Institutional Change in Japan

Magnus Blomström, Sumner La Croix, Magnus Blomström, Sumner La Croix

• Publisher: Routledge
• Year: 2006
• eBook ISBN: 9781134180561
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

This is a newanalysis ofrecent changes in important Japanese institutions. It addresses the origin, development, and recent adaptation of core institutions, including financial institutions, corporate governance, lifetime employment, and the amakudari system.

After four decades of rapid economic growth in Japan, the 1990s saw the country enter a prolonged period of economic stagnation. Policy reforms were initially half-hearted, and businesses were slow to restructure as the global economy changed. The lagging economy has been impervious to aggressive fiscal stimulus measures and has been plagued by ongoing price deflation for years. Japan's struggle has called into question the ability of the country's economic institutions, originally designed to support factor accumulation and rapid development, to adapt to the new economic environment of thetwenty-first century.

This book discusses both historical and international comparisons including Meiji Japan, and recent economic and financial reforms in Korea, Scandinavia, Switzerland, and New Zealand, placing the current institutional changes in perspective. The contributors argue that, contrary to conventional wisdom that Japanese institutions have remained relatively rigid, there has been significant institutional change over the last decade.

Part I
Institutional change in theory and practice

1
Institutional change in Japan

Theories, evidence, and reflections

Sumner La Croix and Akihiko Kawaura

Introduction

I Love You, You’re Perfect, Now Change is the title of a long-running off-Broadway musical in New York City that chronicles the course of love and marriage. One could forgive Japanese visitors if they surmised from the title that the show was actually about the changing perception of Japan in Europe and North America. In the 1980s, the Japanese economy registered strong income growth; the yen soared in value; high domestic savings rates allowed massive investments overseas; soaring equity and land values commanded daily media attention; and Japanese economic institutions and business practices were lavished with praise (and sometimes vilified) by the Western media. North American and European firms and governments studied the Japanese experience closely to see what aspects of Japanese business practices and institutions they could adopt to improve their own performances. In the 1990s, the love affair with Japanese institutions was shaken when Japan’s economic bubble burst. Land and stock market prices began a precipitous fall in 1990 that only leveled off in the 2003–05 period; real income growth was low and volatile for over a decade (1991–2003); deflation in consumer prices from 1995 raised anxiety among foreign and domestic observers that the economy was on the verge of collapse; and massive losses on overseas investments, e.g. in Hawaii and New York City, sullied Japan’s image as an economic superpower with a uniquely long vision in making investments. Calls of Now change! began to resound both inside and outside of Japan after 1995. Yet within just a few years the academic and media chorus began to repeat a new refrain: Why doesn’t Japan change? Why doesn’t Japan reform its unique economic and political institutions, remolding them around the successful models observed in Great Britain and the United States?

Our challenge in this essay is threefold. First, we provide a brief overview of the theory of institutions and institutional change, with considerable emphasis placed on Douglass North’s recent formulation of these issues in his book, Understanding the Process of Economic Change (2005). In particular, we spend considerable space discussing the concept of “path dependence” as we believe that it is critical to an understanding of Japan’s contemporary institutions.

Second, we closely examine the assumptions underlying the initial calls for institutional change and set forth the process by which such change would proceed. We identify four critical assumptions: (1) the underlying reason for Japan’s economic stagnation is that its economic institutions had become obsolete and were no longer capable of generating efficient outcomes; (2) large-scale rather than incremental institutional change was required; (3) the institutional changes could be proposed, enacted, and implemented relatively quickly; and (4) the new institutions would quickly become effective, raising GDP growth within a relatively short period of time. Our analysis critically examines these assumptions and finds that many of them are highly problematic, even in a highly idealized setting. We briefly ponder whether major institutional changes could have been carried out successfully if there had been strong leadership in political, business, and labor arenas pushing for the changes.

Third, we analyze the question Why doesn’t Japan change? from a number of critical perspectives. We begin by critiquing the conventional wisdom, that a coalition of powerful, political interest groups is blocking critically needed reforms because these groups would lose wealth and power. Because the current system is so cozy and inflexible, it is commonly argued that reformers have been and will be unable to muster sufficient political power to force change until the system is confronted with a major crisis. We argue that the conventional wisdom captures essential elements of an answer to the question, yet also provides a far too simplistic portrayal of the determinants of institutional change in Japan in the first decade of the twenty-first century.

We then question the basic premise behind the question Why doesn’t Japan change? and consider whether there really has been little or no institutional change in Japan. As do several other authors in this volume, we argue that Japan has been undergoing incremental change since the early 1980s and that such change is harder to discern and evaluate because of its incremental nature, slow pace, and the continuing economic stagnation. Rather than only asking why Japan does not change, we should also be examining how Japan is changing and whether these changes are likely to be sufficient to generate a new set of social institutions that will be flexible enough to allow Japan to weather and adapt to its current pressing challenges: the shocks of globalization, the dramatic demographic shift in the age structure and size of its population, and the meteoric rise of two new Asian giants, China and India. We analyze several strategies that the Japanese government has been using to trigger institutional change and reflect on why several institutional changes, considered by many analysts to be critical components of stimulating economic growth in Japan, have not been implemented.

We proceed as follows. We first provide a brief survey of the theory of institutions and an overview of a variety of different analyses of Japan’s unique institutions. We then focus more specifically on the theory of institutional change and confront the questions of whether these theories are likely to be applicable to Japan, before drawing our conclusions.

Institutions: theory and applications to Japan

The New Institutional Economics: an introduction

“Institution” is a commonly used word that could refer to an organization that plays a prominent role in society, e.g. Sony Corporation, the Japanese Diet, Tokyo University, or it could refer to the sets of rules, norms and expectations which guide our behavior. In the New Institutional Economics, it is the second use of the word that dominates, although there are significant variations in its usage by its practitioners. One group, which includes Douglass North and Leon Hurwicz, defines institutions as

The humanly devised constraints that structure human interaction. They are made up of formal constraints (e.g., rules, laws, constitutions), informal constraints (e.g., norms of behavior, conventions, self-imposed codes of conduct), and their enforcement characteristics.

(North 1994, 360)

A second group, which includes Andrew Schotter, Avner Greif, and Masahiko Aoki, considers institutions to be the equilibrium outcome of a game. Aoki (2001) defines an institution as a shared, self-sustainable, summary expectation held by agents of the way in which a game is repeatedly played in a certain domain.

Regardless of which definition we adopt, institutions arise because individuals face an environment with multiple sources of uncertainty, and they have an “ubiquitous drive to make their environment more predictable” (North 2005, 14). Ronald Coase (1937, 1960) made this point in a more limited context in his seminal articles on the relationship between markets, firms, and legal rules, arguing that in a world with zero information and transaction costs there would be little need for firms or for legal rules to structure transactions. In a world with imperfect and asymmetric information, environmental shocks (e.g. floods, earthquakes, droughts, etc.), and technological innovations, humans construct institutions to structure their responses to these events and with each other. By structuring the way the game is played among human beings, institutions allow individuals to face a more secure environment, albeit at the cost of encountering a more complex human environment.

North sets forth a concise representation of the broad scaffolding that constitutes the institutional framework of modern societies:

The institutional framework consists of the political structure that specifies the way we develop and aggregate political choices, the property rights structure that defines the formal economic incentives, and the social structure – norms and conventions that defines the information incentives in the economy. The institutional structure reflects the accumulated beliefs of the society over time, and change in the institutional framework is usually an incremental process reflecting the constraints that the past imposes on the present and the future. All this – and more – makes up the structure that humans erect to deal with the human landscape.

(North 2005, 49)

North (p. 60) makes a sharp distinction between institutions and organizations, with organizations being “groups of individuals bound together by some common objectives.” Arising as an endogenous response to incentives provided by the institutional structure, organizations compete to earn rents within the existing institutional structure and to change the institutional structure to their advantage. To gain an advantage in both types of competition, organizations invest in skills and knowledge. This accumulated human capital leads to two critical results: (1) it allows some organizations to be successful in their initiatives to change the institutional structure; and (2) it changes the way in which organizations and their members perceive and evaluate the institutional framework.

The second point is critical, as much institutional change can only move forward when it is approved by legislators, judges, regulators, or the executive. They, in turn, must be convinced that existing institutions have become inefficient; that there is a better alternative which can be implemented in a timely fashion; and that they will be able to convince constituents of these points. A number of factors – specific investments by organizations in the existing institutional framework; interlocking institutions; uncertainty concerning how alternative institutions might work; and the transaction costs associated with the process of institutional change – combine to ensure that in most cases institutional change is incremental, proceeds at an uneven pace, and is path dependent (North 2005, 62).

The basic theory of group adaptation and environmental selection is compelling in the context of a free and open civil society, but one can surely question how easy it is in many countries for new groups, particularly splinter groups, to enter civil society and prosper therein. Governments typically treat various groups in civil society very differently, thereb...

Table of contents

• European Institute of Japanese Studies, East Asian economics and business series
• Contents
• Figures
• Tables
• Contributors
• Series editor’s preface
• Preface
• Introduction
• Part I Institutional change in theory and practice
• Part II Japanese institutions
• Index