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Chapter 8: Introduction to the Japanese Economy (Revised 2009)
(1) Some Points about the Economic History of Japan
This section of the course considers the economy of Japan since 1955 and what we will call Asian Capitalism. We will not devote much space to the Japanese economy prior to 1955. However, there are a few points about the economic history of Japan that are important in understanding the period since 1955. The first part of this introduction will describe these points.
First, it is important to understand that Japan was a feudal country until 1868. By contrast, in Europefeudalism ended 500 years ago. This feudal society was basically isolated from the rest of the world. It was based on a strong sense of personal obligation andpersonal loyalties, with the elevation of social duties above personal rights. It was a very hierarchicalsociety, with the mass of the population docile before authority. It was a very nationalistic society, reinforced by the racial and linguistic homogeneity of the Japanese. And it was a society in which learning was highly regarded;literacy rates were high. As we will see, many of these traits have continued to this day.
Second, between 1868 and 1945,the Japanese government was very involved in the economy. Initially, the government was motivated by its desire to rid Japan of foreign domination. This later turned into Japanese imperialism. The desire to rid Japanof foreign domination andthe non-acceptance of laissez faire has continued to this day. We will discuss the role of the Japanese government in the economy and the Japanese economic relations with other countries in later chapters.
Third, prior to the end of World War II, the economy was dominated by four large groups of companies (or conglomerates) called zaibatsu. The four zaibatsu groups were Mitsui, Mitsubishi, Sumitomo, and Yasuda (later to become Fuji). These had large holdings in industry, finance, international trade, and so forth. They were centered around a holding company owned by one family.We discuss the evolution of Japanese business in the next chapter.
Fourth, as is obvious, by the 1930s, Japan was certainly NOT an underdeveloped country. Between 1900 and 1940, Japan’s real national income had grown at an average annual rate of 4.5%, a rate unprecedented for the time.Japan’s investment in capital goods was high and it was a major exporter of manufactured goods. The “Japanese economic miracle”did not begin in 1955.
Fifth, while Japan had very large and modern manufacturing companies, it also had a large number of small companies. These had little capital and thereforewere labor-intensive. They were quite poor. So Japan had what has been called a “dual economy”. In addition, Japan had a politically weak labor force and an absence of strong labor unions.
Sixth, from 1945 to 1953, Japan was under occupation, mainly by the United States Army (under General MacArthur). Among the economic policies undertaken by the occupation, several were especially important. One was the break-up of the zaibatsu. The stock in their companies was sold to the public and the zaibatsu leaders were prohibited from further business activity. We will see later how the groups of companies re-established themselves (although the modern groupings are in no way similar to the old zaibatsu). A second occupation policy was land reform. All the land of absentee owners and all but about 2.5 acres of land owned by landlords resident in the rural areas was bought by the government and resold to tenant farmers. This virtually destroyed the landlord class. In 1946, 46% of the land was worked by tenant farmers; by 1950, only 10% of the land was worked by tenant farmers. A third occupation policy was the introduction of anti-monopoly lawssimilar to the Sherman Act in the United States. As we will see, these were not well enforced. A fourth occupation policy was to introduce labor laws similar to those in the United States. The proportion of workers in unions grew from 0 to 60% between 1945 and 1949. This led to a series of major strikes. The unions were defeated in these strikes. The employers responded to their victory by instituting the modern system of Japanese industrial relations. We discuss this in the next chapter. A final occupation policy was called the Dodge Plan. It involved a number of austerity measures imposed on Japan in 1949. (Austerity measures are designed to reduce total spending.) These austerity policies included a balanced budget, the abolition of government subsidies, and a devaluation of the yen to Y360 = $1. This led to deflation (falling prices) and was the cause of the workers’ strikes. Until at least the 1970s, the Japanese policy-makers were strongly attached to the idea of balanced budgets and to the exchange rate of Y360 = $1.
Seventh, because of the experience of WorldWar II, Japan emerged with a deep commitment to economic growth and industrialization. This commitment was widely shared throughout the population until at least the early 1970s.
In 1953, Japan became an independent country, free of occupation. It was fortunate in that its economy benefited economically from the Korean War.Japan sold materials to the American military under special procurements. It also served as a base for American troops. The Cold War also ended any attempt by the United States to punish Japan for World War II. Japan was now to be aided so that it would enter into alliances with the Western countries. This meant that the United States would provide most of Japan’s defense, as Japan was prevented from having a significant military by its own constitution. With this desirable beginning, postwar Japan went on to have one of the most outstanding records of economic performance ever experienced. Let us take a brief look at that performance.
(2) Survey of Japan’s Economic Performance from 1955 to 1990.
(1) To many, the success of Japanese economic performance was a miracle. In many ways, no other country achieved what Japan achieved (although China has been exceeding this economic performance in recent years). This economic miracle is best seen in terms of economic growth rates.
The table below shows the annual growth rates in Real GDP for Japan and for the United States. Real GDP is the best measure of overall production.
Table 1. 1961-651966-701971-751976-8219831984 1985 1986 1987 1988
Japan 12.4% 11.0% 4.3% 4.5% 3.2% 5.1% 4.7% 2.5% 4.4% 5.4%
U.S.A. 4.6% 3.0% 2.2% 2.3% 3.6% 6.8% 3.4% 2.8% 3.4% 3.8%
As you can see, in the 1960s (and also in the 1950s), Japanese growth rates were truly astounding. While they fell in the 1970s and the 1980s, they were still quite good in most years. In 1955, Real GDP (production) per capita in Japan was only 21% that of the United States. By 1988, it was approximately 80% that of the United States. According to the World Bank, in 1986, Japan had a GDP per capita of $12,840, making it the sixth richest country among the 129 countries surveyed (behind only Switzerland, the United States, Norway, Canada, and Sweden).
(2) From 1955 on, much of Japan’s economic growth has been intensivegrowth. For example, writing in the mid-1970s, Edward Denison (perhaps America’s leading scholar on economic growth) found that for the period 1953-71, only 45% of Japan’s economic growth could be explained by increases in labor, capital, and land (extensive growth). The other 55% is explained by increases in production per worker (intensive growth). This means that Japanachieved large increases in productivity (production per hour worked). For example, from 1965 to 1972, productivity in Japan grew at an annual average rate of about 9%, compared to a little over 2% in the United States. And from 1973 to 1983, Japan’s productivity grew at an annual average rate of 3.5%, while American productivity was virtually stagnant. This productivity growth led to a large increase in real wages in Japan. (Real wages are wages in constant purchasing power.) Real wages rose over 350% between 1956 and 1983. In subsequent sections, we will need to understand the cause of this rapid rise in productivity.
(3) Another aspect of Japan’s economic performance also requires explanation. This is shown in the data below. Note that Japan’s official unemployment rate (on American definitions of unemployment) was very low and did not increase muchduring bad economic times. Also, note that, while Japan has experienced some years of high rates of inflation, generally inflation was well under control.
Table 2UNEMPLOYMENT INFLATION (CPI)
YEARJAPANU.S.A.JAPANU.S.A.
19651.2%4.5%6.4%1.6%
19661.43.85.42.9
19671.33.83.53.1
19681.23.65.64.2
19691.13.55.35.5
19701.24.97.55.7
19711.35.96.24.4
19721.45.64.93.2
19731.34.911.76.2
19741.45.623.211.0
19751.98.511.99.1
19762.07.79.25.8
19772.07.18.26.5
19782.36.14.27.6
19792.15.83.711.3
19802.07.17.813.5
19812.27.65.010.3
19822.49.72.76.2
19832.79.61.83.2
19842.87.52.34.3
19852.67.22.13.6
19862.87.0.61.9
19872.96.23.6
(4) Behind the rapid economic growth and the rapid rise in productivity was a very high rate of investment spending (buying of new capital goods), financed by a high rate of savings. This is shown in table 3 (the numbers are “percent of GDP”):
Table 3. 1965-69 1970-74 1975-79 1980-83
Gross Investment33.8%37.5%31.5%30.5%
Net Investment20.2%23.8%18.5%16.5%
Household Saving10.6%13.5%15.6%13.6%
Corporate Saving5.0%4.7%1.2%0.9%
Government Saving5.4%6.5%0.9%2.7%
Several points about Table 3 are noteworthy. First, both gross and net investment rates were very high (gross investment is the total spending on new capital goods as a percent of GDP while net investment subtracts that spending merely to replace the capital goods that had depreciated). To compare, from 1980-83, gross investment rates in the United States averaged 15.7% and net investment rates averaged about 4% (these were recession years in the United States, but the gaps are substantial in any other period as well). Second, household saving rates were very high in comparison to most other countries, as shown in Table 4.
Table 4. Net National Saving as a Percent of National Income
1960-1973 1974-1979 1980-1989 1990-1994 Overall 1960-1994
Japan 26.3% 23.1% 21.1% 21.3% 23.6%
USA 10.8 8.8 5.2 3.3 7.8
Germany 17.6 11.5 10.1 10.5 13.5
France 19.5 15.2 9.0 8.0 14.3
Italy 19.4 15.5 11.1 7.3 14.7
Britain 11.1 6.2 5.4 3.0 7.5
Canada 11.5 13.0 9.5 2.7 10.0
What is especially unique to Japan is the high savings rate among low-income and working-class households. Even the poorest 20% of Japanese households save a much higher share of their disposable income than do most American households. Since the mid-1970s, the savings in Japan actually exceeded the desire of Japanese companies to spend on business investment. These “excess savings” went mainly as loans to the American government, as loans to American businesses, and as purchases of American assets (land or companies). We consider the reasons for these high savings rates below.
(5) Another interesting feature of Japanese economic performance has been that the high rates of economic growth seem to have been accompanied by considerable equality in the distribution of income. In the mid-1970s, the Gini Index for Japan was 0.335 before taxes (0.316 after taxes) compared to 0.404 for the United States (0.381 after taxes). The Gini Index is a number between zero and one; the lower the number, the more equal is the distribution of income. Japan’s distribution of income was more equal than that of the United States. However, inequality in Japan increased in the 1980s and 1990s as it did in most countries.
(6) One final aspect of Japan’s economic performance involves international trade. Japan ran large current account surpluses, especially in the 1980s and particularly in relation to the United States. In a later chapter, we will discuss Japan’s trade policies and how they have evolved since 1955. We will also discuss the trade issues between the United States and Japan. (The current account balance is the difference between exports and imports, counting both goods and services The surplus indicated that Japan exports more than it imports..)
(3) Explanations of the High Savings Rates in Japan
Before continuing our survey of Japan’s economic performance, let us try to understand the reasons for the high savings rates in Japan. Many hypotheses have been suggested.
Prior to World War II, Japanese savings rates were quite low. This fact forces us to reject the notion that the high Japanese savings rates are a product of Japanese culture. There have been many hypotheses to try to explain the high rates of saving in Japan.
One hypothesis is that the high rates of saving result from the high rates of economic growth. The idea here is that incomes rose faster than people expected. Therefore, they were slow to adjust their living standards as their incomes increased. The extra income then went into savings. The trouble with this hypothesis is that, when incomes fell in the early 1970s, people reduced their living standards to maintain their high rates of saving. If they would reduce their living standards when income fell, why would they not increase them when income rose?
Another hypothesis examined the age structure of the Japanese population. Until recently, Japan had a very small proportion of its population over age 60. The years after age 60 are usually years for spending one’s accumulated savings. However, unlike the United States, in Japan, people over age 60 have actually been savers—they still add to their savings. And in Japan, people under 35 are also high savers, whereas they are usually heavily in debt in the United States. Therefore, the age structure does not explain the reason for high savings in Japan.
The fact that Japanese elderly continue to save led to a recent hypothesis. This is that Japanese elderly save because they desire to leave bequests to their children. Presumably, American elderly do not have this desire. No one has explained why there should be such differences in motivation. The evidence for this hypothesis comes from the fact that Japanese elderly save more (other things equal) if they have more adult children.
Another hypothesis involves the way Japanese workers are paid. As we will see in Chapter 8, for those who work in large companies, a significant portion of income comes in the form of a semi-annual bonus. It has been argued that Japanese workers make their spending decisions based on their regular monthly income; the bonus income is then saved. Since workers know that the bonus is coming, it is hard to explain why they would behave this way. But studies do show that bonus income is more likely to be saved than regular monthly income. However, these studies find that the effect of this on the overall savings rate seems to be small.
Yet another hypothesis has to do with the large number of Japanese workers who work in family-owned businesses. The argument is that, because these people own their own businesses, their incomes are much less certain from year to year than is true for workers. They must save when income is high for the years when income will be low. There is no study of the magnitude of this effect, but it could be part of the story. Why there are so many family-owned businesses will be considered in the next chapter.
For younger people, a main reason that they would save is the high cost of housing in Japan. An average home in Japan costs about five times the average income, much higher than in the United States (although similar to California). On average, about 40% of the purchase price must be paid as a down payment (compared to 0 to 20% in the United States). Repayment periods are typically much shorter than the 30-year period commonly found in the United States. In Japan, interest payments on mortgage payments are not tax-deductible, as they are in the United States. Most Japanese who buy homes do so in their 30s or 40s. To afford this expensive purchase, they must save for a considerable time. (This explanation would also hold, but to a lesser extent, for purchases of home appliances, automobiles, and so forth.)
Another reason people might save is the high cost of education in Japan. In secondary education, families often pay for private “tutoring” so that pupils can pass the entrance examinations to the major universities. While the total costs of college are about the same in Japan as in the United States, Japanese families must pay a much higher percentage of these costs. Savings in Japan are particularly high for families with high school age children. A related reason that families with children might tend to save so much is the relatively high cost of children’s weddings.
Another major reason people might save is retirement. In Japan, “retirement” from good jobs typically occurs at age 60. This is a relatively young age for “retirement” compared to Western countries, especially in a country that has one of the longest life expectancies in the world (76 for men and 83 for women). At age 60, a (male) worker receives a lump-sum payment, commonly equal to about 3 years’ income. Most of these men then take other jobs, usually at low wages. Nearly half of Japanese men over age 65 are still in the labor force (compared to fewer than 20% of American men). Men need to save during their years of working at good wages to be able to live adequately during the many years of retirement. (The three-generation household is still very common in Japan. People may be saving in order to be able to have greater independence in their old age.)
One final reason for the high savings rates in Japanhas involved the inadequacies of the financial system. Stock markets, bond markets, and especially markets involving consumer lending were undeveloped in most of the postwar period (although they too have improved considerably in recent years). There was no Japanese equivalent of the American savings and loan. As a result, the mortgage market in Japan was not nearly as developed as it is in the United States. The same is true for other consumer durables; most payments for automobiles, home appliances, and so forth were made in cash. Credit cards existed in Japan but were used relatively little. And the inefficient system of retailing made the prices of consumer goods high. All of these are additional reasons for saving.