Explaining Japanese Economic Reforms: Past and Present

Running head: JAPAN REFORMS Kennedy

Explaining Japanese Economic Reforms: Past and Present

Trevor Kennedy

POLI 513A

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JAPAN REFORMS Kennedy

Introduction

In the past quarter century, Japan has undergone some

significant structural changes, departing from the postwar

status quo, in which bureaucrats wielded great power,

imports were heavily restricted, the government owned many

Special Public Corporations (SPC), and many sectors of the

economy were protected, towards a system that accommodates

an economy that is “free, fair, and global.” (Dore, 1999)

The liberalization of the Japanese economy has been a slow,

but constant process, delayed only by minor political

disruptions or other unforeseen events. While some elites

have long advocated for a push towards liberalization, many

Japanese have remained opposed to the dismantling of the

postwar CME model, in which inequality was low, employment—

for men—was often for life, and where the social fabric was

perceivably strong. This paper will address the question,

why has Japan continued to move towards the LME system, when

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many Japanese are/were opposed? Furthermore, this paper will

focus heavily on the second tenure of Abe Shinzo and his

Abenomics polices, to test if his policies fit within the

framework of a larger trend towards liberalization, and his

initiatives enjoy more public support than previous moves

towards liberalization.

What is the Japanese Model?

During the boom years of the postwar period, the

Liberal Democratic Party, various ministries, and business

interests controlled the reigns of power, in an arrangement

coined by Chalmers Johnson as the “Iron-Triangle” in his

seminal book MITI and the Japanese Miracle: The Growth of Industrial Policy

in 1982. Additionally, the Japanese economy benefitted

greatly from the era of the Yoshida Doctrine, during which

time, Japan focused its national resources on economic

growth. This period of rapid growth was enabled by an import

substitution industrialization (ISI) policy. However, unlike

most ISI nations, Japan had virtually unrestricted market

access to the American market, without having to allow

American firms equal access to its own market. Kent Calder

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believes that “America accorded Japan unusually favourable

(and highly asymmetrical)” (2004) economic benefits because

it was a member of the San Francisco System.

As the Japanese economy began to catch up to the United

States, the justification for a continued asymmetrical

arrangement between the United States and Japan decreased.

Previously, the United States accepted an uneven economic

relationship in favour of boosting Japan as a regional

bulwark against Soviet influence. Michael Auslin explains

that after Japan regained its independence with the San

Francisco Peace Treaty, it “immediately became America’s linchpin

in the Pacific, a position to which Japan’s leadership

acquiesced” (2012, pg. 237) out of economic and security

interests. As concerns over the capability of the Soviet

Union waned, and China became an American ally, the United

States began to pressure Japan into opening up its economy

and follow Western economic norms.

American politicians also came under sustained pressure

from interest groups in the United States claiming that

Japan for one had too many restrictions to entering its

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market, two that its currency was undervalued, giving it an

unfair trade advantage, and three that Japanese firms were

protected and aided by the state, providing another unfair

advantage to manufactures in Japan. David Brock explained in

1989 that, “Japan-bashers stress that the Japanese

officially practice ‘adversarial trade’ - the phrase coined

by the economist Peter Drucker to describe conditions in

which one country uses trade barriers combined with policies

favouring certain industries to obtain advantages over a

trading partner.” (1989)

Popular media was rife with anti-Japanese sentiment, often

bashing the Japanese economic model as being predatory. One

famous example of Japan-bashing in American media came from

Theodore White of the New York Times. White published a

piece in 1985 titled The Danger From Japan. In his article,

White made a series of linkages to the risk that he believed

Japan would pose the United States if it continued along its

trajectory in the 1980s. White believed that:

American industry grew up in partnership with European industry. But Japan rouses different fears. Behind Japan (''the Big Dragon,'' some call it) march the ''four

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little dragons'' (Korea, Hong Kong, Taiwan, Singapore) following in its path. And behind loom China and India, desperate as they are to raise their standards of living - at the expense of American standards, if necessary. (1985)

White’s views merely reflected the popular opinion of many

Americans at the height of the Japanese miracle.

American diplomatic pressure, along with fears that

Japan-bashing would hurt Japanese economic interests,

provided a policy window for pro-reform politicians in Japan

to being making structural reforms towards a liberal market

economy.

Pressure to Change (Isomorphism)

Based on the aforementioned reasons, etc. Japan began a

process of restructuring, based on a LME model. Some believe

that Japan—for its own wellbeing—should have begun the

process of liberalization well before the bubble economy.

Richard Katz in Japanese Phoenix: The Long and Bumpy Road to Revival

argues that Japan “reached maturity in the mid-1970s,” and

from then onwards, “developmentalist policies should have

been loosened.” Conceivably, many in Japan felt the same

way. For example, Prime Minister Nakasone, with the support

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of Keidanren, privatized “Nippon Telephone and Telegraph

(NTT), Japan National Railways (JNR), and Japan Tobacco

(JT),” and also created “Management and Coordination Agency

(MCA, created by merging the Administrative Management

Agency with the Prime Minister's Office) in order to give

the prime minister greater power to oversee the

bureaucracy.” (Bevacqua, 1997) However, instead of viewing

the privatization as a genuine effort to liberalize the

economy, many pre-bubble reforms could also be interpreted

as efforts to consolidate the power of certain stakeholders—

in this case the Keidanren and the LDP.

When it comes to reforms that affect Japan’s economic

performance globally, it would appear that Japan was more

greatly pressured by external forces, than it was by

domestic forces. As mentioned above, the ending of the San

Francisco System, along with Japan-bashers influencing the

policy options of politicians in the United States, the US

began to pressure Japan to adopt norms relating to currency,

financial regulation, and corporate governance, in an effort

to eliminate any perceived unfair advantages that Japan

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enjoyed within the previous asymmetrical economic

arrangement.

One sociological phenomenon that can explain the

cognitive process that influenced the decision by Japanese

policymakers to adopt liberal polices, ending the prewar

economic status quo, is isomorphism. Paul J. DiMaggio and

Walter W. Powell explain isomorphism—in the context of

institutions—as the process of the “homogenization” (1983)

of norms and practices among peers. Within the Japanese

context, one can imagine the pressure for the Japanese to

homogenize their economic practices with other major

economies. However, there are different motivations to

homogenize in different circumstances. DiMaggio and Powel

separate isomorphism into three categories.

The first category was “mimetic” isomorphism. Mimetic

isomorphism emerges “from standard responses to

uncertainty.” One mimetic explanation could be that as the

economy matured, Japanese policy makers failed to identify

the next step of economic development. Out of uncertainty,

Japan followed a liberal agenda, by imitating the US.

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The second more probable reason for convergence is

coercive isomorphism. DiMaggio and Powel believe that

“coercive isomorphism results from both formal and informal

pressures exerted on organizations by other organizations

upon which they are dependent.” (1983) External pressure

from actors in which Japan was dependent resulted in a push

towards policy homogenization. Two notable cases in the

1980s were the “Foreign Exchange and Foreign Trade Control

Law in 1980” and more importantly, the “U.S.-Japan Yen

Dollar Agreement of 1984.” (Tiberghien, 2005) These reforms,

along with others edged on by external actors, are blamed

for some of Japan’s economic woes. Tiberghien argues in

Navigating the Path of Least Resistance: Financial Deregulation and the Origins

of the Japanese Crisis that, “the origins of the Japanese crisis

lie in the great bubble of 1985-1990 and that the bubble was

partly caused by an ill-supervised, externally induced

financial deregulation.”

The third force for regulatory homogenization is

normative isomorphism. DiMaggio and Powel consider the

third type of isomorphism as a consequence of

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“professionalism.” (1983) People-to-people exchanges,

particularly in academia, could be blamed in part for the

convergence of norms within certain professions. Ronald Dore

provides and explanation in Japan's Reform Debate: Patriotic Concern

or Class Interest? Or Both? that may help to explain why some

politicians, bureaucrats, and private interests pushed for a

homogenization for norms based on the American LME model.

Dore claims that, “over the decades, world cultural hegemony

has decisively shifted from Europe to the United States, it

is more exclusively the United States that has acquired the

authority of the teacher.” (1999) Contemporarily, the

influence from professionalism has never been stronger, as

many professionals received their training from some of the

same international institutions. As the power of the Prime

Minister’s Office has increased, and bureaucrats have taken

a backseat, there is increased influence from U.S.-trained

economists on the government to make policy changes. This

paper will discuss Abe in further detail later on, but in

short, during Abe’s second term in government his economic

policies have been heavily influenced by Hamada Koichi

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(Yale), and Yamamoto Kozo (Cornell), favouring a certain

variety of liberalization, with Honda Etsuro (Tokyo)—who is

influenced greatly by Paul Krugman (Princeton) favouring a

different variety. Both sets of actors, influenced by their

profession, encourage systematic change in the Japanese

economy.

A great deal of external pressure has been levied on

Japan since it began restructuring its economy in early

1980s. Politically, some areas have remained out of reach,

such as agriculture and pharmaceuticals. For example, Prime

Minister Hashimoto—despite his efforts on administrative

reform—protected agricultural interests, by sheltering

“special public corporations (SPCs) under the jurisdiction

of the Ministry of Agriculture.” (Bevacqua, 1997) Much of

the reason why areas like agriculture remained protected was

because the beneficiaries are politically invaluable to the

Liberal Democratic Party. In the past, voter disparities

between rural and urban voters ranged from “4.09 and 5.08”

(Iwakuni, 2012, pg. 119) in favour of rural voters.

Overtime, the maximum disparity has decreased due to

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judicial pressure, to “3.94 (1983), 3.18 (1993), and 2.30

(2011).” (Pg. 120) The protection of the agricultural

sector, but reform of other sectors, exemplifies both the

problems with Japan’s partial reform, and with Japanese

policymakers’ inaptitude in choosing winners and losers.

Katz insists, “Japan was being run on the principle of

comparative disadvantage. Because it protected glass and

rice and cement and steel, it drove away autos and

electronics.” (2003) While the public in many instances is

resistant to the direction that the government is moving the

economy, the government has been able to make piecemeal

reforms, so long as critical segments of the electoral

landscape are unaffected.

Reforms under Abe 2.0

Prime Minister Abe was elected for a second term of

office in December 2012, ending a short disruption in LDP

rule by the Democratic Party of Japan (DPJ). According to a

2013 Pew Research Centre poll titled Japanese Public’s Mood

Rebounding, Abe Highly Popular, “Prime Minister Abe” was “seen

favourably by 71% of the Japanese public, with no evident

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gender gap, generation gap, class difference or rural urban

split in his support.” (2013) The equal support was based on

the popular belief that Abe’s Abenomics polices would help

rejuvenate the lacklustre Japanese economy. High levels of

support for comprehensive economic reform are unusual, and

therefore provided Abe with a rare opportunity to make

various reforms to the Japanese economy. Abe outlined three

broad policy actions within the thematic framework of

Abenomics. The three policy areas of Abenomics are referred

to as the three arrows, based on a folktale from the Abe

family’s native Yamaguchi Prefecture. The moral of the tale

of the three arrows is that if all three are held at once,

no matter how hard one tries, they cannot be broken.

First Arrow (Stimulus)

The first arrow of Abenomics was based on a government

stimulus package. The Government of Japan 2013 report

Emergency Economic Measures for The Revitalization of the Japanese Economy

estimated that the stimulus would total 14 trillion yen.

According to James McBride and Beina Yu from the Council on

Foreign Relations, the actual amount of stimulus was closer

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to “20.2 trillion yen ($210 billion), of which 10.3 trillion

($116 billion) was direct government spending.” (2015) The

stimulus package was distributed into three categories of

spending with the intent of increasing real GDP by 2%. The

spending was earmarked for Tohoku reconstruction, social

welfare, and infrastructure. Both Tohoku reconstruction and

infrastructure spending were/are critically needed, but the

additional money dedicated to social spending merely

provided a temporary alleviation to budgetary spending

restraints. According to Gregory W. Noble, “by 2011 social

welfare accounted for over half of all policy spending.”

(2012, pg. 60) Social welfare’s proportion of government

spending at current levels is expected to grow by “one

percent of the budget” (2012, pg. 60) per year. Such

concessions by the government continue a long-term pattern

of pandering to gain electoral support. Abe, despite making

statements that he wants to achieve a balanced budget, is

wary of angering his base of government dependents. As

Grimes puts it, “There are no winners from deficit reduction

in the short run.” (2012, Pg. 96) Therefore, the benefits of

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the first arrow to the Japanese economy—in the long-term—are

negligible so long as unfunded liabilities continue to

mount.

Second Arrow (QE)

The second arrow of Abenomics began with the

replacement of Shirakawa Masaaki with Kuroda Haruhiko.

Kuroda was selected because of his support for aggressive

monetary policy based on Quantitative Easing (QE). Since

taking over as the Governor of the Bank of Japan (BOJ),

Kuroda has followed a mandate of “achieving price stability,

thereby contributing to the sound development of the

national economy.” (BOJ, 2013) The BOJ’s explanation of

price stability has been based on the objective of achieving

annual 2% core inflation. Kuroda’s BOJ is notable in regard

to Japan because unlike previous BOJ Governors, Kuroda has

committed to maintaining the existing policy until the

Japanese economy self sustains the 2% price stability

target, whereas previous governors had followed set

timelines for achieving their respective goals. According to

Martin Wolf in 2013, Kuroda planned to achieve his inflation

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targets by expanding the monetary base by “Y60tn-Y70tn

($600bn-$700bn or 13-15 per cent of gross domestic product)”

a year.

A residual benefit of the QE policy has been that it

has led to a decline in the value of the yen, improving

Japanese competiveness overseas. It has also greatly

increased the amount of corporate earnings that are

repatriated from overseas markets. Toyota, for example,

recorded its best year of corporate earnings in 2014, with

an “operating profit of ¥2.7 trillion ($23.0 billion) in the

fiscal year ending in March, up 17.8% from a year earlier.”

(Kubota, 2014) Other companies have likewise benefited from

a weak yen.

In 2013, Wolf reported that Japanese companies were

sitting on the equivalent of “29.5 per cent of GDP in 2011”

in retained earnings. In 2014, this number swelled to “44%

of GDP.” (Economist, 2014) This dilemma has posed problems

for Abe, because to achieve his inflation targets and to

keep the Japanese public onboard with his economic plans, he

needs corporate Japan to offload some of that money in the

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form of increased wages. So far, efforts by the Abe

Government partially succeeded by encouraging “some large

companies to raise base wages modestly in the spring of

2014. However, many smaller companies didn’t follow suit.”

(Sekiguchi, Warnock, 2014) Wages will need to increase

across the board to make up for the loss in household

earnings posed by the BOJ’s inflationary policies and by

Abe’s decision to proceed with a 3% increase in the

consumption tax rate in April 2014.

Another major obstacle that Abe faces by accomplishing

sustained inflation is how to change consumer behaviours.

Tabuchi Hiroko of the New York Times reported that, among

the general population—particularly those who started

working after the bubble burst, “the entrenched attitudes

and behaviours in the country” follow a “deflation mind-

set.” In other words, people are used to prices falling, or

staying the same over a long period of time. For example:

The Big Mac still costs about the same here as it did in 1998: about 300 yen, or almost $3. The price of another popular fast food offering — the beef-and- rice bowl from the Yoshinoya restaurant chain — has fallen from 400 yen in

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the late 1990s to 280 yen today. During that time, average worker incomes have also fallen. (Tabuchi, 2014)

The recent increase in prices will take time for inflation

wary consumers to adjust to.

On the bright side, after the implementation of the

second arrow, the Japanese Stock Exchange (JSE) has risen

dramatically. In 2014 alone, the “Nikkei achieved a

multiyear high of 17,935 yen on December 8, up from a 2014

low of 13,901.” (Harner, 2014) Before Abe took office, the

index was significantly lower. While the recent bullishness

of the Japanese stock market cannot credit the BOJ’s QE

policies alone, it has certainly been a factor and a clear

area of success for the Prime Minister.

Third Arrow (Reforms)

The third arrow of Abenomics is a more complicated

matter than the former two arrows because it lacks a

coherent definition. The Asian Develop Bank has described

the third arrow as, “structural reforms to boost Japan’s

competitiveness and economic growth.” (Yoshino and

Taghizadeh-Hesary, 2014) To Hamada Koichi, Abe’s third arrow

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means, “reform of the labour market, deregulation, and a

reduction in the corporate-tax rate.” (2014) More recently

however, the government has identified reforms to the

agricultural sector, by decentralizing the “Central Union of

Agricultural Cooperatives,” (2015) ending the rice

production adjustment program, by encouraging land

consolidation, and by slightly easing the American rice

import quota to “50,000 tonnes a year,” (Kajimoto, 2015) as

a priority.

The government has also expressed interest in

reforming the medical sector, but the government backtracked

on plans in 2013 to allow online pharmaceutical sales. This

decision drew criticism from Mikitani Hiroshi, the CEO of

Rakuten. Mikitani argued that “if Mr. Abe cannot decide on

this, he cannot decide on anything,” (McLannahan, Soble,

2013) foreshadowing Abe’s reluctance to displease interest

groups in the future. However, Abe may take a more

aggressive approach to deregulation in the future if he can

survive the displeasure of the medical industry.

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Another experiment that Abe has embarked upon is in the

creation of National Special Strategic Zones. To date, the

Japanese government has identified 5 zones in Yabu, Hyogo;

Fukuoka City, Fukuoka; “Kansai area;” “Tokyo area;” and

Niigata City, Niigata. Each zone will serve different

purposes, with the intent that that they will enable the

government to experiment with new polices. The Economist

took a pessimistic stance on this initiative by stating

that, “there are legitimate worries that Japan’s new zones

will fail because central-government officials reject ideas

for deregulation for fear of offending vested interests.”

(2015) However, it is worth noting that Abe’s designated

zones may serve many vested interests in a productive way.

For example, the Kansai region experienced a political

upheaval with the rise of the Japanese Restoration Party.

The party has since fallen into relative obscurity, but its

central tenants remain popular among Kansai voters. That is,

the desire to gain increased regional autonomy, which could

be enabled with the Kansai-based zone.

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The next identified target of Abenomics’ third arrow is

to achieve a greater number of women in the fulltime

workforce. Abe has good economic reason to make an effort.

According to Kathy Mitsui of Goldman Sachs Japan, “by

closing the gender employment gap (as of 2013), we estimate

the potential boost to Japan’s GDP could be nearly 13%.”

(2014) More women working would also alleviate some of the

pressure of a declining workforce and maximize the output of

many educated women relegated to housework or part-time

labour after their first child.

Much in line with the above reform, Abe has been

overhauling Japan’s immigration system to offset a decline

in the workforce. The government has decreased the time

needed to obtain a permanent residency status for skilled

workers to 3 years. The government has further plans to

increase the quota of foreign workers in japan, along with

an expansion of the permitted professions allowed to work in

Japan. The government also plans to create a “new type of

residence status with an unlimited period of stay.” (2015)

It is unclear if the population will support such an

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initiative. However, there is reason to be optimistic; Japan

ranks very highly on the World Values Survey for its level

of racial tolerance (Fisher, 2013). This sentiment echoes

Kim Mikyoung’s belief that Japanese civil society is

generally accepting of multiculturalism. According to Kim,

“civil society has embraced multicultural coexistence

(tabunka kyosei), the government, business elites, and

journalists tend to maintain the myth of Japan’s uniqueness

of Japan’s uniqueness and homogeneity.” (2012, pg. 173) If

this is the case, it could be a positive move to see the

three former groups change their stance on multiculturalism

out of economic necessity.

Finally, Abe is embarking on a mission to abolish trade

barriers for Japanese goods, also opening up Japan to

cheaper imports. The forthcoming Trans-Pacific Partnership

(TPP) free trade agreement would open up the United States,

Canada, Australia, etc. to Japanese goods. Politically, the

TPP is a contentious issue. It has widespread support from

the Keidanren, but is adamantly opposed by Japan

Agricultural Zenchu and other sectorial interest groups.

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According to an Asahi Shimbun poll from 2013, “Fifty-three

percent of voters support Japan’s participation in the

Trans-Pacific Partnership.” (2013) However, as mentioned

before, rural voters are disproportionally powerful. Still,

instead of bowing to the short-term interests of rural

voters, etc. the TPP may provide more numerous benefits to

the Japanese economy in the long run.

T.J Pempel argues in favour of the TPP and other major

reforms:

The Japanese political system, which has impeded efforts to adjust to the country’s long-term economic slide, would benefit from a bold shock sufficiently powerful to break the stifling lock these groups now hold. Only after the resistance has been effectively defeatedwill Japanese politics be able to embrace economic policies that will address Japan’s long-term loss of

competitiveness and help restore long-term dynamism to the country. The TPP represents one such potential jolt.(2012, pg. 259)

Then again, if the Japanese people disagree with the terms

of the TPP, or if the TPP is watered down so significantly

that the final agreement is insignificant, it will become an

economic panacea.

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For economic reasons, Japan should seriously consider

the merits of the TPP. For one, lower import tariffs could

save Japanese shoppers, in effect, increasing their

purchasing power. For exporters, the TPP would be a clear

boost. Comparatively, Japan fares much worse than its

regional peers when it comes to trade with FTA nations.

Pempel references John Ravenhill’s research which finds

that, “Only 14 percent of Japan’s exports are covered by

existing FTAs (or EPAs), compared to 56 percent for ASEAN,

45 percent for Hong Kong, 25 percent for China, and 28

percent for South Korea.” (2012, pg. 266) So long as

Japanese goods face higher tariffs, exporters will

endemically be disadvantaged in the international market.

Conclusion

In past 30 years, Japan has undergone significant

changes to its economy, its administration, and its

political system. Many of these changes have been encouraged

by necessity, or by opportunity, depending on the vantage

point. According to Leonard J. Schoppa:

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Social norms reinforced what was for many a financial necessity. In contrast, today many parents earn wages generous enough to support or subsidize adult

children who remain at home. Fewer sons or daughters face financial pressure to marry, and some do not even feel much obligation to go to work. Social norms have changed too, with the Japanese becoming much more

tolerant of women marrying later or not at all. These shifts have opened up previously nonexistent exit opportunities for young people who want to postpone or optout of marriage or parenthood. (2001)

As society has changed, so have people’s expectations. The

forces that once created policy rigidity have gradually

fallen to the wayside. Likewise, the agents that influence

policy have changed as well. Different ministries are

elevated, and with less power than before; the gap between

rural and urban voters has closed, and politicians have more

control over policy than in past. The changes coming from

the Abe government—unlike by previous governments—enjoy

public support. That does not mean that every policy

proposed and implemented is popular. Abe’s policy agenda has

frustrated technocrats who wished to see rapid economic

change—particularly in regards to the third arrow. He has

also irritated entrenched sectorial interests that are more

favourable to the status quo. For better or worse, Abe must

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proceed gradually, making changes as they become politically

palatable.

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Explaining Japanese Economic Reforms: Past and Present

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