Japanese Industrial Development and the Role of the State: a short History

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Japanese Industrial Development and
the Role of the State:
A Short History

Yoshiki Mikami1

Summary: The first five chapters of the paper describe the industrialization process of Japan after the Meiji Restoration till 1970s, with a special emphasis on how Japan assimilated western technologies. The last six chapters describe thechnology policy in last two decades, in 1980s and 1990s. The paper focuses the role of the Government in the process.
Key Words: Industrialization, State, Industrial Policy

The Meiji Restoration: The Dawn of Industrialization

1.1 The Reform paved the way for Industrialization

The Meiji Restoration in 1867 was one of the turning points in the history of Japan. The Restoration deprived feudal lords of their political powers, paved the way for industrial development under capitalist rules, and triggered the integration process of the previously isolated Japanese economy into international trade networks2.

The newly created Meiji Government, led by young and passionate ex-lower- samurai-class officials, laid down wide range of reforms in a fairly intensive manner. The reforms included,

The Abolition of the Feudal Class System3 created higher mobility in society in general. Especially important in the context of industrialization, it released millions of unproductive samurai for business, official and other productive occupations. It also mobilized farmers to work in newly emerged factories and services, mostly located in metropolitan or urban areas. In principle, everybody was free to choose his/her occupation.

The Abolition of the Feudal Trade Restrictions4 helped to create a truely "national" market and stimulated entrepreneur-ship among people.

Land Tax Reform and the introduction of a new national currency, the yen: the former created a nation-wide tax system and assured the new government's revenue, and both accelerated the nation-wide circulation of money.

1.2 Infrastructure Development

Together with these reforms, the Government gradually developed various elements of an infrastructure for national development. A Nation-wide postal/telegram network was established, and a series of civil engineering works was started to expand land transport and water supply networks. In the late 1890's, national railway construction was started. In 1870 the Ministry of Engineering was created to manage these infrastructure development programs.

Invisible infrastructures were also arranged. A patent regulation was issued in 1885, and a unified metric system was introduced in 18915.
1.3 Government Industrial Investment and Its Divestiture

Although extensive small-scale manual production already existed in traditional industries such as textiles, metal working and wood processing before the Restoration, the Meiji Government took initiatives towards industrialization by investing directly in some strategic sectors of manufacturing with the slogan "Shokusan Kogyo"6. The Ministry of Engineering was in charge of these investments. It established government-owned factories in several sectors such as shipbuilding, steel, paper, chemicals and modernized fiber spinning, to demonstrate modern technology imported from abroad.

It must be noted that most factories were sold to the private sector during the 1880s, with several exceptions in military production facilities, because of the fiscal crisis that resulted from civil wars in Japan. As this divestiture was associated with the transfer of technological resources from the public sector to the private sector, it offered private business opportunities to transform commercial capital into industrial capital, and helped to form the Zaibatsu groups as a result.

In textiles , which had been the mainstay industry in Japan until World War II7, although the government's activities were limited mainly to technological support for quality improvement and control, the operations of government spinning factories had a substantial demonstration effect on private activity in the sector. It stimulated the adoption of modern technology with some modifications to fit the Japanese environment8.

With the divestiture of government-run factories, the Ministry of Engineering was abolished in 1890. The Ministry of the Interior performed general supportive functions for industry until 1890, and the then-formed Ministry of Agriculture and Commerce took over the role afterwards.
1.4 Foreign Experts and the Education System

During the first few decades after the Restoration, the government invited thousands of foreign educators, engineers and other experts to provide assistance in managing the government-led civil works, and in running government-owned factories and educational institutions9. The Ministry of Engineering allocated about 42% of its total budget to salaries for foreign experts from 1870 to 1885. This shows the strong eagerness of the new government to obtain western invented modern technologies. But on the other hand, the cost to the national budget of these high salaries forced the eventual substitution of Japanese nationals for foreign experts. This had almost been achieved by 1890s.

The government started compulsory education in 1872. Modern-style school facilities were constructed and newly trained teachers were sent to all corners of the country. The enrolment rate had reached almost 50% in 1890 and more than 80% in 1900. The Ministry of Engineering established schools for engineering, telecommunications, iron and steel making, and handicrafts. The government sent a number of young talents overseas for study.

All the engineers and technicians educated through these programs worked in government-owned factories and in educational and training institutions, gradually replacing foreign experts.

Later most industrial training schools were transferred to the Ministry of Education. The focus of education shifted to more general and higher-level disciplines. The investment in technological resources, including in the educational system, was heavily oriented to practical engineering. University education also put emphasis on engineering rather than on science. Government research institutions were oriented to providing technical services for enterprises as well. This emphasis on engineering was a natural choice for a latecomer to industrialization and was maintained after the Second World War.
1.5 The International Trade Regime

After more than two hundred years of isolation from international trade, Japan re-appeared in international trade arena, through the almost peaceful conclusion of a trade treaty with the United States in 185810. Similar treaties with other trading powers followed it in successive years. As a result of these treaties, Yokohama, Kobe and a few more ports were opened.

Up until around 1900, industrial development took place under an almost neutral trade regime11. This was not necessarily desired by the Japanese government. It was not allowed to have independent authority over the formulation of tariffs until 1899. Until that year, tariff rates, which had been bound by an international treaty, were 5% or less. Export was also taxed to a similar extent. Quantitative restrictions played no role until 1931.

The growth of ocean fleets played an important role in the expansion of trade. The total tonnage of Japanese ocean fleets was 23,000 in 1872. It jumped to 3.05 million in 1920 and increased to 6.4 million in 1941, which was the third largest in the world only after the UK and US.

1.6 Foreign Direct Investment

Before the Restoration, a few foreign trading companies had some stakes in mining sectors12. These foreign stakes were purchased back by the new government. Foreign firms resumed direct investment in Japan only after 1899. Most foreign investments were joint ventures, and mostly in technology-intensive sectors such as electrical machinery and automobiles, established through the initiatives of Japanese enterprises that encountered demand from foreign enterprises for equity participation in exchanges of technology and equipment13.

The Series of Wars and their Impact on Industries
2.1 Heavy Industries supported by Military Concerns

Through wars fought with China (1894-1895) and Russia (1904-1905), industries such as shipbuilding, steam shipping, and even railway transportation got strong government support for military considerations. These industries expanded their production and geographical scope of services. Although specially military production sectors successfully achieved a world-class technical standard14, their material and equipment base was not stable. Among others, steel production had been regarded as having prime importance as a basis for all heavy industries and military production. In 1901, the national steel mill at Yahata started operations with the support of the military. Japanese colonial expansion into northeastern China (Manchuria), Korea and Taiwan15 assured the supply of raw materials to those heavy industries16.

During the First World War Japanese Imperial Forces showed a keen interest in automobiles and airplanes, which played impressive roles on the European battlefields. Backed by the military, automobile and aircraft industries emerged as new industries, yet it took another twenty years for full take-off17.
2.2 WWI urged Self Sufficiency in Strategic Commodities

Until the first decade of this century, the Japanese economy was involved in international trade networks to a substantial extent, but the outbreak of the First World War gave a shock to Japan. There was a sudden supply-cut or shortage of many commodities which were essential to support industrial production and daily life in Japan. Both industry and the Government learned a lesson from this experience.

In reaction to the situation, the Government launched a series of industrial policies to assure the domestic supply of these threatened strategic commodities. These included machine tools, medicine, dyes, fertilizers, soda and foodstuffs. The Government set legal frameworks to get authorization for adopting sector-specific direct support to industries by means of R&D subsidies, special tax exemptions and so on18. Several national research laboratories were came into existence to promote the development of indigenous technology resources19. The formulation of national industrial standards was started in 1921.

After Japan regained authority over tariff formulation in 1899, it raised tariffs gradually to increase revenues and to protect domestic industry. During the post-war global trend towards protectionism, tariffs were raised again and again, with a stronger emphasis on protection through tariff escalation. The average tariffs (arithmetic average) were 4% (1893), 20% (1913), 11% (1924) and 30% (1938)20.

Reflecting the increasing importance of industrial policy, the role of the Ministry of Agriculture and Commerce was expanded and a new independent ministry, the Ministry of Commerce and Industry (MCI, the direct precursor of the current MITI) was formed in 1925. A variety of government / industry interaction mechanism such as advisory councils to the Minister21, subsidy schemes and preferential tax relief for business22 was introduced around the same time.
2.3 The Depression and the Move toward Protectionism

The Great Depression drove major nations to adopt protectionist policies and divided the globe into a few economic blocs. The Japanese economy was also affected and suffered from serious depressions. In addition to these economic problems, Japanese colonial expansion was creating military tension in northeast China, and this forced Japan into further military buildup.

In 1930, the Bureau for Rationalization of Industry was created in the Ministry of Commerce and Industry and a "Buy Japanese" policy was announced. Direct trade restrictions were also introduced in 1931.
2.4 The War-Time Mobilization

In the 1930s, many highly regulatory laws were enacted23. Among others, the Strategic Industries Control Act of 1931 and the National Mobilization Act of 1938 empowered the government to intervene directly in production and distribution. In order to exert power systematically, almost all industrial entities were organized into a nation-wide hierarchy. Private companies cooperated and were expected to operate under the umbrella of sector-wide industrial associations, which worked as a single point of contact with the government authorities.

During the War, the major operations of the MCI were given to other ministries, mainly the new Ministry of Munitions, which concentrated on allocating resources to the production of airplanes, ammunitions and other war materials. The government bureaucracy gained experience in how to manage and control the whole national economy and devised diverse methods of implementing industrial policies. The cooperative and intimate relation between bureaucracy and private industry was formed and strengthened as a result.
3. Post-War Reconstruction
3.1 War Damages

The war cost Japan dearly. Two million of people died during the War. In economic terms, the total damage to industry, housing and other social assets was estimated to be 100 billion yen, equivalent to 28 percent of the national wealth of Japan in 193524. Part of the losses was caused by bombing, and part of them was caused by industrial and civil assets being dismantled for conversion to military usage. The production of consumer goods had fallen to 30% of the prewar levels and producer goods were as low as 10%.

3.2 The Economic Reforms under the US Occupation

Immediately after the Japanese surrender, the US military was sent to demilitarize Japan. The initial occupation policy of the United States was said to have been complete demilitarization, including the destruction of all the potential for military production25. But the beginning of the Cold War affected the political role of far-east countries. The birth of the Peoples Republic of China (1949) and the outbreak of the Korea War (1950) finally changed the US Policy towards Asia26, and narrowed the planned scope of reparations against Japan.

The reforms of the Japanese economic system however were carried out as planned. The reforms included

Dissolving the 15 Zaibatsus, including Mitsui and Mitsubishi, which had dominated various industrial fields in the prewar Japanese economy.

Farm-land ownership reform: Almost all tenant farming land was purchased by the government and sold back to the former tenant farmers.

Labor reform: The condition of the working class were improved by the enactment of the Labor Union Law, the Labor Relation Adjustment Law and the Labor Conditions Law.

3.3 Reconstruction and Rationalization

During the few years of chaos after the War, priority was given to the reconstruction of key industries such as coal, iron and steel and fertilizers. The Government allocated the limited resources to these sectors and subsidized them to sustain their production level27.

Professor Dodge's strict financial policy successfully brought hyperinflation under control, and the outbreak of the Korean War offered a windfall business opportunity to Japanese industry.

The Ministry of Commerce and Industry was reorganized into the Ministry of International Trade and Industry (MITI) in 1949. The Enterprise Rationalization Act in 1952 promoted domestic technological modernization, setting up preferential depreciation system for important equipment for key industries. Government banks to promote industrial development, including Japan Development Bank (JDB), the Japan Export and Import Bank (EXIM) and the Small and Medium-sized Enterprises Finance Corporation, were established in the first half of the 1950s.

3.4 Temporary Protection under FOREX Control Regime

In 1951, the Foreign Exchange(FOREX) Control Law was legislated. It provided an assurance of payment to foreign exporters and thus laid down the basis for post-war technology imports. On the other hand, quantitative restrictions administered through the foreign exchange control system played a major role in the 1950's. In 1955, only 16 percent of foreign exchange was allocated on an automatic basis. In some cases, government intervention saved payments28.

Since technology importation was closely associated with investment, especially in the 1950s, the regulation of technology imports also affected the allocation of investment resources. The regulation gave priority to industries with high potential for foreign exchange earnings, and suppressed the demand for consumer goods. Therefore, the regulation tilted the investment pattern toward the trade sector, especially toward basic industries.

4. Trade Liberalization and the High Economic Growth

4.1 The Liberalization and Its Implication Policy

In the field of trade, Japan joined GATT in 1955. In 1960, when the rate of liberalization was still low at approximately 40 percent, the government declared the "Foreign Exchange and Trade Liberalization Plan". By 1964, the rate of liberalization had reached 93 percent. In that year, Japan became an Article VIII nation in the IMF29 and also joined OECD. The first step to capital liberalization was taken in 1967, and liberalization was almost completed by 1973.

During this period of transition, the primary task of the nation was to strengthen industry's international competitiveness in order to overcome balance of payment constraints on economic growth.

As far as policy measures are concerned, transition to an open economy also meant a transition from direct and regulatory measures to indicative and indirect ones. Under such circumstances, a long-term vision for industrial structure was elaborated on the basis of a thorough study of the present and future state of Japanese industry.

This vision was finalized in 1963 after three years of discussion30. In the vision, two criteria for an optimum industrial structure were introduced: (1) "Income Elasticity Criteria" on the demand aspect; and (2) "Productivity Increase Rate Criteria" focusing on the supply side. Applying these criteria, the path of heavy and chemical industries was chosen as the most desirable. The vision and the declared liberalization "road map" had played an important role in urging industry and letting them prepare for the coming years of free competition in an international market.
4.3 The Growth of Heavy Industry

Production and investment by manufacturing companies continued to grow. The successful achievement of the challenging "Income Doubling Plan" declared by the Government led by Prime Minister Hayato Ikeda in 1960 was symbolic in the period of high economic growth. Per capita GNP of US$378 in 1960 had jumped to US$1,515 in 1970. Japanese industrial structure changed rapidly. The share of primary industries in GNP was 22.7 % in 1955. It had dropped to 13.5% in 1961. The share of secondary industries increased from 28.9% to 37.1%.

In the manufacturing sector, the share of "light" industry declined. The share of heavy and chemical industries grew from 66% in 1960 to 72% in 1970. The growth of heavy industries was lead by fixed capital investment and exports. The average yearly growth rate of exports was 16% during the same period. The share of heavy and chemical industries exports to total exports increased from 54% in 1960 to 80% in 1970. In terms of peoples' daily lives, income levels continued to grow and consumer durable goods such as televisions, electric refrigerators and cars became widely owned, which created a mass consumption society in Japan. Consumption per capita grew by around 70% in the 1960s. In 1968, Japanese GNP became the second largest outside the Soviet block.
4.4 Declining Industries and the Positive Adjustment

Even in the period of high growth, some manufacturing sectors lost international competitiveness and were forced to reduce employment and in the worst cases some disappeared from the scene. Under these circumstances, excess labor was basically absorbed by growing sectors. Although the government took various measures when serious regional and social problems were anticipated, it never resorted to direct trade-restrictive measures which tend to freeze unproductive labor in declining sector. The resulting dynamic reallocation of labor among industries has been regarded as one of success factors in the Japanese growth experience.

The coal mining industry experienced a drastic decline both in terms of production and employment. Production dropped to less than 20 million tons in the late 1970s, roughly one-third of its prior peak figure of 55 million tons recorded in 1961. The number of employees decreased from 200,000 to 20,000, i.e. to one-tenth of the original figure during the same period. In 1955, the government passed special law31 to ensure smooth industrial conversion. It included: (1) providing an information service to the unemployed through the public employment service office; (2) providing incentives to attract business to start-up in the affected region; (3) direct unemployment relief projects; (4) financial support to local government in the coal mining area.

The textile industry was an another example. The number of employees in the industry decreased from 1.33 million in 1964 to 0.85 million in 1979 roughly one-third less than the peak figure, due to rapid expansion in production in newly industrialized economies. Despite the serious social problems, Japan has faithfully observed the principle of a commitment to free trade and refrained from protectionist measures, unlike other high labor-cost countries32.

The "Dollar Crisis" , "Oil Crisis" and their Aftermath
5.1 The Changing Global Economic Environment

President Richard Nixon announced that US Dollars could no longer be converted to gold in 1971. This was followed by the moves towards a floating system for major currencies in successive years. The yen appreciated more than 20% from the fixed rate of 360 yen to the US dollar set forth a quarter century before. On the other hand, the devaluation of the US Dollar pushed oil-exporting countries to raise oil prices as compensation for their devalued US dollar income. This finally caused the "Oil Crisis" in 1973, coupled with growing nationalism over economic rights and politico-military tensions in the Middle East.

The appreciation of the Yen and the price hike of oil had a huge impact on the Japanese economy, whose energy base had been heavily dependent on imported oil and whose income had been heavily dependent on exports. In the short term, it caused hyperinflation and depression. In the long run, more importantly in the context of industrial development, it necessitated urgent structural adjustment to a new resource price environment. The two crises had totally changed the "rules of the game" in international competition among industries.
5.2 The Shift to an Energy Efficient Structure

From oil crisis onward, all industry aggressively adopted energy saving technologies. In particular, energy-intensive industries, such as steel, non-ferrous metals, petrochemicals, cement and glass plate making, explored alternative energy-efficient processes as much as possible. Due to all these efforts, unit energy consumption of Japanese industries has improved significantly. However aluminum smelters were forced to close their domestic operations, which were transferred abroad. Several other industries were also forced to reduce their domestic production and moved out of the country, but to a lesser extent than aluminum amelters.

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