Japan's Industrial Policy: Objective evaluation and feedback are crucial

Faculty Fellow, RIETI

In the course of the 70-year history of the postwar Japanese economy, the government implemented various forms of industrial policy, including in particular microeconomic interventions administered by the Ministry of International Trade and Industry (MITI) and its successor, the Ministry of Economy, Trade and Industry (METI). In this article, I divide the postwar history into three phases, focusing on changes in the state of the economy and policy issues, to look back and examine what challenges and problems the Japanese economy faced in each phase and what kind of industrial policy was implemented in response.

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The figure below illustrates a Japan-U.S. comparison in real gross domestic product (GDP) per capita and total factor productivity (TFP). The slope of the lines representing real GDP per capita (in logarithm) denotes the rate of growth.

Figure: Postwar Japan's Economic Growth and Catch-Up to the United States

Figure: Postwar Japan's Economic Growth and Catch-Up to the United States
Note: Real GDP per capita is expressed in logarithm. GDP data have been converted to constant 1990 U.S. dollars using the purchasing power parity of each country's currency.
Source: Created by the author using data from Maddison Project Database and estimates in Jorgenson, Nomura and Samuels (2015).

The history of the postwar Japanese economy can be divided into three phases based on the pace of growth. The first phase, from 1945 through 1973, is the period of reconstruction and high growth. During this period, Japan's real GDP per capita grew at an average annual rate of 7.6%. Usually, the high growth period refers to the years from 1955 through 1973. However, economic growth in the preceding reconstruction period was just as high. The second phase is the period of stable growth from 1974 through 1990. During this period, real GDP per capita grew at an average annual rate of 2.9%, significantly slower than the previous phase but still fairly strong. The third phase, from 1991 through 2010, is the low growth period following the burst of Japan's economic bubble. The average annual growth rate of real GDP per capita was down to 0.8%.

In response to such changes in the real economy, relevant policymakers explored and identified various policy issues through their interactions with private-sector players such as industry organizations and businesses, whereby they developed and implemented industrial policy measures to address them.

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In the period of reconstruction and high growth, the focus of Japan's industrial policy was on rebuilding and fostering selected key industries. Shortly after the war, the government instituted a system called "priority production" designed to boost coal and steel production through a preferential allocation of resources.

This high-profile policy has a unique position in the history of Japan's postwar industrial policy. Back then, the basic framework for the Japanese economy was that of a controlled economy. As such, the priority production system was implemented by restrictive means, such as the allocation or rationing of material and financial resources by the government. With market competition limited, the priority production system achieved its goal of boosting production volume, but this came with some adverse effects such as decreased productivity and high inflation.

In 1949, with the introduction of the Dodge Line, a financial and monetary tightening policy prescribed by Joseph Dodge, the Japanese economy shifted to a market economy. While industrial policy continued to pursue the goal of rebuilding and fostering industries, policy tools changed significantly. New policy tools were developed in succession to replace various forms of controls, particularly, in the first several years after the shift.

First, government financial institutions, such as the Japan Export-Import Bank (JEXIM) and the Japan Development Bank (currently the Development Bank of Japan), were established as a tool for policy implementation. Second, the government introduced tax incentives for capital investment as per the Enterprise Rationalization Promotion Act enacted in 1952. Third, the same law established a subsidy program to help finance research and development in the private sector. Those three schemes--financing by government financial institutions, preferential tax measures, and subsidies for research and development--have been and continue to be used as key policy tools.

Apart from those cited above, Japan instituted a foreign exchange allocation system, a policy tool unique to the 1950s. All foreign currencies were brought under the control of the government and allocated to private-sector importers based on a government-dictated foreign exchange budget. MITI was responsible for preparing the portion relating to goods imports, and each company wishing to import goods subject to this foreign exchange quota scheme made an application with MITI for an allocation of foreign exchange. This system was utilized as a powerful industrial policy tool. For instance, by restricting the allocation of foreign exchange for the import of certain goods, MITI was effectively able to restrict the import volume of such goods.

During the high growth period, MITI developed and implemented a number of industrial policy measures by combining those policy tools discussed above. Leading examples include measures designed to promote the modernization of facilities for power generation and steel production, and those aimed at fostering new industries such as synthetic fiber, automobile, and petrochemical industries. Those measures implemented during the high growth period are the underlying reason why industrial policy implemented by MITI has been often defined as "targeting policy" designed to promote specific industries.

Meanwhile, MITI's industrial policy in the high growth period also included measures aimed at supporting declining industries, such as coal mining and natural fiber industries which lost competitive advantage due to rising wages. And then, from around the mid-1970s when the postwar Japanese economy entered into the second phase, measures to help declining industries with necessary adjustments, collectively referred to as "industrial adjustment policy," came to occupy a central position within Japan's industrial policy. This is because many Japanese industries--particularly those in the basic materials sector--fell into structural depression amid surging oil prices, which came on top of a significant slowdown in macroeconomic growth.

How to downsize these industries while minimizing friction was the challenge posed to the industrial adjustment policy. In order to address this challenge, the Act on Temporary Measures for the Stabilization of Specified Depressed Industries was enacted in 1978 and the Act on Temporary Measures for the Structural Improvement of Specified Industries in 1983. The laws established a mechanism under which the government set out plans for the disposition of excess facilities in industries designated by the minister of MITI as being "structurally depressed," and then supported the implementation of the plans with a set of schemes such as availing financing via government financial institutions, providing preferential tax treatment, and exempting concerted actions taken by companies in such industries from the application of the Anti-Monopoly Act.

Japan's industrial adjustment policy delivered its intended effects but came under attack from the United States amid intensifying economic friction between the two countries. The U.S. government criticized it for causing its current account deficit with Japan and a decline of its industries. Consequently, industrial adjustment policy targeted at a specific industry vanished in the latter half of the 1980s.

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The burst of the asset bubble in 1991 pushed the Japanese economy into the third phase and Japan's industrial policy again changed significantly. From the 1990s onward, a structural reform of the economy took over industrial adjustments as a key policy issue. In its initial stage, the structural reform was, at least in part, a response to criticism from the United States and designed to harmonize domestic regulations and institutions with international standards. However, as it became clear that the economic stagnation would be prolonged, it was redefined as an initiative that is crucial to building a new foundation for growth.

Beside the prolonged economic stagnation, there was another important factor that occasioned calls for a new foundation for growth in the 1990s onward.

As shown in the figure, at that time, Japan was almost on par with the United States not only in real GDP per capita but also in the level of TFP. In other words, Japan became a frontrunner in the world. This meant that Japan needed to shift from its traditional growth pattern based on the import and refinement of technologies from advanced countries, which dates back to the Meiji Period (1868-1912), to a new pattern of growth revolving around made-in-Japan technological innovations. In order to achieve this end, it was considered necessary to reform the entire structure of Japan's economic system.

Since the latter half of the 1990s onward, MITI/METI has been playing the leading role in shaping government policy on economic structural reform, which is now being taken over in the form of the government's growth strategy. Indeed, in the government's latest growth strategy unveiled in June 2015, the reform of regulatory and institutional systems, particularly those for the capital and labor markets, is emphasized as a way to promote industrial metabolism. Given the need to shift to a new growth pattern, a challenge Japan has been facing for more than 20 years, we can say that the growth strategy is pointed to the right direction,

However, there is room for improvement in the way of its implementation. Japan hitherto has failed to reflect feedback from past experience, i.e., the objective evaluation of past policy outcomes, on its new industrial policy measures. Meanwhile, in the field of economics, we have an established method for quantitatively evaluating public policy. What is important in implementing industrial policy is to verify the effectiveness of each and every policy measure by conducting a midpoint review to make necessary adjustments in the process of implementation and a final review to accumulate knowledge to be reflected in future policy.

>> Original text in Japanese

* Translated by RIETI.

July 15, 2015 Nihon Keizai Shimbun

August 27, 2015