Japan's Secret

What explains Japan's success in the international marketplace? Hint: "industrial policy" is not the right answer.

Japan-bashing seems to be America's favorite sport these days. Once viewed as a nation of purposeful, innovative, hard-working people, Japan has become something of an economic pariah. By now we all know the familiar protectionist litany by heart: Japan takes "unfair" trading advantage of the United States through "sweatshop" wages, direct subsidies, import restrictions, an undervalued yen, and other predatory economic policies.

So much of the protectionist prattle is just downright nonsense that it's hard to know where to begin setting the record straight. Today, 40 years after World War II ended at Hiroshima and Nagasaki, Japanese wages have reached a level that is comparable to, or higher than, those of most industrialized nations of the West. Direct subsidies to manufacturing industries from the Japanese government are nonexistent. Japan's average level of import duties on foreign-made goods compares very favorably with those of the European countries and the United States. Only foodstuffs and a few minor categories of manufactured items remain covered by quantitative import controls. And the Japanese yen has appreciated more than 30 percent since 1971 under the system of floating exchange rates.

Nonetheless, as the US bilateral trade deficit with Japan increases (from $37 billion to $50 billion over the last year), the criticisms of Japan are intensifying. The newest bipartisan bogeyman is Japanese "industrial policy."

Popular Democratic economist Lester C. Thurow claims that "Japan is marked by a degree of central investment planning and government control that would make any good capitalist cry." Reagan trade advisor Lionel H. Olmer tells National Journal that "government-directed industrial policy and how it affects Japanese performance in the United States is more important than the openness of the Japanese markets." University of California professor Chalmers Johnson asserts that "central to an understanding of Japan's 'miracle'…is the role of the Ministry of International Trade and Industry (MITI)." From left and right, industrial policy paranoia has swept the political community.

Once the existence of a Japanese industrial policy has been "proved," usually by adducing brief, anecdotal evidence, these analysts get to the point. To wit: If American firms are to compete in world markets, the US government must assume a similar, major role in directing and protecting this nation's economy. To compete with Japan, the argument goes, we need an American industrial policy.

But the trouble with this supermyth about Japan's government-directed success is the trouble with all myths—it just ain't so.

MYTH: Japan is marked by a degree of government control that "would make any good capitalist cry."

FACT: During the 1960s, when the Japanese economy was growing fastest among all industrialized nations at a rate of nearly 10 percent per year, Japanese government spending was 19 percent of Japan's gross national product (GNP)—smallest among industrialized nations. Though government spending sharply increased during the 1970s due to costly social welfare programs, the ratio of government spending to GNP—now 26 percent—is still lower than that of France (42 percent), West Germany (37 percent), the United Kingdom (36 percent), and even the United States (30 percent).

MYTH: The Japanese government funds and directs most of that nation's research and development.

FACT: The government's share of gross research and development expenditure is 28 percent in Japan—compared to 58 percent in France and 48 percent in the United Kingdom and the United States.

MYTH: The Japanese government owns and operates many of the most profitable firms in the Land of the Rising Sun.

FACT: State ownership of enterprises is very limited in Japan. The Japanese government does not own any manufacturing industries. In Europe, by contrast, almost all governments own and operate some major manufacturing industries, from Renault in France to British Leyland.

It is true that the Japanese government has targeted certain industries with public money—but not those industries you might assume. Agriculture, for example, is heavily subsidized, just as in the United States. Because food was scarce in the postwar period and more than 50 percent of the Japanese population was engaged in agriculture, the government involved itself in the farming business as never before. Once in, never out. Today, Japanese farmers receive more than $10 billion a year in direct financial subsidies—about the same amount the government spends on defense. (The US government spent more than $50 billion on agricultural price supports from 1981 to 1985.)

Other politically powerful groups have benefitted from government assistance, among them the national railway system, ports, roads, airports, and the panoply of so-called infrastructure projects.

With all these influential interest groups scrapping for government assistance (Japan's National Railway alone accounts for 18 percent of the government's annual budget), precious little has been left for direct financial support to the manufacturing sector. The vaunted MITI, the central icon in the temple of industrial policy worship, received only 1.6 percent of the government budget last year.

It is true that MITI has targeted certain industries with Japan Development Bank (JDB) funds—but again, not those industries assumed by the American public. Until the early 1970s, the majority of JDB's low-interest loans went to the shipping industry and various energy-related industries such as coal mining, nuclear power plants, and oil refineries. Over the last decade the JDB has switched its emphasis toward investing in environmental quality control and urban and regional development.

And what has mighty MITI wrought? The agricultural and coal-mining industries, which are the most heavily subsidized by the government, are by far the most inefficient industries in Japan. Other industries dependent on government largesse—for example petroleum refining, petrochemical, and shipbuilding—are unable to compete in the international market. More than a few companies are nearly bankrupt.

So there you have the miracle of Japanese industrial policy. It has helped create inefficiency in one of the most robust economies in the world!

In stark contrast to the feeble above-mentioned industries, Japan's most successful and internationally competitive industries have received almost no financial help and little protection from the government. This is true right down the line—for iron and steel, computers, and automobiles, all of which are often cited as shining examples of the blessings of Japanese "industrial policy."

The steel industry, for example, received less than one percent of the JDB loans from 1951 to 1972—or half the assistance received by the hotel business during the same period. Similarly, the Japanese government's R&D expenditures in the semiconductor field have been vastly overstated. According to the authoritative Journal of Japanese Trade and Industry, Japan spent $127 million on semiconductor research and development from 1975 to 1982. The US government, by comparison, allocated $279 million on semiconductor R&D over the shorter 1978–82 period.

And the fantastically successful automobile and consumer electronics industries, objects of such venom from American trade protectionists, have enjoyed virtually no special favors from the government.

Yes, government officials in Japan do engage in an extraordinary amount of consultation, communication, and discussion with business groups. However, this does not mean that the tens of thousands of Japanese entrepreneurs and corporate executives invest their capital, hire their workers, select new technologies, or adopt new marketing strategies after consulting omniscient Japanese bureaucrats. Nor do they operate their businesses according to any government vision or guidance.

Japanese entrepreneurs know that government officials do not possess any superior knowledge of the workings of the market. Contrary to popular impression, most private businessmen are suspicious of government authority and go to great lengths to avoid bureaucratic meddling and proffered assistance. For example, in the early 1960s, MITI was concerned about the lack of competitiveness in the automobile industry. Their answer—consolidate many automobile companies into just a few large companies. Only strong resistance by Mazda, Honda, Mitsubishi, and others scotched MITI's plans.

How, if not by activist government policy, has Japan accomplished its phenomenal economic growth since World War II? Though political scientists and industrial-policy groupies prefer to cast about for a statist explanation, the real savior has been the new market economy. The key to Japan's great postwar success has been the unleashing of creative and dynamic forces brought on by the destruction of the old order and the emergence of a new one. The Japanese after World War II gained a freer and more democratic social and political environment permitting them, as individuals, to maximize their energy, talents, and ideas. They have taken advantage of these new opportunities, not unlike the American immigrants earlier in this century. Freedom is invigorating Japan's traditional feudal society, which discouraged the bold and creative individual, has collapsed. The Japanese today enjoy unprecedented individual freedom: the freedom to engage in the occupation of one's choice, freedom of speech, freedom of investment and pricing, and the freedom to take chances. Individuals may use their capital and talents as they choose.

Under the postwar American occupation, many of Japan's old leaders were purged and the old order was reformed. Cartels, such as Zaibatsu, were dissolved and private businesses were substantially freed of government control and intervention. For the first time, practically any Japanese citizen, regardless of age, class, or family background, could venture into business and succeed if the elements of hard work, imagination, willingness to take risks, and luck were present. Established businesses prospered under fresh young management, and thousands of entirely new enterprises—Honda, Yamaha, Sony, and Suzuki, to name a few—were born in this new climate of freedom.

Literally hundreds of thousands of small businessmen and entrepreneurs invested in capital goods and equipment. Not because some MITI bureaucrat suggested it after gazing into a crystal ball, but because they sensed opportunity in a newly freed society. These small businesses—860,000 companies, or 99.5 percent of the nation's manufacturers, employ fewer than 300 workers—are the wellspring of Japan's economic vitality.

Of course, other factors have contributed to Japan's economic miracle. Inexpensive raw materials (especially petroleum), stable and open world markets for Japanese goods, and readily available foreign technology have played no small part. But these propitious conditions were not created by the Japanese government or even the fabled MITI.

Rather, Japan's success in international markets is testament to the work of thousands of private firms and individuals operating in a free environment. These private firms aggressively entered world markets as importers of raw materials, exporters of Japanese products, and negotiators for advanced technologies and know-how. Vigorous private traders, not state officials, are the heroes of Japan's economic rebirth.

Just as heroic is Japan's abundant and well-educated labor force. Much has been written in its praise—Japanese workers are said to be disciplined, hardworking, readily adaptable to new technologies, and both willing and able to help management develop new ideas and techniques. All true. But there is another quality, less-heralded but vitally important to a strong economy: Japanese workers save their money.

The average Japanese worker saves approximately 20 percent of his income. The reason for all this saving is, again, the fresh air of freedom. The postwar environment is such that millions of individuals, regardless of social background and lineage, can rise in society by virtue of their own efforts.

Competition for advancement is fierce, and those who acquire an education of the highest possible quality have the best chance to get ahead. Most parents are willing to pay the high price of preparing their children for the entrance examinations to Japan's finest universities. Because such preparation is expensive, they tend to put away regularly a large portion of their income for their children's future and in doing so ensure an educated workforce and a healthy level of national savings.

A second motive for saving is the "inadequacy" of the Japanese welfare state. Relatively low government expenditures on social welfare programs encourage individuals and families in Japan to provide for their own security after retirement and in the event of illness or unemployment.

The lack of an overweening welfare state helps explain the exceptional loyalty workers feel toward their employers. Workers know very well that their present and future well-being depends on their company's success in competing in what are usually highly competitive markets. Consequently, they eagerly contribute their energies to the corporation and willingly focus on long-term benefits rather than short-term gains from labor negotiation.

There is a final factor critical to Japan's amazing growth. Since the early 1950s (when "Made in Japan" was still an epithet), Japanese entrepreneurs have been firmly committed to quality control. American experts in statistical quality control, most notably Dr. W. Edwards Deming, have been far more influential in the top management circles of Japanese manufacturing firms than with US firms. In fact, for over 25 years the annual "Deming Prize," awarded to the companies with the best quality control records, has been one of the most prestigious and sought-after industrial awards in Japan.

This commitment to quality control by both management and labor has had profound ramifications. When companies selling consumer or industrial goods adopt strict quality control requirements, suppliers to those companies must adopt similar exacting specifications. As a result, quality control is common practice in Japan and is now even being touted in the United States.

This near-fanatical commitment to productivity and quality control by Japanese entrepreneurs is a main reason why Japanese manufacturing goods are still competitive in the international market. It also may explain why Japan has a trade surplus today despite its almost total dependence on imported OPEC oil.

The protectionists and industrial policy enthusiasts are right about one thing—the Japanese government has contributed to the nation's enormous postwar success. But it has contributed not by action but by inaction. Its interference in the economy has been sporadic and slight.

In a market-oriented economy like Japan's, government support in the form of subsidies to targeted industries is rarely an ingredient vital to the nation's economic growth. History reveals an unblemished record of failure by governments to improve on the workings of the free market. Japan's economic success over the past 30 years owes nothing to government interference and everything to the genius of free men and women. Let us hope that American policy-makers draw the correct lesson.

Katsuro Sakoh is a senior policy analyst at the Heritage Foundation. Parts of this article were drawn from an earlier paper published in the Cato Journal (Fall 1984).