Chapter 5 Japan’s Postwar Political Economy

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Rosenbluth, Frances McCall; Thies, Michael F. (2010-04-12). Japan Transformed. Princeton University Press. Kindle Edition.
CHAPTER 5 Japan’s Postwar Political Economy
The Japanese economy grew at a stunning rate in the postwar years, achieving a tenfold expansion of nominal GDP between 1965 and 1990. Japan went from a country laid waste in World War II to one that appeared poised to rule the world economy. Tokyo was awash in money. Eight of the world’s top ten banks, measured by loan assets, were Japanese, and Japanese companies were on an extended buying spree around the world, not only to set up production plants overseas, but also for luxury destinations such as five-star golf courses and Rockefeller Center in New York City. Tokyo cafés had trouble keeping up with the demand for coffee adorned with gold shavings, and there was talk of filling half of Tokyo Bay with landfill to add office and living space at the cost of over ¥ 2 trillion. No wonder American managers yearned to discover the secrets of Japanese efficiency and management genius. 1
The collapse of Japan’s economy was equally spectacular, after the asset bubble burst in 1990. The Nikkei stock market index dropped from its record high of 39,000 in December 1989 to less than 15,000 in the fall of 1990 (see fig. 5.1). Property prices plummeted by 80 percent in the space of a few months. Not only did the markets in stocks and property crash, but Japan’s economy languished in a recessionary trough for more than a decade. Bankruptcies and suicides rose in tandem. 2 Japanese banks that had dominated world rankings in assets were found to be sitting on enormous mountains of nonperforming loans, and construction of skyscrapers in cities and of massive concert halls in rural towns stalled in midproject for lack of funds.
How did Japan tumble so quickly from an economic powerhouse to a basket case? In this chapter, we argue that an economic growth strategy based on industry protection contained the seeds of later failure from the very beginning. Japan’s rapid economic development in the postwar years and its later decline were both products of a postwar political deal to protect big investors in war industries after World War II. Industry grew quickly in a pro-business climate, to be sure, but protectionist policies accommodated increasingly large amounts of deadwood into the Japanese economy, especially in the nontraded sectors that were most sheltered from competition.
Japan’s industrial policy was supported by well-known economic institutions— the main bank, cross-shareholding, and lifetime employment, to name just three. The minimalist nature of the Japanese welfare state, and the unequal opportunities for women in the workforce, are also well documented. A political logic undergirded the entire system of “convoy capitalism,” 3 propping up firms and whole industries that would have failed in a less-regulated economy, and foisting on Japanese taxpayers high prices and taxes, limited choice in the marketplace, and rigid career paths.
For the staying power of the postwar system, we blame Japan’s rules of electoral competition that pitted LDP politicians against each other in multimember districts. As we described in the previous chapter, LDP politicians were unable to campaign on the basis of a party platform, however public spirited they may have been, and therefore had to “sell” protective regulation in exchange for campaign contributions. Any notion of the “public good” was swamped by the flood of patronage doled out to specific private interests. Moreover, the multimember-district system lent itself to creating new protected groups, and before long big business in Japan had to share policy favors with farmers and small business proprietors in sectors of the economy not engaging in international trade and who were therefore under less market pressure to innovate. Along the way, so many different producer groups were cut in on the bargain that, as it turned out, Japanese economic development proved to be relatively egalitarian.
Over time, the LDP had to spend ever more to keep all of its diverse group of supporters in tow. It was only when the economy finally collapsed under the weight of massive resource misallocation that the hidden costs of convoy capitalism became clear. Reformers within the LDP demanded an end to money politics, splitting the party and destroying its parliamentary majority. Within a year, the politicians agreed to change the electoral system to one that would foster party-based competition. We describe the process and the political effects of that reform in chapter 6, and the economic policy effects in chapter 7. In the remainder of this chapter, we lay out the logic of Japanese convoy capitalism, and explain how global economic integration in the 1980s and early 1990s pulled the rug out from under the LDP’s money politics.
Toward the end of the U.S.-led Occupation of Japan, American officials increasingly ceded control of the economy to the Japanese government. The United States was no longer worried about resurgent militarism in Japan and instead hoped that Japan would contribute to the Americanled defense against encroaching communism in Asia. Prime Minister Yoshida Shigeru (in office 1946, 1948– 1954) worked hard to deflect American pressure on Japan to spend more on defense, for although the United States had imposed on Japan a “peace constitution” that forbade Japan to rearm, the U.S. government had changed its mind and was pressing for a flexible reading of Article 9 that would permit rearmament. 4
The Yoshida government was less alarmed than was the United States by the prospect of Communist expansion, and would have normalized relations with Mao’s China if the United States had permitted; but the Japanese also knew that a strong alliance with the United States would be cheaper than full-scale rearmament. Thus was born the Yoshida Doctrine, to “concede to the United States as much as necessary but as little as possible” to keep the alliance strong. In this way, Japan was able to reserve more government spending for economic recovery. 5

The Japanese government still had many choices to make concerning how to marshal its resources for recovery and growth. Given the short-age of capital and an abundance of labor, Japan’s comparative advantage in world trade should have been in light manufacturing. The textile industry had been the engine of Japan’s economic growth before the military coup in 1932, and a number of economists, including Bank of Japan governor Ichimada Hisato, argued that Japan’s government would be best served by the decentralized, small-scale capitalism of the prewar period. 6 In theory, Japan’s investment in heavy industries during the war constituted a misallocation of resources and should have been considered unrecoverable sunk costs. But in politics, as Gary Becker famously noted, there is no such thing as sunk costs. 7 Political backing can alter economic calculations, because government policies such as subsidies and regulatory favoritism can make an otherwise inefficient business proposition into a profitable investment.

Thus big business in Japan came through the war with portfolios skewed toward heavy industry, since cooperation with the military government had been the firms’ path to survival. 8 Companies with large investments in steel, cement, shipbuilding, and machinery lobbied for a development strategy favoring heavy industry, and received favorable regulations from politicians of the ruling Liberal Party in exchange for campaign contributions. Once the Liberal and Democratic Parties merged to form the LDP in 1955, they developed an even greater appetite for campaign contributions. 9 With two sets of incumbents seeking seats under a common party label, LDP politicians pumped large sums of money into personal support networks to be electorally competitive against each other in multi-member districts, putting a premium on campaign finance.
Japanese businesses were willing to bankroll the LDP in exchange for a favorable business climate. This did not mean wanton public expenditures for any business desiring a handout, because that would have caused ruinous inflation. In exchange for campaign contributions, the LDP gave businesses protective regulation and low-interest loans from the postal savings system, but kept outright budget subsidies within modest limits so as to maintain fiscal and monetary responsibility. Although Ichimada lost the argument about Japan’s trade policy, he served in the first LDP cabinet as the minister of finance and worked hard to keep the government budget in balance. 10
Industrial Policy— the Coalition of Steel and Rice
The Japanese government’s heavy industrial development policy (keisha seisan hoshiki), administered principally by the Ministry of International Trade and Industry and reinforced by other agencies and quasi-public banks, favored heavy industry in a variety of ways. 11 The MITI Heavy Industries Bureau limited entry and often regulated pricing to help stabilize profits. Favored industries received some government budget subsidies and tax breaks, as well as tariff protection and favored access to foreign exchange. Heavy industrial firms also enjoyed privileged access to cheap loans from the Japan Development Bank. 12 The Japan Development Bank was the largest of several quasi-governmental financial institutions funded by the Fiscal Investment and Loan Program (FILP) which pooled millions of savings accounts from post offices around the country. The FILP is sometimes referred to as the “second budget” because the enormous sums of money it disbursed in the form of low-interest-rate loans through a range of financial institutions were comparable to the sums in the government’s general account budget. 13
Japan’s industrial policy was a boon to heavy industrial firms, at least in the short run. But without import competition, many businesses that grew rapidly in this hothouse environment failed to keep innovating and eventually proved incapable of competing globally. It is true that Japan’s GDP grew at an annual average rate of over 10 percent in the decades between the 1950s and the 1970s, a feat that stunned the rest of the world. But the firms and sectors that received the most JDB loans, subsidies, tariff protection, and tax relief actually grew at a slower rate and showed lower productivity growth than did the rest of the Japanese economy. 14 Steel and cement manufacturing, shipbuilding, and mining, for example, lagged behind the less favored electronics and auto sectors.
The incentives that Japan’s electoral rules gave politicians to develop loyal personal support provided an opening for new interest groups besides big business to find representation in the LDP. The Occupation Era reforms had redistributed land to millions of tenant farmers at bargain prices, and in the late 1950s the LDP brought farmers into the fold in response to successful bids by the Socialist and Communist parties for the new “small farmer” vote. 15 The result was a “steel and rice” coalition backing the LDP, whereby heavy industry provided money for campaigns and farmers turned out the vote in large numbers. 16 As with Bismarck’s “iron and rye” coalition in nineteenth-century Germany, both members of the coalition were willing to make a costly trade for the bigger prize of protection. Japan’s heavy industry would have preferred protection for themselves but open markets in agricultural products to lower food prices and therefore wages. Farmers would have preferred open markets in industrial goods to lower the costs of food production while keeping their own markets closed to foreign competition. Instead, the LDP brokered a deal to give each group its highest priority, of market protection, at some cost to each group— and especially high costs to consumers— of higher prices. 17
In the late 1950s and early 1960s, small businesses also joined the LDP support coalition, forming the third leg of the stool that propped the LDP’s long-term tenure in office. Mom-and-pop retailers, as well as small manufacturers and subcontractors of the manufacturing giants, were present all around the country and were organized into many LDP Diet members’ support networks. In exchange for their votes, the LDP gave small stores regulatory protection from retail giants, 18 and leniency on tax reporting. 19
Policy advantages enjoyed by farmers and small business proprietors were, it seems clear, political favors rather than plans to put resources to their best use. The supposed security advantages of self-sufficiency in agriculture made for politically convenient rhetoric, but stockpiling foreign rice would have been a far cheaper way to achieve that goal. 20 Although Japanese agriculture and retail are known for their low productivity of labor, allowing the market to winnow out the less productive enterprises would have been counterproductive for the LDP, which liked them precisely because of their large numbers that could turn out at elections and vote in predictable ways.
Japanese Corporate Governance: Main Banks and Keiretsu
Kent Calder once called Japan’s political economy a Banker’s Kingdom because of the centrality of banks to the investment decisions of Japanese corporations and, indeed, to the direction of the entire economy. 21 Banks are one piece of an interlocking set of economic institutions that characterized the postwar Japanese system of corporate governance: banks loans and stable shareholding arrangements released management from short-term thinking, and lifetime labor contracts motivated workers to invest in productivity-enhancing skills and routines. 22
The Occupation authorities had broken up the zaibatsu holding companies with the U.S. antitrust model in mind, and for a time stock market shares were widely held by individuals. But when the Occupation ended, many companies regrouped into families of firms referred to as kigyo shudan or keiretsu. 23 Keiretsu firms bought each other’s shares to maintain internal control over shareholding, and beginning in the 1960s when the terms of Japan’s accession to the articles of the IMF included acceptance of inward foreign direct investment, keiretsu firms bought even more shares to defend against the possibility of hostile foreign takeovers.
From the standpoint of the Anglo-American model of corporate governance, shielding incumbent managers from market discipline is a bad idea. 24 While shareholders, as the firm’s owners, want to maximize profits, managers, as salaried agents of shareholders, may prefer some mix of goals that includes their job security and leisure. In a stock-market-based system of corporate finance, share prices provide a constant measure of how well managers are marshaling the firms’ assets, and a low share price can trigger takeovers or otherwise result in the replacement of management. 25 To solve the potential problem of managerial slack, according to the Japanese model of corporate governance, banks monitor firm performance and play a managerial role if necessary. If they get it right, the system is nearly perfect: cross-shareholding allows corporate managers to take the long-term view, while oversight by main banks ensures that managers do not use the freedom from short-run performance metrics to enjoy job security at the expense of the firm.
But there is more to this argument. Not only do banks keep managers on their toes, but long-term bank loans also make it possible for firms to offer employees long-term labor contracts, and this is crucial if workers are key players in the Japanese model of the firm. Job security motivates workers to invest in firm-specific skills, making possible the Japanese manufacturing techniques of team production and quality control that rely extensively on inputs from skilled labor, and that are central to productivity in Japanese manufacturing. 26 According to this model, Japanese workers are not merely replaceable cogs in a generic production process. Instead, because of their superior loyalty and stock of knowledge, they are suppliers of indispensable ideas and techniques that make Japanese products of reliably high quality.
Lifetime labor contracts first emerged on a large scale after World War I when Japanese manufacturing firms found a ready market in a Europe still prostrate from wartime destruction. An export boom in Japanese textiles created a scarcity of skilled workers for whom companies competed with attractive contracts. This was a new phenomenon in Japanese labor markets that had been characterized by high levels of mobility among artisans. 27 When the Japanese economy gained momentum after World War II, labor scarcity again drove companies to compete with one another for scarce labor with offers of lifetime employment.
There is much truth to this characterization of the generic Japanese corporate model, which Masahiko Aoki has labeled the “J-firm.” The Japanese have shown that there are multiple efficient ways to produce things, only one of which is the U.S. way of using low-skill labor to fill in the cracks around capital-intensive production processes. Highly skilled and motivated workers have been protected from layoffs in economic downturns through a variety of measures. But this rosy picture of Japanese stakeholder capitalism is only one part of the story. Banks were sometimes poor monitors, and the companies that relied on long-term bank loans did not in fact become the engines of Japanese economic growth. 28 The banks, moreover, were recipients of political favors in their own right. 29
Banking Regulation
In prewar Japan, stock and bond markets accounted for much of firms’ external financing. 30 This changed during the war, however, when the military government forced bank mergers on a massive scale, squelched the stock and bond markets, and channeled private savings into bank deposits for loans directed to munitions industries. 31 After World War II, attempts by SCAP to reduce the market power of the largest banks were cut short by the Reverse Course, and by 1947, the Occupation authorities began to prioritize the health of the banking system over economic deconcentration. 32 SCAP abolished holding companies and drafted an antimonopoly law that prohibited banks from owning more than 5 percent of any company’s shares, but otherwise banks could retain close ties to “family firms” as before.
Along with steel and construction, banks were among the three biggest contributors to the LDP’s electoral coffers in the 1960s through the 1980s. In exchange, banks enjoyed various regulatory favors including a low ceiling for interest rates paid on savings accounts, which prevented banks from competing away the spread between their cost of money and the rates at which they could lend to growing businesses. The Ministry of Finance (MOF) implicitly guaranteed the solvency of banks, not by requiring banks to hold capital in reserve against the possibility of bad loans, but by regulating the competition among banks and across different types of financial institutions in a way that maintained even the weakest as a going concern. 33
In trying to maintain the stability of the banking system by suppressing competition among financial institutions, the MOF incurred considerable risk that bank failure would sully its reputation (and after the bubble burst in 1990, the MOF’s worst nightmares came true). The MOF had attempted repeatedly to shift more responsibility for financial system stability onto banks themselves through prudential rules of various kinds, but in each instance the ministry was thwarted by LDP politicians with close ties to the banks. 34 As we have argued, LDP politicians were more preoccupied with providing particularistic policy favors to big campaign contributors than with formulating public policy with the average citizen in mind. 35 Banks were favored players in the postwar economy because they were able to parlay their market concentration, via the political influence of massive campaign contributions, into profit-padding regulation.
Japan’s most productive firms, in automobiles and electronics, typically had lower than average dependence on main banks. When the MITI in the 1960s pressured the smaller automobile companies to merge with either Toyota or Nissan, they were able instead to solicit capital investments from foreign firms: Mitsubishi from Chrysler and Isuzu from General Motors in 1971, Mazda from Ford in 1979, and Suzuki from General Motors in 1981. By the mid-1980s, when firms such as Toyota or Canon or Panasonic began to look good to banks, those firms no longer needed loans. They had become profitable enough to finance their investments through retained earnings, and had established corporate credit ratings that gave them access to the cheapest sources of capital in the world. International product competition and internal competition for the top corporate jobs, rather than monitoring from banks, kept the management of these firms on their toes.
It would be an exaggeration, however, to say that these exporting firms grew hardy in the thin air of laissez-faire, for they, too, were recipients of a variety of government measures to promote domestic businesses. Until the mid-1970s, the Japanese government protected domestic manufacturers from international competition behind a high wall of import tariffs. Japan (like Germany) also benefited from having its currency fixed at a low level against the dollar. 36 Although a weak currency was appropriate when Japan was recovering from the ravages of the war, by the 1960s the weak yen was seen as artificially depressing the prices of Japanese goods on world markets, thus rendering them artificially competitive. By 1967, Japan (and Germany) had begun running chronic trade surpluses against the United States, prompting calls for exchange rate revision. 37 When Japan refused in the late 1960s and early 1970s to revalue the yen to make Japanese goods more expensive on international markets, the Nixon administration took the dramatic step of bringing down the entire fixed rate system by allowing the U.S. dollar to depreciate against gold in 1971.38 The Japanese yen floated upward and did cut into export profits, but not enough to turn the tide.
Throughout the 1970s and 1980s, chronic Japanese trade surpluses against the United States aroused ferocious pressure from the U.S. Congress. The Japanese responded with a string of concessions, including the elimination of import tariffs on manufactured products by 1978, voluntary export restraints on steel, automobile, and textile exports to the United States, and promises to buy more U.S. products. But farmers and retailers continued to hide behind protectionist barriers. Moreover, although many of the visible barriers to trade in manufactured goods were out of the way by the 1980s, American trade officials complained that the real problems were invisible “structural impediments,” including the keiretsu and main bank arrangements just described, 39 while Japanese trade officials countered that Japanese companies were just better at manufacturing. There was truth to both sides: companies like Toyota were outcompeting American companies wherever they met, whereas other industries, including agriculture, food processing, construction, and transportation, were backwaters that could not survive without props. The LDP had supported its tenure in office for decades by selling these props— budget, tax, and regulatory favors— in exchange for votes and money, at least until the whole edifice was toppled by its own excesses.
Japan’s welfare state does not fit easily into typologies that have been built around European and American examples. 40 Like the liberal market economies of the United States and the United Kingdom, Japan is a chary welfare state as measured by direct government spending on welfare as a percentage of GDP. On the other hand, much of Japan’s labor market is characterized by long-term labor contracts, as in the coordinated market economies of Europe. Japan has universal health insurance, but because pensions are employment based and relatively modest, many Japanese citizens sock away a large chunk of their wages into savings accounts to make up the difference. 41 This jumbled picture does make sense, however, once one understands the nature of Japanese political coalitions.
We have argued that the distributional patterns in Japan’s postwar economy cannot be understood without an appreciation of electoral politics and the demands of the LDP’s favored constituents. The same can be said about social insurance policies. Here, as elsewhere in Japanese policy making, we find a pattern of favoritism to corporate contributors. Indeed, we argue that the notable egalitarianism that accompanied Japan’s rapid postwar economic growth was substantially a by-product of business coddling, anticompetitive regulations that kept weak firms and industries operating (and their employees working) at the expense of high corporate taxes and restrictions on the market behavior of the more competitive firms. Convoy capitalism was not designed in order to produce a relatively equal distribution of wealth and welfare, but whatever its attendant inefficiencies, that was one of its effects. 42
Employment Protections
Long-term labor contracts in Japan emerged in conditions of labor scarcity but not labor political empowerment, first after World War I and then in their current form after World War II. 43 Unlike the continental European model, in which the interests of organized labor were championed by strong social democratic parties that participated in, or even dominated, governments, the LDP’s coalition excluded labor. 44 Japan has no counterpart to the legislative protections of labor that European labor parties have succeeded in incorporating into the industrial bargaining landscape. 45
Japanese employers were gratified by the government’s suppression of industry-wide unions and the resulting establishment of quiescent firm-level unions during the Occupation. Unions organized at the level of the firm are more willing to restrain wage demands because their livelihood is tethered to the firm’s competitiveness vis-à-vis other firms. Lifetime employment is another matter, because that reflects the interests of employers themselves. Long-term labor contracts were designed and implemented by firms for whom skilled labor was central to their production method. Firms wanted to avoid training workers only to have them leave for greener pastures, and therefore back-loaded wages in a system of seniority advancement. Since workers were underpaid in their early years and overpaid in their later years, they had incentives to stay.
Firms’ willingness to avoid layoffs even during economic downturns had the effect of maintaining social stability and softening the bite of recession, even if it was motivated by their interest in maintaining their reputations as good employers for the better years ahead. In contrast to European arrangements, however, where the terms of wage bargaining typically cover all employed workers, Japan’s lifetime employment applies only to the 25 percent or so of the workforce who are cultivated as core, skilled workers. For the rest of the labor force, employment is less secure and less well remunerated.
The biggest group to be left out of corporate largesse is women, for whom Japan’s long-term labor contracts have been a disaster. As labor economists noted decades ago, employers who expect to invest in employees over the course of a career will avoid hiring or promoting women as long as women are more likely to quit or take time off for child rearing and other family work. 46 Women should look like particularly bad investments when lifetime employment is common, and Japanese women have, in fact, fared poorly in Japan’s labor markets. Any weakening of lifetime employment, then, should be a relative boon for women, because it would level the playing field somewhat by making men less secure about their own employment (that is, more like women in that regard).

The distribution of retirement benefits in Japan, keyed to earned wages, bears more similarity to that of the liberal market economies of the United States and the United Kingdom than to those in the coordinated market economies of continental Europe. As with employment protections, pension benefits in Japan overwhelmingly hinge on employment status. The public pension is universal and pays out a flat rate that is not enough to live on in Japan generally, let alone in Tokyo, one of the most expensive cities in the world. Workers rely instead on Employee’s Pension Insurance, which is linked to salary and length of employment. Retirees received a monthly pension of about 50 percent of their average monthly wage, though as we will see in chapter 7, Japan’s aging population, combined with its shrinking workforce, has made the traditional payout rate unsustainable, leading to a downsizing of pensions in 2000.47 The point we wish to make here is that pensions, like employment protections, rest on workers’ market power rather than on their feeble political clout. 48
Health Insurance
Health insurance, which is provided universally at a far lower price than the private health insurance scheme in the United States, is one of Japan’s success stories. But even this ostensibly social welfarist outcome bears the unmistakable mark of Japanese politics. National health insurance is an umbrella for substantially unequal plans that are based on employment status and wages.
SCAP initially put forward a more progressive, redistributive plan that would have brought together Japan’s patchwork system of public health insurance into a comprehensive social insurance system on the British model, but this ran into insurmountable opposition in both the United States and Japan. 49 The Occupation itself had lost its New Deal flavor by 1947, and the so-called Dodge Plan of 1949 aimed at balancing Japan’s government budget by cutting social welfare spending. Japanese businesses insisted on separate programs for industrial workers where they could control insurance premiums and ceilings, given the political power of doctors to balk at managed rates. 50
By 1962 when the government passed health insurance legislation, the Japan Medical Association (JMA) had persuaded the LDP to leave substantial control of treatment and fees to doctors, a feat that is often attributed to the colorful Takemi Taro, who was JMA president from 1957 to 1980. We will never know how much he was bluffing, but Takemi threatened to mobilize doctors to bring down fifty LDP members in the following Lower House elections if the LDP did not agree to physician latitude in treatment methods and payment. 51 The result is health-care coverage that is universal but not unified because doctors retain considerable freedom in treating their patients, while firms control premiums, copayments, and benefits of their employees. 52

In summary, Japan’s welfare system, in health as in other categories, is more extensive than a measure of direct government spending would indicate53 because many of the benefits provided by governments in other countries are, in Japan, tied to employment. This requires, in turn, that employment, at least for a substantial percentage of male heads of households, be stable. 54 And stability of employment, in turn, requires either a powerful union movement that bargains for job security, or else a corporate governance system that shelters firms from the discipline of the market for ownership and can therefore afford to carry their employees through hard times. In Japan, labor was weak, but cross-shareholding arrangements and main bank relationships were the keys to employment protections and hence welfare protections.

We noted above that the system of lifetime employment led to discrimination against women in the workforce— it was a greater risk (or higher cost) to commit to a female employee who might leave the firm to have children. 55 Absent any state provision of child-care or elderly-care services, women were expected to provide those services for their families at home. 56 This arrangement again depended on stability of employment (and sufficient salary) for their husbands. Families could afford to have one spouse stay home and take care of children and grandparents only if the other spouse earned enough money, and was protected sufficiently from the risk of a layoff, to make a one-career household feasible. As Leonard Schoppa has elaborated, women could choose between careers (albeit not as well remunerated or upwardly mobile as those open to men) and motherhood, but the Japanese social welfare system depended on their not being able to have both. Over time, however, Japanese women increasingly have chosen careers, and have opted to postpone or even eschew marriage and motherhood altogether. This has sent the Japanese fertility rate plummeting and contributed significantly to the rapid aging of Japanese society. “Traditionalists” might bemoan the fact, and feminists applaud it, but there is no disputing that the choice of more and more women to “exit” the role of unpaid welfare provider in favor of paid employment has contributed to the “unraveling” of the Japanese welfare system, and perhaps to convoy capitalism writ large. 57
Japan’s economy overheated in the 1980s for reasons having to do with its reaction to pressures of economic globalization. But the reasons for the government’s response, which was to turn on the spigots of money supply, reach back into the early postwar years, and to the structure of Japan’s political system itself. The LDP was simultaneously trying to satisfy exporters and import-competing sectors, a task that looked increasingly like a stunt rider standing astride two horses that have begun moving in different directions.
The world economy began exerting pressure on Japan even before the strain was perceptible. In the early postwar years, although Japanese exports were bolstered by an artificially low exchange rate and a variety of tariff and nontariff barriers, successful exporting nevertheless required investing enormous assets in learning about foreign markets and improving productivity. By the late 1970s, owing to pressure from the United States, Japanese firms lost much of their tariff protection and exchange-rate protection. This forced exporters to improve productivity, while firms in the nontraded sectors of the economy, such as local service providers, invested instead in political lobbying for collusive deals to limit competition.
With advances in transportation and communication technology worldwide, the category of goods and services that were considered to be naturally “nontraded” shrank over the years. Time was when farmers, retailers, and bankers enjoyed such a home-country advantage that they had relatively little to fear. But as time passed, overseas farmers found ways to ship even delicate produce, such as strawberries, profitably to Japan; foreign retailers could offer lower prices than could mom-and-pop grocery stores, thanks to computer-assisted inventory management; and foreign financial-service providers with global investment strategies could offer higher yields than could domestic providers. The natural barriers of distance and cultural knowledge lost much of their power.
For decades, embattled producers of goods and services sought to protect their “nontraded” status. LDP politicians unfailingly came to their aid, because the party’s divide-and-conquer electoral strategy protected them from mass consumer movements, and, for that matter, from political competition by parties that might take up the cause of consumers and taxpayers who were feeling ripped off. The LDP government responded to globalization’s early losers with legislation including the Large Scale Store Law of 1975, which gave small firms the ability to block the entry of large stores in their neighborhoods, and backed Japanese farmers against foreign growers of oranges, beef, and rice. Although the LDP leadership sometimes made timely concessions for the sake of the U.S.-Japan alliance, the LDP politicians who represented the farmers earned the sobriquet of “Vietcong,” because of their dedication to the cause of agricultural protection “until death.” 58
Early signs of disaffection of Japanese manufacturing exporters toward backwater sectors appeared during the mid-1970s, when the post– oil shock recession put a severe strain on the government’s budget. Firms competing in export markets were leery of government budget deficits, lest taxes rise or inflation raise their input costs, cutting into margins on foreign sales. The Administrative Reform movement of the early 1980s, backed by the captains of Japanese industry, singled out agriculture, Japan National Railways, Nippon Telephone and Telegraph, and the national health system for special attention, because of the size of the government budget subsidy allocated to each. Not yet ready to inflict a full measure of pain on farmers, 59 the LDP government met the demands for budget discipline in agriculture by raising the consumer price of rice rather than cutting the price going to rice producers.
By the 1980s, foreign ire aimed at Japanese protectionism threatened to impose on Japanese exporters costs even greater than the tax burden of outright subsidies. In response to Japan’s enormous and growing trade surplus, the country’s trading partners insisted that Japan either revalue the yen (to make Japanese products less competitive overseas) or throw open Japan’s domestic markets to foreign manufactured goods. 60 The Japanese government opted for exchange-rate adjustment in hopes of blaming the pain of economic adjustment on market forces.
Following the Plaza Accord of 1985 and the Louvre Agreement of 1986 in which Japan agreed to allow substantial appreciation of the yen, the Japanese government reduced real interest rates to zero as a domestic painkiller. 61 The LDP wanted to ease the adjustment to market forces for Japanese exporters and import-competing firms, but in the process produced one of the biggest asset bubbles of the twentieth century. Banks and corporations went on an enormous spending spree with nearly free money, bidding up the price of real estate and other assets until the land under the Imperial Palace in Tokyo (about three square miles) was valued as highly as the entire real estate of California. 62
For successful Japanese manufacturers who could compete without government favors, foreign anger against Japanese protectionism soon struck home. The U.S. Congress equipped the 1988 Omnibus Trade and Competitiveness Act with a zinger clause, known as Super 301, which authorized the administration to retaliate against countries considered to be engaging in unfair trading practices. Although the Reagan administration and congressional Republicans resisted a full embrace of economic protectionism, bipartisan support for a more activist American trade policy gelled around the national security angle. The Exon (D-NE)-Florio (D-NJ) amendment to the 1988 Trade Bill granted the president authority to block an acquisition by a foreign firm in the event of “credible evidence” that a “foreign interest exercising control might take action that threatens to impair the national security.” Fujitsu, a Japanese electronics company that had signaled an interest in purchasing Fairchild Semiconductor Corporation, backed off rather than stumble into a thicket of hostile congressional scrutiny. 63
Japan’s bubble economy of the late 1980s eliminated government budget constraints, temporarily relieving one of the pressures on the LDP’s shaky electoral coalition between exporters and the nontraded sectors. But the bubble finally burst in 1990 when the Bank of Japan began raising interest rates. The collapse of the stock and real estate markets came as a genuine shock to the many people who had thought that Japan would come to dominate the world economy.
After the market crashed, the voting public in Japan expressed unprecedented disenchantment toward the ruling Liberal Democratic Party, and politicians began running for cover in every direction. Now that firms and jobs were in mortal danger on account of the asset collapse, the Japanese government that had once looked like the proud managers of a first-rate economy looked like a bunch of incompetent (and corrupt) bumblers. There was no papering over the opposed interests of traders and antitraders in an economy for which export revenues are so important to growth and livelihood.

In years past, the LDP had held the productive and unproductive groups together by reminding each that they needed the other. While export businesses oiled the LDP’s electoral machines with campaign contributions, the farmers and shopkeepers were equally indispensable because of their mobilizational capacity to turn out the vote. This symbiosis between money and votes eroded, almost imperceptibly at first, when steady and ultimately vast migration from rural into urban areas turned Japan into a nation of “floating” voters untethered from the communities of their rural ancestors. While farmers and shopkeepers remained motivated as ever to protect their livelihoods, they had become vastly outnumbered by company employees and other urban dwellers for whom high grocery bills were an irritant and the prospect of foreign protectionist retaliation a real threat to their careers.

Japan’s economic miracle was operating on borrowed time. Government protection from competition made for some spectacular early achievements, and some Japanese companies went on to become household names around the world because of their successful production strategies and desirable products. Many other companies, particularly those in the nontraded sectors, mistook a lack of competition for success and settled into comfortable lassitude. 64
Japan’s postwar political economy was built on a complex but delicate web of political coalitions and economic policies. The LDP relied on votes from farmers and small business owners in exchange for protectionist regulations, government subsidies, and tax breaks. The party also depended on enormous campaign contributions from big business, and had to maintain a favorable investment environment (secure bank loans, low interest rates, an undervalued currency) and diplomatic efforts to keep foreign markets open for Japanese products. As long as the government could hold foreign finished products at bay, could force Japanese firms to raise their capital domestically, and could subsidize inputs, the “steel and rice” coalition was viable. But once the regulatory net began to tear, the unraveling came quickly.
One source of strain on regulatory protection was foreign pressure. Japan’s trading partners, particularly the United States, demanded the opening of Japanese markets to imports and threatened retaliation against Japanese exporters. Big Japanese manufacturers, the firms that had driven the economy’s spectacular growth, took these threats seriously and pressured the LDP to jettison the most heavily protected sectors, which were in any case an enormous drain on the national budget.
Other leaks appeared when, as Schoppa tells us, Japanese firms that sought flexible, lower-cost labor markets abroad, and women, who exited the home in favor of paid employment, undermined the Japanese system of welfare provision. 65 And of course the excesses that led to the formation of the bubble economy in the late 1980s were the result of incomplete regulation even of the domestic economy. Individual lenders and borrowers took advantage of loopholes and the bad incentives of “free money” to amass a mountain of ultimately unrecoverable loans.
The concentration of wartime industries goes far toward accounting for business’s privileged position in Japan’s postwar economy, but leaves unexplained how rigidities survived for decades and to an extent not seen in many other countries. Japan’s postwar electoral rules, by forcing politicians from the Liberal Democratic Party to spend most of their money and effort differentiating themselves from one another in multimember districts, were an important reason for Japan’s convoy capitalism. One implication of this argument is that overlaying different institutions onto the same material conditions would have generated pressure in different directions. Majoritarian institutions of the Anglo-American variety would have pushed politics toward broader coalitions, reducing the premiums captured by organized groups with extreme preferences, and appealing more to the interests of unorganized voters. Proportional representation would have given labor a persistent and politically potent voice of the kind we see in continental Europe. 66 We realize this is a strong claim, that material conditions are filtered by electoral competition in powerful and predictable ways. The next two chapters take advantage of the electoral rule change of 1994 to see how well our logic holds.

1Self-deprecating humor in America in those years included a joke about President George H. W. Bush awaking from a coma, nervous about what might have happened to the U.S. economy while Vice President Dan Quayle presided on his behalf. “What is our growth rate?” “Five percent, sir.” Surprised, Bush asked about interest rates and unemployment. “They’re both around five percent as well,” answered Quayle. “How did you do that?” the president asked, genuinely astonished. “We asked the Japanese to take over our economy,” came the answer.
2Amyx 2004: 2.
3The metaphor of the “convoy system” evokes the image of a naval flotilla that moves only as fast as the slowest ship. It has long been used to describe postwar Japanese financial regulation, and we follow Schoppa 2006 in extending the metaphor to refer to Japan’s postwar political economy as a whole.
4The U.S. government was frustrated with Yoshida’s staunch opposition to bigger Japanese defense budgets and began to push the candidacy of the more hawkish Hatoyama Ichiro behind the scenes. See, for example, the now-declassified top secret Department of the Army document 0029 of August 17, 1955, on the merger between the Democratic and Liberal Parties.
5By Hugh Patrick’s estimate, Japan’s economy would have been 30 percent smaller by 1976 if it had allocated 4– 5 percent of its GNP to defense rather than the 1 percent it spent (Patrick and Rosovsky 1976).
6Inoue 2002.
7Becker 1983.
8Tiedemann 1971.
9Behind the push for the merger were business groups seeking more generous government financing and protective regulation. They got rid of Ichimada as the Bank of Japan governor, because he was holding to a tight monetary policy. Asahi shimbun, March 16, 1954, p. 4, and August 16, 1954, p. 1. At the same time, businessmen worried aloud that the Liberal Party’s spending would cause inflation. Asahi shimbun, September 7, 1954, p. 3. Supporting favored groups in a fiscally responsible way became the LDP’s central creed.
10Asahi shimbun, October– December 1955, various issues; Inoue 2002.
11Johnson 1982.
12Uriu 1996; Noble 1989; Beason and Patterson 2004.
13Calder 1988.
14Beason and Weinstein 1996: 289.
15Calder 1988.
16This point echoes Calder 1988 and Pempel 1998.
17Calder 1988. Not only did the government block imports of foreign rice, but it ensured that farmers received artificially high prices for rice through a buying scheme paid for by the general government budget. During the 1970s, Japanese rice farmers received up to seven times the world price, though consumers were able to buy at only three or four times the world price, thanks to government subsidy.
18Schoppa 1997; Upham 1993.

19Kishiro 1985. The street wisdom about who paid what in taxes is known as 9-6-4 (kuroyon): wage workers paid taxes on 90 percent of their income; small businesses paid taxes on 60 percent of their income because they systematically underreported; and farmers paid on 40 percent of their income because their books, too, were not carefully monitored, and because all land under cultivation was taxed at a far lower rate than other land.

20Hoshi, Kashyap, and Scharfstein 1990.
21Calder 1993.
22Aoki 1988, 2007.
23Japanese refer to groups of firms with interlocking shareholding patterns as kigyo shudan, or “corporate groups.” In American scholarship on Japan, the term keiretsu has been popularized, perhaps first by Japan watcher James Abegglen, to refer to the same phenomenon. In Japan, keiretsu is a generic term that means linkage and is more often used in connection with the vertical relationships between parent companies and subsidiaries (Hoshi and Kashyap 2001).
24Berle and Means 1932; La Porta et al. 1997.
25In the Anglo-American model, performance-based executive compensation is a way to align the interests of managers with those of owners, and an outside board of directors is an additional monitoring mechanism.
26Aoki 1988; Soskice 1990; Jackson 2001; Vogel 2006.
27Thelen and Kume 2001; Streeck 2001.
28It should also be noted, however, that banks probably increased the quantity, if not the quality, of capital going into industry in the 1950s and 1960s, and main banks gave borrowers the security to keep investing borrowed money even in tough times.
29Our view of Japanese corporate governance takes seriously its political roots, and is consistent with Gourevitch 2003 and Gourevitch and Shinn 2005, who argue that strong labor unions and the PR electoral institutions that helped to translate union strength into political clout underpin “stakeholder capitalism” in the coordinated market economies of Europe. By contrast, weak unions and majoritarian electoral rules in
liberal market economies such as the United States and the United Kingdom give shareholders far more scope for ensuring regulation that favors shareholders over other “stakeholders” in the corporation. In Japan, workers were politically weak, but their scarcity motivated employers to compete for them with long-term contracts. See also Pagano and Volpin 2005 for the way regulation and corporate governance are shaped by electoral rules.
30Prewar banks sought capital requirements and other entry barriers to consolidate the banking sector but were thwarted by the prewar Diet, where small banks retained considerable clout. In 1892, Shibusawa Eiichi, of the Tokyo Bankers’ Association and founder of the Daiichi Bank, proposed minimum capital requirements, but without success. Sakairi 1988: 191; Ramseyer and Rosenbluth 1995: 104.
31Alexander Gerschenkron (1966) argued that late developers tend to establish bank-centered finance as a way to play economic catch-up, but the reason for concentration of finance into banking rather than in a decentralized stock market in both Germany (under Bismarck) and Japan (under the military government in the 1930s) was to build a war machine.
32Hadley 1949; Tristan Beplat, an economic officer in charge of banking, remembers that the Japanese bankers soon learned to come to him over regulatory issues rather than to the Occupation’s antitrust office. Tristan Beplat, personal communication, 1987.
33The MOF regulated competition among banks and between banks and nonbank financial companies in a way that ensured the viability of weaker institutions. For example, big banks for many years were not allowed to offer ATM services beyond the hours that smaller banks (which could not afford ATMs) kept their doors open. Simultaneously, the MOF enforced walls separating commercial banking, investment banking, life insurance, nonlife insurance, agricultural cooperative banks, postal savings, and so on.
34The final version of the Banking Act of 1982, for example, gutted the MOF’s proposals for stiffer capital adequacy requirements. See Rosenbluth 1989.
35Rosenbluth and Schaap 2003.
36Fixed exchange rates were a pillar of the postwar international monetary system hammered out principally by the British economist John Maynard Keynes and American Treasury official Harry Dexter White at Bretton Woods, New Hampshire, in 1944. Their hope was to prevent a
repeat of the spiraling worldwide depression triggered by competitive rounds of currency devaluation before the war. The other Allied nations, including the Soviet Union, were represented at the Bretton Woods conference as well, but the American and British views dominated the planning for the postwar international financial institutions including the World Bank and the International Monetary Fund.
37Kindleberger 1972.
38Closing the gold window on August 15 was the second of two “Nixon Shocks” that summer. On July 15, the trip to Beijiing by U.S. National Security Advisor Henry Kissinger to begin rapprochement with China had caught the Japanese off guard, because they had been forced in 1952 by the American government to recognize as the official government of China Chiang Kai-shek’s government on Taiwan. Nixon took both actions without consulting the Japanese in advance.
39Schoppa 1997.
40Esping-Andersen 1990.
41Dekle 2005. Since the bubble burst, however, Japanese household savings have declined precipitously, from 11.4 percent in 1997 to 7.9 percent in 2000 to only 2.2 percent in 2007 (Noble 2009).
42A much more thorough treatment can be found in Estévez-Abe 2008. She characterizes many of these welfare-affecting economic regulations as the “functional equivalents” of more explicit public-goods-oriented welfare programs. The differences lie in the means by which certain outcomes are produced, and especially the extent to which benefits are targeted to favored groups.
43Moriguchi and Ono 2006.
44Pempel and Tsunekawa 1979.
45Swenson 2002 points out that strong labor unions could be, in some circumstances, useful to businesses in managing production cartels. Negotiations over wages could also be used to anchor production quotas. But businesses in Japan did not need the help of labor to form cartels, since the government was protective of business interests.
46Mincer 1968; Polachek 1978; Estévez-Abe, Iversen, and Soskice 2001.

47Clark and Mitchell 2002. Chopel, Kuno, and Steinmo (2005: 22, 30) note that the United States and Japan are similar not only in their generally low levels of social spending, but in the large shares of those small amounts devoted to the elderly. For Japan, with its low fertility rate, this poses a far bigger fiscal problem. In 1973, 25 percent of the Japanese government’s welfare spending went to the elderly; by 2001 it was 68.7 percent.

48Estévez-Abe 2006.
49SCAP Public Health and Welfare 1946; Sheingate and Yamagishi 2006.
50When health-care costs began to climb at a faster rate in the 1970s, the business community insisted that the LDP put a tighter lid on them.
51Takemi Taro won the gratitude of the medical profession when he demanded of the LDP that the health insurance law of 1962 guarantee physicians’ professional freedom and give the JMA a say on any changes in fee schedules. See Steslicke 1973; Campbell and Ikegami 1998; Khoon 2006.
52Campbell and Ikegami 1998: 107; Sheingate and Yamagishi 2006: 158. Premiums range from 7.3 to 9.5 percent of the wage base. According to empirical analysis by Komamura and Yamada (2004), firms passed along the costs of employers’ contributions toward health care to employees but not the costs of long-term-care insurance, reflecting relative demand for each.
53Estévez-Abe 2008.
54Schoppa 2006.
55Of course, we do not mean to imply that there were not also other causes of gender discrimination. But lest we assume that the ultimate source of gender discrimination is some notion of Asian patriarchy, it is worth noting that women are more likely to be employed in Taiwan, where the small-firm economy is characterized by fluid labor markets, compared to Japan and Korea (Brinton 2001).
56Indeed, as has often been noted, housewives were most likely to be responsible for the care not of their own parents, but of their in-laws.
57Schoppa 2006; Campbell 2002.
58“ Vietcong” in Japanese, betokon, also sounds amusingly similar to beikon, shorthand for the Beikakondankai, or Rice Price Deliberation
Council, which set the producer price of rice each year. This was a supremely political decision, because it required setting the amount of the subsidy going to agriculture from the General Account Budget.
59But see Thies 1998.
60Why Japan’s trade surplus was so large is another question. Part of the answer, no doubt, is simply that Japanese automakers outperformed their American counterparts, but the weak yen also contributed, as did various tariff and nontariff barriers against foreign imports.
61The Bank of Japan set the nominal discount rate at 2.5 percent, which left the real rate at zero, controlling for inflation. The BOJ raised the rate to 3.25 in mid-1989, and to 4.25 by the end of the year, still only marginally above the rate of inflation.
62Wood 1992.
63Crystal 2003. Ironically, Fairchild at the time was owned by Schlumberger, a French oil field services company that was courting Fujitsu as a buyer.
64These are the companies that would become the source of massive nonperforming loans in the postbubble world when banks once again had to evaluate loans on a more realistic basis.
65A similar source of partial “exit” had begun in the late 1970s when the strongest Japanese firms began to raise capital on the Euromarkets rather than depend on loans from domestic banks (Rosenbluth 1989).
66Rogowski and Kayser 2002; Schaap 2002; Bawn and Thies 2003.
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