (1985, pp. 166±168, 174±175, 183±186). A rigorous theoretical analysis of the mechanism through which the willingness of firm's owners, managers, and bankers to accept less-thanmaximum profits will lead to a misallocation of resources is not developed here.

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

313

borrowing rates (and hence, its pro®t), and to help in rescuing and reconstructing the ®rm when it runs into ®nancial dif®culty.15 But, it should be emphasized, the lack of concern within the Japanese ®rm about its failure to maximize pro®t is not only due to the fact that it can count on banks' help during times of severe ®nancial distress. For, as has been repeatedly noted earlier, ®rms do not consider pro®t maximization to be a goal. Indeed, Japanese ®rms have generally done quite well without maximizing pro®t and there is, therefore, no reason to be concerned about it. Of course, Japanese ®rms do care about the possibility of bankruptcy because it implies a failure to achieve their primary goals of service to society and bene®t to employees. But any worry about bankruptcy still does not focus their attention on pro®t maximization. In any case, previous argument indicates that the net effect of these practices and policies by Japanese ®rms is to reduce their pro®tability to levels lower than those that would be secured if they behaved like pure capitalist ®rms and maximized pro®ts. And being content with less-than-maximum pro®t tends to mitigate the effects of taking obligation, internal harmony, and loyalty as the primary motivations behind business decisions in general, and of using, say, the preservation of the ®rm's social status as a criterion for investment decisions in particular. That is, although the allocation of resources that results is not ef®cient with respect to either input-mix or output-level or, in other words, although the Japanese economy is ``wasting'' resources by producing beneath what, in terms of the pure capitalist model assumed here for comparative purposes, is designated as its production possibility surface,16 the inef®ciencies that arise are offset on the plane of competition in domestic markets by the willingness to accept smaller pro®ts and lower rates of return on invested capital. The same conclusion applies with respect to world markets too. For pure capitalist economies, the explanation of why countries trade and what they gain from doing so is provided by the theory of comparative advantage. In that theory, comparative advantages, as traditionally de®ned under western assumptions, are based on marginal rates of transformation along an economy's production possibility surface and, to be on that surface, requires, in part, that all ®rms produce outputs with cost minimizing quantities of inputs, which the ®rms in a pure capitalist economy automatically do. Countries specialize in the production of goods in which they have comparative advantages and trade part of their output to other countries in exchange for goods in which the original countries have comparative disadvantages. At equilibrium exchange rates after trade has taken place, and ignoring international capital ¯ows, a country that has a comparative advantage in a speci®c good produces that good at a smaller dollar cost after exchange rates are taken into account. Thus, it sells that good in world markets at lower prices than other countries are able to offer. Those other countries buy the good rather that produce it at home because it costs them less to do so. But none of this applies to a country like Japan which cannot generally be represented as producing on its production possibility surface. And the Japanese cost disadvantage in 15

In this regard it might also be noted that downward pressure on lending rates was exerted by the monetary policy pursued by the Bank of Japan throughout the miracle period. 16 If, by chance, it actually wound up on that surface, the absence of output-level efficiency is likely to result in the Japanese economy producing at the ``wrong'' (i.e. allocatively inefficient) surface point.

314

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

world markets that results, assuming the theory of comparative advantage is used as the point of reference, is offset by pricing goods at levels at which they will be sold and accepting smaller pro®ts and, sometimes, even losses. This is entirely consistent with the goals of Japanese ®rms described above to grow in the long term and expand world market share. 4. Some suggestive data on productivity and returns to captial As described in the Section 3, two inef®ciencies that, from a western vantage point, might prevent the Japanese economy from growing as fast as it could are the hiring of too many employees and the using of criteria other than expected rate of return maximization in investment decision making. In sustaining the Japanese economic miracle, however, it has been argued that these inef®ciencies were partially offset by compensating labor with less than what it would normally pay to meet its labor requirements (for example, w0 in Fig. 1). An additional offset was due to a willingness, on the part of the owners of capital, to accept pro®t or a rate of return on capital that was lower than what could otherwise be obtained. To test empirically these latter propositions would, ideally, require comparing estimates of actual wages and normal wage requirements on the one hand, and estimates of actual and maximal pro®t rates on the other. Such comparisons are far to complex too undertake here. Rather, it will suf®ce instead to present some data that are not only consistent with the propositions, but also suggest that they might hold up under more rigorous empirical scrutiny. Data are provided not only for portions of the miracle period (1955±1973), but also for certain time intervals up to 17 years beyond in order to cast doubt on the claim, held in may quarters, that the Japanese economy was highly ef®cient until the early 1990s. The idea is to take the US economy as representative of an ``ef®cient'' economy and use it as a foil against which the Japanese inef®ciencies and their offsets mentioned above can be empirically placed in sharp relief. This is quite parallel to the approach outlined in Section 2 and applied in Section 3 of thinking of the Japanese ®rm in terms of a pure capitalist model in which the assumption of pro®t maximization has been dropped. Thus, under the appropriate conditions, lower wages in Japan as compared to the US would point to the possibility that Japanese ®rms were overhiring as described earlier and paying labor less than what normal requirements would demand, and lower pro®t rates in Japan would suggest the possibility that Japanese investors willingly accept smaller rates of return on their invested capital. Consider wages ®rst. Actually, it will be convenient to focus on productivity data which may be assumed to re¯ect wage values.17 Pilat (1993, p. 368) compares Japanese±US labor productivity both for the economy as a whole and in seven of its sectors (agriculture, 17 For example, in terms of the marginal products implicit in Fig. 1 (which are assumed to approximate average products), an American firm would be thought of as being at point A where it employs y0 and pays a wage of w0. The comparable Japanese firm, however, would hire, say y0, where marginal productivity is lower than in the American firm, and pay the wage (2/3)w0 < w0 . Thus, lower productivity in the Japanese firm would correspond to a lower wage.

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

315

Table 1 Comparative labor productivity levels by sector and GDP per person employeda,b 1953

1965

1975

1990

Agriculture, forestry, and fisheries Mining Manufacturing Construction Transport and communication Electricity, gas, and water Government and other services

5.8 4.5 22.5 19.8 15.6 15.5 42.6

8.3 11.2 36.3 19.7 25.5 22.1 48.0

9.4 31.2 69.7 49.0 39.2 29.2 67.9

9.1 68.7 100.6 75.5 39.1 43.3 91.2

Whole economy

19.8

30.7

52.5

77.7

a b

Japan as a percentage of the US. Source: Pilat (1993, p. 368).

forestry, and ®sheries; mining; manufacturing; construction; transportation and communication; electricity, gas, and water; government and other services) for selected years between 1885 and 1990. The speci®c measure with respect to which his comparisons are made is estimated sectoral contributions to GDP per number of persons employed in those sectors. In the years in and around the miracle period that he covered (1953, 1965, and 1975), Pilat found that labor productivity, compared to the US, was consistently and signi®cantly lower overall and in all sectors in Japan (Table 1). For example, in 1975, manufacturing GDP per person in Japan was 69.7% of that in the US. With one exception, the same was true in all other years included in his study (6 years running from 1885 to 1939 Ð not shown in Table 1 Ð and 1990). The one exception was in manufacturing in 1990 where GDP per number of persons employed was essentially the same in both countries. However, it does not follow that the Japanese were not overhiring and paying labor less than normal wage requirements in manufacturing in 1990 for at least two reasons. First, Pilat (1993, p. 366) also indicates that manufacturing GDP per hour worked was still signi®cantly lower in Japan as compared to the US in 1990 (as a rule, there was a greater sectoral discrepancy than that indicated above between Japan and the US in terms of GDP per hour worked18). Second, in 1990 the US economy was close to the trough of its business cycle, whereas the Japanese economy was near its peak. Under such conditions, aggregate productivity data at the sectoral level would tend to blur the comparison between wages paid in manufacturing by individual Japanese and US ®rms. Movshuk (1999, p. 61) provides an alternative approach to productivity comparisons that is broader in concept but relates only to manufacturing. Using the Tornquist-Theil index, and accounting for labor, capital, and intermediate inputs, he estimates total factor productivity in the manufacturing sector and 23 of its subsectors, and compares the results for Japan (among other countries) and the US in 1975 and 1990. Movshuk concludes that, in both years, total factor productivity in manufacturing as a whole was signi®cantly lower in Japan (Table 2): 72% of that of the US in 1975, and 84% of that of the US in 1990. 18 To the extent that the Japanese work longer hours than actually reported (it has been suggested earlier that they work more hours than those for which they are paid), this discrepancy would be increased. See Footnote 9 above.

316

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

Table 2 Total factor productivity in Japan relative to the US in 1975 and 1990a,b

Food products Beverages Textiles Clothing Leather products Footwear Wood Furniture Paper products Printing, publishing Industrial chemicals Chemical products Rubber products Plastic products Pottery, china, etc. Glass products Non-metallic products Iron and steel Non-ferrous metals Metal products General machinery Electrical machinery Transport equipment Total manufacturing a b

1975

1990

86 107 79 123 133 112 28 47 77 51 68 97 150 75 60 88 68 100 68 87 77 60 96

66 84 66 95 119 109 31 42 84 66 66 81 136 64 73 84 79 115 78 102 92 118 100

72

84

US total factor productivity ˆ 100. Source: Movshuk (1999, p. 61).

Moreover, it was higher in Japan in only ®ve of the 23 subsectors in 1975 (beverages, clothing, leather products, footwear, and rubber products), and in only six, three of which were the same, of the 23 subsectors in 1990 (leather products, footwear, rubber products, iron and steel, metal products, and electrical machinery). Thus, under the assumptions made here, Movshuk's results are suggestive of the same phenomenon of wages paid being less than normal wage requirements in Japan.19 Turn now to the comparison of pro®t rates between the US and Japan. Ando and Auerbach (1990, p. 327) provide two estimates of the returns to capital in Japan and the US in each of the 22 years from 1967 to 1988. One of these estimated series is derived from 19

It should be noted, however, that there are other possible explanations of why labor productivity and returns to capital (to be discussed next) have been lower in Japan. For example, labor productivity might have been lower due to technological backwardness. And returns to capital might have been lower because, in the catchingup-to-the-west process, Japan was more dependent on physical capital accumulation than was the US (Hayami and Ogasawara, 1999) implying, thereby, a lower marginal productivity of capital. Thus, although the data presented here are unable to establish the proposition that overhiring and a willingness to accept lower rates of return on invested capital were present in Japan between 1955 and 1990, they are still consistent with it. A rigorous test of the proposition is beyond the scope of the present paper.

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

317

Table 3 Returns to capital in Japan and the US from 1967±1988a Japan

US

1967 1968 1969 1070 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

0.070 0.088 0.083 0.081 0.082 0.065 0.030 0.010 0.045 0.042 0.048 0.047 0.058 0.067 0.082 0.076 0.076 0.068 0.069 0.054 0.045 0.046

0.090 0.075 0.069 0.077 0.085 0.087 0.097 0.140 0.140 0.135 0.140 0.170 0.193 0.173 0.138 0.117 0.122 0.124 0.121 0.093 0.103 0.127

Average

0.060

0.119

a

Source: Ando and Auerbach (1990, p. 327).

accounting earnings (adjusted for such things as the in¯ation-induced understatement of depreciation and inventory costs, capital gains on net ®nancial liabilities and, in the case of Japan, reserves) and is presented in Table 3. The table shows that the average rate of return to capital over the entire period was considerably higher in the US (0.060 in Japan as opposed to 0.119 in the US). Furthermore, in only three of the 22 years (1968±1970) was the rate of return on capital higher in Japan. The second series estimated by Ando and Auerbach is based on market equity yields and includes capital gains on land. Since the conclusions drawn from the second, although not as strong, largely mirror those obtained from the ®rst, the second series is not reproduced here. It has been argued that the data presented above are suggestive of the possibilities that, as a rule, the Japanese pay labor less than normal wage requirements, and accept less than the maximal rate of return on their invested capital. To the extent that these characteristics hold in fact, they may be viewed as compensating offsets to the inef®ciencies created by the practices of Japanese ®rms of (i) hiring too much labor, and (ii) using criteria other than maximizing the expected rate of return in making their investment decisions.20 20 The deterioration of the Japanese economy after 1990 does not necessarily mean that these offsetting effects disappeared or even were reduced in size. Rather, the offsetting effects could be seen as still present, though no longer sufficient to maintain prosperity and stave off decline.

318

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

5. Conclusion The argument of this essay has been that Japanese ®rms led the Japanese economy to and through the economic miracle period in part by successfully compensating for what in western economics would be regarded as signi®cant inef®ciencies. These inef®ciencies are suf®cient in pure capitalist economies to result in large numbers of bankruptcies, unemployment, and possibly even depression. They arise from the pursuit by Japanese ®rms of goals other than pro®t maximization, and they manifest themselves at least in overhiring by ®rms, and a misallocation of resources in general and among investment opportunities in particular. There are several implications of this argument that can be applied on a much broader scale rather than simply to the particular case of Japan. First, ef®ciency in the western sense (i.e. technological, input-mix, and output-level ef®ciencies, and optimal resource allocation) may be partly suf®cient, but it certainly is not necessary for strong economic performance and development. As long as there are appropriate offsetting features that compensate for the inef®ciencies, signi®cant economic progress can still occur as it did for almost 40 years in post-World-War-II Japan. In such economies, which have been referred to above as quasi-capitalist, the price mechanism operates differently and does not function to allocate resources in the same way as in a purely capitalist system. Regardless, it is clear that the normative idea that western ef®ciency is ``good'' and ought to be pursued is culturally based. Such ef®ciency may be relevant and appropriate for western-type economies or purely capitalist systems, but its pursuit in the quasi-capitalist economies of the non-western world may, at best, not have the desired effects and, at worst, could cause substantial harm. Second, such quasi-capitalist economies, that is, their institutions and the behavior of economic agents in them, can re¯ect cultural and social norms and traditions quite different from those of the west. In the argument of the present paper, this appears in the motivations other than pro®t maximization that drive economic action.21 The cultural and social roots of such alternative motivations in the case of Japan have been described by Bellah (1957), Benedict (1946), and Nakane (1970).22 And the occurrence of the Japanese economic miracle is prima facie evidence that strong economic growth can take place in a cultural and social environment that eschews western norms and values. Different (i.e. nonwestern) cultural and social norms and traditions, then, need not necessarily relegate an economy to a permanently undeveloped state. Finally, re¯ecting on the entire post-World-War-II Japanese economic experience, it is clear that quasi-capitalist economies are subject to boom and bust just like capitalist economies. The western world is not the only one vulnerable to in¯ation, speculative price bubbles, miscalculations by individuals and policy makers, and so on. Sustained prosperity is possible as is recession and, although not in recent Japanese and western history, depression. Of course, since the internal structures and dynamics of these economies are different, the causes of downturns and upswings, and the economic reactions and adjustments to them, will not be the same. And different policies are likely to be 21 Japanese institutions such as the life-time employment system can also be thought to emerge from cultural characteristics that do not exist or are of relatively minor significance in the west. 22 See also Katzner (1999).

D.W. Katzner / Japan and the World Economy 13 (2001) 303±319

319

required to deal with problems like in¯ation and unemployment that arise over the business cycle. Acknowledgements Thanks are due to Charles Yuji Horioka and Douglas Vickers for their considerable help. References Abegglen, J.C., Stalk, G., Jr., 1985. Kaisha, The Japanese Corporation. Tuttle, Tokyo. Ando, A., Auerbach, A.J., 1990. The cost of capital in Japan: recent evidence and further results. Journal of the Japanese and International Economies 4, 323±350. Bellah, R.N., 1957. Tokugawa Religion. Free Press, Glencoe. Benedict, R., 1946. The Chrysanthemum and the Sword. Houghton Mifflin, Boston. Clark, R., 1979. The Japanese Company. Yale University Press, New Haven. Hayami, Y., Ogasawara, J., 1999. Changes in the sources of modern economic growth: Japan compared with the United States. Journal of the Japanese and International Economies 13, 1±21. Higa, T., Lupardus, K., 1998. Why do not workers claim all their overtime? In: Mak, J., Sunder, S., Abe, S., Igawa, K. (Eds.), Japan: Why it Works? Why It Does not? Ð Economics in Everyday Life. University of Hawaii Press, Honolulu, pp. 91±97. Katz, R., 1998. Japan: The System that Soured. Sharpe, New York. Katzner, D.W., 1999. Western economics and the economy of Japan. Journal of Post Keynesian Economics 21, 503±521. Movshuk, R., 1999. International Comparison of Productivity Levels and Consumer Preferences in Industrial Countries. Ph.D. Thesis, Osaka University, Osaka. Nakane, C., 1970. Japanese Society. University of California Press, Berkeley. Pilat, D., 1993. The sectoral productivity performance of Japan and the US, 1885±1990. Review of Income and Wealth 39, 357±375.