$Unique_ID{bob00333} $Pretitle{} $Title{Japan Chapter 4A. Character and Structure of the Economy} $Subtitle{} $Author{Stephan B. Wickman} $Affiliation{HQ, Department of the Army} $Subject{percent government economic economy growth industrial nation's public japan corporations} $Date{1981} $Log{} Title: Japan Book: Japan, A Country Study Author: Stephan B. Wickman Affiliation: HQ, Department of the Army Date: 1981 Chapter 4A. Character and Structure of the Economy Japan's gross national product has been the world's third largest since 1963 (after the United States and the Soviet Union), although in per capita terms-the equivalent of US$8,900 in 1980-the economy has ranked lower than most other industrial market economies. This was no mean achievement for a densely populated nation that depended on imports for the bulk of its raw material needs and for an economy that was critically disrupted by World War II. Because economic growth rates often in excess of 10 percent per year were attained in the postwar period, the gap between Japan and the other major industrial economies was closed in remarkably short time. The reasons for this success were numerous and complex. A latecomer to the Industrial Revolution that began to transform Europe and the United States in the eighteenth and early nineteenth centuries, Japan nonetheless sustained a seventy-year period of increasingly modern economic development before World War II. This experience contrasted sharply with those of its Asian neighbors. Many of the conditions favorable to growth persisted, despite the destruction of the war, including the abundant and literate labor force, productive agriculture, strong government support for industrial investment, efficient and large-scale enterprises, and the willingness to import foreign technologies. Following an initial period of reliance on United States aid to feed the war-ravaged populace, the economy was able to generate ample domestic savings to support a high level of constructive investment. Most of these savings were channeled into manufacturing and the infrastructure to support it, and under government guidance and private initiative these industrial projects flourished. Other institutional factors have played an important role in determining the performance of the economy. Many large corporate groupings and individual enterprises have vied against each other in highly competitive markets. The multifarious small and medium-sized corporations, though plagued by bankruptcy during business recessions, responded rapidly to the needs of the larger enterprises and to consumer demand, and they lent flexibility to the economic system. The government also aided the economy by promoting cartels or mergers, providing research funds and credit facilities, and by protecting enterprises from foreign competition when deemed necessary. Corporate management practices provided strong incentives for efficient production, while the nation's labor unions generally cooperated with management to keep wages in line with productivity. Most Japanese industries have been able to pass quickly through a stage of dependency on imported technologies and government protection to a position of strong international competitiveness. Licensing agreements for foreign technologies continued to be important in the 1980s, but innovation, particularly in the application of scientific breakthroughs to new products, has distinguished the nation's industry. As a result Japanese products have become less labor intensive and more capital or technology intensive. In turn the nation's exports have produced enough revenue to pay for the raw materials and primary energy so desperately needed to support the national welfare. As Japan improved its own capacity for basic scientific research and development, it could be expected to achieve an enduring technological advantage in many industries. In the past, however, the nation's achievements in basic scientific research have been behind those of the United States and Europe. Some Japanese industrialists still express the fear that the nation could not only be left behind, but isolated from scientific research and technological patents developed elsewhere. The efficient and highly productive manufacturing sector remained the heart of the economy in 1981. Innovations in manufactured products stimulated development in other sectors. The creation of new generations of office equipment and computers, for example, greatly expanded the production potential of many service industries. Services were generally labor intensive and generated more than half the nation's employment and income. Service enterprises also stimulated demand for manufactures and supported factory management and operations. Agriculture, forestry, and fishing production, despite government subsidies, continued to decline relative to other sectors but remained important for political as well as economic reasons. Among the several issues that posed actual or potential problems for the economy in 1981, the first was how to secure the needed energy to support production. Japan was almost completely dependent on imported energy, and in addition to searching for stable suppliers, industry launched a concerted effort to conserve oil and to develop alternate forms of energy. A second problem was that of adjusting business strategies to slowing rates of economic growth. After the international oil crisis of 1973, the economy grew at less than half the pace of the 1960s. Some industries developed excess capacity and suffered from rising costs and foreign competition. Problems were also arising because of the chronic trade surpluses that the economy had registered with some of its most powerful trading partners since the late 1960s. The prospect of trade barriers to Japanese exports was all the more threatening in 1981 since much of the economy's growth in that year seemed to depend on export expansion. The most complicated issues, however, were distributional-who was to receive the benefits (or losses) from economic growth? Some groups, particularly labor and management from the largest corporations, benefited most directly from the economic system. Others, including consumers, part-time and nonunionized laborers, women, and small-scale businessmen profited only indirectly and irregularly. In the 1970s and early 1980s the government had become more involved in the provision of public welfare than in the past. Social security, employee and health insurance, housing, transportation, and pollution control were common areas of focus. The administration of Prime Minister Suzuki Zenko, however, was committed to the reduction of the massive and mushrooming national debt, and the scope of government programs in the future was not liable to increase. In such an environment most families and individuals would be left to their own resources to adjust to economic conditions. Patterns of Development Rapid growth and structural change have characterized Japan's economic development since the Meiji Restoration (1868), the point most historians regard as the beginning of the nation's modernization. At first the economy grew only moderately and relied heavily on the traditional agriculture sector to generate the savings to finance investment in a modern industrial infrastructure. But after the trough year of 1904, when 65 percent of employment and 38 percent of the gross domestic product (GDP-see Glossary) remained in the agricultural sector, modern industry began to expand substantially. By the late 1920s manufacturing and mining industries contributed 23 percent of GDP compared to 21 percent for all of agriculture, forestry, and fishing. Moreover the transportation and communications infrastructure had developed to a level capable of sustaining heavy industrial development. In the 1930s the economy expanded at the rapid rate of 5 percent per year, while manufacturing and mining grew to account for over a third of GDP-more than twice the size of the agricultural sector. Most industrial growth, however, was geared toward expanding the nation's military power, and this policy emphasis contained the seeds of its own devastation. By the end of World War II, 40 percent of the nation's industrial plants and infrastructure had been destroyed, and production had reverted to levels of about fifteen years earlier. The early postwar years were devoted to rebuilding this lost capacity, and major investments went to the electric power, coal, iron and steel, and chemical fertilizer industries. By the mid-1950s production matched prewar levels. Released from the demands of the militarists, the economy not only recovered its lost momentum but surpassed the growth rates of earlier periods. During the 1953-65 period GDP expanded by over 9 percent per year; manufacturing and mining by 13 percent; construction by 11 percent; and infrastructure by 12 percent. In 1965 these three modern sectors employed over 41 percent of the labor force while only 26 percent remained in agriculture. The mid-1960s ushered in a new type of industrial development as the economy opened itself to international competition in some industries and developed the heavy and chemical manufactures. While textiles and light manufactures maintained their profitability internationally, products such as automobiles, ships, and machine tools assumed new importance. Manufacturing and mining value-added (see Glossary) grew at the rate of 17 percent per year in the 1965-70 period. Growth rates moderated to about 8 percent and evened out between sectors in the 1970-73 period, as the retail trade, finance, real estate, information, and other service industries streamlined their operations. The nation's economic prowess faced a severe challenge in the mid-1970s. The onset of the worldwide oil crisis in 1973-74 shocked an economy that had become vitally dependent on foreign supplies of petroleum. As a result Japan experienced its first postwar decline in industrial production together with a severe round of price inflation (see fig. 6). The recovery that followed the first oil crisis revived the optimism of most business leaders, but the maintenance of industrial growth in the face of high energy costs required shifts in the industrial structure. Changing price conditions favored conservation and utilization of alternate sources of industrial energy. Although the investment costs were high, many of the nation's most energy-intensive industries successfully reduced their dependence on oil during the late 1970s and enhanced their productivity. Technological advances in the field of microcircuitry also led to the development of new growth industries in consumer electronics and computers and to savings in already established industries. The net result of these adjustments was to increase the energy efficiency of manufacturing and to expand what was called "knowledge-intensive industry." As a result the services industries have expanded in importance to the economy. The structural changes taking place in the economy, however, were unable to check the natural tendency for the pace of growth to slacken. As the economy matured in the late 1970s and the early 1980s, it became unrealistic for the Japanese to look for annual growth rates of more than 4 to 6 percent. But these were still remarkable in a world of expensive petroleum and in an economy having few domestic resources. During another round of sudden international oil price increases in 1979, the strength of the economy was apparent. The economy expanded without the double-digit inflation that had afflicted other industrial nations and that had bothered Japan itself after the first oil crisis. In 1981 the prospects for the economy seemed in line with the patterns of the late 1970s, but there remained a fear on the part of many economists and businessmen that sooner or later Japan must fall into the "stagflation" so characteristic of other free market economies. A whole set of complex economic and institutional factors have affected Japan's postwar growth. First, the nation's prewar experience contained several important legacies. The Tokugawa era (1603-1868) bequeathed a vital commercial sector in the burgeoning urban centers, a relatively well-educated elite having some knowledge of European science, a sophisticated government bureaucracy, and a productive agriculture (see The Tokugawa Period [1603-1868] ch. 1). After the Meiji Restoration the success in industrializing to the point where Japan could vie for world power was an important prelude to postwar growth and provided a pool of experienced labor. Second and more importantly was the high level of investment which persisted even into the 1980s. Investment in capital equipment averaged over 11 percent of the gross national product (GNP-see Glossary) during the prewar period, rose to some 20 percent of GNP during the 1950s, and since 1967 has been over 30 percent each year. An uncommonly high rate of savings, efficient financial institutions, and government incentives supported this investment. The quality of investment was also critical to the economy's performance. Japan's businessmen imported the latest technologies to rebuild and expand the industrial base. As a latecomer to modernization, the nation was able to avoid some of the trial and error needed to perfect industrial processes. This was especially so during the prewar era, when the importation of capital equipment and the hiring of foreign technicians was significant. But even in the late 1970s and into the 1980s, technology licensing, patent purchases, and the imitation and improvement of foreign inventions was important. At the same time, Japan's industrialists and technicians must be credited with the basic urge to innovate. Japan's labor force contributed importantly to economic growth, not only because of availability and literacy, but also its reasonable wage demands. Before and immediately after World War II, the transference of the numerous agricultural workers to modern industry resulted in rising productivity and only moderate wage increases. As population growth slowed and the nation became increasingly industrialized in the mid-1960s, wages adjusted upward significantly. But cooperation from the labor unions kept salary increases generally within the range of productivity gains. In addition the average Japanese worker has been well educated by world standards, and some scholars have argued that the level of education has consistently surpassed the needs of the economy since the Meiji period. The economy has also benefited from economies of scale. Although medium- and small-scale enterprises have generated much of the nation's employment, large-scale facilities have been most productive. Ownership and management of many industrial enterprises have also concentrated into large units. Before World War II large holding companies or zaibatsu (see Glossary) dominated most industry. The groups were dissolved after the war, but new ones have emerged in different forms. The coordination of activities within these groupings and the integration of smaller subcontractors into the group operations have enhanced industrial efficiency. Finally a number of circumstances beyond Japan's direct control contributed to its success. With the exception of World War II, international conflicts have tended to stimulate the Japanese economy. The Russo-Japanese War (1904-1905), World War I (1914-18), the Korean War (1950-53), and the Vietnam conflict (1965-72) brought economic booms. In addition benign treatment from the United States after World War II facilitated the nation's reconstruction and growth. United States assistance totaled about US$1.9 billion during the 1945-52 period, or about 15 percent of the nation's imports and 4 percent of GNP in that period. About 59 percent of this aid was in the form of food; 15 percent was industrial materials; and 12 percent was transportation equipment. United States grant assistance, however, tapered off quickly in the mid-1950s. United States military procurements from Japan peaked at a level equivalent to 7 percent of Japan's GNP in 1953 and fell below 1 percent after 1960. Moreover institutional reforms enacted by the United States during its occupation of Japan, including land reform and the dissolution of the large zaibatsu families, contributed to the economy's later performance by increasing competition. In particular the purge of industrial leaders allowed new talent to rise in the management hierarchies of the nation's rebuilt industries. Lastly the economy has benefited from foreign trade, especially since the late 1960s; the goodwill of Japan's trading partners in accepting its products in the face of their own mounting trade deficits was not insignificant. It was, however, the high quality and competitive pricing of those exports that attracted foreign buyers to the nation's merchandise. The consequences of Japan's economic growth have not always been positive. Large-scale and modern industrial enterprises exist side-by-side with the smaller and technologically less developed firms, creating a condition of economic dualism (see Glossary). The stability of profits and wages in firms in the former group greatly surpasses that of those in the latter. Likewise, temporary employees, mostly women, have received much smaller salaries than permanent workers. The modernization of the service industries (including trade, banking, and real estate) and the provision of subsidies to farmers have reduced some wealth differentials, but they remained a source of political concern in the 1980s. Additionally Japan's preoccupation with boosting the rate of industrial growth has led to the relative neglect of some consumer services and also to the worsening of industrial pollution. Housing and urban services, such as water and sewage systems, and social security benefits have lagged behind the development of the manufacturing industries. Agricultural subsidies and the complex distribution network have also kept the prices of essential consumer goods very high by world standards (see Living Standards, this ch.). Concern about industrial pollution came to a head in the 1970s. Although many industries had significantly reduced the level of pollution by 1981, it remained a potent public issue and a direct consequence of industrial growth. Finally the nation's rapid economic growth has led to increasingly problematic trade surpluses in Japan's favor, which have upset even the country's allies (see Background and History, ch. 5). Since the second oil crisis in 1979-80, much economic growth has been the result of export expansion. In late 1981 the growing dependence on exports and the sluggish demand from domestic consumers was disturbing the nation's own economic policymakers. Many economists argued that continued prosperity would require Japanese consumers to increase their personal consumption and the maintenance of a more equitable international balance of trade. Economic prosperity, therefore, has not diminished the importance of economic issues in the national political life. Indeed it was a major task of the government to balance the demands of the nation's most important economic groups to form an optimal economic strategy. Government Policy and Guidance Although Japan's economic development was primarily the product of private entrepreneurship, the government has directly contributed to the nation's prosperity in a number of ways. Its actions have helped to initiate new industries, cushion the effects of economic depression, create a sound economic infrastructure, and protect the living standards of the citizenry. Indeed so pervasive has government influence in the economy seemed that many foreign observers have popularized the term "Japan, Inc." to designate this alliance of business and government interests. Whether Japan in 1981 actually fit this picture seemed questionable, but there was little doubt that government agencies continued to influence the economy through a variety of policies. The most important national economic agencies were the Ministry of Finance (MOF) and the Ministry of International Trade and Industry (MITI), though a host of other organizations performed essential economic functions (see Institutions for Trade, ch. 5). The Economic Planning Agency (EPA), Federal Trade Commission (FTC), and Ministry of Agriculture, Forestry, and Fisheries (MAFF), for example, wielded considerable influence (see Policy-making Dynamics, ch. 6). Achieving a consensus on national economic policy was the ideal, but ministries and consultative bodies often vied with each other over finances, projects, and policies. Long-term economic planning was purely indicative and subject to frequent and overlapping adjustments. The EPA was responsible for drafting long-range plans in consultation with other economic agencies. The most recent EPA plan spanned the 1979-85 period and contained targets for the growth of GNP, investment, taxes, and other variables. Simultaneously, however, MITI and other agencies have developed a set of policy "visions" for the 1980s. In either form such long-term strategies were hardly as important as the day-to-day adjustments of economic policy. Some leaders in private business have even derided economic planning in Japan as being inaccurate, if not completely ineffectual. Monetary Policy Throughout most of the postwar period the economy has responded quickly to changes in the supply of money and credit, and monetary policy was the primary instrument of government control. By restricting or expanding the money supply the government was able to restrain or to stimulate economic growth almost at will. Each economic recession, for example, was preceded by a period of tight monetary policy and followed by an expansionary policy. The Bank of Japan, the nation's central bank, was responsible for conducting the government's monetary policy. The bank's policy board consisted of the bank governor, representatives from the EPA and the MOF and appointees from the private banking community. The most influential guidance over the board's decisions, however, came from the Banking Bureau of the MOF. Since much of the nation's economic activity depended on the provision of credit, the MOF had a strong influence on private enterprise. In 1981 Japanese businesses were becoming less dependent on domestic banking credit than in the past, and direct government control was slowly waning (see Banking and Finance, this ch.). The main instruments for monetary control were the lending and discount policies of the Bank of Japan, supplemented by a form of banking control called "window guidance" (see Glossary). The central bank periodically adjusted the discount or bank rate-the rate of interest charged on central bank loans and discounts to commercial banks. The discount rate was set high during periods of monetary restraint and low during expansion. Through "window guidance" the central bank set quarterly loan quotas for each major public and private banking institution, based upon the lending record for the same quarter of the previous year. Less important instruments of monetary control were reserve requirements and operations in the financial markets. The Bank of Japan determined the ratio of reserves to be deposited in the central bank for all types of deposit institutions. The maximum reserve ratio allowed by law was fixed at 20 percent, but the actual requirements were much lower, typically less than 2 percent. In 1980 the bank's total reserves averaged about 2 percent of total deposits at financial institutions. Until the mid-1970s the Bank of Japan engaged in only limited forms of open market operations. The gradual liberalization of the financial system and the need to increase government borrowings, however, have caused the government to become increasingly active in the marketing of securities. Purchasing securities in the open market was therefore another means of pumping money into the system. Japan's monetary policy has shifted significantly since the mid-1970s. Just before and during the first oil crisis, monetary policy was usually expansionary, both in order to promote full employment and to eliminate the foreign trade surpluses. As the oil shortage developed, however, the rapid expansion of the money supply resulted in double-digit inflation accompanied by a massive business recession. Subsequently the nation's monetary authorities placed price stability above all other policy objectives. The government's argument was that in the long run the goals of full employment and external balance would best be served by restraining the growth of the money supply. By closely monitoring price increases, strictly adhering to quarterly targets for money supply growth, and liberalizing some forms of bank interest rates, the Bank of Japan was able to halt the inflationary pressures from excess domestic demand. The test of this conservative monetary policy came during the second international oil crisis. Petroleum price increases were passed on to Japanese consumers in the form of higher relative prices for those commodities that used oil as a major input, thus exacerbating inflation. But the government resisted the temptation to expand the money supply. In fact the central discount rate rose to an all-time high of 9 percent in mid-1980. As a result the nation experienced less overall inflation than other developed economies. Fiscal Policy The government's fiscal policy revolved around the formulation of the national budget, which was also the responsibility of the MOF. The Budget Bureau of the MOF prepared expenditure budgets for each fiscal year (FY-see Glossary) based upon the requests from government ministries and affiliated agencies. The Tax Bureau was responsible for adjusting the tax schedules and estimating revenues. The ministry also issued government bonds, controlled government borrowing, and administered the Fiscal Investment and Loan Program-sometimes referred to as the "second budget." Three types of budgets were prepared for the approval of the National Diet each year. The general account budget included most of the basic expenditures of current government operations. Special account budgets, of which there were about forty, were designed for special programs or institutions where close accounting of revenues and expenditures was essential. (These accounts included public enterprises, state pension funds, and public works projects financed from special taxes.) Finally there were the budgets required for the fifteen major public enterprises, including the three public service corporations, ten loan and finance institutions, and the two special public banks (see Public Corporations, this ch.). Although these budgets were approved before the start of each fiscal year, they were usually addended or revised with supplemental budgets. The nation's local budgets were heavily dependent on transfers from the central government (see table 2, Appendix). Although general government expenditures were smaller as a proportion of GNP than in most other industrial economies, the government's fiscal policy was not restrictive. Government fixed investments in infrastructure and loans to private and public enterprises strongly stimulated both current and long-term production. In 1979 the total fixed capital formation from government and public enterprises was about 13 percent of GNP. The effective level of investment, however, was higher. Loans from the Fiscal Investment and Loan Program, which were outside of the general budget and funded primarily from postal savings, went to public and private enterprises as well as to some of the special accounts. The total amount of these loans represented more than 20 percent of the general account budget, and their total effect on economic investment was not completely accounted for in the national income statistics. Taxes formed the major share of government revenues, and the total tax burden in 1979 represented 17.4 percent of GNP. This was low in comparison to other developed economies but was an increase over the 15.8 percent tax burden for 1971. Individual income and corporate taxes provided some 67 percent of the revenues. Income taxes were graduated and progressive; the higher brackets were given smaller deductions and higher tax rates than the lower. Corporations could claim special deductions or accelerated depreciation for certain activities, such as investment in pollution control equipment. Many types of individual savings and welfare expenditures were also deductible. An inheritance tax and indirect levies on specified commodities, travel, capital gains, and securities transactions were less significant. A major source of revenue came from contributions to social security (an extra-budgetary item). If these payments were added to the national tax revenue, the total burden to the economy would come to about 25 percent of GNP in 1979. Increasing the level of taxation by some six or seven percentage points of GNP during the 1979-85 period was a major long-term goal of the government. To accomplish this the government planned to institute a value-added tax as soon as politically feasible. The first significant initiative to start such a tax caused a controversy for Prime Minister Ohira Masayoshi in 1979, but popular resistance to the proposed system seemed to be lessening in 1981. Prime Minister Suzuki Zenko planned to implement a value-added tax of some kind as early as 1983. It was not known whether corporate and personal income taxes would be cut as a result of the added tax revenue. The need for additional state revenue was a growing cause of public concern as the central government registered a deficit that was over 5 percent of GNP in 1979. The rising levels of expenditures, including efforts to finance the public debt, prompted the government to make massive issues of public bonds. These issues reached over 14 trillion Yen (for value of the yen-see Glossary) in FY 1980, or 34 percent of the total planned budget for the year. Amidst the reluctance of the nation's banks to purchase the bonds at artificially low rates of interest, the Suzuki cabinet planned to reduce the level of bond issues drastically and to balance the budget within five years. The FY 1981 budget incorporated the reduction of bond issues to less than 30 percent of revenues for the first time in four years, while increasing the corporate and commodity taxes to expand revenues. The government also planned to decrease its subsidies for the national pension plans and social security. Overall the nation's planned expenditures from the general account were to increase only by 9.9 percent in FY 1981, the smallest increase in twenty-two years. If the government debt service payments and transfers to local governments were excluded, as the MOF did in its analysis of expenditure trends, the general expenditure would increase only by 5.3 percent. The fastest growing budget items in 1981 were for defense and social security. Public Corporations Japan's numerous public corporations were unique features of an otherwise wholly private enterprise economy. At the end of 1979 there were 111 such corporations at the national level and several thousand at the local level. Those at the national level were normally affiliated with one of the economic ministries, although the extent of direct management and supervision varied. The receipts of the national corporations represented about 6 percent of GNP in 1979, and they employed about 941,000 people, or 1.6 percent of the labor force. The government divided the national-level corporations into several categories (see table 3, Appendix). The first category included the three main public service and monopoly corporations: Nippon Telegraph and Telephone (NTT), Japanese National Railways, and Japan Tobacco and Salt. The second category included the major development corporations. Together these two groups of corporations utilized the bulk of the funds from the Fiscal Investment and Loan Program. Their activities were devoted to housing, agriculture, highways, water resources, ports, energy resources, and urban projects. Other categories of corporations included those charged with special government projects, loans and finance, and special types of banking. Public corporations at the local level usually were involved with utilities. Public corporations benefited the economy in several ways. Some, like NTT, were important sources of technology development funds or poles around which private industry could cluster. Others performed vital public services that private industry would find it impossible to finance. The development banks, particularly the Japan Development Bank, were important sources of long-term investment funds and were instrumental in shaping the pattern of industry. Since they also added revenue to the national budget and were (theoretically) self-financing, the corporations required little from the government in the way of financial support. These enterprises also provided employment for retired bureaucrats. The system of public corporations had negative aspects as well, however, in that their operations were apt to be less efficient than those of the private sector. In some of the corporations, close government supervision impeded corporate responsibility. The decision to increase railway fares, for instance, required as much politicking as rational economic analysis. Conflicts between corporate heads who were retired from competing ministries and envy among career employees who saw their paths to advancement blocked by the influx of retired officials also created frequent management problems. Labor relations were often less harmonious in the public than in the private sector, and some of the nation's most debilitating strikes or work slowdowns have been launched by the public transportation workers. Given their traditional importance to the economy, however, the number of public corporations would probably remain about the same in the 1980s.