The Myth of Japanese Industrial Policy
APRIL 01, 1988 by C CROCKER
Mr. Crocker is a financial planner in San Diego.
Record trade deficits and the fear that America is losing its manufacturing base have focused attention on the need to restore American competitiveness. One proposed solution, which is making its way toward the political front burner, is “industrial policy”—government intervention in specific sectors of the economy geared toward “improving the patterns of our investments.”
This idea last came to the fore when Walter Mondale adopted it in his 1984 presidential bid. Although the term “industrial policy” is somewhat vague, and is used to mean different things by different people, it usually encompasses some form of government intervention aimed at specific industries. Such intervention ranges from subsidies or tax breaks to government-financed employee training programs.
It is incumbent upon industrial policy proponents to answer three questions: First, under ideal circumstances, can industrial policy work? Second, in the real political world, will industrial policy degenerate into yet another means for politicians to pass pork-barrel legislation? And third, is the sacrifice of individual liberty involved in implementing a serious industrial policy worth the supposed gains? This article is concerned with the first two questions, for if the advocates of industrial policy fail on these two points, the last question is moot.
Proponents of national industrial policy often point to Japan as a showcase of what such policies can do. The Japanese government, through such agencies as the Ministry of International Trade and Industry (MITI) and the Ministry of Finance, has played a powerful role in the economy, the argument goes, turning a war-battered Japan into an economic juggernaut in 25 years. The reality of the Japanese experience, however, does not provide support for a U.S. industrial policy.
During the 1950s and 1960s, the Japanese banking system wasn’t well developed, nor did Japanese companies have access to an efficient capital market. This enabled the government, mainly through the Ministry of Finance and the Bank of Japan, to influence the availability of funds to specific industries. The government controlled a vast pool of private savings deposited with the post office, which had a virtual monopoly on private savings deposits.
With this power, the Japanese government effectively rationed credit, giving greater amounts to targeted industries such as steel, utilities, and communications. As domestic credit markets matured, however, and Japanese firms expanded and were able to tap foreign capital markets, the Japanese government lost the ability to control the flow of capital. Nevertheless, the government still controls a substantial amount of private savings which it uses for subsidized loans and loan guarantees.
MiTI has long tried to influence company policies, while attempting to coordinate some industry activities, such as research and development. This role has grown in importance as credit rationing is no longer practicable. MITI has also loosened antitrust laws to allow firms to engage in joint research activities and to permit firms in troubled industries to cooperate.
However, the fact that a government has attempted to play an active role in an economy does not necessarily mean that it has significantly altered the final workings of the market. This seems to be the case in Japan.
During the 1950s and 1960s, when the Japanese government used credit rationing to allocate capital to target industries, Japan was rebuilding its industrial infrastructure which had been battered during the war. This made it relatively easy to see which industries needed to be developed in order to catch up with other industrialized countries. A private commercial banking system, however, probably would have targeted these same industries since they offered profitable returns at low risk. But even if the government’s efforts at targeting industries after World War II hastened Japan’s economic rebirth, such a policy would not be relevant to an already developed economy such as the United States in 1988.
MITI’s Overstated Influence on Japanese Firms
MITI’s influence over Japanese businesses is often overstated. Japanese firms generally follow only the MITI proposals with which they concur. MITI, for instance, did not want Mitsubishi and Honda to build cars, and did not want Sony to purchase U.S. transistor technology. The companies, however, went ahead, and entire industries were transformed.
MITI has not had any real power over Japanese industry since the Japanese government lost its near monopoly on the supply of credit in the early 1970s. Since then, MITI has made only suggestions, or has ruled on proposals from business leaders concerning industry cooperation and government loans. As Sadanori Yamanaka, Minister of International Trade and Industry, stated in 1983, “MITI works in an indirect fashion. When it guides industry, it is with soft hands. It has no real coercive power anymore. The main player is private industry.”
The savings still controlled by the Japanese government are spread so thin among special interests that they are not an effective tool for industrial policy. Charles Schultze, chairman of the Council of Economic Advisors under President Carter, has concluded, “In Japan as in any other democratic country, the public investment budget has been divvied up in response to diverse political pressures. It has not been a major instrument for concentrating investment resources in carefully selected growth industries.”
A case in point is semiconductors. This industry has been lauded as an example of the successful use of government financing for research and development. Yet the government’s main investment ann, the Japanese Development Bank, has spent only one per cent of its budget for semiconductor research and development, which represents only a few percentage points of total research and development in the industry.
In addition to being spread thin, Japan’s public investment budget is relatively small. During the 1970s, net lending by the Japan Development Bank amounted to only one per cent of private non-housing capital formation. The Japanese government is responsible for about 28 per cent of its nation’s non-defense research and development—four per cent less than what the U.S. government supplies. Far from being an aggressive partner in funding industrial research and development, the Japanese government is actually less active than is the U.S. government.
One true success story of Japan’s industrial policy has been the government’s ability to assist distressed industries. The Japanese government has achieved this by relaxing antitrust laws so that firms can work together in industries burdened by over-capacity and reduce research and development expenditures by entering into joint research projects. But this is not an argument for an increased government presence in the market; it is quite the opposite. The success of this policy comes from reducing government intervention.
Though the extent of Japanese industrial policy has been exaggerated, it cannot be denied that it has had some effect on the Japanese economy during the past 35 years. There is no convincing evidence, however, of a causal relationship between industrial policy and Japan’s economic success. In fact, the argument could be made that the Japanese economy has flourished despite the activities of agencies such as MITI.
Aside from targeting basic industries after World War II, the performance of Japan’s economic planners has left much to be desired, by the planners’ own standards. In contrast to the examples of Mitsubishi, Honda, and Sony, which had the determination and foresight to disobey MITI, some of Japan’s big industrial disappointments such as shipbuilding and aerospace received much government favor and funding. The Japanese cement, paper, glass, bicycle, and motorcycle industries—all of which are success stores—never received much assistance, and occasionally encountered some resistance from MITI. The two industries most associated by Americans with Japanese success—automobiles and consumer elec-tronics-were never selected by the Japanese government as priority industries.
The Japanese economy has benefited from a number of factors since the early 1950s, none of which have had anything to do with industrial policy.
First, encouraged by low tax rates (especially on interest income, which for most individuals is tax-free) and the absence of a social security system, the Japanese have saved at a high rate. Over the past 25 years, the Japanese individual savings rate has ranged between 17 per cent to more than 20 per cent of after-tax income; over the same period Americans saved only four to seven per cent.
Second, the Japanese have had access to relatively cheap labor until recently, as economic growth has bid up wages. This labor force has a strong work ethic, with most Japanese working six-day weeks and rarely taking holidays.
Third, Japanese management has done an excellent job in controlling production costs, recognizing and meeting consumers’ desires, and in formulating human resource policies which have kept worker morale and productivity relatively high, and the power of labor unions low. With so many favorable variables at work, there is little cause for hailing industrial policy as the reason for Japan’s economic robustness.
History clearly shows that the United States government is not well suited to making hard decisions on resource allocations, separate of political considerations. Charles Schultze cites the examples of the Economic Development Administration (which categorizes fully 80 per cent of the counties in the United States as being eligible for “aid to depressed areas”) and Lyndon Johnson’s Model Cities program, which ended up dividing its budget among 150 cities. Government policy toward the tobacco industry, which is simultaneously taxed, restricted, and subsidized, is another indication of the government’s ability to implement a consistent industrial policy. A national industrial policy would not be any different from the existing hodgepodge of politically inspired handouts, except that more special interests, and significantly more funding, would be involved.
The Japanese government no longer “targets” industries as some industrial policy proponents would like to see the U.S. government do. The reason for this has been the realization by the Japanese government that it cannot predict what the best industries will be for Japan.
Aneel Karnani, Professor of Corporate Strategy at the University of Michigan, states the issue clearly: “What will be the better growth industry in the next decade, computers or biotechnology? Do you want some bureaucrat somewhere making that decision?”
Austrian economist Friedrich Hayek has provided the answer: “It is through the mutually adjusted efforts of many people that more knowledge is utilized than any one individual possesses or than it is possible to synthesize intellectually; and it is through such utilization of dispersed knowledge that achievements are made possible greater than any single mind can foresee.”
The market brings together the information possessed by all individuals in the market and, therefore, is able to make better decisions on questions of optimal resource allocation than can any group of bureaucrats. To try to identify “winners” and “losers” beforehand is folly.
Japan’s economic success is not due to industrial policy. The Japanese success story is based on high savings, hard work, and excellent business leadership. These are the areas in which the United States must improve to re main competitive in the world market. The U.S. government can make positive contributions by reducing the budget deficit, repealing burdensome regulations, and implementing tax policies which encourage work and productive investment. But attempts at “planned” meddling will not help.