The half-life of institutions

I’m continuing my travels back to the days when Japan’s economy was the envy of all. This time, I’ve been reading a 1979 best-seller, “Japan as Number 1,” by Harvard Professor Ezra Vogel. Not everyone’s idea of a beach read, I know, but I’ve found it interesting from a number of perspectives, most notably for the view it provides on shifting views of what makes for good political and economic institutions.

Vogel was writing at a time when Japan’s economic success was viewed in the US with a mix of fascination and alarm. What’s fascinating is that many of the characteristics seen as critical to Japan’s success in 1979 are nearly identical to those pointed to as holding Japan back now:

* A lifetime employment model was seen as providing incentives for on-the-job training while strengthening worker loyalty, both raising productivity.

* A strong nexus among big business, banks, and government. Close links between firms and banks assured stable financing, while government–led by the Ministry of Industry and Trade (MITI)–implemented a sort of “industrial policy lite.” This was viewed as generating a more rational industrial structure and aiding in Japan’s competitiveness.

* Limited shareholder pressure. The relative lack of equity financing allowed firms to eschew a focus on short-term profit-making and to take long-term strategic positions, including by investing in new plant and equipment and R&D.

* Political stability. Japan’s politics was (as today) dominated by the conservative LDP. A pipeline of Prime Ministers was developed well in advance, while an elite bureaucracy exerted significant control over policy, even as political leadership changed. It is argued that this, again, allowed a more rational and long-term approach to policy-making.

* Decision-making by consensus. More than simple “splitting the difference” compromise, the need for broad societal agreement was baked into policy design and supported by formal and informal participation by key interest groups–what we now disparage as “special interests.”

The overall view one gets is of a hyper-rational system, making use of information from a broad range of sources to bring about rapid and equitable growth with economic security. And who could really argue with the results? Over the 30 or so years following the end of World War II Japan created from the rubble a wealthy, highly educated and long-lived society that, in many ways, was Number 1.

What went wrong? Much has been written about the enormous equity and real estate bubble, the bursting of which led to the “Lost decades” beginning in 1992. And it is well-known that the historically unprecedented aging and shrinking of Japan’s population is weighing down economic growth and contributing to an enormous debt burden.

But what about Japan’s institutions? The highly praised lifetime employment model now represents a bit more than half of a dual labor market, with a large and growing group of non-regular worker, reform of which is seen as key to reviving growth. The close and complex relationship among large companies, banks and government is seen to have contributed to a delayed response to the financial difficulties of the 1990s. Corporate governance is a current focus of reform in Japan, with firms criticized for insufficient attention to efficiency and shareholder returns. And political stability and consensus decision-making is seen as standing in the way of much needed reform.

Why, in Japan’s case, did good institutions “go bad”? Were they simply overwhelmed by economic and demographic shocks? Were they optimal for long-run planning but less nimble in response to risks? Or were they designed for a period of economic catch-up but became less effective as society evolved and social cohesion declined? Do Japan’s institutions need tweaking or a major overhaul?

Answers to these questions are important not just for Japan, but for other Asian economies that borrowed at least pieces of the Japanese economic model in the 1979s and have experienced their own successes over a number of decades. I’m thinking here of Korea, which has had its own economic miracle but is now questioning the sustainability of its economic model. But other “Asian tigers” as well as China, may be wondering whether new institutions and policy frameworks are in order.

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