New Developments in Economic Policy: Complementarity between Government and the Market Place

In this paper, the economic structural reforms currently being implemented by the Japanese government, along with the economic policies that are needed to make the Japanese economy dynamic and vigorous in the 21st century, are discussed from the basic viewpoint of comparative institutional analysis, with an emphasis on institutions and social and economic system. This paper also outlines the basic relationship between markets, private-sector institutions and governments, and asserts that the expansion of market functions is now an extremely important role of the Japanese government.

The market is inherently capable of achieving dynamic efficiency in resource allocation through innovation when it is complemented with private-sector coordination and with the institutions that result from the spread and firm establishment of this coordination. However, the market's performance is also greatly influenced by private-sector institutions, which are at various degrees of development in each nation. According to comparative institutional analysis, an institution possesses historical path dependence as a system, and so evolves within the context of a nation's economic and social environment and occasionally, when institutional complementarity exists, achieves stability as a firmly established economic and social system that determines that country's comparative advantage. However, when the surrounding environment changes or a higher stage of development is achieved, institutions that had previously promoted proper performance can cease to function and in some cases actually hinder economic activity. The major environmental changes affecting Japan - namely, globalization, informatization, declining birth rates combined with the aging of society, and Japan's emergence as a front-runner in international society - are indeed changes that demand institutional reform.

Amid such circumstances, the Japanese government is being called on to play the role of facilitating the private-sector coordination intended to bring out the market's inherent dynamic resource allocation functions, which are achieved through the integrated action of the market and private-sector institutions. In short, these are "market enhancing" policies. Market enhancing policies must enhance the abilities of private-sector coordination efforts and institutions to generate incentives for market agents, reduce moral hazards, and correct the asymmetry of information, and must also promote the establishment of intermediaries capable of assuming this role. With respect to Japan's current circumstances, it is essential to reinvigorate innovation, to overcome the inertia that arises from institutional complementarity, and to secure a diverse range of options that permit economically driven challenges.

From this basic point of view, the second half of this paper discusses the direction that is preferable for the individual policies Japan is currently promoting: introduction of the pure holding company system, reevaluation of corporate governance, making proper conditions to encourage the creation of new industries, tax system reforms, reevaluation of employment systems, university reforms, designing a proper intellectual property rights, environmental policies, introducing market functions into government activities, and improving the social safety net, among others. The formulating of a package of such policies from a market enhancing view is seen as contributing to evolution that culminates in a new Japanese economic and social system.

It is also imperative to expand those policies - which the authors term type 2 market enhancing policy - in which the market complements government action through the introduction of market functions and private-sector coordination functions in fields where government involvement will continue, such as regulation and the providing of public goods. Establishing a trial period for government measures prior to full implementation and establishing an effective system of checks and balances in the government are also important issues in view of the need to address growing uncertainty about the future by reducing the possibility of government failure.