RIETI Symposium

Asian Economic Integration - Current Status and Future Prospects -


Opening Remarks

The Flying Geese Pattern of Institutional Evolution?

AOKI Masahiko, RIETI and Stanford University

We now open the first ANEPR round-table conference. The topic of the conference this year is "Asian economic integration". Representing the host institution of the conference, I would like to extend a warm welcome and sincere gratitude to those participants who have accepted our invitation to the conference and traveled from abroad to exchange their views on the subject with the fellows of our institution. Having read the draft papers prepared by all the participants, I feel that this conference is already promised to produce fruitful discussions and a deeper understanding about the subject matter, which is undoubtedly becoming one of the most important and exciting agendas of economic policy today in East Asian and beyond.

RIETI anticipated from the time of its inception the growing importance of dialogues among researchers, as well as policy makers, in East Asia and beyond. It is beneficial for them all to gain a better understanding of the evolving state of the Asian economy and explore policy options of mutual interests that may lead to stable and efficient economic cooperation, integration, as well as competition. ANEPR (Asian Networking of Economic Policy Research) was envisioned to promote and sustain such dialogues and an experimental round table conference was held in January of last year prior to the foundation of RIETI. Today's round table conference will be the first of formal round table conferences to be held for many years to come.

If we take Japan, NIES, China and ASEAN countries together, their aggregate GDPs roughly equals to that of the U.S. Thus these economies potentially constitute a large economic zone, but they are lagging behind Europe and North America in terms of formal economic and political arrangements for market integration. As many papers to be presented in this conference, particularly those in the second session, show, however, they are becoming more and more tightly connected in terms of trade flow and FDI, with the rapid economic growth of China as one of important driving forces. As a result, de facto market integration is emerging. These economies will also interact with each other more closely in terms of

  • mobility and contacts of the people across borders (tourists, students and researchers, entrepreneurs and engineers)
  • competition and strategic alliances in the development of transportation and communications infrastructure
  • environmental spill over
  • technological transfer and knowledge dissipation.

An important question to be discussed in this conference will be: Are East Asian economies competing for the same market? Or, are they complementary in terms of resource endowment and division of labor? Last summer, the Japanese media was caught by surprise by the reality of industrial development of China and regarded it as a "threat" to Japanese dominance in the manufacturing industry. However, it seems that public opinion is beginning to move towards a more balanced view. A recent speech by Prime Minister Koizumi at the BOAO Asian Forum in Hainan Island noted: China is not a threat to Japan, but the stable growth of China will benefit neighboring economies. The economic law of comparative advantage dictates that it is inevitable for labor intensive production basis to move from Japan to China, while it is becoming imperative for Japan to explore into higher-end products to remain competitive.

Although trade across East Asian economies is growing in intricate patterns, further market integration may require the presence of effective infrastructures of market governance. As corporate organization needs an effective corporate governance structure in order to control the moral hazard of management, the domain of potential trade opportunities requires an effective governance structure in order to enforce contracts and remove artificial obstacles for trade. Also, just as there is a variety of corporate governance structures, there can be a variety of market governance mechanisms. The contract enforcement and protection of property rights by the rule of law by a third party (the court) is one such mechanism. The rule-setting and panel procedure of dispute settlement mechanism of the WTO may be viewed as an extension of this mechanism from the domain of the nation state to the arena of international trade. However, WTO rules are yet largely incomplete, allowing for various interpretations and discretionary specifications by individual countries. Just as the mechanism of trust and reputation plays a complementary role in enforcing contracts not only in the process of market development but even in advanced market economies, bilateral and/or multilateral trade agreements between nation states may also play an important role of expanding trade opportunities, enforcing contracts and protecting property rights across national economies. From this perspective, formal regional economic integration ought to be considered not as detrimental to efficient market integration on global scale but as a complementary step toward it.

Some concerns have been voiced that Japan's prolonged stagnation may constitute an unfortunate obstruction for market integration in East Asia, depriving it of exercising political and entrepreneurial initiatives toward integration and rendering the country susceptible to protectionism. My own view about relationship between the Japanese stagnation and Asian economic integration is different from this. Japan's problem has not been caused just by a mistake in macro-economic policy. Rather it may be regarded as a symptom of the significant institutional transition that Japan has entered in an age of closer international interactions. Unfortunately this process has been slow to evolve, too slow for my taste. I would argue, however, that significant changes are beginning to take place. Institutional change in Japan, if it moves in right direction, will facilitate the development of stable and efficient economic integration in the East Asia region. Conversely on-going, spontaneous market integration in the region will induce Japan to pursue its institutional evolutionary trajectory toward a more open system.

I regard institutions as more than laws, regulations, and/or organizations. If they were merely so, institutional change may be brought about only by political will or conscious organizational design by experts and elites. Those who criticize the slowness of Japanese institutional change seem to subscribe to this view. I do not deny the importance of political leadership and rational organizational design in the evolution of social change. However, law, regulation and organizational design sometimes generate unintended social outcomes when millions of economic agents strategically react to them and choose their own actions. Adam Smith wrote: "In the great chessboard of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder." (Moral Sentiment)

I conceptualize institutions as "shared beliefs among economic agents about how the game is actually being played". The reason why these beliefs become shared and sustainable among people, so that implied rules of the game become self-enforcing, is that they reflect an equilibrium pattern of strategic behavior by all the agents including the government. An agent cannot benefit from deviating from the rules when others do not. Indeed, the main bank system and life-time employment in Japan may be considered institutions par excellence, but at least initially they were not defined either by law or contract. They emerged spontaneously, became prevailing practices, and constituted beliefs of people about how the game was being played. Further, because of interdependencies of (subjectively) best strategies chosen by people across economic, political, organizational and social domains, there can be many different equilibria. In jargon, institutional complementarities allow for a diversity of institutional arrangements to evolve. There is no reason whatsoever that there is only one institutional arrangement that is viable and optimal under any condition.

This conceptualization of institutions, which I explored in my recent book in detail, hopefully helps us understand the complex nature of institutional change (Aoki, Toward a Comparative Institutional Analysis, MIT Press, 2001). The process of institutional change may be triggered by the wide-spread loss of confidence among people in the existing rules of the game. Such collective-cognitive crisis may occur in response to large scale external shocks (such as a currency crisis), accumulation of internal conflicts and inconsistencies, or possibly a combination of both. However, it would not be straightforward for a new institutional arrangement to evolve from a crisis. Law and regulations may be redefined in response to crisis. New ways of doing things in the private domain of organizations and markets may be experimented with and evolutionarily selected. Competing ideas about the desirable direction of change may be expressed and debated in public discourse. Political leadership matters. Only through the intricate interactions of these and other factors a certain direction of change from a possible many may become a focal point. A new institutional arrangement will emerge only when people's expectations converge about the new ways of playing the game, regardless of whether or not each of them individually approves of it ideologically or benefits from it.

From this perspective, East Asia may be considered to be currently in the process of great institutional transformation as a whole. Institutional change in one national economy has greater impacts on the processes of institutional changes in other economies in the region through increasing market transactions and FDI, as well as more frequent political, academic and private communications and contacts across national borders. However, this does not necessarily imply that the processes of institutional changes in Asian countries will immediately converge to a single mode through economic and political integration. But at the same time there may be a certain generic pattern of institutional evolution in the region, which may be hypothetically traced to a common (agrarian) heritage.

There have been frequent references to the so-called "flying geese pattern" to capture a characteristic of the East Asian economic development process in academic as well as popular writings. Indeed some papers to be presented in this conference are engaged in the current debate concerning whether or not the "flying geese patter" has finally begun to crumble because of the rise of industrial China and the hollowing out of Japan's industrial basis. The original idea of the "flying geese" pattern due to the late Professor Akamatsu, as well as the current debate about it, is concerned with a cross-national pattern of industrial structural development. However, an analogous idea may be applied to cross-national pattern of institutional evolution.

Let us hypothetically and tentatively imagine the following three schematic stages of industrial development and corresponding institutional evolution.

The First Stage : Resources and surpluses are transferred from the agricultural sector for industrial development by the mediation of the government. The government selectively finances or aides particular industrial groups (industrialists). The collusive structure of the monolithic government and elite industrial groups at the expense of the rural sector may be referred to as the "developmental state." The efficiency of this state depends on the credible commitment of the government to performance-contingent subsidies (cf. Aoki, ibid., chapter 6). In the industrial sector an authoritarian organizational architecture may ensue, homeomorphic to that of the government.

The Second Stage : As industrial development successfully proceeds, a portion of its fruit is transferred as compensations to the less productive and disadvantageous sectors to achieve social stability. This state may be characterized as a sort of economic-pluralism mediated by the government. In the industrial sector worker-inclusive insider control may evolve. The efficiency of the industrial firm may then depend on the credible mechanism of outside intervention in the insider control in the event of its poor performance (the "contingent governance": cf. Aoki, ibid., chapter 11).

The Third Stage : The government-mediated pluralism becomes eventually unsustainable as the industrial basis for cross-subsidizing the less productive sector starts to erode due to the follower's catching up in industrial capability. The phasing-out of the less productive sectors and practices becomes imperative. Conflicts arising out of such structural change may be reflected as pluralistic competition among parties in the polity.

The above developmental patterning is highly hypothetical and tentative and requires empirical testing. The three stages may not be clearly distinguishable from each other in practice. They may intermesh with each other in intricate and idiosyncratic ways in each economy. However, it might provide a preliminary conceptual framework for capturing certain important aspects of industrial cum institutional development patterns among East Asian economies. For example, the recent emphasis for rural redevelopment in China, as well as the admission of private entrepreneurs to the ruling, may be indicative of the transition of the first to the second stage. In other words, the Chinese state may be becoming more as a machinery for pluralist interest-mediation, although it is very different from the Western model of liberal democracy.

Korea had distinctive features of the first stage developmental state under the Park regime. Afterwards, Korea's political regime gradually transited to gradually incorporate pluralistic elements of the second stage. Yet corporate organizational structure failed to adapt to the new stage and, as the balance of bargaining power became less in favor of the government, the elite business groups became more and more free from outside discipline. This lack of effective governance may be considered largely responsible for the cause and magnitude of the currency crisis in 1997. The crisis triggered the transition of Korea from the second to the third stage, although the end outcome is not yet predictable. But an interesting hypothesis can be that the very fragility or inconsistency of the second stage regime may have facilitated a more decisive (big-bang) search for a third stage institutional solution to the crisis.

It is hard to pinpoint the period of the transition from the first to the second stage for Japan. However, a refined administered pluralism was formed in the aftermath of the environmental and associated political crisis in the late 1960s. I have characterized this political-economy institution as "bureau-pluralism" and/or "compartmentalized pluralism" (shikirareta tagennsyugi) and analyzed its nature and implications in various places. Referring to the incompatibility of the protection of low productive sectors and sustenance of competitiveness of high productive sector under the emergent international environment as "the dilemma of bureau-pluralism," I stated in a writing of 1988 as follows:

[I]t is likely that the dilemma of bureau-pluralism will persist for some time to come. It might be that the LDP-bureaucracy alliance will retain its role as quasi agent of benefit recipients, backward groups, and those in a declining economic sector, while limiting itself gradually to a laissez-faire policy-making role in the jurisdiction where private entrepreneurial initiatives are active. Ultimately, however, such a move would not resolve the dilemma. Whether the tension created by the dilemma will give rise to stagnant, inactive conservatism that could pose a threat to efficiency, fairness, political stability, and international harmony, or whether the Japanese polity will continue maneuvering to meet political exigencies with its renowned flexibility and eventually arrive at some kind of solution that is consistent and harmonious with pluralism and the future international environment remains to be seen." (Information, Incentives and Bargaining in the Japanese Economy, Cambridge University Press, 1988. P.297)

Unfortunately it seems that a social solution to the dilemma has not been found yet, aggravating the problems I predicted. In contrast to Korea, the very fine, tightly knit institutional structure of Japan crafted in the second stage may make a transition to the third stage more inertial and gradual.

Thus, the goose flying at the apex of the group seems to be unsure about the direction in which it should fly to. It may be inevitable, however, for nobody has been able to draw a clear map toward the third stage yet. Notwithstanding, in the course of trial and error, the field of vision may become clearer. There seem to be symptoms. For example,

In polity : localized public-policy making via the compartmentalized, triangular collusion between the private interest group (association), the relevant administrative bureau, and associated politicians in a particular sector generates external diseconomies in other sectors more and more frequently under the increasing openness of markets. This undermines the political basis of bureau-pluralism. For example, the formal implementation of safety guard measures against the rising imports of Chinese farming products was not materialized last year despite the strong lobbying of the affected farmers and associated politicians. These measures would have had adversarial external impacts on the manufacturing sector, due to possible Chinese retaliation. The issue was settled through bilateral negotiation between the two countries. If both countries can develop the practice of rational negotiation in the general framework of the WTO framework, it may foster stable market integration.

In the domain of organizational architecture : Because of the development of ICT, the value of exclusive information processing and sharing within large scale organizations is declining (e.g., the Mizuho system debacle). Modular organizations can process information faster and be more flexible in generating systemic-innovation are efficient supply chains by connecting themselves to other organizations of similar type. Established firms in Japan tend to be slow in adapting their organizational practices in response to new market and technological environments (because many of them are entrapped by the myth of past success). But there are also a number of firms, old and new, which are making their organizational architecture more flexible and modular by utilizing the international division of labor.

In markets : Upcoming break-through university reform will facilitate not only a smoother transfer of knowledge from the university to industry, but also the mobility of the people between the two with the possible emergence of new intermediaries (e.g., TLO, venture capital, various professional services). This will contribute to the erosion of the norm of life-time employment in general. Increased labor mobility will mitigate the value of the industrial associations evolved to protect incumbent interests and thus that of bureau-pluralism. Finally foreign entry to Japanese markets and organizational domains will be better facilitated.

Norms : The norm of organizational loyalty is eroding among younger cohorts. New professional norms (e.g., norms among netizens, volunteer activities) are evolving. As norms of this type can be shared in principle across national borders, this emergent phenomena may also contribute to cross border integration and vice versa. The phenomena of the sharing of pop culture among the Asian youth may be regarded as a symptom of this.

These phenomena are not yet overwhelming so as to generate new institutional arrangements in Japan. However, it is indicative of the nature of systemic complementarities that may exist between institutional change in Japan, on one hand, and Asian integration, on the other. I would suspect that similar, yet unique complementarities can be observed in other Asian economies. I am very much looking forward to learning about these possibilities in this conference. One thing I am sure of is that it is impossible for us to understand the nature of institutional change and formulate effective national public policy without taking into account the evolving state of neighboring countries and mutual interactions of markets and other institutional mechanisms. This situation is decisively different from that existing prior to the currency crisis, which took place only five years ago.