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Foreign Affairs
Japan's Economy, at War With Itself
By William H. Overholt
William H. Overholt is a Fellow at Harvard University's Asia Center. He has served as Chief Economist and Asia Strategist for three major investment banks based in Hong Kong and Singapore and is the author of The Rise of China.
On the Brink
A major historical era is ending in Japan. Institutions that created the country's economic miracle a generation ago have now brought Japan to the verge of an economic debacle. And the changes needed to resolve that crisis will broadly affect the nation's economy, finances, politics, foreign policy, and family life.
The roots of the current malaise extend back to the years between 1937 and 1945, when most of the economic structures that still dominate Japan today were created. This "1940 system" was developed as a rational way to put Japan's economy on a wartime footing, and it served that purpose well. It also proved useful after the war; the 1940 system functioned brilliantly for many years after Japan's surrender, helping the country rebuild and leading to years of spectacular growth.
The same features that once did so much good for Japan, however, have now brought the nation to the brink of collapse. Thus the question today is no longer whether the country will reform its economy and finally abandon its wartime footing; Tokyo no longer has any choice. The question, rather, is how Japan will manage such a radical change, for the 1940 system has grown deeply entrenched in all aspects of Japanese society.
Guns and Butter
Wartime mobilization created many of the practices now regarded as distinctively Japanese and wove them into the 1940 system. As one authoritative study of the country describes: Before the war it was common for employees to move from one enterprise to another, most industrial funding was secured through issues of stocks and bonds, and shareholders were granted high status in corporate governance. Frequent bankruptcies brought down businesses of all types, including banks, and the government introduced no economic planning or detailed regulations.
Such a chaotic system was, unsurprisingly, ill suited to the extreme demands of war. The solution was the creation of a new, highly centralized economy partly modeled on aspects of Hitler's Germany and Stalin's Soviet Union. Among the changes introduced by the Japanese government were lifetime employment, seniority pay, company unions, firms that gave priority to employees over shareholders, government policies that put banks before capital markets, and the institutionalization of policy coordination between government and corporations.
All of these changes made sense as Japan ramped up for war. The new system squeezed individual consumption to a minimum, channeled savings into the government and thence into favored industries, allowed banks to focus their lending on affiliated companies, coordinated business and government planning, and gave bureaucrats vast financial and economic power with limited political accountability. It also reduced shareholders' rights in favor of the interests of banks and employees, made it harder for workers to leave big companies, and encouraged domestic cartels and international protectionism to safeguard Japan's most important industries.
The general principles behind these arrangements, in fact, were not very different from the ideas behind the centralization of the U.S. economy during the war. The difference is that the Japanese measures went much further and lasted a lot longer — until today, in fact. Soon after . . .