Market Quality Laws and Economics: Sound development and growth of the economy by raising market quality

Faculty Fellow, RIETI

Why does innovation not lead to prosperity in Japan?

Throughout history, innovations have appeared, revolutionized the world's economic and social activities and made our lives more prosperous. The development and spread in the 20th century of automobiles, computers, the Internet, etc.—examples of such innovations are too numerous to count here.

In recent years, innovation efforts in Japan appear to be robust. For example, Japan ranked fifth in the World Economic Forum's innovation ranking (2015-2016). Moreover, in the ranking of Nobel laureates by country (2016), Japan came in fifth in the natural sciences field, following the U.S., UK, Germany and France. While some have pointed out the recent decline in Japan's international presence in such specific areas as innovation capabilities and business-academia collaboration (White Paper on International Economy and Trade 2017, page 223), it is safe to say that Japan has been playing a crucial part in the world's innovation.

On the other hand, what about prosperity? In terms of the levels of per capita GDP, Japan has continued to lag behind the U.S. and the industrialized countries of Europe. In various surveys measuring happiness, including the World Values Survey, Japan's happiness index has been low across the board in comparison to other industrialized countries. These phenomena strongly point to the fact that many Japanese people are not fully experiencing prosperity.

Why is it that innovation in modern Japan has not sufficiently led to prosperity?

The answer lies in the poor quality of the market.

According to the theory of market quality (Yano 2005, Yano and Nakazawa 2015), the main reason why innovation does not lead to prosperity may be attributed to "poor market quality." Just as there are high and low quality products, there are markets with different levels of quality. This concept is at the core of the theory of market quality. With this understanding, what kind of market is considered to be a high-quality market?

To answer this question, let us first of all imagine a low-quality market. Markets dominated by coercive selling or fraudulent practices may, no doubt, be characterized as markets of low quality. Furthermore, markets with low-quality products and poor variety; and markets with an excessive mix of inferior and superior quality products can also be described as low-quality markets. Therefore, if we define a market that does not have these unhealthy elements as a high-quality market, the answer to the above question becomes clearer.

A good market is "one where you can trade better products at a more appropriate prices and to which better products are constantly introduced." (Yano 2005)

Additionally, in order to continue enjoying good products and services at appropriate prices, it is essential that the quality of the market is improved. Consequently, the next thing that we need to consider is the method by which we can improve the quality of the market.

Market infrastructures that support market functions and raising market quality

One of the fundamental propositions of the theory of market quality is that "appropriate coordination of market infrastructure is indispensable for a high-quality market" (Yano 2009). The term market infrastructure referred to here is a composite concept that includes various factors surrounding the activities of market participants such as legal systems, culture, local customs and values. From the standpoint of the theory of market quality, the problems facing the Japanese economy can be expressed as follows.

How should the various market infrastructures including legal systems, culture, local customs and values be coordinated to create a high-quality market? Will it then be possible to realize the sound development and growth of the Japanese economy?

Centered on this theme, in March 2018, a research group led by the author embarked on a new project, "Evidence-based Policy Study on the Law and Economics of Market Quality."

New laws and economics based on the roundabout approach

In order to achieve a given goal, formulating strategies that directly approach the goal is not always the best method. If you want to catch fish, it is preferable that you make a net first rather than jumping into the ocean. If you collect wood, build a ship and cast a large net, it would be even better. This is the example, which Wilhelm Roscher, the 19th century economist of the historical school, set forth to illustrate the roundabout approach to production.

The theory of market quality is strongly rooted in the roundabout approach. To achieve the goal of raising market quality, rather than limiting the approach directly to a product's quality, price and production volume through standalone political measures such as granting subsidies, the theory aims to explore basic remedies and fundamental solution methods to the problem. In other words, the major goal of the theory of market quality is, through observation of the entire network of market infrastructures—including culture, local customs and values, as well as legal systems, policies and rules—to consider the desirable coordination of such elements and to design an economic system that will raise market quality. This type of approach, in a broader sense, may be said to be an extension of one of the major trends in 20th century social sciences that have succeeded in refining the roundabout approach, such as the legislation theory in the study of law, governance in political science and the study of business administration and mechanisms and design in economics.

Nevertheless, even if we were to enact roundabout processes rather than taking the direct approach, it would be meaningless to simply proceed blindly in a roundabout way. Unless they are based on sufficient evidence and refined theories, it would be difficult to pursue appropriate roundabout strategies. Having become aware of such problems, our project set out to theoretically clarify the mechanisms required to raise market quality, and at the same time, to validate our theory based on the evidence that we have collected. To this end, it will be necessary to accurately measure and quantify market quality based on data and to understand the causal relationship between market infrastructures such as legal systems and economic phenomena.

Currently, the project, being undertaken with the cooperation of Japanese and overseas researchers, is focusing on market infrastructures, which had not been fully analyzed in the past, including the relationship of trust in society, elements of life science (e.g. genome information and medicine), culture, trading systems and information systems; and building theories, as well as accumulating evidence. Once we have findings based on a sufficient amount of data, we hope to take the further step of proposing the design of desirable legal systems which will enable sound development and growth by raising market quality. By doing so, we hope to eventually explore the possibilities for a new field of law and economics that would be called the laws and economics of market quality, which would strictly be based on the roundabout approach.

Understanding the national character of "desiring novelty" as market infrastructure

Finally, in concluding this column, I would like to present one of the various research themes of this project, which is being led by the author.

The more the people "desire novelty"—that is, the stronger the trait for people to prefer new ideas and products—the greater the number of innovations that will be created in a society. This is generally accepted as true. There are people who think that given that innovation is the source of economic growth, this trait of preferring new things—the so-called "novelty-seeking traits"—is central to economic growth and development.

However, results of recent empirical studies have shown that, contrary to this accepted truth, people's novelty-seeking traits do not necessarily impact economic growth in a positive way. According to the project's first paper, the Discussion Paper titled Novelty-Seeking Traits and Innovation (Furukawa, Lai and Sato, 2018), the national character of "desiring novelty" could have the opposite effect of restricting innovation in the economy as a whole. In his article (Gören, 2017) published in the Journal of Development Economics, the foremost periodical on development economics, Erkan Gören pointed out that excessive novelty-seeking traits could have the effect of inhibiting economic growth.

The national character of "desiring novelty" may not necessarily have a positive effect on innovation and economic development. These results point to the fact that when deliberating policies and systems, the culture and national character represented by the novelty-seeking trait should be taken into account as significant market infrastructure. This also suggests that

even if policy and institutional designs which have successfully survived in foreign countries with different cultures and national characteristics are exactly adopted in Japan, they would not function properly.

"Novelty-seeking" and "non-novelty-seeking" societies must coordinate their market infrastructures differently and thus must have different designs for desirable legal systems and economic policies that can raise market quality. This perspective is unique to the project and the author believes that such a perspective will provide a new point for discussion on innovation policies.

Looking towards the future

The concept of market quality, upheld by Yano (2005) and others, is a relatively new concept in economics. Although a number of dissertations have been written that form the core of this concept, research is still in the development phase and in terms of the role of market infrastructure, many issues remain to be clarified. Going forward, the project will clarify the role played by each piece of market infrastructure in the quality of the market. We plan to comprehensively consider the evidence obtained from this research and to clarify the design of the market infrastructure such as laws, policies and systems that will enable sound development and growth. Through this process, we hope to ultimately explore the possibility of developing a new legal and economics discipline based on the theory of market quality.

I would like to thank Takaji Suzuki (Professor, Chukyo University School of Economics) and Makoto Yano (President, Research Institute of Economy, Trade and Industry) for their invaluable comments received in writing this column.

November 7, 2018
  • Ministry of Economy, Trade and Industry, White Paper on International Economy and Trade 2017
    (Link to paragraph 3 of Section 2:
  • Yano, Makoto, 2005, System Reforms in the Age of Quality: What Are Good Markets? Iwanami Shoten
  • Yano, Makoto and Nakazawa, Masahiko, 2015, Why Does Science Not Lead to Prosperity? Keio University Press
  • Yano, Makoto and Furukawa, Yuichi, Theory of Market Quality, published in Introduction of 2016, Market Quality and Modern Economics, ed. by Yano, Makoto and Furukawa Yuichi, Keiso Shobo
  • Furukawa, Yuichi & Lai, Tat-kei & Sato, Kenji, 2018. "Novelty-Seeking Traits and Innovation," RIETI Discussion Paper Series 18-E-073, October 2018.
  • Gören, Erkan, 2017. "The persistent effects of novelty-seeking traits on comparative economic development," Journal of Development Economics, 126: 112-126.
  • Yano, Makoto, 2009. "The foundation of market quality economics," Japanese Economic Review 60, 1-32.

December 11, 2018