Chapter 59 – Japan’s Unbalanced Economy


Try Walking on Two Legs 

1. Trade Problems 
2. Endaka (yen appreciation) Problems
3. Harmful Exchange-rate Protectionism
4. Textbook versus Sensible Protectionism
5. Trade Frictions
6. Merits of Local Production
7. Manufacturing versus Services
8. Anti-Service Sector Bias
9. The Colin Clark Factor

As we enter the 1980’s Japan began to run into trade frictions.

The economy was clearly out of balance. 

Using Nikkei I could get some of these ideas into print  – in Nikkei Weekly, Nikkei Business etc. 

But while some of us may have had some influence on thinking about the trade question, I doubt if any of us could have done anything to curb Japan’s determination to rush into that speculative frenzy that came to be called the Bubble.

1. Trade Problems

Topic Number One in those innocent days was trade frictions, with the US especially. By today’s standards they were miniscule.

But at the time any hint of a continuous trade deficit was seen as proof of impending disaster for one side, and nefarious scheming by the other. 

Nor should it have been hard to find the main culprit. 

At 360 yen to the dollar the yen had been grossly undervalued, and this was helping exports unduly (just as an undervalued yuan was later to help Chinese exports unduly). 

So Japan’s trade partners had a legitimate grievance. 

Tokyo’s constant talk about the need to preserve the principles of free trade was meaningless, given that its own growth had been helped greatly by protectionist policies. 

Besides, how can you possibly claim to adhere to free trade principles when the undervalued currency you cling to means a subsidy of say 50 percent on all exports and a tariff penalty of say 50 percent on all imports? That is about as protectionist as you can get.

And that was only part of the protectionist action. 

Prohibitive tariffs, arbitrarily determined quotas, non-tariff trade barriers, subsidies both open and disguised all combined to create the image of a ruthless Japan Inc. determined to try every protectionist trick possible in its eagerness to exclude foreign goods and dominate foreign markets.

 (Among the critics at the time a favourite trade barrier story was the one that said European skis had to be kept out of Japan because Japanese snow was different from European snow. 

(The one I liked to note was the ban on Guatemalan face-cleaning cloths (oshibori), claiming the thick edges around the rectangular mats were a danger to the eardrums of Japanese men in the habit of using the mats to clean their ears.

(Then, as now, Guatemala needed a textile industry much more than Japan did. )

2. Endaka (yen appreciation) problems

With the Nixon Shock of 1972, the yen rose to 240 to the US dollar. Japan fell into a coma of doubt and apprehension.

 I think I managed to get it on the record then, both in Nikkei and the London Financial Times, that at 240 the yen was still heavily undervalued relative to Japan’s export strength – that Japan would survive. 

Years later in the wake of a few other shocks – the 1985 Plaza Accords especially – the yen was to appreciate to well under 100. Even so the economy managed to keep breathing.

Japan just happened to be a very efficient producer of many manufactured goods. If it could not sell its manufactures at home it was bound to try to sell them abroad. 

Even in the areas where initially it was not a very efficient, it realised how if it protected domestic producers from foreign competition long enough, eventually through domestic sales, and cut-price exports they would gain the scale economies needed to be competitive. 

At the time the foreign commentators liked to blame the trade surpluses on Japanese mercantilism. 

Or worse, on some kind of plot to destroy Western industry and dominate the world economy.

In fact they were simply the result of a very natural desire of the Japanese firms to survive. If firms could not do that through domestic sales, they would do it through foreign sales.

And the government was very happy to help them, thinking that boosting exports and restricting imports was needed for poor little resource-poor Japan to survive.… 

True, there are limits to the extent to which one nation can be allowed to poach and thrive on the markets of another nation. But instead of complaining, those being poached upon should do more to protect their own industries and markets. 

For years the US did nothing as key manufacturing industries – the US machine tools industry especially – fell before carefully planned export onslaughts by particular Japanese firms and industry groups. 

In the US especially enormous time and effort was spent on trying to prove that Japanese competition was unfair, that it relied on predatory pricing to break into foreign markets. 

Instead the US should have just slammed the door whenever it saw crucial industries under threat.

Market fundamentalists like to claim that if foreigners want to use predatory pricing to sell you their products cheaply you should just lie back and enjoy the bargains. Your citizens gain.

But they do not gain.  If the loss of those industries weakens the industrial base or creates intractable unemployment, those citizens can end up with a very large net loss.

3. Harmful Exchange Rate Protection

Finally in the early eighties the US began to do what it should have done from the beginning – threaten to impose surcharges on imports from Japan to the extent the yen was undervalued against the dollar.

And once again, it was bitterly accused of protectionism by Tokyo. Western free trader textbook economists chimed in, saying that import surcharges were the worst kind of protectionism. 

Strange how not just the Japanese but even our Western textbook economists have seemed for so long not to want to realise the protectionist effects an undervalued currency. 

They will fret over say a ten percent tariff protection for some product. But they will happily accept a ten percent currency devaluation by trade competitor’s currency, even though the devaluation is equivalent to ten percent tariff protection for all of the competitor’s tradable domestic products, regardless of whether they deserve it or not, and a ten percent subsidy for all that competitor’s export products.

4. Textbook Versus Sensible Protectionism

How do our Western free traders get to think this way? I suspect it is because currency movements seem to be the result of free market actions, which by definition are seen as good, while tariffs are seen as the result of political actions, which by definition are seen as bad.

This is textbook free market fundamentalism taken to its dogmatic extreme. Ironically, it also has its benefits.

A political decision to protect a key industry with tariff can be crucial to the development of that industry. That was clearly the case with Japan’s car and computer industries. Can anyone possibly argue that Japan and the rest of the world would have been better off without those industries? 

Japan realised it had the potential to create a viable car industry. Free trader theory admits the right to protect infant industries. But not much more. 

Japan rightly decided that a viable car industry may need decades of heavy protectionism (unless they follow the Thailand route, or which more later). 

It takes time to develop all the ancillary industries – the entire manufacturing base even- needed for a competitive car industry. 

Besides, devaluations as often as not have little to do with the free movement of currency markets. 

They too are often the result of political interventions. Or else of speculators and irrational market moods. 

Handled properly, a tariff is no more than a tax on domestic consumers to promote an industry that in the long run should benefit those consumers.

 Devaluations usually have much less justification because of their open-slather, across-the-board effect. 

For a backward nation,  that across the board effect handled well can be a useful way to protect the entire economy until that economy gets on its feet. But in an advanced economy needed protection has to be selective.… 

This curious bias against tariffs goes back to prewar years when they were used excessively for beggar-thy-neighbor purposes. Warnings against tariff protectionism have been embedded in our economic textbooks ever since, together with elaborate and often mistaken diagrams * showing the theoretical benefits of unfettered free trade. 

Devaluation protectionism is more of a postwar affair. The textbooks have yet to catch up with its implications. 

Even when the under-valuation of the Chinese yuan was doing great harm to the world economy some free market economists opposed pressure for revaluation. 

Remarkable how outdated economic fashions, like outdated religions, manage to take control of peoples’ thinking.*

*for example, in the 1960’s textbooks I had to use most took no account of scale economies, either for particular industries or for economies overall. Some even assumed scale diseconomies – this was an assumption that increased growth caused the price of needed inputs to rise, not fall.

5. Trade Friction Policies

As the trade frictions reached a peak in the early eighties, I was invited to join a committee organised by the Finance Ministry to discuss the issue. 

Trade problems did not belong to the ministry’s turf. But it got round that problem by saying that its responsibility for collecting import duties allowed it to be involved.

 Myself and the economist Hosomi Takashi suggested what to us seemed to be the obvious answer, namely that Japan should offer to impose export taxes equal to the amount of the import surcharges that the US was threatening to impose. 

That way Japan would not only show cooperative good will. It would also guarantee that the funds which would have been taken by the US in import surcharges would remain in Japan in the form of export taxes. 

And to pacify the inevitable protests from less competitive Japanese exporters hit by export taxes, the funds raised should be pooled and used to help those marginal Japanese exporters survive and restructure. 

Taken together it seemed a neat solution. But in those days suggesting that Japan should tax exports was like suggesting a tax on motherhood. 

We ended up as a paragraph in the final report. It was my first lesson in the inability of the Japanese to think strategically. 

Years later when the Chinese ran into the same problem with the US, Beijing immediately promised export taxes.

In Japan, for someone to seem coldly and deliberately to have set out to devise policies which might cause economic harm to someone else is a serious sin. Far better to do nothing.

True, as a result of your inaction that someone else might end up suffering far more harm in the future. 

But that was OK since the much greater harm did not seem to have been caused by you deliberately.* 

Instead the harm was ‘shikata ga nai’– something that could not be helped. Blame fate instead.

Harm caused by a cold deliberate policy action is unforgivable.  If it is caused by some accidental or irresistable force – ‘hand of god’ so to speak – then it is acceptable.* 

*An especially horrible example of this kind of thinking came with the 1997 Kobe earthquake. I was in Kobe that day for some committee meeting and from our hotel windows we could see the fires dotting the devastated areas.  If there had been any wind that winter day the entire town would have been reduced to ashes.

Since blocked roads meant fire engines could not get to many of the burning houses, the obvious answer should have been helicopters scooping up and dropping water from the ocean just a few hundred meters away. 

But that solution was vetoed, it seems. Why? Because large buckets of water dropped on a burning house could collapse timbers causing harm to people trapped underneath. 

So it was better to let them die a certain and horrible death from the flames rather than risk injury while being saved by water?

Yes, according to Japanese thinking. Death by fire was acceptable – the result of unstoppable fate. Death caused by dropping water was unacceptable – the result of deliberate action by the authorities. Brilliant thinking.….

With the trade problem, the inaction was eventually to lead to the yen appreciating to 80 to the dollar. 

Not just the marginal exporters were suffering but quite a few more deserving producers also.But once again, shikata-ga-nai.

(The inaction during the late eighties as the dangerous bubble in asset prices got underway was very similar. 

(That bubble could have been killed by an early increase in interest rates.

 (But there too, there would have been some collateral damage. 

(Better to wait till things were completely out of hand and there was no choice but to move.

(This time the collateral damage was virtually to wreck the entire economy. 

(All democracies suffer this consensus-imposed inaction problem. But Japan suffers much more than most.)

6. Merits of Local Production

Japan should also have considered seriously at the time the US demand that car makers produce in the US rather than export from Japan if they wanted to avoid import surcharges or quotas. 

Instead, the car makers were up in arms. ‘Complete disregard of free trade principles’ they cried.

True, they were also terrified by the seeming difficulties of having to recruit and train US labor, little realising that the problem with US labor had been bad US management – an area where Japan already had an advantage, at least when dealing with Western labor in rural areas. 

Eventually the Japanese car makers realised they had no choice. 

Today their US factories are not only very successful (due mainly to that superior management and mechanisation – another US industry they have managed to destroy), but they are close to becoming the mainstay of their global business. 

Once again, we saw the inability of the Japanese to think strategically.

The very conservative Toyota was the worst. It was slow and reluctant to move into the US. It was also to be slow to move into China. 

Meanwhile Chinese makers were moving into the UK even before trade frictions got underway. 

Production close to markets has many advantages. The Chinese seem to realise that point, while the Japanese have been much more reluctant.

7. Manufacturing Sector Versus Service Sector

In writings and lectures I began to focus in on the efficiency gap between Japan’s manufacturing industries and its service sector.

Not only did this distort the economy. It provided extra pressure to export, since the goods being manufactured in such volume at home were being weakly distributed at home.

In quite a few cases it was easier and cheaper to distribute and sell them to foreigners than it was to sell them to Japanese. 

This efficiency gap between the two sectors was curious. At one stage I calculated that Japan could make cars at almost half the US cost. 

But the cost of distribution and sales in Japan was around four times more than in the US. 

Already I could see some of ‘cultural’ factors involved. For example in the case of cars, much of the extra sales cost was due to a quaint reliance on homon hanbai – having salespeople call personally and repeatedly on potential customers to persuade them to buy.

Anywhere else in the world the customers would be expected to visit the showroom, where, incidentally, they could have a better choice of which car to buy. 

But in Japan’s human relations-oriented society excessive services like homon hanbai were seen as essential to make customers happy (some of the services included even having to repair customers’ car punctures). 

Besides, if that is what your competitors were doing you had to do the same.…

Similarly with the banks. When I was opening an office for The Australian in Tokyo I had a young salesman standing outside my door for an entire week waiting for me to appear so he could persuade me up to open an account with his bank (Fuji). 

(The bank had prior advice from Sydney that I would be opening an office.)

And when I did open an account I was treated to just the same slow, expensive and outdated practices as everyone else.

Customer relations is often touted as the key to business success. 

But in Japan’s service sector, at least, it can lead to great waste and inefficiency. 

The Competition Factor

Competition differences were another reason for different productivities between the two sectors. 

In manufacturing, competition was hard to avoid. When the product is specific and concrete, even Japan’s emotionally charged customers will tend to want to look at the quality and price before deciding to buy. 

The manufacturer who ignored such things would not survive long, especially if he also had to rely on exports. 

Abroad, the hard-nosed, unemotional customers would look even more closely at quality and price. 

In short, if efficiency as the only way for the ‘tribe’ enterprise to survive, then efficiency it would have to be. 

(This collectivist survival, or ikinokori, factor is strong in the Japanese mentality. 

(Individuals see identity in terms of the collective and if the collective ceases to exist, the individual too ceases to exist. 

(People tend to work very hard and productively in this situation. 

(In a more individualistic society if people felt their company was in trouble they would soon begin to look for other places of employment. 

(In the late eighties, when it was already clear that Toyota was headed for Japan, if not world, domination I was able to sit in on a staff seminar. 

(For over an hour we were told how the US car industry was about to stage a comeback and the Korean industry too was gearing up to become a serious competitor. Toyota would soon be in trouble. 

(Every one would have to work that much harder, we were told repeatedly. The audience loved it, even though it is highly likely that everyone knew Toyota was in no trouble.  

(Japanese in those days liked to be jolted into action by the thought of some looming crisis.

 Books predicting every kind of crisis were easy best-sellers. 

Service Sector Survival

But in the service sector it was much easier to survive in other ways. Markets were domestic and often fragmented. So competition was weaker. 

One could survive quite nicely by just doing what everyone else was doing, or by collusion with rivals. 

Besides, comparing the price and quality of a service is not easy. Slick sales campaigns to deceive Japan’s mood-sensitive consumers could be very effective. 

One example of his, often noted by Western advertising executives, was the way TV commercials concentrated almost entirely on mood creation with little mention of price. 

Competitive – Brand X – ads were almost non-existent. 

Other examples were the never-ending ponzi and other fraudulent investment schemes, often run by charismatic figures able to lull Japan’s many emotional investors into depositing their life earnings. 

Phoney religions also seemed to proliferate and prosper on the same basis. 

8. Anti-Service Sector Bias

Another problem was the poor reputation of service sector employment.

It was traditionally seen as having to rely on kyaku-hiki – customer touting; something seen as on a level not very much above that of Japan’s many mizushobai (literally, water trade) bars, salons and eateries in the downtown areas.… 

In manufacturing, however, and as in feudal days, you survived only by the quality of the goods you made – a much nobler activity.

Indeed, the feudal shi-no-ko-sho (samurai, farmer, craftsman, trader) ranking borrowed from Confucian China still seemed to apply, with the trader (the service sector person) well behind the craftsman (the manufacturer) in prestige. 

Manufacturing had yet to acquire the drab, dirty-hand stigma it was clearly suffering from in the West. 

I had already begun to notice how my best Sophia students happily went to work for Toyota, Nissan or Nippon Steel. 

Only the semi-dropouts wanted to work in the service sector. 

I could compare this with my Oxford cohort back in the fifties. 

For them, even then, jobs in manufacturing firms were virtually out of consideration. 

Most wanted to be bankers, scholars, teachers or bureaucrats – office managers rather than factory managers. 

At the time the Japanese, flushed with their trade and economic success, were to dub this the ‘British disease.’ 

In fact, and as argued earlier, it was also the Chinese or Indian disease. 

How to Walk on Two Legs

The manufacturing-service sector dichotomy was important in another context. 

Japan was still in its high growth phase at the time. Many wanted to know how long the high growth could continue. 

My pulpit theme was that if Japan using only one leg – manufacturing – could do as well as it was doing, how much better could it do if it got the other leg – the service sector – into action.

(I was yet to know how determinedly the Japanese would set out later to wreck their economy with bad economic policies.)

Improved sales and distribution would ease trade problems. Improved services would also provide more and better balanced growth.

Reduction in excessive service costs – something very easy to achieve in Japan – would also be a major damper on inflation.

As well, and to the extent the service sector share in total GDP was much greater than that of the manufacturing sector, a five percent improvement in service industry productivity would not only be easier to attain; it would also provide much more GDP growth than a five percent improvement in manufacturing productivity. 

Yet Japan seemed to be devoting most of its energy and hopes on improvements in manufacturing productivity – improvements which for the most part would simply add to trade frictions and ultimately harmful yen appreciation.… 

(True, in those days Japan was still caught up in the mantra that said it was a small island nation devoid of resources. Manufactures provided the exports needed to buy imports. 

(Yes, was my response. But did it need to buy trade frictions also? And was it so short of resources? It had the two of the world’s most non-importable resources – water and skilled labor. 

(All the rest it could access – probably more easily and cheaply than most because of most of its heavy industries were close to large-scale harbours.)

But in those days the concept of abstract, intangible services being just as important as, or even more important than, concrete manufactures was hard for most to grasp. 

Most seemed to regard services as some kind of free good, in the production of which efficiency was not important. 

It was similar to the thinking in the West before the development of economics as a science (though it did have a Japanese rationale: excessive use of manpower in the service industries kept unemployment at bay).

9. The Colin Clark Factor

I would often fall back on my father’s path-breaking writings of the 1940’s. 

His name was well known in Japan; almost all school textbooks in postwar years used to mention how he had developed the concept of an economy divided into three sectors – primary, secondary and tertiary. 

But he had also pointed out how not only were services (the tertiary sector) just as relevant to an economy as manufactures (the secondary sector). 

But also that in an advanced economy the share of the service sector output in total GDP would increase while the manufacturing sector share would inevitably decrease with rising incomes. 

Those points had some effect on the audiences. My father had a lot more prestige in Japan than I had. 

(Ironically, and as mentioned earlier, in the 1940’s my father’s works had been welcomed by Japan’s progressives since they pointed out how at the intermediate economic growth stage the share of manufacturing in GDP would increase at the expense of agriculture.

(In those days, Japan’s conservatives had seen agriculture as the source of all wealth, rather like the conservative French economic school in the 18th century. Manufacturing was a less important activity. 

(In Japan, it took until well into the 20th century for the importance of manufacturing to be realised.

(Only since the eighties has the role of services in an economy finally begun to be realised, and then reluctantly.)