Japanese Voters Seek Change as Their Economy Deteriorates: New Prime Minister Vows to Break Political Logjam

The Conflict

Japan's economy, which had achieved an almost miraculous rise in the decades after World War II, has been in a prolonged period of slow or no growth since the early 1990s. Some of the same factors that led to its success have led to its failures, particularly the close ties between government and business and the conglomerates of businesses that defy open competition on the market. To correct the situation, the voters have elected a reformer, Koizumi Junichiro. His administration is faced with the daunting task of shutting down the crony system that is carrying some of Japan's financial institutions and businesses in order to, in the long term, make Japan over into a free market economy. It promises to be a painful process, with Japan's entire economy, at least in the short-term, in grave jeopardy.

Political

• In order to reform the economy, Koizumi will have to defy long honored traditions and an old guard in Japan that is used to taking care of its own. Reforms could also result in huge layoffs and the demise of small businesses. It could be difficult to rely even on those who elected him president hoping for reform, if those very reforms further destabilize the Japanese economy.

Economic

• Japan's national deficit now stands at 1.3 times the amount of its gross domestic product. Banks are burdened with more than a trillion dollars worth of bad loans, and normal lending can no longer carry on. The Japanese people, lacking confidence in their economy, are saving their money. In order to clear the way for growth in Japan's economy, its very foundations will have to be shaken.

When the wildly popular prime minister of Japan, Koizumi Junichiro, was elected in April 2001 he promised the Japanese people that he would once and for all rescue the country's ailing economy, then going into its second decade of slow or negative growth. In stark contrast to the soothing but meaningless assurances of previous leaders, Koizumi repeated that the reforms necessary to rescue the economy from its ten years of stagnant performance would require deep sacrifices by everyone. Voters applauded Koizumi's fresh candor and said they were willing to accept such sacrifices. But the wealthy businessmen and old guard politicians to whom they're beholden may very well stymie Koizumi's good intentions.

Koizumi, who is known familiarly as Junchan, knew all of this, and yet he seemed determined to push ahead and implement the necessary reforms. This made him the most popular leader in 30 years, even though he admitted that Japan's economic situation would get worse—a lot worse—before it got better. "No pain, no gain," he told the Japanese public. Even so, expectations were high. It was those entrenched party bosses Koizumi would have to fight. And it could get nasty. The question was, could Koizumi do it?

Time was not on his side. As of September 2001, the $5.6 trillion public debt was nearly 130 percent of the gross domestic product (GDP, the total value of all goods and services), the highest ratio in the industrialized world. Nonperforming loans, at one time over $250 billion worth, continued to drive down banks' balance sheets. Nonperforming loans are loans that are not being paid back. Fear that the state pension program might not be solvent drastically cut consumer spending. Unemployment remained near record highs, officially around five percent but more likely double that. Bankruptcies kept on rising. In addition, in mid-September 2001 the Tokyo stock exchange fell to its lowest point since 1984.

All of this led Moody's, the U.S. credit-rating agency, to judge Japan's credit as risky as Portugal's. In its Global Trends 2015 report, the U.S.

Central Intelligence Agency (CIA) predicted that Japan would have "difficulty maintaining its current position as the world's third largest economy [after the United States and Europe]," to be replaced by China. In contrast, as recently as 1990 Japan was the world's second largest economy and fast gaining on the United States.

Everyone knew what had to be done. Big banks, long tied to the government's apron strings through receiving virtually interest-free loans, would have to be allowed to go bankrupt when their outstanding loans no longer performed satisfactorily. The Japanese farmers—long pampered by powerful politicians who lobbied to keep out foreign agricultural imports—had come to grow the most expensive rice in the world. Clearly they would have to compete with world markets. And the umbilical cord between inefficient public-works construction companies and entrenched bureaucrats who provide funds for building highways that go nowhere needed to be cut. In other words, Japan had to stop doing "business as usual."

Unless and until Japan is able to deal satisfactorily with these and other problems (such as the rapidly aging population, which will go from a 4:1 to a 2:1 ratio of workers to retirees by 2025), this once leading economy will continue to deteriorate and possibly pull down all of Asia with its implosion. American and European officials are holding their breath in hopes that the world's number two powerhouse won't create a world depression. There has been no shortage of advice and promises of support from abroad, but the problem was Japanese, and only Japan could solve it. Koizumi needed to pull off a tough balancing act between a popular desire for change and the vested interests in his party and the bureaucracy.

Historical Background

The Meiji Challenge

For more than 200 years, beginning in the early seventeenth century when the new shogun (a military dictator), Tokugawa Ieyasu, proclaimed a new dynasty, Japan purposely locked itself away and refused any contact with outsiders in the hope that this would assure a peaceful and stable country. The plan seemed to work: during most of that time Japan was relatively free of conflict. The problem lay in the fact that Asia was being picked apart by Western imperialist powers engaging in a very lucrative trade there. It was only a matter of time before Japan would begin to feel the pressure to open up. By the mid-nineteenth century the foreigners were knocking on her door, threatening to break it down.

On the afternoon of July 8, 1853, American Commodore Matthew Perry's flotilla of four ships steamed into Tokyo Bay and demanded that the Tokugawa leaders trade with the United States. The Japanese found themselves in a dilemma. In order to open up, the policy of sakoku, or self-imposed isolation, had to be changed and to change that policy required the emperor's agreement. When the de facto ruler of Japan, the shogun of the Tokugawa clan, explained that he could never stand up to American naval firepower, he was rebuffed by His Majesty the emperor. This left the shogun in an impossible situation: he could not oppose both the emperor and the Americans. Japan resisted, but America insisted. Perry said that he'd be back in six months for an answer.

When Perry did return early in 1854 the shogun could not but give in to a superior power and signed the Treaty of Kanagawa. This gave the Americans certain preferential rights in Japan, including the opening of two ports to trade, the guarantee of low customs duties, and the principle of extraterritoriality by which U.S. residents in Japan were subject to American, not Japanese, law. This accommodation was seen correctly by the Japanese as a humiliating concession. Even worse was the fact that the treaty had been signed against the emperor's wishes. This opened the door for anti-Tokugawa forces to take the upper hand.

After several years of civil war between proand anti-Tokugawa samurai (elite warriors), in 1868 the shogun was ousted by a coalition led by the Satsuma and Choshu clans, two groups that had long harbored anti-Tokugawa sentiment. But instead of putting themselves in power, they enthroned the young emperor. Under the slogan of sono joi ("revere the emperor and expel the barbarian") they proclaimed him the true leader of Japan, rather than the figurehead that all emperors under the Tokugawa dynasty had been. It must be noted, however, that this was only a pretext. Those who elevated the emperor made sure that they controlled his seals and in fact ruled in his name. The period of his reign was dubbed Meiji, "Enlightened Rule."

From the fall of the Tokugawa in 1868 until 1890, when a new constitution was put into effect, Japan would experience a thoroughgoing restoration that laid the foundation for the political-commercial relationships that are today besetting the nation. Having learned to appreciate the superior weaponry of the Westerners, Japan's young revolutionaries agreed that it was better to learn from them than be annihilated by them. As one samurai put it: "We have swords but they have cannons; they'll mow us down!"

In order to resist the Western powers and to assure that Japan not be colonized by them as Southeast Asia had been—or carved up into concessions as China had been—Japanese leaders knew they had to strengthen the country. Under the slogan fukoku kyohei ("rich country, strong military") they set about to create a favorable climate for economic growth as well as to build a powerful army and navy.

From the outset the government played a prominent role in Japan's economic development by first creating a financial and educational framework, and then a technological physical infrastructure. A system of universal education was adopted, patterned after the French and American forms. Japan was the first country in the world to implement mandatory schooling. A national banking system was implemented, and the tax system standardized. The government took the lead in building shipyards, mines, armories, textile mills, railways, and telegraph communications. It did all of these things with foreign loans and government subsidies, and relied on foreign advisers and technicians to train ex-samurai warriors until the advisors could be replaced by skilled Japanese.

By the 1880s the government had run out of money. Inflation, a trade deficit, and overextended capital expenditures had depleted the treasury. In order to continue the building program and to further the economy, the government auctioned off most of its enterprises to private businessmen, usually friends of government leaders, at bargain prices. Buying these businesses at steep discounts and then doing business with the government led to the appearance of huge industrial-financial combines known as zaibatsu, the core of the Japanese economy until the end of World War II (1939-45). By the end of the nineteenth century the association of business with government became the dominant characteristic of Japan's commerce and trade.

A zaibatsu, a business combine or cartel, was more than just an enormous business enterprise. It was a network of corporate alliances of various manufacturers organized around a common bank and trading company called a sogo shosha. It wasn't a single business but a group of separate companies, each of which owned parts of the others through interlocking shares, all of which were financed by their central bank. A zaibatsu, such as Mitsubishi, Mitsui, or Sumitomo, might have controlled a railroad, a shipping line, coalmines, department stores, a construction company, a trading firm, and above all a central bank. It is as if the Bank of America also controlled General Motors, American President Lines, Alcoa copper mines, the Union and Pacific Railroad, and K-Mart.

From the end of the Meiji period, which ended in 1912 with the death of the emperor, until the late 1930s Japan refined and solidified its industrial structure. The partnership between government and business epitomized by close collaboration between state officials and corporate elites continued to develop into what has come to be known as a "developmental state" or more colloquially, "state-guided capitalism." This describes neither a capitalist economy, where there is a relative separation of government and business in favor of market-driven forces, nor a command economy, wherein the government controls all factors of production.

According to Japanese specialist Chalmers Johnson, who is credited with coining the phrase, the "capitalist developmental state" combined private ownership of property with goals set by the state. The government did not displace the market as it does under socialism, but the bureaucrats created incentives for businesses to operate in the market. In other words, according to Johnson, as quoted in Mark Borthwick's Pacific Century: The Emergence of Modern Pacific Asia and paraphrased here, the government blurred the public and private sectors to the point that achievements of privately owned and managed enterprises were regarded as national achievements, but any profit that resulted was treated as private property.

This incestuous old-boy network helped to prolong Japan's war effort during World War II (1939-45). The great zaibatsu were the core of the armament industry and turned out everything from rifles and hand grenades to bombers and battleships. These giant business cartels were not the primary reason for the war, they weren't responsible for its onset, but they almost certainly enabled the Japanese military machine to carry on as brutally and as long as it did.

The Occupation: MacArthur's Free Market Vision

The United States believed that the ultra-nationalist leaders of Japan had been responsible for the war with their aggressive policies that had cost so much loss of life and destruction throughout Asia. The Occupation forces, primarily U.S. forces overseeing Japan's surrender, therefore decided to render the Japanese military state unable to wage war ever again. The way to assure this was to destroy the very foundation of the war-making machinery. The United States intended to impose its own form of democracy—and its economic concomitant, free-market capitalism—on the defunct Japanese fascist government. This meant that market forces, not government-business cronyism, were to direct the economy.

It was with that in mind that U.S. Army General Douglas MacArthur, otherwise known as Supreme Commander of the Allied Powers (SCAP), the head of the Allied Occupation of Japan from 1945 to 1952, set out to break the zaibatsu, whom MacArthur referred to as "merchants of death," and put its leaders behind bars. In what came to be known as "the purge," some 200,000 "warmongers"—government officials, military officers, business leaders, even teachers and academics—were accused of carrying out Japan's aggressive policies. They were removed from their positions and barred from returning to their former stations; many were also imprisoned. In addition, MacArthur ordered that all zaibatsu be dismantled and abolished and replaced by small business and light industry.

The shares of these multi-industrial combines were placed on the open market, forcing the components of each combine to carry on as independent companies. A newly enacted anti-monopoly law prohibited all cartel activities. Japan was suddenly a country of cottage industries and corner manufacturing plants that catered to the needs of the time, primarily providing inexpensive consumer items. Neither U.S. nor Japanese visionaries saw any need for large-scale projects, at least for the near future.

In addition, in his design to democratize Japan MacArthur released from prison all political prisoners. Many of these prisoners were members of the outlawed Japan Communist Party, the only major group that had consistently opposed the militarists. Others were labor leaders, many of whom were also communists. Immediately they began to organize unions to assure that business management would meet their demands.

This resurgence of union activity quickly led to a growing conflict between labor and business. The political left soon gained influence over the workers' movement and demanded better pay and work conditions. The leftist militants wanted far more than higher wages. They sought worker control of the factories and real political power. In May 1947 a union coalition called for a nationwide general strike. The response was overwhelming: more than five million workers pledged to stay away from their jobs in a total work stoppage that would paralyze the entire country, which is exactly what the unions hoped for.

MacArthur was forced to intervene just hours before the strike was due to begin. According to John Hunter Boyle in his book Modern Japan: The American Nexus, a communiqué from MacArthur's headquarters flatly forbade any action on the grounds that "the paralysis … would produce dreadful consequences upon every Japanese home." MacArthur had had in mind a moderate labor union activity, not communist-led nationwide strikes that threatened chaos.

The Cold War Influence on American Policy in Japan

By 1948 the Occupation was facing two growing problems. The fear of an increasing Communist presence in Japan's labor movement was paralleling the ominous signals emanating from both the Soviet Union and China, where the beleaguered Nationalist Party of Chiang Kai-shek (or Jiang Jeshi) was daily losing ground to Mao Zedong's communists. Related to this was a second problem: the dissolution of the zaibatsu had removed the very concentration of power that provided the foundation upon which to build an economy and create jobs. It would simply take too long for a nation of small businesses to develop to that point; in the meantime labor, and the communists, were losing patience.

Several factors prompted the United States to concentrate on reviving the Japanese economy rather than reforming it, that is, making it over into a free-market capitalist economy. The most obvious was the deteriorating state of the economy. Three years into the Occupation, industry remained stagnant and production was below even that of the 1930s. Moreover, such a wretched economy created labor unrest and runaway inflation. This led to a flourishing black market that brought on crime, corruption, and demoralization. A third problem was that the United States was paying for most of Japan's economic activity, a burdensome relief expense that showed no signs of abating. American Congressmen worried about how long U.S. taxpayers would have to foot the bill.

What was soon seen as the most important issue in Japan's unsteady situation was the onset of the Cold War in Europe and the rising tide of communism in China. Washington's Far East policy had been pinned on a stable and prosperous noncommunist China, a "strategic anchor" in the Pacific. But by mid-1949 Mao Zedong's communist armies had swept Chiang's Nationalist troops from the mainland to their exile on the island of Taiwan. When Mao stood at the rostrum in Tiananmen Square in October and proclaimed the new People's Republic of China, America's foreign policy abruptly shifted gears. The United States needed a strong ally to replace the defeated Chinese Nationalists. Japan would become that ally—the centerpiece of resistance to communism in Asia.

Led by Cold War diplomat George Kennan, many conservative U.S. officials wondered if MacArthur had not taken Japan too far to the left in trying to implement a capitalist democracy. Kennan and his ilk were all for building up Japan in order to "immunize" the region against communism, just as the United States was building up Germany in Europe as a bulwark against a rising Soviet Marxism there. To them it seemed the only thing to do was to resurrect the zaibatsu and rebuild the economy as quickly as possible lest it become a hotbed of communist activity attracting poor and unemployed workers.

MacArthur strongly disagreed. According to Walter LaFeber in The Clash: U.S.-Japanese Relations throughout History, MacArthur saw his conflict with Kennan as one "between a system of free competitive enterprise … and a socialism in private hands." But backed by a group of Old Japan Hands known as the "Japan Lobby," Kennan's position held the day. The Japan Lobby pressured Truman and the Congress, in a move known as the "reverse course," to turn Japan around by allowing the former zaibatsu to recover their holdings. Conservative Washington officials argued that Japan needed the infrastructure that the zaibatsu could provide in order to finance construction and provide employment. Their dissolution, says Boyle, came to be seen as a dead end and "nothing less than a declaration of war on capitalism." In the end only nine of the more than a hundred businesses slated to be dismantled were in fact dissolved.

The reverse course may have solved the political issue of communist influence, but it failed to address the growing problem of inflation. Expensive war reparation payments and poor currency controls caused severe stagnation in the Japanese economy. In order to jump-start the new economy, Washington sent Detroit banker Joseph Dodge to Japan with instructions to halt the inflation, remove government controls on trade, and revitalize the economy. The measures he proposed were draconian: balance the budget, end government subsidies, and fix the exchange rate for the yen. Inflation was stopped but Japan was plunged into recession and labor unrest grew.

The Korean War Lifts the Economy

It began to appear that Dodge's cure was worse than the disease as the economy continued to spiral downward and more people were put out of work. But suddenly Japan received a "gift from the gods." In June 1950 the Korean War (1950-53) broke out. This proved to be a tremendous shot in the arm for the floundering Japanese economy because nearly US$3 billion worth of goods and supplies were contracted by the American government—equal to two-thirds of all Japanese exports during the early 1950s—in what was called the "procurement boom" (tokuju bumu).

How important was this? The following example from Boyle is instructive. The president of a Japanese company that made gunnysacks was invited by the U.S. Army Procurement Office to stop by for contract talks just after the Korean War began. The officer in charge informed the company president that the army needed all of the gunnysacks the company had, whether they were new or not. The company, barely managing an existence prior to this by making sacks for rice, jumped at the opportunity, which ultimately netted them an order for more than 200 million sacks.

Japanese companies lost no time in exploiting this wonderful opportunity. They modernized and expanded production, employing the excess labor and stabilizing the economy well beyond the end of the war. By 1952 the conflict accounted for more than 60 percent of all Japanese exports. The Korean War proved to be an unexpected windfall for the Japanese economy, just as the Vietnam War would be 15 years later.

From Zaibatsu to Keiretsu

The Allied Occupation of Japan ended in 1952, and the Japanese government quickly took steps to support industrial reconstruction. For instance, government-funded banks supplied state funds to strategic industries in long-term, low-interest loans. The government also gave priority to heavy industry such as electric power, coal, shipping, and steel, over light industries. One of the biggest changes was to modify the anti-monopoly laws to allow the formation of cartels and to permit companies to hold inter-locking shares. This was the final step in the comeback of the zaibatsu, although in the post-war reorganization they became known as keiretsu, or "linked chain."

The links were very tight, indeed. Vera Simone, in her book The Asian Pacific: Political and Economic Development in a Global Context has shown how each group (not company) in a keiretsu is itself a network of corporate alliances organized around a single bank and trading company. Each group exercises control over its subsidiaries through its monopoly of credit. Take, for example, Sumitomo, which is not a single manufacturer but a group of distinct companies. Each of these companies owns parts of the others through mutual share-holding. They also do business with each other rather than with outsiders. Just as important are their relations with subcontractors, the companies that make parts for the keiretsu groups' products. These relations are not contractually based on competitive pricing. Instead, the individual enterprises in a keiretsu incorporate suppliers and subcontractors into the network based on loyalty and personal relationships. This means that in return for the keiretsu guaranteeing to contract with a certain supplier because of personal relations, that supplier will provide a part at an agreed-upon price outside the normal rules of free-market competition.

Borthwick explains that because keiretsu shares are not publicly traded but instead held by other companies in the link, they are not subject to the opinions of small or foreign shareholders. This means that the keiretsu companies can, and do, cooperate (Western free-marketers might prefer the word "collude") to leverage and dominate buying and selling their products and thereby overwhelm any "go it alone" small firms. In other words, they have changed the rules of free competition.

Given this situation it should be obvious that the Japanese business world does not operate in a competitive environment. It never has. How, then, did Japan manage to do so well beginning in the 1950s and continue without a break for over 30 years to create such a powerful economy? And how does all this relate to Koizumi Junichiro? There are as many answers to this as there are experts to answer it. Setting aside any arguments about how "unique" the Japanese are, Japan's former success and its current malaise rest on three major factors: technology transfer, export markets, and the corporate-government relationship.

Technology Transfer

Recall that the United States and its allies saw Japan as the new anti-communist bulwark in Asia after the communists took over China. At that time, in the late 1940s and 1950s, the United States' economy was clearly number one. There was no question about this, and there was no competition to concern her. Therefore, the United States' largesse rolled long and strong to any government that professed to be anti-communist, especially to Japan, its hand-picked Asian ally.

In this enthusiastic and patronizing environment the United States was only too happy to provide the new technologies that Japan needed for its industrial development, technologies that were being advanced primarily in America. By the 1950s Japan was catching up with other advanced countries by importing the innovations and knowhow already developed in the United States. This cheap or even free access to key American technologies was an essential ingredient in Japan's economic resurgence. Chalmers Johnson, however, argues that we miss the point if we think that Japan's acquisition at low cost of Western technologies was a "free ride." In fact, it was the heart of the matter. Technology transfer was for Japan a central component of its postwar industrial policy. Had it not been for this technology transfer, companies such as Kawasaki Steel, Matsushita Electric, and the Sony Corporation would likely have had a much more difficult time of building their businesses, and may have never gotten off the ground at all.

The World Export Market

Another instrumental factor in Japan's miraculous economic rise was the world export market, primarily that of the United States. Many countries, especially those in Asia, have developed their economies in a similar process. Following World War II most manufacturing plants in Asia were destroyed and many Asian countries were forced to import the majority of their products until they were able to begin producing some of their own.

This stage of "import substitution" enabled these countries, including Japan, to substitute some of their own manufactures for those that might otherwise have to be brought in from outside, thus saving a good deal of hard currency. As the economies grew to a higher level of technology, they were able to produce more items for export. "Export oriented" economies are those that have reached a mature level whereby their economy is able to produce goods to be consumed by other countries. This not only saves money at home, it earns profits through the exports.

And so it was with Japan. The economy shifted from the high tariffs of its import-substitution policies to lower tariffs that promoted exports of labor-intensive manufactured goods. This led eventually to the production of electronic equipment such as TVs, radios, and VCRs. By the time other Asian countries were starting to compete at this level, the Japanese moved on to high-tech information equipment. But because Japan was the leader, all the other economies were to various degrees dependent on Japanese imports (of both technology and capital). This turned into what has become known as the "flying geese" formation, with Japan as the lead goose and the other developing Asian economies ranked behind it in a spreading "V" of decreasing levels of technical sophistication. For instance, Walter LaFeber has shown in The Clash: U.S.-Japanese Relationsthroughout History that as Japan moved into cutting-edge, profitable electronics at home, it passed auto and steel production down to lower-waged countries, such as Taiwan and South Korea.

The Relationship between Business and Government

Following technology transfer and an export-oriented economy, a third factor also accounts for Japan's phenomenal economic growth—what is at the very core of her success and what accounts for her problems today. This is the special relationship between big business, party officials, and government bureaucrats.

Nearly 20 years ago in his landmark study of the Japanese economy, MITI and the Japanese Miracle (1982), Chalmers Johnson showed how Japan's economic development was not the result of a free-market laissez-faire environment, but rather "an authoritarian state's active intervention in shaping business decisions," as quoted by Vera Simone in The Asian Pacific: Political and Economic Development in a Global Context. According to Johnson, ever since the Meiji period (1868-1912) Japan enjoyed a market economy that benefited from the conscious direction of a bureaucratic authoritarian state. The organization that has controlled the strings is the Ministry of International Trade and Industry (MITI).

The Japanese bureaucracy, especially MITI and the Ministry of Finance (MOF) have various means of obtaining compliance in their planning priorities. The Japanese enjoy a very high savings rate, generally between about 14 and 20 percent of disposable income, compared to the 1 to 4 percent in the United States. These huge pools of funds, found mostly in the national postal savings system, allow MITI to provide low or no-interest loans to banks and other institutions. In late 2001 the official interest rate was near zero—approximately .25 percent. MITI also enjoys the authority to set interest rates, as well as currency exchange rates, tax bases, and some prices of strategic goods. MITI negotiates and arbitrates a consensus among private businesses to assure there will be no undue competition among Japanese firms as well. This does not mean that there is no competition. Often Japanese companies go head-to-head when seeking to introduce a new product, but once a company establishes a position with a product it has virtually a free ride from then on.

There are two ways in which this special relationship between government bureaucracy and private business is so tight: what Vera Simone has called (1) the "institutional interlocking" of government, financial, and production organizations; and (2) the "cultural interlocking" of lifetime employment, the tightly integrated educational system, and the public conception of the "market."

The "institutional interlocking" of government, financial, and production organizations, as epitomized by the keiretsu, is at the core of Japan's economy, and has three main consequences for the economy. Supply and demand are created through member groups, who buy and sell amongst themselves. Since these organizations own each other through the keiretsu, hostile takeovers are difficult to nonexistent. Additionally, the pressure to achieve short-term profits is lessened by the fact that stock shares are typically held by other firms within the group, giving management more freedom to pursue long-term planning goals.

Additionally, lifetime employment, the tightly integrated educational system, and the public conception of the "market" all, through personal and professional relationships, create a complex "cultural interlocking" within the keiretsu. An individual who retires from a government post and takes a new position in private industry is commonly expected to use any connections from the preceding job to further the interests of his current employer. This practice is called amakudari, translated as "descent from heaven."

Finally, Japan's education system reinforces the "company culture" by providing the personnel for the bureaucracy. The scores one receives on high school and university exams determine which university or ministry one will be assigned to. For instance, the top scorers in high school will be admitted first to Tokyo University, then Waseda University, then down the line. Similarly, Tokyo University graduates with the highest grades will join MITI, then the MOF, and so on. This also serves to assure a close-knit "old boy" network atmosphere.

It is this network that has woven such a tight web around the Japanese business environment that Koizumi has to untangle in order to breathe new life into the economy. In order to assess his chances of success we will consider what needs to be done and the consequences of making those changes.

Recent History and the Future

Sacred Cows: Koizumi and Reform

When he came into office, Koizumi and his advisors laid out three major reforms they had to tackle: (1) generating greater consumer spending; (2) taking on the banks' huge piles of debts; and (3) opening up Japanese business to real competition. First, let's look at the consumer. The Japanese are well known for their penchant for saving, as noted above. This is reinforced through the postal savings system, a quasi-government institution that takes in billions of yen every year from private citizens investing in its tax-free (admittedly very low) interest-bearing accounts. This very strong savings tradition has enabled Japan to provide low-interest loans to big business.

The problem was, and remains, that very little of this money goes directly into the economy. To create a metaphor: money is the oil that lubricates the economic engine. Without oil the engine stops. Because the Japanese people are fearful of a continuing recession they are, like anyone else, holding onto their money. Again, fine for bank loans but bad for generating economic activity.

If the government does succeed in loosening people's purse strings, however, there will be that much less for banks to rely on for their loans, thus slowing down the economy, which is already in a recession. If people continue to hang on to their money, the nation is faced with the current problem, that of a slowdown in the economy. It's a lose-lose situation.

The second problem that Koizumi must deal with is that of the banks' nonperforming loans, meaning loans that are no longer being paid back. The numbers are frightening. The government itself admits that the banks have ¥150 trillion (US$1.23 trillion) in bad or doubtful loans. Even in Japan that is a magnitude that cannot be easily dealt with. Until these bad loans are eliminated, the normal lending that sustains any economy cannot take place, and neither consumers nor companies will regain the confidence needed to start spending again.

In a recession, doing nothing exacerbates the weakness in the economy. When prices fall, lower prices make the real value of the debt grow so that businesses that have over-borrowed have even greater debts. This makes it harder for them to pay back their loans to banks, and thereby decreases earnings of both the lending banks and the borrowing corporations. Furthermore, when there is slow growth, the government gets less tax revenue. In order to raise money to meet expenses it must sell more bonds to cover a bigger deficit, but Koizumi has declared a cap on bond issues (at ¥30 trillion, or US$245 billion) citing the already over-burdened government deficit of 1.3 times the amount of Japan's gross domestic product. If the cap is lifted the deficit grows. If the cap remains the recession grows.

The third problem facing Japan's economic crunch is the lack of open competition in the building industry, particularly in highway and infrastructure construction. Koizumi has vowed to review the public works budget that has long been a source of largesse from politicians to private business. This review would include scrapping the laws that reserve gasoline and vehicle tax revenues exclusively for road building. Just the idea of tampering with a long-honored tradition of pork-barrel politics—the government patronage system where public funds benefit a specific locale and a legislator's constitutents—however, sends howls of dismay from all sides.

Koizumi's vow to cap the issuance of government bonds, noted above, will squeeze public-works spending that has been the lifeblood of many construction firms. David Kruger of the Far Eastern Economic Review notes that "the construction industry accounts for about 10 percent of all jobs in Japan and bankruptcies would mean large numbers of layoffs."

There is also talk of deregulating the economy, meaning that the government will no longer be the safety net ready to protect smaller businesses from larger companies. This would likely lead to greater competition in the long run, but in the meantime cottage industries would be negatively affected. Those same groups have benefited from government protection and in return have been faithful supporters of the ruling Liberal Democratic Party (LDP).

Another sacred cow that Koizumi wants to kill is the vast postal savings system, which he wants to privatize. Again, in the long run this will probably benefit more people. But getting there will likely mean layoffs. It will also cut into some of the sources of funds that have been at the heart of the LDP's power structure. If implemented it would undermine its traditional support base—money given away by politicians to industry.

So where do we go from here? What's the bottom line? The short answer, and the easy one, is that it's too early to tell. Koizumi has yet to provide specific information on how he intends to go about chopping, cutting, and replacing. No specialist yet has gone public to predict what will happen. It's a "wait and see" situation. Having said that, there is a general consensus among the experts that nothing short of a miracle will be able to turn Japan around any time soon. It's not for want of wishing and trying—everyone wants Koizumi to succeed. But there are many toes to step on and much pain to feel before his plans will work.

Koizumi must deal with the Big Three: big business, big politicians, and big bureaucrats. They have enjoyed a cozy arrangement for years and like vested interests anywhere, they all want to protect their own turf. Koizumi is operating within a consensus-oriented society where nothing much gets done without unanimous approval. No one bets that that will happen. So the onus is on him to force through programs that will certainly be unpopular somewhere along the line, bucking the age-old tradition that everyone has to agree. It will also run against the grain of the very core of the "capitalist developmental state." The prime minister, who for now has the people on his side, will have to hope that they'll be in it with him for the long haul. If not, the needed reforms won't happen and Japan will continue to muddle along, perhaps going to negative growth.

And if that happens the whole world will probably feel the shock waves. Even in such dire straits as Japan is in now, its economy is still number two in the world and is still so huge that the repercussions of a continuing recession will be felt around the world, from the rest of Asia to Europe to America. The income that Japan generates, the loans and investments it makes globally, the exports it sends abroad, and the markets it opens up to other countries are so vast that any retraction will have immediate and direct effects. Foreign direct investment that so many Asian economies have relied on will dry up. The high levels of trade between Japan and the United States and Japan and Europe will plummet, which could lead to layoffs and bankruptcies in all these areas. Even the funds that Japan expends to provide for U.S. service personnel will decline.

As if that were not bad enough, the September 11, 2001, bombing of New York's World Trade Center and the Pentagon in Washington, DC, will only exacerbate the problem. Although the long-term effects are impossible to know, analysts agree that the situation in the immediate future will only worsen if simply because the entire industrialized world will likely feel the impact. With the slowdown in air travel, the steep fall in major stock markets, including Japan's, the tendency for people around the globe to reduce their purchases of nonessential items, and the falling yen/dollar exchange rate (which makes Japanese imports more expensive), there seems little likelihood that any stimulus to jolt the Japanese economy will become available to Koizumi.

With nowhere to turn, Koizumi Junichiro and Japan seem forced into a corner from which there is little possibility of escape.

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Allen Wittenborn

Chronology

1591 Sumitomo Masatomo develops a copper refining process and opens a copper mine, laying the foundation for the later Sumitomo zaibatsu.

1673 The Mitsui zaibatsu begins when Mitsui Takatoshi opens a group of textile shops.

1825 An edict to drive foreign vessels from Japan is issued.

1853 American Commodore Matthew Perry arrives inTokyo Bay demanding that the Tokugawa leaders trade with the United States.

1854 The Treaty of Kanagawa is signed between theUnited States and Japan, opening Japan to the United States.

1868 A new government is established in Japan withTokyo (Edo) its new capital.

1873 Iwasaki Yataro buys out a government-operated shipping line to lay the foundation for the Mitsubishi zaibatsu.

1894-95 Sino-Japanese War.

1904-05 Russo-Japanese War.

1914 Japan enters World War I, declaring war on Germany.

1932 Japan withdraws from the League of Nations.

1937 War breaks out between Japan and China.

1940 Japan enters the Tripartite Alliance with Germany and Italy, entering World War II.

December 7, 1941 Japan attacks Pearl Harbor.

August 15, 1945 Japan surrenders after the UnitedStates drops atomic bombs on the cities of Hiroshima (August 6) and Nagasaki (August 9).

1945 The Allied Occupation of Japan begins under U.S.General Douglas MacArthur.

1947 Under a new constitution, Japan passes a law disbanding the zaibatsu.

May 1947 When a union coalition calls for a nationwide general strike, more than five million workers pledge to stay away from their jobs in a total work stoppage that could paralyze the entire country. General Douglas MacArthur intervenes at the last moment to stop the strike.

1948 Joseph Dodge, a Detroit banker, calls for a balanced budget and an end to subsidies in order to halt Japan's inflation and strengthen Japan's economy.

1950 The Korean War breaks out, giving a huge boost to Japanese economy.

1952 The Allied Occupation in Japan ends.

1953 A union strike against Nissan results in limited union activity but gains workers the promise of "lifetime employment."

1990 Japan's economic surge causes a "bubble economy," with inflated values of Japanese real estate and businesses.

1993 The Liberal Democratic Party (LDP) loses its ruling position after 38 years of control.

1996 New prime minister Hashimoto Ryutaro pledges to reform Japan's pro-business economy and bureaucracy. He's out of office in less than a year.

2000 Japan enters its tenth year of low-growth, or recessionary economy.

2001 Koizumi Junichiro is elected prime minister. He vows to turn Japan around but warns that the transition will be painful.

The Propensity to Save

The Japanese have the highest rate of personal savings as a share of gross domestic product ever recorded by any market economy in peacetime. Does the explanation lie deep in cultural roots—for instance in the traditional frugality of the samurai? Maybe, but other external factors have also been noted. Consider:

• The high cost of education, both secondary and university level
• An inadequate social security system
• Inflated housing prices, which require large down payments
• Interest on home mortgages not being tax deductible
• A wage system that includes large, semiannual bonus payments
• An underdeveloped consumer credit system
• The government-run postal savings system with guaranteed competitive rates
• The lack of alternatives to personal savings
• The exemption from income taxes for interest earned on savings accounts

Sources: Borthwick, Mark. Pacific Century: The Emergence of Modern Pacific Asia, 2nd ed., Boulder, CO: Westview Press, 1998; Boyle, John Hunter. Modern Japan: The American Nexus. San Diego: Harcourt Brace Jovanovich, 1993.

A Few Key Figures in Japanese Economic History

Tokugawa Ieyasu (1542-1616): Became the founder of the Tokugawa shogunate (1603) after winning one of the most famous military engagements in Japanese history, the Battle of Sekigahara (1600). The Tokugawa shogunate would last until 1867.

Fukuzawa Yukichi (1835-1901): Perhaps more than anyone else in Japanese history, Fukuzawa was successful in introducing Western learning and institutions to the Japanese public. In many respects ahead of his time, especially in his views about the oppression of women and the need for self-fulfillment, his later philosophical convictions took on an increasingly nationalistic tone.

Ito Hirobumi (1841-1909): Japan's first prime minister (1885-1888), Ito was perhaps the symbol of the new Meiji era: given to modernization and open to the West, yet a diehard nationalist.

Hirohito (1901-1989): Japan's 124th emperor, whose reign was marked by rapid militarization and wars of aggression against China in the 1930s. Under the Allied Occupation of Japan, he renounced his divinity. His reputation remains under a cloud as research continues concerning his role vis-a-vis the more radical generals in the onset and continuation of the war.

Douglas MacArthur (1880-1954): U.S. general who became commander-in-chief of all army forces in the Pacific during World War II. MacArthur was appointed Supreme Commander of the Allied Powers (SCAP) during the Occupation of Japan (1945-52). He also led the UN forces in the Korean War, but was ultimately relieved of command by President Harry S. Truman.

Yoshida Shigeru (1878-1967): Twice prime minister (1946-47, 1948-54), Yoshida played a key role in shaping Japan's post-war economy by positioning Japan as an anticommunist bulwark of democracy. This stance, which led to considerable American diplomatic and financial aid, and his resistance to any new military buildup (the Yoshida Doctrine), enabled Japan to begin its economic advance.

Ikeda Hayato (1899-1965): Prime minister (1960-64) instrumental in Japan's phenomenal economic growth due to his "income doubling" plan, in which he proclaimed to see every Japanese family double its income in ten years. With minor exceptions, the policy was successful.

Nakasone Yasuhiro (1918-): The first prime minister (1982-87) to attempt to replace the Yoshida Doctrine (see Yoshida Shigeru), Naksone believed that Japan's pacifist stance was no longer relevant in the new world order. This led him to call for more overseas investment and aid and an increase in imports. These and other policies (such as reduced working hours) were highly unpopular with the same interests that, in 2001, Koizumi must contend with.

Koizumi Junichiro (1942-): Elected prime minister in April 2001 on a platform promising to radically reform and restructure Japan's economic institutions.

"Secrets " to the Japanese Economic Miracle

How did Japan rise from a devastated war-torn country to the world's second largest economy in forty years (1945-85), which is exactly the same time it took to go from an isolated feudal state to a leading Asian power (c. 1853-95)?

• Japan's high savings rate means low or no-interest loans to businesses.
• Not having to worry about anxious stockholders, Japanese companies can take a longer range view of business strategy—up to 20 years longer.
• In Japan there is much greater investment in new capital projects because of low research and development funding, especially compared to the United States.
• Japan's scarcity of raw materials has required it to be more innovative in compensating with lower cost production.
• Because Japan started from nothing after World War II, it was able to rebuild with the latest technology.
• The Japanese decided to build high-quality products rather than those with "built-in obsolescence" as in the United States.
• Japan has had good access to open markets—had it not been for its exports to America, Japan's post-war economic boom might not have occurred.
• In Japan, government and business collaborate closely, forming a kind of "Japan, Inc."