Pitfalls and Adhesions in Japan's Approach to Structural Reform

Consulting Fellow, RIETI

Recently, I had the opportunity to dine with a rather interesting group of people. It comprised two Diet members, two former executives of large organizations turned frontline entrepreneurs in the financial sector, two young CEOs of IT companies, and one director of an influential economic agency. Most salient about the group was that the businessmen in it were all elites-that is, of class that might be called "lords of their domains." Normally, I would hesitate to introduce such a conversation in this column. I dare to do so, however, because the discussion that transpired was quite insightful in understanding how Japan's leading businessmen, politicians and bureaucrats view the future of "Japan's structural reform." Though theoretical and ethical issues surrounding Japan's bad loan and financial problems were also discussed, I will not concentrate on them here, as they have already been addressed in this column by other RIETI research fellows.

Rather, what I wish to write about is the issue over which the group voiced its greatest apprehension: The effectiveness of Japan's various efforts and policies amidst a climate of rapid change. It is the very structure of the existing Japanese system itself that may slow down the pace of reform. As a consequence, the policies it generates are causing convulsions in the financial and capital markets, which adjust much quicker to change than does the real economy. What struck me most about the conversation was the strong sense of anxiety expressed by the businessmen, who were people that had taken a personal risk to leave large organizations to take their places on the frontlines of the financial sector, about the lack of readiness on the part of existing companies and organizations to adopt reforms.

An article written by RIETI president Masahiko Aoki was recently carried in a column of the evening edition of a nationwide newspaper. Its gist was that systems do not exist by themselves-the inertia that either allows or spawns them exists within society. I became painfully aware of this fact when I myself left a large organization, the bureaucracy, to work at a small one.

In my field of information technology, some Japanese say "In America, venture companies led the IT revolution, but the real revolution in Japan will occur when IT starts to cause changes in large companies." Though there is no logical basis for this assertion, many people are persuaded by it. Why? Despite repeated calls for innovation and reform, there is much to lead one to believe that the Japanese will continue to place their faith in existing structures and authorities. For example, let's look again at IT, which is more radically in a state of flux than other fields. I have prepared the following table to compare the transition which has taken place in American companies that have led each related field over a period of 20 years. As can be seen, most of those that were at their apex of success 20 years ago have disappeared from the chart, while a group of new companies has emerged in their place. (Those printed in blue are companies that didn't exist 20 years ago.)

Computers (hard- and software) IBM, HP, DEC, Cray, Spree, Amdar IBM, HP, Dell, Compaq, Gateway, Microsoft, Oracle, Sun Microsystems
Telecommunication Equipment Western Electric, Motorola Cisco Systems, Nortel
Telecommunications and Network Services AT&T MCI-Worldcom, Qwest, AOL, YAHOO
Semiconductors TI, Fairchild, Motorola, Intel Intel, AMD, Solectron

Now, just image what the table would look like if it were of Japanese companies in the same fields over the past 20 years: The left and right-hand columns would be virtually the same. What may we ask then is the reason for this lack of change in Japan?

In discussing reform in Japan, the following view is often voiced: "If the government doesn't listen more to the private sector, it will not be able to get a handle on the economy. Economic policy decisions should not be made by bureaucrats but are better left to experts in the private sector." But just how accurate is this postulation? An interesting discussion evolved at a session on the debate over the Japanese economy in a conference I recently attended at Harvard Business School. Someone posed the question, "Isn't the reason that Japan is slow in responding to change in fact due to the government's listening too much to private sector voices?" To explore this notion further, assume that the American government established its policy for promoting the IT industry some 20 years ago listening to opinions from the private business sector. The companies that came to the fore at that time must have been those listed in the left-hand column of the above table, since most of those in the right-hand column had either not yet been born or were just infants. It's safe to say that those leading companies on the left did not propose policies to the government that would facilitate technological breakthroughs by newcomers. Doing so would be to cut short their own heyday.

In the case of Japan, however, virtually all the government's advisory and strategy councils are replete with "successful people," that is, people who are successful now (not those who will be in the future) and who have a position to protect. It is precisely such people who have led the discussion on structural reform in Japan. Frankly, policies crafted by the government based on the inputs of these people serves no other purpose than to solidify their empowerment. Even worse, such a process of policy formulation can even be harmful. Under the existing system, giving such people power in the policymaking process means that the same principles that worked in Japan's period of rapid growth will continue to be applied in the current period of radical transition. Heeding these established authorities, however, causes policy diversions to protective positions, slowing down the pace of change. This can be seen in Japan's financial policies formed on the inputs of big banks and security firms, its telecommunication policies based on wisdom sought from large telephone operators, and its energy policies derived from the views of energy companies and public utilities with markets protected by regulation. Such examples speak emphatically to why Japan has difficulty in adjusting to changes in the economic environment and is relegated to playing catch-up in each succeeding era.

As these examples show, the placing of trust in vested authorities is under the current system much more extensive than typically imagined, as is the adhesion between them and policymakers. However, as shifts in financial and capital markets occur swiftly, it is not certain whether those markets can be sustained until changes occur in the real economy. How to quickly overcome this structure of adhesion is what most perplexed the members of the conversation I mentioned, and is I believe the greatest challenge facing Japan's economy today.

September 25, 2001

September 25, 2001

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