De La Salle-College of Saint BenildeSchool of Multidisciplinary Studies

Consular and Diplomatic Affairs Department

JAPANESE ECONOMY VS.PORTER’S GLOBAL COMPETITVE ADVANTAGE

ECONOMIC DEVELOPMENT THEORY

Maria Victoria Y. SibalContemporary National Development (NADEVCO)

2nd term, School Year 2007-2008

Page 2 of 12

JAPANESE ECONOMY VS. PORTER’S GLOBAL COMPETITIVE ADVANTAGEECONOMIC DEVELOPMENT THEORY

Disclaimers: (1) Gross National and Domestic Products economic indicators as the fundamental statisticalbasis for the formulation of the thesis statement; and (2) economic development will mainly focus from post-

World War II era to present time.

Porter’s Global Competitive AdvantageThis theory of economic development conceptualized the development process as a series of stagesthrough which an economy passes as it moves towards maturity. Porter’s Global CompetitiveAdvantage theory seeks feasibility in its possible application to modern world economies through theadvent of the reality of globalization—as may have possibly defined by the increasing interdependenceand interconnectedness of economic systems and their respective regions. As a possible corollary toRostow’s Modernization Theory of Economic Development, Porter also supports the inherent need foran economy to modernize—a process supported by a national commitment to development policieswhich promote domestic investment and industrialization.

Four Major ConsiderationsPorter contends that a region’s global competitive advantage is an outcome of four majorconsiderations.

A. Factor endowments: The internal condition of a region’s infrastructure and its physical,human, capital, and knowledge-based resources, which includes the way in which economicagents organize themselves, utilize information, skills, tools, and production inputs, and createand combine knowledge of how to produce. Basic factors include resources, climate, location,population size (labor force), and land. Advanced factors include education attainment levels,the competitiveness of a region’s labor force in relation to skills and productivity, research anddevelopment capabilities, and the quality and characteristics of its communication andinformation networks.

B. Internal Demand Conditions: The size, health, vitality, and characteristics, of a region’sinternal market (domestic demand).

C. Density of Industrial Linkages: The recognition that production efficiency andcompetitiveness is directly proportional to the breadth and depth of a region’s industriallinkages.

D. Corporate Structure: Highlighting the importance in the way in which firms are organizedand managed; things which have a direct bearing on the competitiveness of a firm—in abusiness environment that has become sensitized to customer service and satisfaction. Efficientorganization is known to enhance a firm’s decision-making processes, increasing both itscompetitiveness and its longevity.

Page 3 of 12

Stages of Economic DevelopmentPorter provides a unique perspective on the development of nations as part of global economicintegration. Economic development status is discussed in terms of regions’ global competitiveadvantage. Similar to Rostow’s modernization theory, Porter’s competitive advantage ranks a region’sdevelopment status in four stages.

A. Factor-driven stage: Economic growth and development potential is first tied to a region’scomparative advantage. This is determined by the availability of “basic factors” ofproduction—availability of natural resources and labor force. This is commonly associated withnations that are large exporters and/or processors of primary sector commodities.

B. Investment-driven stage: It is based upon a region’s willingness and ability to invest indomestic industries in an attempt to improve its competitive position. It is the stage ofmodernization of industry and infrastructure. The stage focuses on the use of “advancedfactors” of production. Emphasis is on production of standardized commodities usingproduction methods or technologies transferred from industrialized or developed countries.Activities generally include the manufacturing of textiles, clothing and shoes, toys, etc. Asdomestic industries mature, production emphasis may turn toward commodities of higher value(e.g. machinery and electronic devices).

C. Innovation-driven stage: The stage is characterized by creation of new products and newproduction technologies for new markets, where competitive advantage is no longer tied tobasic factors or cost, but is a direct result of technological innovation and the techno-drivenstage. This stage is likely to bear witness to the rise of transnational corporations—firms andindustries which operate across international boundaries.

D. Wealth-driven stage: It is typically associated with the relative decline of a national economydue to its inability to consistently reestablish itself as an innovator in a globally competitivesystem. Emphasis is placed upon the preservation of status and long-term economic stability—as opposed to entrepreneurial and innovative-led change. Economic growth becomes morerelatively sluggish as consumers and industries become complacent. The secondary sector—production and manufacturing—contracts as it shifts to external low-production-cost locations.Export growth slows while import penetration intensifies.

Page 4 of 12

Overview of Japanese Economic Development

Japan went through a period of restoration followed by high economic growth, after World War II. Iteventually became the economy with the second largest GDP in the world in 1967. Through two oilcrises and a prolonged recession which began in the 1990s, Japan has since retained its economic cloutas world's third-largest, industrialized, free-market economy, after the United States, and People'sRepublic of China. It is the second-largest by market exchange rates. Its economy is relativelyperceived to be highly efficient and competitive in areas linked to international trade, although current-day productivity is lower in areas such as agriculture, distribution, and services.

Government-industry cooperation, a strong work ethic, mastery of high technology, and acomparatively small defense allocation have helped Japan advance with extraordinary speed to becomeone of the largest economies in the world. Their reservoirs of industrial leadership and technicians,well-educated and industrious work force, high savings and investment rates, and intensive promotionof industrial development and foreign trade have produced a mature industrial economy. Japan, to date,has few natural resources, and trade helps it earn the foreign exchange needed to purchase rawmaterials for its economy.

Economic Development: Main Industries of JapanThe nation’s industrial activities (i.e. mining, manufacturing, and power, gas, and water utilities)contributed 46.6% of total domestic industrial production in 1989, up slightly from 45.8% in 1975.This steady performance of the industrial sector in the 1970s and 1980s was a result of the growth ofhigh-technology industries. The service industry sector grew the fastest in the 1980s in terms of GNP,while the greatest losses occurred in agriculture, forestry, mining, and transportation. Most industrycatered to the domestic market, but exports were important for several key commodities. In general,industries relatively geared toward exports over imports in 1988 were transportation equipment (with a24.8% ratio of exports over imports), motor vehicles (54%), electrical machinery (23.4%), generalmachinery (21.2%), and metal products (8.2%).

The fields in which Japan enjoys relatively high technological development include semiconductormanufacturing, optical fibers, optoelectronics, optical media, facsimile and copy machines, andfermentation processes in food and biochemistry. Japan lags slightly in such fields as satellites,rockets, and large aircraft, where advanced engineering capabilities are required but they madeheadway through their aerospace exploration agency, JAXA with possible manned independentmission to moon, and in such fields as computer-aided design and computer-aided manufacturing(CAD/CAM), and databases, where basic software capabilities are required, and natural resourcesexploitation, due to the lack of them.

Page 5 of 12

Macro-level Economic PerformanceFrom the 1960s onwards, overall real economic growth has been called a “miracle”: a 10% average inthe 1960s, a 5% average in the 1970s, and a 4% average in the 1980s.

Table 1.Economic Growth Rate

In 1973, the fourth Middle East War led to the first oil crisis, triggering high inflation. Accordingly,Japan recorded negative economic growth in 1974 for the first time in the post-war period. Followingthe second oil crisis in 1978, efforts were made to change Japan’s industrial structure from “energy-dependent” to “energy-saving,” enabling Japan to successfully overcome inflation.

At the end of the 1980s, Japan’s economy enjoyed favorable conditions, with low inflation and a lowunemployment rate.

Table 2.National Wealth in Trillions of Japanese Yen

The change of Japan’s net worth (nationalwealth) has reflected the status of itseconomy well. At the end of 1980, Japan’snational wealth stood at ¥1,360 trillion, 5.6times its GDP. It then increased, reaching¥3,533 trillion, eight times its GDP, at theend of 1990, due to increasing land and stockprices. With the collapse of the bubbleeconomy, Japan’s national wealth has sinceshifted into decline, dropping to ¥2,640trillion at the end of 2005.

Page 6 of 12

Japan and the Global Comparative Advantage TheoryIn accordance with the general underlying principles of the Global Comparative Advantage theory andthe basic economic structure of Japan, a characteristic analysis may be derived from the two mainfacets of the theory: (1) according to the four major considerations; and (2) according to the stages ofeconomic development.

Four Major ConsiderationsA. Factor Endowments

Japan has inadequate natural resources to support its growing economy and large population.Although many kinds of minerals were extracted throughout the country, most mineralresources had to be imported in the postwar era. Local deposits of metal-bearing ores weredifficult to process because they were low grade. The nation’s large and varied forest resources,which covered 70% of the country in thelate 1980s, were not utilized extensively.Because of the terrain, underdevelopedroad network, and high percentage ofyoung trees, domestic sources were onlyable to supply between 25-30% of thenation’s timber needs. Agriculture andfishing were the best developed resources,but only through years of painstakinginvestment and toil.

In 2001, Japan’s labor force consists ofsome 67 million workers, 40% of whomare women, and is rapidly shrinking.Labor union membership is about 12million. The unemployment rate iscurrently 4.1%

B. Internal Demand ConditionsThe nation therefore built up the manufacturing and processing industries to convert rawmaterials imported from abroad. This strategy of economic development necessitated theestablishment of a strong economic infrastructure to provide the needed energy, transportation,communications, and technological know-how.

C. Density of Industrial LinkagesIndustry is concentrated in several regions, in the following order of importance: (1) the Kantōregion surrounding Tokyo (Chiba, Kanagawa, Saitama and Tokyo prefectures—the Keihinindustrial region); (2) the Tōkai region (Aichi, Gifu, Mie, and Shizuoka prefectures—theChukyo-Tokai industrial region); (3) Kansai, Osaka, Kyoto, Kobe, (the Hanshin industrialregion); (4) the southwestern part of Honshū and northern Shikoku around the Inland Sea (theSetouchi industrial region); and (5) the northern part of Kyūshū (Kitakyushu). In addition, along narrow belt of industrial centers is found between Tokyo and Fukuoka—established byparticular industries that have developed as mill towns.

Page 7 of 12

D. Corporate StructureDistinguishing characteristics of the Japanese economy include the cooperation ofmanufacturers, suppliers, distributors, and banks in closely-knit groups called keiretsu; thepowerful enterprise unions and shuntō; cozy relations with government bureaucrats, and theguarantee of lifetime employment (shushin koyo) in big corporations and highly unionizedblue-collar factories. Recently, Japanese companies have begun to gradually move away fromsome of these norms in an attempt to increase their global competitiveness and profitability (thelatter due mostly to their increased reliance on equity rather than debt financing).

Stages of Economic DevelopmentA. Factor-driven stage

Ever since, only approximately 12% of Japan’s land was suitable for cultivation. A system ofterraces is used to farm in small areas, due to the lack of arable land. This result in one of theworld’s highest levels of crop yields per unit area, with an overall agricultural self-sufficiencyrate of about 50% on fewer than 56,000 km² cultivated. Currently, Japan’s small agriculturalsector is highly subsidized and protected, with government regulations that favor small-scalecultivation instead of large-scale agriculture.

B. Investment-driven stageThe period of rapid economic growth between 1955 and 1961 paved the way for the “GoldenSixties,” the second decade that is generally associated with the Japanese economic miracle—the Japanese government, under the leadership of Prime Minister Ikeda, rapidly expandedgovernment investment in Japan’s infrastructure: building highways, high-speed railways,subways, airports, port facilities, and dams. Ikeda’s government also expanded governmentinvestment in the communications sector of the Japanese economy previously neglected.

Table 3.Gross Domestic Product of Japan (1955-2005)

(¥ millions)

This prompted a steady increase in investments and developments of the secondary and tertiarysectors.

Page 8 of 12

Table 4.Increase in Secondary and Tertiary Sector Participation

C. Innovation-driven stageDuring the 1960s, Japan’s economy grew at a rapid pace of over 10% per annum. This rapideconomic growth was supported by: (1) expansion of private capital investment, backed by ahigh rate of personal savings; (2) a large shift in the working population from primary tosecondary industries, and abundant supply of high-quality labor; and (3) an increase inproductivity brought about by adopting and improving foreign technologies.

Table 5.Changes in Industrial Structure

Prime Minister Ikeda furthered Japan’s trade liberalization and global economic integration byjoining the GATT in 1963 and the IMF in 1964. By the time he left office, the economy wasgrowing at a rate of 13.9%, despite a largely protected economy.

At the end of the 1980s, Japan’s economy enjoyed favorable conditions, with low inflation anda low unemployment rate. Corporate profits were at their highest level in history, and corporate

Page 9 of 12

failures were at their lowest level in several years, while investments in plant and equipment formanufacturing products—such as semiconductors—were very active. Stock and real estateprices continued to rise rapidly, and large-scale urban developments and resort facilitydevelopments in rural areas progressed at a very fast pace. However, excessive funds flowedinto the stock and real estate markets, causing abnormal increases in capital asset values—theJapanese economic bubble.

D. Wealth-driven stageAt the beginning of 1990, stock prices plummeted, followed by sharp declines in real estateprices. This marked the start of a series of major economic recessions (collapse of the bubbleeconomy). Japan’s financial and economic systems, which were excessively dependent on land,consequently approached collapse.

Huge bad debts were created in the loan portfolios of financial institutions because corporateborrowers suffered serious losses due to declining land prices. As a result, shareholders’ equityin financial institutions shrank. In 1997, large banks began to fail. In 1998 and 1999, thegovernment injected public money into the banking sector to stabilize the financial system.

The Japanese economy began to make a moderate recovery in April 1999. However, this wasonly a temporary phenomenon because investments in plant and equipment were weak and theeconomy was too dependent on foreign demand and information and communicationtechnologies. With the global decline in IT demand from mid-2000, Japan’s exports to Asiadropped, necessitating adjustments of excess inventory and production facilities. In line withthis, the Japanese economy again entered into an economic downturn in 2001.

When the war in Iraq began to come to an end around mid-2003, exports began to recover, andcorporate profits and capital investments in plants and equipment also began to increase.Recovery in the household sector was slower than that of the corporate sector. Theunemployment rate began to decline at the beginning of 2003, and employees' incomebottomed out at the end of 2004, with consumption remaining steady.

The global demand and supply for information-related goods slackened in late 2004. Due tostagnation in export growth and inventory adjustment within information-related sectors,Japan’s economic recovery slowed down again. However, inventory adjustment of information-related sectors remained relatively modest because global demand for information-relatedgoods picked up, and signs of improvement began to show in mid-2005. The economy hascontinued to recover since then, led by recovery of demand in the private sector such asconsumer spending and capital investment, keeping a balanced recovery of corporate,household and overseas sectors.

Although temporary adjustments have occurred twice during this phase of economic recoverysince 2002, excesses in corporate employment, plant and equipment, and debt have virtuallydisappeared, improving the deflation situation which had continued from the end of the 1990s.While the state of regional economies still varies, the overall economy is on its way torecovery.

Page 10 of 12

Critiques of the Global Comparative Advantage TheoryThe theory, whereas objective and balanced, fails to incorporate the possibility of external economicshocks and phenomena in the course of economic development, such as the oil crisis of October 1973.Japan was in the stage of economic ascendancy (innovation-driven stage), but still suffered a negativegrowth rate due to the lack of economic and social safety nets to protect against such events.

Aside from external economic shocks, the theory also fails to materialize on the possibility of socio-political issues coming into play in the midst of the said economic development. Japan was in theprocess of making a recovery (attempting to regress to the economic peaks of the innovation-drivenstage) when the US-Iraq war broke out. Japanese exports subsequently fell, and the economy sloweddown.

The theory also turns a blind eye to the social aspect of the economy at hand. Japan clearly has someissues regarding civil society (the aging population), and Global Comparative Advantage neglects tofactor in this possible hindrance in the economic development. Regardless of economic prosperity, ifthe general public lacks the younger generation’s capability, economic progress will definitely not besustainable in the long run.

And lastly, the theory was not able to anticipate the possibility of excess liquidity coming into play.Japan is a country wherein consumerism has still to take roots in the general population. Again, this isa social construct that was probably overlooked by the theory.

Current Economic IssuesThere is no single explanation that may successfully abridge the Japanese economic recession andstagnation. However, there exists in their country certain institutions that mat have contributed to thesaid economic phenomenon.

Japanese Economy in Relation to Political StructureThe Ministry of Finance (MOF) has the responsibility of managing government fiscal policy andtariffs, as well as holding sufficient influence over monetary and security policies. This particularresponsibility for watching each bank reserve’s capitals led to scandals. Ministry officials notifiedbanks prior to inspections, allowing problem loans to be concealed. Moreover, the MOF might havehelped some banks and securities firms to hide losses to prevent them from shutting down.

They were slow to take responsibility for the continuing stagnation despite its clearly ineffectivepolicies.

Japanese Economy in Relation to Social IssuesLike many industrial nations, Japan faced a serious aging problem. Demographics play a major role;with the rapidly aging population posing huge issues for government policy and personal savings.Japanese social security costs had expanded rapidly in turn.

Also, costs of living in Japan are extremely high. Part of this problem is being attributed to the fact thatthere is a current lack of competition in the market and extensive regulation on business activity.

Page 11 of 12

Japan and the International Economy

Table 6.Japanese Economic Growth (GDP) in Comparison with Other Countries

Japan, along with most of its industrializedcounterparts, is currently experiencing a sluggisheconomic growth. This is one of the repercussions ofa free-market state—vulnerability to externaleconomic shocks, especially when induced by afellow industrialized or developed state.

Economic Forecasts

Table 7.Quarterly Economic Trends

Japan’s economic recovery willcontinue. The portraying the currenteconomic trend of Japan signifies that asubstantial performance from thecorporate sector may be sustained, andthat various households are finally beingmotivated to spend which, in theory, canboost GDP according to consumerspending index. Domestic private-sectordemand may be sustained at this level,especially if propelled by a strongforeign exchange rate for the next twoyears.

Page 12 of 12

BIBLIOGRAPHY

Comparative Real Gross Domestic Product per Capita and per Employed PersonU.S. Department of LaborBureau of Labor and StatisticsOffice of Productivity and Technologyhttp://www.bls.gov/fls/home.htm

Economic DevelopmentJapan Ministry of International Trade and Industryhttp://www.stat.go.jp/english/data/handbook/c03cont.htm

Allen, G.C. Japan’s Economic Recovery. Oxford: Oxford University Press, 1958.

Johnson, Chalmers. MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975.Stanford: Stanford University Press, 1982

Pomfret, Richard. Economic Development and Modernization: Processes and Perspectives.Development Economics 1997. Chapter 4