JPRI Occasional Paper No. 22 (August 2001)
Japanese "Capitalism" Revisited
by Chalmers Johnson

Almost twenty years ago, I unintentionally set off a controversy concerning the nature of the Japanese economy that is still active at the present time. In my history of Japan's Ministry of International Trade and Industry (MITI), entitled MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975, I enlarged the dichotomy between so-called plan-rational and market-rational economies that had dominated Cold War ideological debate to include another basic prototype-- the plan-rational market economy, neither socialist nor Anglo-American capitalist in orientation or operation (see Johnson, 1982a; 1995). I argued that Japan was a leading exemplar of this type (for important works on the Japanese economy that apply and extend this argument, see Anchordoguy, 1989; Arase, 1995; Carlile and Tilton, 1998; Gao, 1997; Huber, 1994; Tilton, 1994; Tilton, 1996; and Woodall, 1996). In the Japanese-style economy, the government imbeds incentives and disincentives within the market to achieve its goals; market-players, enjoying private ownership of property, respond as they see fit in order to secure their personal advantage. It is not a command economy and there is no socialist displacement of the market.

The Capitalist Developmental State

After a long period of prewar and wartime experimentation, Japan's state-guided but privately-owned economic system was the primary agent responsible for Japan's spectacular, if unexpected, post-World War II advance to the rank of the world's second most productive economy. I called Japan an example of a "capitalist developmental state," in contrast to the "capitalist regulatory state" found in orthodox English-language capitalist theory, and also noted that Japan's economic achievement was not unique; its main principles and institutions were being duplicated in South Korea and Taiwan with equally impressive results (the most important works on the "developmental state" concept are Appelbaum and Henderson, 1992; Chang, 1994; Fallows, 1994; Fields, 1995; Mathews and Cho, 2000; Wade, 1990; Weiss and Hobson, 1995; Weiss, 1998; Woo-Cumings, 1999; and Wu, 1994).

The primary focus of my work was the evolution, structure, capabilities, and powers of the Japanese state's bureaucratic apparatus for implementing "industrial policy." I emphasized the state's importance because until that time there had been no serious research on this subject; the extraordinary powers of the Japanese bureaucracy in the economy, as compared to the powers of the parliament or the private sector, were virtually unrecognized among Japan's Cold War allies. I did not say that the state was the sole element influencing the economy, but I stressed that unelected, elite officials played much larger roles in economic affairs than was suspected by those who categorized and studied Japan as a late developing version of the Anglo-American type capitalist economy.

This argument, although widely accepted by a broad range of Japanese and foreign analysts, turned out to be both controversial and an ideological challenge to the leaders of the American and Japanese economies in ways that I had not anticipated. The publication of my study coincided with the emergence of Japan as a formidable challenger and even threat to the viability of many manufacturing industries in other capitalist countries, particularly in the United States. By the mid-1980s, Japan was no longer "catching up" with the so-called advanced industrial societies; it was the size of two Germanies and posed a competitive challenge to the automotive, steel, consumer electronics, robotics, semiconductor, liquid crystal displays, and other industries of many countries. The United States produced libraries of articles and books on Japan's business secrets; titles like Trading Places: How We Allowed Japan to Take the Lead and Blindside: Why Japan Is Still on Track to Overtake the U.S. by the Year 2000 dominated public policy debate (see Prestowitz, 1988; Fingleton, 1995); and Michael Crichton wrote a best-selling novel, Rising Sun (1992), with a bibliography attached. The film made from the book portrays Japan's aggressiveness in advancing into the United States and the ease with which it could buy the collaboration of American political leaders in undercutting American enterprises. There were many calls for Americans to wake up to the Japanese "threat" or to learn from Japan in order to be able to compete effectively with Japanese companies.

There were also two quasi-official ideological responses to the new analyses about what made Japan so successful: one American and one Japanese. The American view was to deny that Japan constituted a different kind of capitalism because, if it did, that would weaken the ideological monopoly of so-called neoclassical economics as a fighting ideology in the Cold War. For example, the Wall Street Journal's Paul Gigot had long maintained that Japan's economy operated just like the U.S. model. "Japan's miracle, like Britain's and America's before it," he wrote in 1986, "was largely the product of creativity and enterprise by individuals and their businesses." To the extent that the Japanese economy was outperforming that of its mentor, this was usually explained via mysterious Japanese cultural traits. Surprisingly, a decade later, in a column entitled "The Great Japan Debate Is Over: Guess Who Won?," Gigot had switched sides and was now deriding Japan's "model of bureaucratic-led economic growth" as a failure. His new point was that people like myself may have been right about how Japan worked but we were wrong to think it was a success. To the extent that the Japanese economy might ever stage a comeback, Gigot argued, in a fashion typical of his colleagues, it would have to do business "in a framework that more resembles the American model" (Gigot, 1986; 1997).

The Japanese view was more subtle. Most Japanese analysts recognized and accepted the accuracy of the "developmental state" concept; in fact, the Ministry of International Trade and Industry itself translated my history of its activities and had it published commercially (see Johnson, 1982b). But after a few years of favorable publicity, the Ministry concluded there was one major problem with analytical writing about its history and methods-- it revealed far too much information to Japan's competitors who did not read Japanese and knew little of Japan's modern economic history.

Japan's high-speed economic growth depended fundamentally on large and growing exports to the United States, an important point to which I shall return. By the 1980s, the American trade deficits had become a serious source of conflict between Japan and the United States. The U.S. argued strenuously that Japan utilized non-tariff-barriers to protect its domestic market, whereas Japan downplayed the deficits as mere "trade friction" while negotiating interminably over the rules both sides should follow. The new idea coming from the U.S. that Japan, in fact, constituted a different kind of economy and that the focus of negotiations should be on results rather than rules (as in trading relations with command economies) constituted a threat to Japan's continued surpluses. The idea that Japan was different therefore had to be discredited.

In a coordinated campaign that lasted well into the 1990s, the Japanese government and much of Japan's academic establishment attacked as economic "revisionism" (i.e., contrary to orthodoxy) the idea that Japan was a "developmental state" and insinuated that "revisionist" writers were "Japan-bashers," a barely disguised euphemism for anti-Japanese racists. Any article in an American newspaper that commented on structural features of the Japanese economy or on the interventionist role of the Japanese government normally elicited a letter to the editor from the local Japanese consul denying the charge. The campaign had some effect in silencing people who were afraid of being called racists and in muddying the waters for the uninitiated about the nature of the Japanese economy.

The Plaza Accord and the Bubble Economy

Meanwhile, an entirely different analytical debate and international policy initiative started the unraveling of the Japanese economy. This, in turn, reinvigorated the debate about the "developmental state"-- but now with a focus on whether it was the cause of Japan's "lost decade," its near recession conditions throughout the 1990s. Ever since the late 1960s, when America's trade deficits with Japan first became a serious political problem, one prominent explanation for Japan's economic success was that it enjoyed an exceptionally favorable exchange rate-- namely, US$1=«360, which had been established during the postwar occupation in order to help Japan's economic recovery. One major purpose of President Richard Nixon's 1971 initiative to end the Bretton Woods system of fixed exchange rates was to force an upward revaluation of the yen, thereby weakening the price advantage of Japanese goods in international trade (see Angel, 1991).

Fifteen years later, with the United States's current account going from a surplus of $5 billion in 1981 to a deficit of $125 billion in 1985, the focus was again on exchange rates. For neoclassical economists advising the U.S. government, this was a "safe" approach. It avoided the delicate issue of whether Japan was a different kind of capitalism, and it promised some relief from the trade deficits, which had begun to elicit Congressional calls for protectionist measures. The problem was that while exchange rates affect prices, Japan's competitive advantage was not primarily in prices. Japan's trade surpluses and the worries they created in the United States were caused by its developmental state-- easy access to capital for Japanese exporters in designated strategic industries, research and product development consortia, the blocking of foreign investment and sales in Japan, governmental efforts to separate foreign technology from foreign ownership rights, and many other industrial policy measures. Japan also enjoyed privileged access to the American market because it was the United States's primary political and military satellite in East Asia-- an aspect of the relationship that it was taboo to discuss. Therefore, like Nixon, American leaders in the Reagan administration again turned to the manipulation of exchange rates to ease the economic pressure from Japan. They were aided by neoclassical macroeconomists, such as C. Fred Bergsten of the Institute for International Economics, who confidently argued that "the rise in the U.S.-Japanese trade deficit from 1980 to 1984 can be fully explained by changes in the exchange rate and rates of economic growth" and that "to achieve equilibrium in the countries' global current accounts, the yen would have to strengthen to a range of at least 190 to 200 yen to the dollar" (Bergsten and Cline, 1985: 6, 45-46).

On September 22, 1985, the Ministers of Finance and central bank governors of France, Germany, Japan, the United Kingdom, and the United States met in the Plaza Hotel (hence "Plaza Accord") in New York. The United States and Europe insisted that Japan was benefiting too much from its price advantage in international trade and forced it to agree to a coordinated program of dollar selling that led to a 30 percent decline in the value of the dollar and a comparable rise in the yen over the next two years. This initiative worked, but not in the way its sponsors had expected it would. The change in the prices of Japanese and American goods had little effect on the trade balance since Japanese goods were more attractive to international consumers because of their quality, fuel efficiency, and design than because they were cheap. At the same time, United States government officials made no real effort to follow up the Plaza Accord by forcing open the Japanese market to cheaper American products, because they assumed that "market forces" would do it for them. Instead, the Plaza Accord brought down the Japanese economy because of the Japanese government's wild and ill-considered overreaction to it.

Until 1968 Japan was a net debtor nation and the United States was the world's largest creditor nation. After 1968, as Japan's trade surpluses grew each year, it became a creditor nation and began to overtake the United States. In the middle Reagan years, 1985 and 1986, the positions of Japan and the U.S. became reversed. Japan's net external assets at the end of 1984 were $74.3 billion, up from $37.2 billion in 1983. In 1985 they grew to $129.8 billion and in 1986 to $180.3 billion. In 1985, Japan became the world's largest creditor nation; and the following year, the United States became the world's biggest debtor nation. This change in the two nation's respective financial positions was important. As Akio Mikuni, head of Japan's leading independent, investor-supported bond-rating agency, explains:

The Japanese economic system is . . . predicated on the ability to export surplus production, the result of which is an onerous imbalance in the relationship between Japan and the rest of the world. . . . Back in the 1950s and 1960s, Japan could exploit external markets without affecting them. But Japan is now too large. . . . The intention behind the system [is] to ensure that [Japanese] companies in so-called strategic industries enjoyed financing at costs that gave them a competitive edge over foreign rivals. . . . MOF [Ministry of Finance] officials . . . cannot accept a reversal of Japan's postwar policy of unlimited expansion of productive capacity, which is implied in any structural reduction of the current account surplus. Such a reversal would undermine MOF's power and legitimacy, as historically industries and banks depended on MOF for guidance. . . . The system of maximizing the current account surplus worked well for Japan until it replaced the U.S. as the world's largest net creditor nation. By becoming the world's largest net debtor instead of its largest creditor, the U.S. could no longer act as a very good customer for Japan, as Japan can sell goods to the U.S. but cannot convert the sales proceeds into yen without driving down the yen/dollar rate (Mikuni, 1998: 2, 5, 8, 21).

The Plaza Accord came about because of the need to rectify the growing imbalances between an ascendant Japan and a declining United States-- and it did succeed in making Japanese products much less competitive. The yen/dollar exchange rate went from «262=US$1 in February 1985 to «158=US$1 by early 1987, thereby significantly increasing the prices of Japanese goods on international markets. The Ministry of Finance, lacking real understanding of or confidence in Japan's economic achievements, panicked; it feared that Japan would be crushed by losing its artificial exchange-rate advantage.

The appropriate policy for Japan in these circumstances would have been to shift its economy to one that relied much more on domestic demand than on exports, to undertake reforms in order to expand domestic demand, and to forge mutually beneficial trading relations rather than ones based entirely on Japanese advantages. The unleashing of domestic demand was what former prime minister Hayato Ikeda had engineered back in the 1960s in his "income doubling plan" (shotoku baizo). Ikeda's consumer revolution in a society with a population half the size of the United States had been the basis of Japan's initial takeoff into high-speed economic growth. There were equally great opportunities to expand domestic demand in the Japan of the late 1980s-- housing, hospitals, urban planning, and urban transportation all were (and still are) inadequate-- but this is not the route that the economic bureaucracy chose.

Instead, the Japanese government chose to bind itself ever more firmly into its Cold War relationship with the United States and to respond to the Plaza Accord by trying to undercut it. Under orders from MOF, the Bank of Japan slashed interest rates in order to generate an investment boom. The reduction in the cost of capital was intended to expand and modernize factories so that they could produce goods that would remain competitive abroad despite a price disadvantage. According to Kenneth Courtis, then chief economist for the Deutsche Bank in Tokyo, between 1986 and 1991, Japan invested some $3.6 trillion in new plants and equipment and in research. This was targeted at reducing the costs of making products by 40 to 50 percent (McCormack, 1992). The net result, however, was to build huge excess capacity without regard to international or domestic consumer demand. And this led to a banking crisis--- as well as a stagnant economy-- that Japan has yet to overcome.

With interest rates so low, Japanese banks also loaned to risky and speculative borrowers, particularly in the real estate sector. Japan's land use pattern desperately needs reform. It is wildly skewed in favor of agricultural land, which rigs the political system in favor of farmers, who in turn are one of the pillars of one-party rule by the Liberal Democratic Party. Under this structure, urban land in Japan will always be expensive. When urban land began to grow even more spectacularly in value during the late 1980s investment boom, it became the basis for a classic speculative bubble. Land became the collateral on which banks lent huge amounts of money, which was in turn used to buy more land (or shares on the Tokyo Stock Exchange) and to borrow even more from the banks on the basis of the newly acquired land and stock.

Satoshi Sumida, governor of the Bank of Japan during the late 1980s and a former MOF official, was the actual author of the "bubble economy." During December 1989, when the bubble was at its height, he was replaced as governor by Yasushi Mieno, an official who had spent his entire career within the Bank of Japan and was much more attuned to sound monetary policy than MOF officials. Recognizing that land prices were soaring beyond any realistic measure of value, he instituted tight money policies to stop the banks' lending to speculators. On December 25, 1989, Mieno raised the discount rate to 4.25 percent and in August 1990 raised it again to 6 percent. The resulting tailspin of the property and stock markets produced a crisis of "non-performing loans" (i.e., loans that could not be repaid) and a threat of insolvency to the entire banking system that has lasted well over a decade and that as of early 2001 still shows no signs of being rectified. Mieno "now holds the record for destroying more financial wealth than any central banker in history" (Williams, 1999).

In the early years after the bubble burst, the Japanese government remained complacent about the need for reform, and it was never candid with the public about what had gone wrong. Even though its response to the Plaza Accord had left the country saddled with vast overcapacity in autos, steel, consumer electronics, and other products, the actual performance of the economy did not force the government to undertake crisis management. Rather than a decade of recession, Japan actually had a decade of slow to moderate growth. Between 1994 and 1997, the U.S.'s per capital gross domestic product (GDP) grew by some 13.6 percent whereas Japan's grew by 5.3 percent.

In response to the immediate cause of the slowdown-- the crippling of the banking sector-- the Japanese government chose to try to "grow" its way out of the problem. As in the past, it relied on its powerful export sector to pay the bills and tried to get the stronger banks to help the weaker banks via the so-called convoy system (goso-sendan soshiki). This meant that the government would deal with banking inefficiency and overcapacity gradually through mergers and cutting employment through natural attrition. The government did not use Japan's huge hoard of savings to liquidate the non-performing loans; nor did it order the consolidation of the financial sector, which, as we shall see, it was too weak politically to do. "Growing out" of its troubles was also a wildly unrealistic policy. Ronald Bevacqua of Commerz Securities, Japan, quotes estimates from the Industrial Bank of Japan that in real estate, wholesale and retail sales, and construction, repayment of debt out of projected cash flow would have required 84 years, 32 years, and 19 years respectively (Bevacqua, 2000).

"Growing out" of its problems might have seemed superficially like a good idea because it would avoid the huge social costs associated with wholesale reform-- a lesson that was being driven home throughout the 1990s as post-communist Russia followed U.S. advice on how to reform its economy and inflicted as much domestic damage as Leninism and Stalinism had in earlier decades. But this policy also drew Japan inextricably closer to the U.S., its primary export market. And the 1990s-- the Clinton years-- were an unusual time for the United States, with messages, policies, and advice emanating to Japan and the rest of the world that were a complex mixture of ideology, dissimulation, and industrial policy. Under the Clinton administration, the United States enjoyed an exceptional burst of economic growth and revelled in the triumphalism of being the "lone remaining superpower." But much of this was achieved with smoke and mirrors and had almost nothing to do with underlying realities.

The Japanese-American Relationship

During the late 1940s, when it became apparent that the forces of the Chinese Communist Party were going to win the Chinese civil war, the United States reversed its policies of attempting to democratize occupied Japan and instead devoted itself to making Japan the U.S.'s leading satellite in East Asia. Many of the new policies it implemented were similar to those utilized by the Soviet Union in setting up and maintaining its satellites in Eastern Europe (for development of this argument, see Johnson, 2000). But the U.S.'s economic policies toward Japan and its other satellites in East Asia (e.g., South Korea) were markedly different. They rested fundamentally on two American beliefs: that the poverty stricken economies of postwar East Asia could never compete successfully with the United States and that economic growth was one very important way to divert the people of these economies from the attractions of socialism, neutralism, communism, or other anti-American orientations.

The United States entered into an informal bargain with its dependencies in East Asia, of which Japan was the first and by far the most important. In return for the Asian nations' willingness to tolerate the indefinite deployment of American weapons and troops on their soil, the United States would give these countries preferential access to the American market and would tolerate their protectionism and mercantilism. These were advantages the U.S. did not extend to its European allies in the Cold War. As the American Embassy in Tokyo reported to the Department of State in 1960, "Our economic policy accorded Japan a fair and reasonable share of our market as premise and precondition for U.S.-Japan relationships in political and security fields and has led to substantial expansion of Japanese exports, making possible Japan's present economic prosperity" (Telegram from the Embassy in Japan to the Department of State, June 24, 1960, in United States Department of State, 1994: 378).

This policy is still in effect some fifty-four years after it was first implemented-- in return for playing host to 43,000 American troops, Japan still takes as its due privileged access to the American economy and protectionist barriers against American sales and investment in the Japanese market. The overall results had become apparent in the 1970s and acute problems for the American economy in the 1980s-- namely, huge excess manufacturing capacity in Japan, the hollowing out of American manufacturing industries, and the largest trade imbalances (in Japan's favor) ever recorded between two economies. The United States nonetheless continued to tolerate the unintended consequences of its own policies, even though from time to time it vacillated between trying to force a more equitable trading relationship with Japan and maintaining the postwar Japanese-American security relationship unchanged. Generally speaking, both the U.S. and Japanese governments over the years found it politic to pretend that there was no connection at all between their military arrangements and their trade since to admit that they were related would have made the nature of Japanese-American ties all too obvious. Most American military strategists saw the economic privileges given to Japan as unavoidable costs of maintaining the U.S.'s global empire, which they justified in terms of its Cold War competition with the former USSR.

During the 1980s, the distortions caused by the traditional trade-off between trade and military bases became acute and led to the Plaza Accord. But it has never been clear whether the United States truly intended that the manipulation of exchange rates should correct its huge trade imbalances with Japan or whether it was merely making a politically appropriate gesture to deflect growing domestic opposition to Japan's economic ascendancy. Similarly, it is not clear whether Japan was truly defying the will of its hegemon in launching an investment drive to maintain and enhance its competitive ability or whether it was behaving in a traditional and tacitly tolerated way. Both sides had become schizophrenic: the U.S. government often justified particular economic inequities in terms of the need to maintain the "broader relationship" while Japanese nationalists countered American economic demands for a "level playingfield" with threats to sell militarily relevant technologies to Russia and China. The 1989 book by then Diet-member and today mayor of Tokyo Shintaro Ishihara and the late Sony chairman Akio Morita, The Japan that Can Say "No," is the most famous example of the latter position (see Ishihara and Morita, 1989).

In any case, in the late 1980s, Japan did not try to reduce its huge surpluses in its trading relations with the United States and sought instead to shore-up the old bases-for-economic-advantages relationship that it had long enjoyed. But after Japan had become the world's largest creditor nation and the U.S. the world's largest debtor nation, it was simply no longer possible to go back to the status quo ante. That had always depended on the United States being overwhelmingly stronger than Japan in economic terms, which was no longer the case.

In order to prevent an intolerable rise in the value of the yen, Japan essentially had to disguise its surpluses by leaving them in Japanese-owned financial institutions in the United States where they became capital exports for American use. This did not enrich Japan in any real sense but it did give the country enormous financial leverage over the U.S. As Eamonn Fingleton has noted, for the first seven years of the 1990s, Japan's net external assets jumped from $294 billion to $891 billion. By contrast, America's net external liabilities rocketed from $71 billion to $831 billion (Fingleton, 1999:215).

Both countries also became more dependent on each other. Following the U.S.'s 1987 stock market crash, Japan bought large amounts of American shares and thereby helped prevent a more serious panic. Moreover, Japan's low-cost financing replaced America's virtual dearth of domestic savings and allowed the United States to run huge external deficits without paying any of the usual costs, particularly a catastrophic loss in value of the dollar, while keeping inflation low and American financial markets buoyant. If Japan ever does become a genuine market economy and the United States is forced to finance its own debts from domestic savings, the deflationary impact on the U.S. will be devastating.

In the same manner, when in 1995 Japan asked for American help in promoting its "growing out" strategy, the U. S. obliged with a "reverse Plaza" campaign to lower the value of the yen and raise the value of the dollar. Of course, it had no choice since if Japan's hidden threat of withdrawing funds from the U.S. had been carried out, it would have ensured the end of the Clinton presidency with the 1996 elections. Neither the U.S. nor Japan was particularly concerned about what these currency manipulations would do to the other economies of East Asia, but they contributed directly to the 1997 global economic crisis, which began in Southeast Asia. Strengthening the value of the dollar to please the Japanese made the goods of countries like Thailand and Indonesia, whose currencies were tied to the dollar, uncompetitive in international markets.

American Criticism of East Asian Economies

Even though Japan and the United States were more dependent upon each other in the 1990s than either was willing to admit, the publicly perceived relationship between the two was one of a triumphantly recovered United States and a hopelessly wallowing Japan. Moreover, the U.S. took advantage of this new situation to comment ideologically on what was wrong with the Japanese economy in an attempt to overcome the 1980s perception that the Japanese-type economy constituted a genuine alternative to American-style capitalism. With the end of the Cold War in Europe in 1989 and the collapse of the Soviet Union in 1991, the United States entered a high-profile phase of its existence as the ostensible "winner" of the Cold War and exemplar of economic correctness.

The end of the Cold War also brought into much clearer focus the implicit American imperialist vision that had guided it since World War II and that the Cold War had camouflaged. As Linda Weiss puts it, after World War II, "International political cooperation (systematized through the institutions of Bretton Woods) paved the way for economic integration (mainly through trade) rather than vice versa. . . . Cold War politics served to deflect attention from this evolving internationalist ïliberal democratic order.' . . . The end of the Cold War appears less as a watershed than a marker in the rediscovery and retrieval of the liberal internationalist project that had all along been developing at its own pace" (Weiss, 1999:67). During the 1990s, the Clinton administration devoted itself, particularly in East Asia, to advancing this "liberal democratic order." It pressured, advised, and induced Japan and the late-developing capitalist economies of the area to undertake economic reforms if they wished to adjust to the new, American-dominated world order. The Americans took up a new foreign policy project; in John Gray's phrase, they became "ranting evangelists for global capitalism" (Gray, 1998: 104).

At a minimum the Asian capitalists had to dismantle governmental supports for economic development, fully open their borders to flows of goods and international capital, and submit themselves to the rules and regulations forged and administered by the World Trade Organization, the International Monetary Fund, and the World Bank. At a maximum they should take the United States economic system as a model of the most perfect form of capitalism. The United States implemented much of its program to induce these changes through the so-called Asian-Pacific Economic Cooperation (APEC) forum and disguised what it was doing by claiming that the U.S. itself was merely adjusting to what it called the forces of "globalization." These were alleged to be ineluctable and irresistible even though, concretely, globalization turned out to be almost entirely an American project and one that the United States pursued only so long as it served United States interests.

The result of this promotion of the liberal democratic order was the economic meltdown that began in Thailand in the summer of 1997, then spread to Indonesia, Malaysia, and South Korea, leapt to Russia, and finally destabilized Brazil. The metaphors used by the American press to characterize the crisis reflected its progressive stages. At first the financial panic was the Asians' own fault and reflected their "crony capitalism," an allegedly higher degree of insider trading and governmental corruption than existed in New York or Washington DC. Then the term became "currency contagion," also known as the "Asian flu," which suggested that even Western countries in which crony capitalism had not been detected might be susceptible to attacks on their currencies. Finally, the press devoted itself to the need for a "new financial architecture," acknowledging that the cause of the crisis was extremely volatile capital flows and that these had been made worse by following American advice and dismantling supervisory and oversight organs in the name of liberalization. When it turned out that there were no Anglo-American interests that actually wanted a new financial architecture, the whole idea was dropped; and the world waited for the next financial crisis. The only East Asian countries to have avoided the crisis of 1997 were China, which ignored the American advice; Malaysia, which defied the advice it got from the International Monetary Fund; and Japan, which was itself one of the suppliers of volatile capital rather than a recipient of it (see Miller and Kojima, 2000: 37).

Throughout the 1990s, the United States criticized Japan. Much of the criticism was disingenuous since it would have devastated the United States if the Japanese had heeded it. Many American critics understood full well that the 1997 crisis had not affected the Japanese economy in the way that the economies of Thailand, Indonesia, and South Korea had been devastated. Japan's economic problems antedated 1997 and were unrelated to America's attempts to impose its liberal democratic order in East Asia. Moreover, Japan certainly did not need an IMF rescue package-- at the end of 1998, Japan had personal financial assets of «1,253 trillion; at the end of fiscal year 1998, its current account surplus was «12.8 trillion; and at the end of February 1999, foreign exchange reserves were $221.5 billion. But Japan was in Asia, and it was therefore convenient for American propagandists to include Japan along with all the other countries of the area that were said to have "failed" economically because they had not followed the American model of capitalism.

The intent of this criticism was to discredit alternatives to the American model, particularly East Asia's "capitalist developmental state," and thereby provide a sound ideological foundation for further pursuit of the liberal democratic order. The American ideologues were indifferent to the relevance of their criticism-- e.g., to the fact that none of the Southeast Asian economies even approximated a capitalist developmental state as it existed in Japan, South Korea, and Taiwan. They ignored cultural orientations that made the purpose of capitalism in many East Asian countries different from that of serving only the short-term interests of shareholders. They wildly overstated the attractiveness of the American model-- the fact that, as John Gray puts it, "The idea that the United States is a universal model has long been a feature of American civilization. . . . Yet the claim of the United States to be a model for the world is accepted by no other country. The costs of American economic success include levels of social division-- of crime, incarceration, racial and ethnic conflict and family and community breakdown-- that no European or Asian culture will tolerate" (Gray, 1998:216). Nonetheless, the focus of the American critics remained on Japan's failings and how these demonstrated the correctness of Anglo-American capitalism.

The RAND Corporation's Charles Wolf, Jr., insisted that governmental control caused both Japan's crisis and the Asian crisis despite libraries of evidence that state intervention was a key factor in the economic development of England (e.g., the Navigation Acts, which required that all imports be carried in ships owned by Englishmen), Germany, Russia, and the highly protectionist pre-World War II America (Wolf, 1998). Michael Porter, the Harvard Business School guru and two Japanese collaborators, concluded that "The [Japanese] government mistrusts competition and therefore is prone to intervene in ways that harm the nation's productivity and prosperity. . . . To develop a comprehensive solution, Japan will need to embrace some elements of the Western approach, much as it has in the past" (Porter, Takeuchi, and Sakakibara, 2000: 138, 188). The term "Western" here is, of course, a euphemism for the United States and perhaps the United Kingdom and New Zealand; American-style capitalism is assuredly not part of any Western heritage that includes France, Germany, Italy, Scandinavia, or Latin America.

Richard Katz focuses on Japan's keiretsu, financial system, protectionism, and other structural features of the developmental state and says they caused the economic doldrums of the 1990s. He does not explain, however, why this structure performed so well over the first forty years of the postwar period and failed only in the 1990s (Katz, 1998). Rich Miller of Business Week takes a position similar to Katz's except that he accepts the American argument that "globalization" has created fundamentally new economic conditions: "After a lost decade riddled with economic recession, Japan is suffering an identity crisis. Its financial success after World War II was built on an economic model that no longer seems to work in the new era of globalization. . . . It is U.S.-style capitalism-- and the culture that accompanies it-- that seems better suited for the new globalization age of rapid economic and technological change. America has an open society and an open economy" (Miller and Kojima, 2000: 45, 50).

It is interesting that Miller cites cultural differences as an element in the U.S.'s superior performance. Most critics of Japan are aware that Japan has its own culture-- that the pursuit of profit is thought of as selfish, that the high value placed on full and stable employment helped legitimate the postwar developmental system, and that the Japanese do not want to change their management system's emphasis on much greater equality of rewards than in the American version. But they rarely seem to understand that for Japan to adopt American practices would require a cultural revolution. John Gray summarizes this problem: "Western prescriptions for Japan's economic problems are an incongruous mixture. Today, as in the past, transnational organizations insist that Japan must restructure its financial and economic institutions according to western-- more precisely, American-- models: the solution to Japan's economic problem is wholesale Americanization. For them, Japan will resolve its economic difficulties only on condition that it cease to be Japanese" (Gray, 1998: 227).

President Clinton: "It's the Economy, Stupid"

A striking feature of these American views is how clouded they are by ideology about the United States itself. There is no recognition whatsoever that the U.S. government during the 1990s was extremely active in promoting the American economy and that a neutral comparison between Japanese and American economic performance would almost surely conclude that Japan had a weak industrial policy and the United States a strong one.

President Clinton, elected in 1992 and reelected in 1996, made the American economy the government's number one priority and restored fiscal discipline to governmental expenditures for the first time in thirty years. He used the resultant surpluses and savings in interest payments on the national debt to invest in education rather than cutting taxes for the rich. He staffed the government with the equivalent of Japan's famous unelected bureaucrats-- men such as Lloyd Bentsen as Treasury secretary; Leon Panetta, a former Congressman with a "passion for deficit reduction" (Klein, 2000: 208), as budget chief; Robert Rubin as head of Clinton's newly created National Economic Council and later as Treasury secretary; Lawrence Summers as Rubin's deputy; and Alan Greenspan as head of the central bank. He pioneered trade agreements with Mexico and China in the face of his own constituents' objections that these would encourage American factories and jobs to move to Mexico or Asia. "Clinton did have one undeniable foreign policy achievement," Joe Klein writes, "he rearranged the traditional priorities, raising economic issues to the same level of importance as strategic affairs" (Klein, 2000: 200). That was also the case in Japan from the end of the occupation in 1952 to approximately 1993.

A concrete example of 1990s U.S. industrial policy-- although the U.S. government would never use that term-- is export subsidies through so-called Foreign Sales Corporations. The United States altered its tax laws to encourage American exporters to set up largely paper presences known as Foreign Sales Corporations in tax havens like Barbados. This allowed an American company to exempt between 15 and 30 percent of its export earnings from taxes on products that it routed through these paper subsidiaries, regardless of whether they were manufactured with American labor or abroad. The European Union objected that these tax breaks were really illegal subsidies and took the case to the World Trade Organization, where it won. The U.S. response was to pass a new law that gives American exporters even more tax relief but that ends the requirement that they channel their products through offshore entities. They now get the tax breaks directly. President Clinton signed the new law on November 16, 2000. The European Union again complained to the WTO, which on June 22, 2001, declared it to be a "prohibited export subsidy" (Alden, 2001; DeFazio, 2000; Meller, 2000).

One obvious explanation for the different performances of the Japanese and American economies during the 1990s is that the Japanese tried to follow American advice too closely while the Americans actually learned from Japan and instituted a pro-growth governmental economic policy. The contrast in policies was great. Whereas the United States ended its budget deficits and began to reduce its huge national debt, the Japanese did precisely the opposite. Pressured by the United States to implement Keynesian policies to stimulate domestic demand, the Japanese government wasted trillions of dollars on unneeded and environmentally destructive construction projects throughout their islands (see McCormack, 1996). The construction industry is also one of the main props of the ruling Liberal Democratic Party. From mid-1998 to the end of 2000, the Japanese government spent $1.4 trillion, the equivalent of the gross national product (GNP) of France, and still could not get its economy to start growing. In 1991, Japan's public sector debt was just over 50 percent of GNP; by the end of 2001 it will be just under 151 percent of GNP, the largest amount ever owed by a developed country in peacetime. It seemed as though Japan was following the United States's 1980s model, with the difference that the U.S. spent its money on worthless armaments whereas Japan spent its money on worthless public works.

This comparison is not entirely fair, however. The U.S. and Japan are not simply the largest and second largest economies on earth; Japan is also a political satellite of the United States. It operates under U.S. military and economic hegemony, which significantly limits its range of options, including its ability to adjust to the turn toward peaceful commerce in China and to peace initiatives on the Korean peninsula undertaken by the Koreans themselves. The key to Japan's challenge to the United States in the 1980s and its decline relative to the United States in the 1990s lies in the old Japanese-American relationship forged in the early days of the Cold War and its persistence long after the conditions that originally justified it had disappeared. Japan's problems are not primarily economic but political.

The Foundations of Japan's Industrial Policies

The possibility of a state being able to implement a successful industrial policy depends upon some precise political arrangements. In attempting to forge an industrial structure that the state believes is necessary for the good of the society as a whole-- one that market forces alone will not produce-- it must prevent what in the jargon of bureaucratic studies is called "agency capture." This refers to the tendency for special interests to bribe, disable, or dominate-- in short, to capture-- the state organs set up to control and direct them in ways that they do not want to go but that the state believes they must.

During the period of Japan's high-speed economic growth, approximately 1955 to 1975, its state organs for formulating and implementing industrial policy, particularly MITI and the Ministry of Finance, achieved exceptional levels of autonomy from vested interests. They also enjoyed high internal esprit de corps and respect from the public. This was possible because of a political structure that the Japanese refer to as the "1955 system." It was the structure of party rule in parliament that came into being in 1955, when the left and right socialists merged to form the Japan Socialist Party (JSP) and the Liberal and Democratic Parties merged to form the Liberal Democratic Party (LDP). The Socialists controlled slightly more than a third of the seats, thereby preventing constitutional amendment by the LDP; and the LDP's majorities provided the political stability which the elite bureaucracy used to make Japan into a rich and powerful nation. The LDP relationship with state officialdom was also enhanced by the fact that from 1957 to 1972, the prime ministers of Japan were all former high-ranking bureaucrats who had entered politics upon retirement.

The LDP and the JSP divided fundamentally over the legitimacy and worth of the military alliance with the United States: the LDP embraced it and the JSP stood for abandoning it in favor of neutralism. But both parties collaborated to an exceptional degree on achieving economic growth and prosperity, including exploiting trade with the United States in order to do so. Because Japanese practice a form of consensus politics, the Socialists always had a voice in setting economic priorities and ensuring equitable distribution of the results of high-speed economic growth. On this point, Ronald Dore quotes a MITI vice-minister from the late 1990s: "Until quite recently, given the parliamentary conventions of compromise established between the LDP and the Socialists, the latter, as the permanent opposition party, had been able to get about 80 percent of what it wanted into policy. But no longer" (Dore, 1999: 88).

Another element that contributed to the autonomy of the industrial policy bureaucracy was the "alliance" with the United States. It eliminated the hopelessly contentious subject of foreign policy from national debate by handing it over to the United States and to the U.S.'s spokesmen within Japan, primarily officials of the Ministry of Foreign Affairs. Fifteen years after the end of the war, the Japanese-American Security Treaty was the most divisive issue in Japan. In 1960, the riots that accompanied its renewal had brought the country to a standstill. In the wake of the ampo toso (Security Treaty struggle), Japan turned decisively toward attempting to become economically powerful and stifled debate about which side it wanted to be on in the Cold War.

It did so because the Japanese-American Security Treaty, which came into being in 1952 and was rewritten and renewed in 1960, was critical to its economic growth. As part of its Cold War grand strategy for containing Soviet and Chinese influence in East Asia, the United States made Japan into a permanent American military base. It asked Japan to tolerate its military bases on the main islands and made Okinawa into a de facto American military colony-- formally until 1972 and implicitly to the present day (there are currently thirty-eight American military bases on Okinawa and a thirty-ninth is planned) (see Johnson, 1999). In order to keep these bases stable and secure, the U.S. had to provide a foreign market for Japanese goods other than its traditional markets in China and elsewhere on the East Asian mainland. The U.S. also supplied funds and covert activities by its Central Intelligence Agency to ensure that the LDP stayed in power uninterruptedly from 1955 to 1993 (see Johnson, Schlei, and Schaller, 2000; Schaller, 1997). The LDP was the institutional link between what the Americans wanted from Japan and what the Japanese wanted from the U.S.

The economic benefits provided to an LDP-led Japan included opening American markets to Japanese imports; sponsoring Japan in international political and economic organizations well before there was any widespread consensus that Japan should be included; allowing the Japanese government to keep Japan and Okinawa closed to direct investment by American companies (see, e.g., Howell, 2000); tolerating high protectionist barriers to the sale of American products in Japan; supporting Japan's policies of licensing technologies from U.S. firms without providing them with the usual protections of intellectual property rights; and encouraging Japan to take advantage of the special relationship with the United States in order to give its people a stake in the Cold War. From 1952 to approximately 1971, the United States extended these benefits to Japan openly and generously. After the "Nixon Shocks" of 1971, it continued the benefits to Japan but did so grudgingly. The United States had become so accustomed to exercising military hegemony in the non-communist areas of East Asia, it could not contemplate the possibility that Japan might demand the return of its military enclaves, even though they were no longer worth what they cost the American economy in lost jobs and distortions to its industrial structure. Despite much fiery anti-Japanese rhetoric during the 1980s and 1990s, the U.S. never abandoned its quasi-colonial position in Japan and when, in 1995, the base structure started to crumble anyway, it moved vigorously to prop up the old relationship (and the LDP).

The End of the Cold War and Its Aftermath

The implosion of the USSR in 1991 eliminated any logic that the Japanese-American military-economic relationship might once have had. But both countries refused to recognize this and pretended that nothing had changed. Since the United States could not get Japan to moderate its economic advantages in the deal, it chose instead to try to get Japan to carry much more of the military burdens of American imperialism in East Asia. It hammered away at the need for "burden-sharing," which ultimately resulted in the so-called omoiyari yosan (sympathy budget) through which Japan pays about $6 billion a year for the upkeep and happiness of the U.S. troops based on its soil. The major test and debacle for burden-sharing was the Gulf War of 1991. Much to the embarrassment of some LDP leaders, Japan refused to join the coalition against Iraq until after the fighting had ended. It then paid some $13 billion to support the war, but only after American leaders had pressured Japan to do so. This contretemps set up the collapse of the LDP in July 1993.

In 1993, the LDP disintegrated because it had lost its only raison d'?tre-- anti-communism-- and its role as a go-between for the Security Treaty. Neither the United States nor the Japanese people any longer felt a need to block the Socialists from power. Ichiro Ozawa, secretary-general of the LDP at the time of the Gulf War, led a motion of no-confidence in the Diet against Prime Minister Kiichi Miyazawa, which succeeded. Part of Ozawa's motivation was his frustration over the LDP's not lending support to the allied coalition in the Gulf War. He wanted Japan to become a genuinely more equal partner with the United States-- what he called a futsu no kuni (an ordinary nation) (see Ozawa, 1994). In the election that followed, the LDP lost its majority in the lower house of the Diet and, for the first time since 1948, a coalition government led by a popular prefectural governor, Morihiro Hosokawa, took power. Amid great hopes among the Japanese people for political and economic reform-- Hosokawa was the most popular prime minister since the populist Kakuei Tanaka in the early 1970s-- it seemed that the post-Cold War era had finally dawned in Japan (for full details, see Jameson, 2000).

But it was not to be. The LDP and the domestic interests it represented (principally farmers, small retailers, the construction industry, and big business) were so traumatized by their loss of a majority that they turned themselves from a pro-business conservative party into a purely preservative organization fighting off assaults against it with every means at their disposal. They no longer much cared about the LDP's chief domestic function-- giving the economic bureaucracy enough autonomy for it to cultivate growth-industries for the future. In fact, the LDP increasingly indulged in "bureaucrat-bashing" in an attempt to shift the blame for the recession. Some of its criticism of the bureaucracy was of course justified in that the failure of the policies that had produced the bubble economy tended to demoralize and unnerve the economic ministries.

Equally important, the United States became alarmed by the Hosokawa government's nationalistic reaction to the Clinton administration's pressure tactics on the economic front and also by signs of an independent spirit in Japan's foreign policy (for example, Japan's post-Gulf War relations with Iran). The leaders of the Pentagon therefore took it upon themselves to herd Japan back into the fold. In February 1995, the Pentagon issued its "Nye Report," named after Joseph Nye, a Harvard professor working for the military, to provide a rationale for its continued "forward deployment" in East Asia. Nye invented any number of threats, particularly "instability," that would erupt if the United States withdrew a single soldier, and he stated that the Pentagon would keep one hundred thousand American troops in Japan and South Korea indefinitely (see Johnson and Keehn, 1995). Only seven months later, these deployments produced precisely the kind of instability they were supposed to prevent. In Okinawa, three American servicemen gang raped a twelve-year-old schoolgirl, setting off the largest protest demonstrations against the United States since the Security Treaty riots of 1960. Changes offered by the American government and military were largely cosmetic, and rebellion against both Tokyo and Washington remains endemic in Okinawa.

In June 1994, a coalition government that had succeeded Hosokawa's was forced to resign and the LDP returned to power, now as the dominant member of its own coalition. The truly startling feature of this government was that the LDP's coalition partner was its old adversary from the "1955 system," the Socialist Party. This was one of the most cynical arrangements of postwar Japanese politics and had the effect of disillusioning virtually the entire electorate with parliamentary politics (see, e.g., Tamamoto, 2000). The Socialists, desperate to participate in government before they became totally irrelevant, compromised every principle they had ever stood for; and the LDP accommodated them in return for their votes by allowing the head of the Socialist Party, Tomiichi Murayama, to occupy the prime minister's seat as the LDP's puppet.

In January 1996, Murayama was replaced by a genuine LDP faction leader, Ryutaro Hashimoto, who held on, doing nothing to revive the economy, until July 1998, when the LDP suffered a decisive defeat in elections for the upper house. Keizo Obuchi replaced Hashimoto until Obuchi's sudden death in April 2000, whereupon LDP leaders, meeting secretly, chose Yoshiro Mori as prime minister. None of these prime ministers offered leadership on any front. They devoted themselves instead to placating the LDP's traditional sources of money and votes. Typical was the meeting of November 27, 2000, at party headquarters between the secretary-general and the chairman of the LDP's Policy Research Council and officials from MOF, the Financial Services Agency, the Economic Planning Agency, and the Bank of Japan. The LDP executives asked the government officials to issue "administrative guidance" to keep banks from selling mutually held shares of the keiretsu, thereby directly countering measures that the bureaucracy wanted to implement in order to begin a long-delayed reform of the economic structure. So far from guaranteeing the bureaucracy's autonomy, the LDP was more interested in protecting the short-term interests of its financial backers.

What Really Failed in Japan in the 1990s

Many American analysts argue that the developmental state and the prominent role it gives the state in shaping a nation's economic destiny is what caused Japan's decade-long slowdown and the catastrophe that overwhelmed South Korea and Southeast Asia in 1997. The evidence suggests precisely the opposite. Japan was not overregulated but underregulated and its capacity to formulate good policies and implement them was undercut by political factors. The country's problems began in the late 1980s when the Ministry of Finance exercised weak or nonexistent supervision over its chief clients, the banks, in their irresponsible lending to speculators. Japan's subsequent failure to undertake serious reforms during the 1990s was not caused by the economic bureaucracy's intervention in the economy but by the economic bureaucracy's loss of autonomy to implement policies in the face of vested interests. The LDP remains the problem. It can no longer play its assigned role within the developmental state, but it is artificially perpetuated in power by the demands of the old Cold War relationship. The LDP is the only Japanese political party sufficiently indifferent to the suffering and humiliation of the Okinawans (and other Japanese living near the U.S. bases) to act as the United States's agent within the country. Unfortunately for Japan, the United States has been more interested in keeping Japan as a docile satellite and discrediting it as an economic alternative to the U.S. than it is in allowing the LDP to pass from the scene and letting political decision-making return to the Japanese people. Despite mountains of propaganda trying to show that the 1997 Asian economic meltdown was the fault of bad economics, the World Bank's former chief economist, Joseph Stiglitz, concluded, "The scapegoat was overregulation; the real culprit was lax oversight" (Stiglitz, 1997). That was also precisely the situation in Japan. What is needed for all of East Asia is an end to American hegemony, the development of a political system in Japan that actually brings genuine leaders to power, and the restoration of industrial policy to its proper place in these societies that pioneered and perfected its use.

CHALMERS JOHNSON is president of the Japan Policy Research Institute. His latest books are Okinawa: Cold War Island (Japan Policy Research Institute, 1999), editor and contributor; Blowback: The Costs and Consequences of American Empire (Holt Metropolitan Books, 2000); and "Special Issue on Dysfunctional Japan: At Home and In the World," Asian Perspective 24(4)(2000): 1-334, editor and contributor. This paper was first published in Thesis Eleven, No. 66, August 2001, pp. 59-81. Copyright © Sage Publications, London.


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