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Japanese industrial targeting the neomercantilist path to economic superpower


Also by William R. Nester
Changes, Challenges

Japanese Industrial
The Neomercantilist Path
to Economic Superpower
William R. Nester
Assistant Professor
Department ofGovernment and Politics,
St lohn' s University, New York

Palgrave Macmillan

© William R. Nester 1991
Softcover reprint of the hardcover 1st edition 1991
All rights reserved. For information write:
Scho1arly and Reference Division
SI. Martin's Press, Inc., 175 Fifth Avenue,
New York, N.Y. 10010
First published in the United States of Arnerica in 1991
ISBN 978-1-349-21286-6
ISBN 978-1-349-21284-2 (eBook)
DOI 10.1007/978-1-349-21284-2
Library of Congress Cataloguing-in-Publication Data
Nester, William R., 1956Japanese industrial targeting : the neornercantilist path to
econornic superpower / William R. Nester.
p. crn.
Includes index.
ISBN 978-0-312-05782-4
I. Japan--Cornrnerce. 2. Japan--Cornmercial policy. 3. Japan--Econornic policy-1989- 4. Industry and state-Japan.
5. Mercantile system-Japan. 6. Protectionism-Japan. 7. United
States-Foreign econornic relations-Japan. 8. Japan--Foreign
econornic relations-Uni ted States. 9. International econornic
relations. I. Title.
HF3826.5.N39 1991

With the deepest love to my brothers
Mark, Brian and Steve



1 Neoclassical versus Neomercantilist Economics:
Theory and Reality


2 Japanese Neomercantilism:
Continuities and Changes


3 For Their Money and Votes:
Farmers, Distributors, and Builders


4 Heavy Industrial Giants:
Steel, Machine Tools, and Automobiles


5 Fueling Industrial Superpower:
Energy, Raw Materials, and Comprehensive Security


6 From Technological "Catch-Up" to "Leap-Frog":
Computers, Semiconductors, and Telecommunications


7 Banker to the World:
Managing Oceans of Cash, Stocks, and Bonds






Leaders of the seven top democratic industrial nations - the United
States, Japan, West Germany, France, Britain, Italy, and Canada have met annually to discuss global problems since President Ford
initiated the first get-together in 1976. Of the twelve summits to date,
none was more richly symbolic of the immense changes that have
occurred since 1945 than the July 1989 meeting. Hosted by President
Mitterrand in Paris to coincide with his nation 's spectacularcelebration
of the French Revolution's 200th anniversary, the summit straddled a
year which recalled Dickens' adage that "it was the best of times, it
was the worst of times. "
The world economy was in its seventh straight year of growth with
North America, Europe, and East Asia leading the way. The European Community's (EC) twelve members were actively preparing for
1992, when they would abandon all internal barriers thus creating the
world's largest common market with 360 million people. For the first
time, the global environmental disasters behind the worsening greenhouse effect and depletion of the ozone layer were a top summit
agenda item. Meanwhile Gorbachev's glasnost and perestroika policies
were partially fulfilled through his renouncement of the Brezhnev
Doctrine which justified Russian intervention in other communist
countries, and his encouragement of quasi-democratic elections in
the Soviet Union, Poland, and Hungary; the Soviet empire itself
appeared to be slowly crumbling as Russian troops withdrew after ten
years of fighting in Afghanistan, and calls for genuine autonomy
swept the Baltic states and many of the Muslim states; Moscow and
Washington took turns announcing unilateral weapon- and troopcuts, and seemed on the brink of major nucJear and chemical arms
reduction treaties - all of which led many analysts to decJare the Cold
War's denouement if not finale. These positive developments,
however, were somewhat undercut by such trends as Beijing's
crushing of China's mass democratic movement, the failure of
Gorbachev's reforms to spark the fossilized Soviet economy, the $1.2
trillion Third World debt burden dragging at the heels of an otherwise dynamic world economy, and another year of mass famine and
natural disasters in Central Africa, South Asia, and elsewhere.
The most startling long-term economic development, however,
seemed to get lost behind all these other headlines - Japan was




rapidly solidifying its manufacturing, financial, and increasingly
technological leadership over the world economy while the United
States remained mired in its immense trade and budget deficits.
Although the American president still occupied the summit's center
stage while the Japanese prime minister remained as obsequious as
ever, the real balance of economic power was revealed by their
respective foreign aid announcements. Before the summit, President
Bush paid a visit to Po land and Hungary during which he promised
American aid of $110 million and $30 million, respectively, to help
alleviate both their immense debts and their attempts at economic
reform. The Poles and Hungarians were openly disappointed, and
commentators on both si des of the iron curtain were critical of these
miserly amounts. But given its own economic difficulties the money
was all the United States could spare. Ouring the same week, Tokyo
announced a five-year $35 billion foreign-aid program. Japan was
clearly fulfilling its röle as the world's financial superpower, a position
it had achieved as recently as 1985.
How could Japan afford to give so much, and America so little? As
of March 31, 1989, Japan had the world's eight largest banks, sixteen
of the top twenty-five banks, and twenty-three of the top fifty banks;
in sharp contrast, only four American banks ranked among the
world's top fifty banks, with the largest, Citicorps, in tenth place, and
the second largest, Chase Manhattan, a distant thirty-sixth. 1 Japan's
financial power reflected its manufacturing and technological power that same year, there were 345 Japanese firms among the world's top
1,000 corporations, and those firms accounted for 47% of the total
assets; aithough the number of American firms was slightly larger
at 353, they accounted for only 32% of the total assets. 2 A 1987
National Academy of Engineering report revealed that Japan was
superior to the United States in twenty-five of thirty-four critical high
technology sectors, while of twenty-five key semiconductor technologies, Japanese producers led in twelve, were equal in eight, and were
rapidly clsoing the gap in five. 3 Japan's 116,000 robots in 1987 were
almost five times greater than America's 25,000 and ten times more
numerous than West Germany's 12,400. 4 Japan's per capita income of
$21,040 and household savings rate of 15.1% in 1989 far surpassed
America's $19,780percapital income and5.4% household savings rate.
Japan's economic superpower is largely based on its ability to
maximize its economic growth and exports and minimize imports.
Between 1977 and 1986, Japan's GNP grew at an annual rate almost
twice that of the United States - 4.4% compared to 2.7%. In 1987



Japan had trade and payments surpluses of $96.3 billion and $87.0
billion while the United States had deficits of $160.2 and $153.9
billion. Despite its trading prowess, Japan's dependence on trade is
actually the second lowest of the OECD countries. In 1987, Japan's
trade dependency to GNP ratio of 8.0% was actually only slightly
higher than America's 7.5%, while both countries were dramatically
lower than Germany's 23.1%, France's 17.6%, and Britain's 21.0%.
The possession of a large merchant fleet in an interdependent world is
as important a basis of international power as the possession of a
naval fleet was in a world in which the great powers were constantly
at war. Japan's merchant fleet of 9,804 ships in 1987 was the world's
largest - the Soviet Union had the next largest fleet with 6,741.
Thousands more Japanese ships, however, fly under Liberian or
Panamanian flags. The achilIes heel of Japan's economic superpower
- one which American policymakers have refused to take advantage
of - is its overwhelming dependence on the Uni ted States. Over
one-third of all Japan's trade (36.5%) is with the United States;
Japan's next largest trade partner is the twelve-nation European
Community which accounts for only 16.4%. In comparison, only
21.1 % of America's trade is with Japan. 5
How did Japan develop so rapidly from the mass poverty and
destruction of 1945 into the world's most dynamic and powerful
economy? How did the United States fall so far behind? Libraries can
be filled with books and articles attempting to answer the first
question. Many of these works fall into either the "Japan Inc." or
"hard work in a free market" theses, both offering outright false
answers. The "Japan Inc." thesis claims that Japan is run like a giant
corporation, with the national government acting as a headquarters
that minutely controls and develops all aspects of the economy.6 In
reality, Japan was never a command economy - industrial policies
always emerged after tough bargaining and compromise between
government and the affected sectors; the big corporations enjoyed
varying degrees of autonomy even before the 1970s when the
government rarely hesitated to use its tight controls over domestic
capital and foreign exchange to yank maverick firms into line.
Equally fallacious is the "hard work in a free market" thesis which
argues that Japan became aglobai economic superpower simply
because Japan's economy is the world's most open and Japanese
work harder than the rest of humanity.7 Japanese assert that their
markets are the world's most open and the only reason why foreigners do not seil more in Japan is because they do not try hard



enough. The recent book, "The Japan That Can Say No," by senior
LDP leader Shintaro Ishihara and So ny president Akio Morita,
reflects the thinking of most Japanese on international trade issues. 8
Across several chapters, Morita unwittingly shows the vast gap
between Japanese public relations claims (tatemae) and Japan's
neomercantilist reality (honne), when he repeatedly mixes claims
that Japan's markets are the world's most open with example after
example in whieh the government carefully manages Japan's markets
in order to develop the economy. 9
In reality, Japan's markets are thoroughly managed through both
government- and private-led cartels, while Japanese may work longer
hours but their productivity is actually among the worst of the OECD
nations. 10 Japanese still work far more than their OECD counterparts, an average 2,129 hours a year in 1988 or about 250 more ho urs
than Amerieans and 500 hours more than Britains. Despite these
differences in work hours, America's productivity rate remains about
50% higher than that of Japan. 11 AIthough recently few observers
support the "Japan Inc." thesis, the "hard work in a free market"
image is becoming increasingly popular as it is systematieally promoted by Japanese government, industry, academic, media, and
hired foreign lobbyists and neoclassieal economists. 12
Essentially, the relative economie success of Japan and the United
States is a simple reflection of their different economic orientations.
Japan's policymakers have discovered a superior way to achieve
economic development and create and distribute wealth. Japan's
success rests on rejection of both communist-style state ownership of
the economy and the neoclassieal belief that free markets and
minimal state interference are the answer. In complete contrast to the
United States, neomercantilist rather than neoclassieal ideals and
practices shape and fuel Japan's economy. Strategie industries are
targeted for development and declining industries for protection, and
those industries are nurtured through adynamie mixture of corporate
collusion and competition. Industrial polieies are implemented with a
range of subsidies, import barriers, technology infusions, and export
promotions. These polieies assumed a similar pattern: "Japan imports a technology ... from the West. It then protects the industry ...
from foreign competition to whatever extent and by whatever means
may be required while it gains scale, experience, cost parity, and
momentum in Japan itself - the world's second largest and fastest
growing market, exporting aggressively, further enhancing its cost
position. Gradually it converts apart of its cost advantage into



improved product quality. At some point the Japanese producer is
able to offer a better product, profitability , and lower price." 13
Japan's policymakers constantly added new, higher value-added
strategie industries to its older targets. Thus the ranks of heavy
industries like steel, shipbuilding, automobiles, textiles, and petrochemicals targeted in the 1950s, were swelled in the 1960s by
computers and consumer electronics, in the 1970s by semiconductors,
aerospace, and robots, and in the 1980s by biotechnology, fifthgeneration computers, and superconductors. Behind these industrial
polieies designed to create global champions was another set of
industrial polieies that propped up inefficient, high employment
sectors like farming, distribution, and construction. These sectors
were targeted with immense protection and subsidies because they
represented huge voting blocks of support for the conservative ruling
party, the Liberal Democratic Party (LDP). By pursuing two sets of
rational industrial policies, one that targeted potential global champions and the other large voting blocks, the LDP achieved a virtuous
circle of political power; economic growth and the widespread distribution of that growth resulted in continual LDP political triumphs
during elections which in turn allowed the LDP to continue its
successful industrial policies, and so on.
Japan's neomercantilist policies have overwhelmingly outperformed America's largely free market policies. Tokyo's industrial
policies fuelled an average annual economic growth over three times
that of the United States before 1973, and over twice the growth rate
since; they have allowed Japanese firms to first catch up with and then
leapfrog their American rivals in one industry after another until
finally Japan itself pushed the United States aside and took over the
throne as the manufacturing, financial, and, increasingly, technological leader of the world economy.
Japan's political economy runs on a dynamic mix of competition
and cooperation. There is tremendous conflict among interest groups
within Japan's democratic political system and competition among
firms within Japan's economy. But extensive behind-the-scenes political and economic collusion is as important to Japan's economic
dynamism as competition. Collusion is aided by the concentration of
political and economic power in an interdependent elite composed of
the LDP, Big Business, and the economic ministries. Both the
political and economic systems have pyramid structures, with those
above monopolizing most benefits while allowing a trickle to those
below to ensure their continued cooperation.



Conservative parties have ruled Japan for all but nine months since
1945. The conservative Liberal Democratic Party rules by maste ring
a virtuous circIe of power in which popular policies, gerrymandered
districts, cash mountains supplied by big business, and vast informal
networks of key voting blocks continually allow the LDP to outspend
and outmobilize the opposition parties during elections; continual
re-elections allow the LDP to concentrate on maintaining the
neomercantilist economic policies that have brought such vast wealth
to Japan, and the special benefits to key voting blocks Iike farmers,
distributors, and construction workers. The LDP is hardly a monolithic block - it is splintered among a half-dozen factions that
compete fiercely to put their candidates in the cabinet, while continuing to cooperate to maintain LDP power. The LDP sits atop a
political pyramid with mainstream opposition parties - the Japan
Socialist Party (JSP), Democratic Socialist Party (DSP), and Clean
Government Party (CGP) - just below receiving secret political
hand-outs, and the Japan Communist Party (JCP) languishing in the
political wilderness on the bottom level. However fiercely they may
publicIy criticize the ruling conservative LDP, the mainstream opposition parties vote with the LDP on 90% of alllegislation and have a
voice on most policies.
Japan's economy also has a dual structure - it is presided over by a
half-dozen huge industrial groups (keiretsu) wh ich are each centered
around a commercial bank, trading firm, and insurance firm, which in
turn are the predominant financial backers for several dozen manufacturing firms which incIude steel, mining, automobiles, shipbuilding, electronics, and machinery components, and each of those firms
in turn sits on top of hundreds of related subcontractors and distributors. Cooperation both within and between keiretsu is reinforced by
the cross-ownership of stock - about one-quarter of a keiretsu firm's
stock is owned by other members while about 5% is owned by the
seemingly rival Keiretsu. The natural cooperation that would follow
from the extensive stock cross-ownership is reinforced by hundreds of
cartels - in 1986, 466 cartels were legally sanctioned by the
government and hundreds of other cartels allowed by an official
wink. 14 The cartel members compete fairly freely among themselves
in times of economic expansion and then carefully collude on market,
price, production, and export levels during downturns, while they
almost always gang up against any foreign firms attempting entry.
The more competitive the foreign product, the more tight the
collusion among the Japanese cartel members to ensure the foreign



firm receives no more than a token sliver of the market. For example,
Japan's cartels determine the prices of Japanese capital goods purchased by foreigners. One American manager revealed that: "If I ask
for competitive bids from Japan, the Japanese producers would get
together and decide on the price and on how to split the business
among themselves. At times when I bought a cheaper bid from
another country the Japanese would lower their bid to remain
competitive. In fact, they sometimes submit a bid 1% below the
German price, having somehow acquired information about the
German bid." 15 The Fair Trade Commission (FTC), which is
supposed to administer Japan's anti-trust laws, is a paper tiger
(tatemae). For example, of 118 cases identified as violating anti-trust
laws in 1987, the FTC only prosecuted six. Meanwhile it officially
allowed 276 additional cartels in 1987 and in 1988 allowed a staggering 4,500 new cartels to emerge to make sure that retailers did not
engage in a price war over the new 3% value added tax. 16
Continued LDP rule and the vast cartel system have allowed
Japan's ruling elite to continue following neomercantilist industrial
policies that maximize the creation and distribution of wealth. But
the ultimate success of Japan's industrial policies depends on Tokyo's
ability to continue maintaining the access of Japanese firms to a
continually expanding, largely open, world economy while simultaneously restricting the access of competitive foreign products to
Japan's vast market of 120 million consumers. By monopolizing
Japan's market and enjoying virtually unlimited access to world
markets, Japanese firms can enjoy greater economies-of-scale production and lower prices than their foreign rivals, and thus a vital
competitive advantage. To these ends, Tokyo's foreign policy has
been based on the principle of trading with everyone, avoiding taking
sides in regional or global conflicts, and staving off foreign demands
for open markets with symbolic gest ures that may make Japan's trade
barriers less obvious but no less effective in discriminating against
competitive foreign goods.
Import barriers and export incentives are the major reason for
Japan's vast trade and payments surpluses. One major indicator is the
relative prices Japanese must pay for goods compared to their
counterparts in other leading industrial countries. Consumer goods
are two to three times as expensive in Japan while food prices range
from three to six times as much. These prices are related to the web
of restrictions imposed on competitive manufactured goods as a share
of total imports. In 1980 Japan's ratio was only 22.8% compared to



America's 56.8%, Germany's 58.3%, Britain's 67.2%, and France's
57.7% ratios. Although Japan's percentage doubled to 44.1% in
1987, it was still far behind America's 79.6%, Germany's 73.0%,
Britain's 76.8%, and France's 73.9% ratios. An extensive study by
Robert Lawrence of the Brookings Institute found that Japan's
manufactured imports are 40% lower than they would have been if its
markets had been as open as other OECD countries, and attributes
this discrepancy to trade barriers and buyers preferences. 17 In a
survey of sixty-two firms in April-May 1988, of which twenty were
Japanese, twenty-two American, and twenty European, Mordechai
Kreinin found that the American and European firms bought their
capital equipment from the lowest cost source on the basis of
competitive bids regardless of its national origin while fifteen of the
Japanese corporations did not use competitive bids at all and instead
bought either all or 80% of their capital equipment from related
Japanese firms even if their's were a more expensive substitute. 18
Yet another indicator of Japanese trade barriers was the difference
between Japan's foreign investments and foreign investments in
Japan. Japan's accumulated foreign investments were valued at
$139.3 billion in 1987 while the total value of foreign investments in
Japan was a mere $8.4 billion. Although, officially, Japan has no
investment barriers, in reality it is virtually impossible for a foreign
firm to make a hostile takeover of a Japanese firm. 19 Tokyo ensures
that foreigners will have a limited ability to buy Japanese firms by
requiring any takeover bid to be carried out through a domestic
securities firm which must give the ministry ten days notice of its
intentions - more than enough time for a rescue operation to be
organized by the government and an appropriate Japanese "white
knight" found. If the foreign firm somehow clears that formidable
obstacle it has only 20-30 days after notification to wrap up the
acquisition. Japanese firms are not subject to these rules. All firms
are required to disclose any shareholding of 5% or more. 20 Foreign
owned firms accounted for 10% of all sales in the Uni ted States but
only 1% in Japan. 21
Another sign of Japan's closed markets is the difficulty with which
one firm can buy another. Japan's firms are highly leveraged - a 1988
survey of 642 publicly traded firms found an average debt-equity
ratio of 86.13% compared to about 20% for American firms - and
would make prime and easy targets for acquisition if a free market
existed. 22 In 1988, while there were 3,310 mergers and acquisitions in



the United States, there were only 223 in Japan. There are signs,
however, that the market for corporations may slowly be creaking
open. The 1988 figure was fourteen tim es higher in value than the 163
deals in 1985. A major reason for Japan's limited investment market
is that about 70% of all outstanding stocks are held by institution al
investors, and with the vast web of crossharing within the industrial
groups (keiretsu) it is estimated that at least 60% of each member's
stock is in friendly hands making it impervious to a hostile takeover. 23 The c1assic example of this lack of reciprocity has been T.
Boone Pickens failure to receive any seats on the board of Koito
Corporation, a Toyota subsidiary, despite his being the largest
stockowner with 20% of its outstanding shares. In contrast, Toyota,
with only 19% of shares enjoys three board seats and appoints key
management. Nissan and Matsushita are other key investors.
In stark contrast, Japanese are free to buy almost any American
companies. Between January to September 1989, Japanese firms
bought $10.2 billion worth of American firms. The biggest of these
deals was Sony's purchase of Columbia pictures for $644 million, but
most were sm all- and medium-sized high technology firms that sold
out to Japan's vast capital reserves. In 1989 Japan enjoyed accumulative investments of $53 billion in the United States. 24 This Japanese
buyout of America's most dynamic firms will continue. A 1989 Nihon
Keizai Shibum survey of one hundred leading Japanese corporation
presidents revealed that 82% planned to acquire foreign firms to
globalize their economic power. 25
But rational industrial policies alone do not fully account for
Japan's economic success. An accurate explanation of Japan's steady
40 year rise from a poverty-stricken war-devastated country in 1945
to the world's wealthiest, most dynamic economy in the 1980s must
carefully analyze a fortuitous combination of both extern al and
internal factors. Japan would have remained a poor, underdeveloped
country had it not been for the American Occupation (1945-52) that
pulled the country back from the brink of mass starvation with a $2.2
billion aid program, and then completely revamped the economy
with massive land, labor, industrial, and political reforms. Even then
Japan's economy would have made little headway without being
jump-started by the massive procurements of the Korean War, and
then grew rapidly only by being allowed largely unhindered access to
America's huge market and an expanding world economy.
Low military spending has been another stimulus to Japan's rapid



growth. Article 9 of Japan's American written Constitution has been
interpreted to outlaw any offensive Japanese military force, while
Tokyo's 1952 defense treaty with Washington guaranteed that the
United States would come to Japan's aid if threatened with invasion.
Thus Japan, unlike most countries, was able to concentrate scarce
financial, technological, manufacturing, and manpower resources on
economic development rather than wasting them on an large, inefficient military sector. 26 As late as 1987 Japan's defense spending
was only 1% of GNP compared to America's 6.7%, Britain's 4.9%,
and Germany's 3.1%. Japan's low defense budgets allowed it to
concentrate on applied, consumer oriented research and development. In terms of overall research and development expenses, Japan
and the United States are relatively equal - in 1987, Japan spent
3.18% of its GNP on research and development compared to 3.06%
for the United States. But the quality ofthe R&D differs dramatically.
About half (48.2%) of America's R&D was government funded with
about 75% of that geared to military demands while only about
one-fifth (19.6%) of Japanese R&D was government funded with
only 2% going to the militaryY
This book provides an in-depth study of Japan's neomercantilist
industrial policies. The first chapter reviews the industrial policy
debate between neoclassicalists and neomercantilist, while the
second chapter examines the changes and continuities in Japan's
economic policymaking system. The five following chapters analyze
specific strategic sectors. Chapter 3 concentrates on industrial policies
for the farming, distribution, and construction sectors, designed to
distribute wealth earned from the more dynamic sectors and thus win
large voting blocks for the LDP. The next four chapters analyze
industrial policies for the heavy industry, energy, high technology,
and finance sectors, respectively.
This book will address two interrelated sub-themes essential to
understanding Japanese industrial policies in particular, and Japan in
general. Perhaps the most important theme that pervades all aspects
of Japan is the difference between what seems (tatemae) and what is
(honne). Tokyo's ten "significant market-opening steps" during the
1980s nicely illustrated the discrepancy between these two concepts,
and how they are used in economic and foreign policy. Each of these
liberalization steps theoretically (tatemae) gave Japan "the world's
freest economy." In reality (honne), as will be seen, Tokyo simply
erected more subtle trade barriers to replace the overt ones it
eliminated; Japan's markets remain protected by a complex web of



non-tariff barriers. A related sub-theme is the dynamic blend of
continuity and change in Japanese policymaking, policies, and the
economy. While immense changes seem to have swept all three
areas, the underlying institutional and cultural foundations have
remained essentially unchanged.

1 N eoclassical versus
Theory and Reality
Government is not the solution, it's the problem ... We need to
unleash the "magic of the marketplace".
(Ronald Reagan, 1980 and 1984 campaign speeches)
Capital is wayward and timid in lending itself to new undertakings,
and the State ought to excite the confidence of capitalists, who are
ever cautious and sagacious, by aiding them overcome the obstacles
that lie in the way of all experiments.
(Alexander Hamilton, Report on Manufacturers, 1791)
Until the twentieth century, the concepts of political liberty and
equality - majority rule, minority rights - was expressed by only a
handful of political philosophers and practiced by even fewer
societies. The words of thinkers like Locke, Montesquieu, Jefferson,
and Mill, and the republics of ancient Athens and Rome, and
eighteenth- and nineteenth-century Holland, Britain, and America
are small islands in the vast ocean of history; virtually all other
civilizations preached and practiced various forms of authoritarianism in which a small hereditary class ruled, usually unhindered, over
everyone else. In some civilizations, there were some restrictions on
power - in China rebellion was justified against unvirtuous rulers
who had lost "the mandate of heaven" - and absolute elsewhere the divine rights of some eighteenth-century European kingdoms.
Not much has changed now-a-days; although the United Nations
Charter and virtually all governments pay at least lip service to
democratic notions, in 1988 less than one-quarter of the world's 167
nation-states were considered political democracies. 1
The concept and practice of economic freedom has been even more
limited. Although philosophically, the notion of economic freedom is
related to that of political freedom, the connection was not clearly
explored until the 1776 publication of Adam Smith's Wealth of
Nations. Smith, however, valued economic over political freedom


Japanese Industrial Targeting

- consumer and entrepreneurial rights in a free market were essential
to public welfare and prosperity, but economic liberty could be
fulfilled by either a republic or an enlightened monarchy as long as
that government minimized its interference in the economy. In a free
economy, "the sovereign has only three duties ... first, the duty of
protecting the society from the violence and invasion of other independent societies; secondly, the duty of protecting, as far as
possible, every member of the society from the injustice or oppression of every other member, or the duty of establishing an exact
administration of justice; and thirdly, the duty of erecting and
maintaining certain public works and certain public institutions,
which it can never be for the interest of any individual, or sm all
number of individuals". 2
According to Smith and his followers, economic liberty provides
both positive and negative incentives for economic development. As
rational animals, human beings naturally want to become as wealthy
as possible. By allowing everyone to specialize in wh at they do, or
think they can do, best, free markets give everyone the opportunity
to make and enjoy the benefits of money, thus maximizing the
welfare of each individual and all of society. Fierce free market
competition forces producers to minimize waste and maximize innovation in order to keep prices low and thus seil more. But economic
liberty also means the opportunity to fail - and starve; if individuals
fail to work, they fail to eat. Unlike a feudal society in which each
class supports the others, a free market society is mobile, and security
depends on the individual's ability to produce what others want in an
impersonal marketplace.
Just as each individual has his own particular skills in which he
should specialize, states also have their own "comparative advantage"
for which they should concentrate production. Since free trade within
astate maximizes that society's welfare, it follows that free trade
between states will enhance the welfare of those states even more by
enlarging market size and thus potential economies-of-scale. International free trade is thus "a system in which all countries gain if each
specializes in its areas of comparative advantage and exchanges
products with other countries in the free market system. A much
larger (world) market permits increased specialization, increased
productivity, and higher incomes .. (just as) free trade among the
fifty states allows productivity not possible in a single state". 3
Although most governments feel compelled to say they are dedicated to political liberty, only a minority claim their economies

Neoclassical v. Neomercantilist Economics


operate on free-market principles, and in reality only a few states
remotely resemble Smith's ideal economy. Over one-third of humanity is ruled by socialist governments which command alm ost all
production and consumption, while the governments of most other
states carefully regulate markets and favor some sectors, industries,
or firms over others. Throughout the late twentieth century, there has
been a slow convergence from the two extremes of pure market- and
command-economies. The governments of traditionally free market
oriented countries like Britain and the United States, whose governments led the campaign to develop agIobaI free trade system in the
nineteenth and twentieth centuries respectiveIy, are taking more
responsiblity for promoting prosperity and welfare, while some
socialist countries like China, Hungary, and Yugoslavia are introducing market incentives to stimulate growth.
Why do so few count ries either preach or practice economic
liberty? Most governments have recognized that many of the assumptions on which neocIassical economics are based are unfounded.
These false assumptions abound, incIuding such conditions rarely if
ever duplicated in the real world as "full employment, balanced
current accounts, the existence of productive factors that are homogeneous and mobile between sectors and which can thus costly be
reallocated from one sec tor to another, ... (and) the comparability of
knowledge and technology from one country to another". 4
The central weakness of neoclassical economics, however, is the
static notion of comparative advantage in which every country has a
unique set of resources that destines it to efficiently produce only a
certain range of goods while requiring it to import everything else.
The trouble with this notion is that in a "world of static comparative
advantage free-trade favors the rich and the strong - those with
natural resources and high levels of productivity in major growth
industries. They can undersell newcomers in less-fortunate or Iessdeveloped countries and maintain their favored position. The issue is
not so much 'exploitation' of the weak as a 'natural state of affairs'
governed by an efficient impersonal marketplace. It is not surprising
that the leading advocates of free-trade have been those who were
strong at the time, first the Uni ted Kingdom, then the United States
... Free trade, like free competition, has political as welI as economic
content: taken literally it is a system that enhances the power of the
powerful and makes it all the more difficult for the poor to catch up". 5
Yet another neocIassical weakness is the assumption that all
industries are of equal value to a nation's economy - that skateboards


Japanese Industrial Targeting

are as important as supercomputers if their market value is the same.
David Ricardo, for example, argued in 1817 that Britain and Portugal
should concentrate on producing cloth and wine, respectively, since
that is wh at each produces best. The trouble is that if "the Portuguese
follow the Western theory of comparative advantage, they are
sacrificing long-term growth for short-term gains and implicitly
accepting a lower standard of living than the British ... the ...
implications for an economic strategy are likely to lead to second-rate
performance at best ... To stick with these natural advantages is to
accept a lower rate of growth and technology development simply
because it is a 'natural state of affairs', for which, unfortunately,
there is no remedy". 6 In reality, some in dust ries contribute far more
to economic growth than others by acting as the dynamic focus of
dozens of related industries. For example, strategic industries like
steel and semiconductors form the bedrock for vast, heavy and
high-technology industrial complexes, respectively.
But comparative advantage does not have to be meekly inherited,
it can be vigorously created. How? The answer for many countries is
the highly visible hand of the state rather than the invisible hand of
free markets. During the sixteenth and seventeenth centuries, the
European states followed the policy of mercantilism whereby they
attempted to maximize exports and minimize imports in order to
develop their economies. The surplus wealth was largely invested in
large armies to either defend or aggrandize the state against its rivals.
States continued to play an important role in developing their
respective economies even during the past 150 years when the
world economy was supposedly "liberalized". Britain from the midnineteenth century and the United States from the early 1940s had
mixed success in convincing the other industrial states to abandon
protectionism in favor of free-trade. In the 1930s, trade wars
collapsed the world economy; while international trade has rapidly
grown almost every year since 1945, it is increasingly managed by
states rather than determined by free-market principles. Led largely
by the extremely successful example of Japan, increasing numbers of
states are following neomercantilist policies of trying to achieve
balance of payments surpluses. The key difference in present from
past mercantilism is that most states reinvest their wealth in the
economy rather than squander it by building up vast military
The argument for neomercantilism was perhaps best summed up
by Friedrich List, a nineteenth-century German political economist.

Neoclassical v. Neomercantilist Economics


After studying the economy of Great Britain, the world's first
industrial state to champion free trade, List advised Germany against
free trade, writing: " ... free competition between two nations which
are highly civilized can only be mutually beneficial in case both of
them are in a nearly equal position of industrial development, and
that any nation which owing to misfortunes is behind others in
industry, commerce, navigation ... must first of all strengthen her
own individual powers, in order to fit herself to enter into free
competition with more advanced nations'. 7 Spanier continues the
argument: "the free market may weil be a superior mechanism for
allocating goods, when those competing and exchanging goods are
of approximately equal power. When one nation is clearly more
advanced economically however, free trade benefits it more because
it is able to penetrate the markets of weaker countries. The laws of
the free market are not neutral. Power is the 'invisible hand'
determining the distribution of wealth. Among nations that are equal
in economic power, economic relations may weil breed interdependence, as in the EEC and relations between it and the United States.
But between the economically strong and the economically weak, the
inevitable result is the dependence of the latter". 8
Thus, adherence to the classical economic trade theory at a time
when most other countries of the world are neomercantilist, is an act
of self-destruction. Kanemitsu clearly identifies the problem: "The
real issue then, is not a pure choice between absolute free trade or
protectionism, but rather to wh at extent government interference
should be allowed to restrict free-market forces in order to accomplish the national goals of each country.,,9 Scott and Lodge write that
the "Japanese appear to have been the first to recognize that
advantages could be created through the mobilization of technology,
capital and skilled labor not just to nurture a few infant industries to
supply the domestic market but as a way of nurturing the whole
industrial sector toward areas of growth and opportunity in the world
market ... government could create policies and institutions that
accelerated the attack of new sectors on the one hand and the
abandonment of declining or threatened sectors on the other". 10
How can states maximize the creation of wealth and the power that
accompanies successful economic development. Neomercantilists
from France's Colbert and Germany's List to Japan's Ministry of
International Trade and Industry (MITI) argue that the state can
overcome any natural disadvantages by pursuing industrial developme nt policies. Industrial policies can be narrowly defined as anything


Japanese lndustrial Targeting

involving "direet or indireet government intervention in the marketplaee, typically by a range of poliey instruments, in order to aehieve a
different alloeation of resourees to speeifieally defined priority industries at any point in time than would oeeur through the normal
operation of the market-plaee". 11
Other writers define industrial poliey more broadly, deseribing
them as any government initiatives "that will improve growth,
produetivity, and eompetitiveness", incIuding "inereasing the eeonomy's supply potential (that is, inereasing resourees, and labor
supply and eapital stock), developing teehnology, fostering industrial
development, and improving mobility and struetural adaptation". 12
More sueeinetly, "industrial poliey interventions should be seen as a
eomplex set of trade, finaneial, and fiseal polieies, eondueted within a
political environment, with outcomes at varianee from market
solutions". 13 Like "a eorporate strategy, anational strategy eonsists
of goals, a eoneept of how to aehieve those goals in a eompetitive
environment, and a set of policies and institutions to implement the
eoneept". 14 Under these broad definitions, any eeonomie poliey is an
industrial poliey, either a maeroeeonomie poliey affeeting all industries or microeeonomic policy targeting a specific economic sector ,
industry, or firm. There is eonsiderable overlap between maeroeeonomic and mieroeeonomie polieies, however, with some maero
polieies favoring or impeding specifie sectors, industries, and firms,
while miero policies affeet the entire eeonomy.
If it is true that both maeroeeonomie and mieroeeonomie policies
ean be eonsidered types of industrial polieies, then the eentral "issue"
is not one of state intervention in the eeonomy. All states intervene in
their eeonomies for various reasons, among whieh are proteeting
national seeurity (the 'military industrial eomplex'), insuring industrial safety, providing eonsumer proteetion, aiding the weak, promoting fairness in market transaetions, preventing monopolization
and private eontrol in free-enterprise systems, seeuring the publie's
interest in natural monopolies, aehieving eeonomies-of-seale, preventing excessive eompetition, proteeting and rearing industries,
distributing vital resourees, proteeting the environment, guaranteeing employment, and so forth". 15 Aeeording to many analysts,
"the issue is whether a government's industrial poliey will be ad hoc,
ineoherent, and run by and for insiders or whether it will be
consistent, long-term, and run for the sake of future generations". 16
Central questions revolving around any state's industrial policies
incIude: How are they justified, eoneeived, and implemented? How

Neoclassical v. Neomercantilist Economics


do they eompare with those of other countries? How effeetive are
they? The justifications for industrial policy vary from one policy and
country to the next, but the most common include the need to
support national development, security, employment, welfare, or
environmental goals. Governments with free-trade ideologies like the
United States may even deny that they employ industrial policies
under the narrow definition; instead industrial policies are explained
away as temporary adjustment measures. The bottom-line for industrial policy, however, is that if left to itself the market might not
produce the same degree of targeted development, or none at all.
A government's conception and implementation of industrial
policies is usually shaped by and in turn shapes the justification for
such policies. As will be seen, a country like Japan with its traditional
state-dominated economy justifies industrial poliey on the grounds of
national development and security, and to those ends has established
a largely centralized, bureaucratic-Ied policy-making regime. In
contrast, the policy-making regime of the free-trade oriented United
States is heavily decentralized and politicized. Despite these differences, there are several Japanese industrial policy areas like farming,
eonstruction, and distribution that are heavily politieized, while there
are Ameriean industrial polieies like defense and aerospaee that are
largely bureaueratie-Ied.
Johnson and others distinguish Japan's "plan rational" industrial
polides from Ameriea's "market rational" polieies. 17 The key differenee in national industrial policies is "between those that are growthl
produetivity/opportunity oriented (Japan) ... and those that are
distribution/seeuritylresource oriented (United States) ... Those
that are resouree oriented te nd to see markets and eompetition
guided by the invisible hand as the most effeetive way to develop
those resourees, with government in the röle of referee and regulator.
Those that are opportunity oriented see a röle for the visible hand of
government as supplementing market forees; not as a substitute, but
as a supplement in shaping ineentives to promote savings and/or
diseourage eonsumption, promote mobility of resourees, and alter
risk/reward relationships". 18
Many argue that the effeetiveness of a given industrial poliey is
strongly related to the state's power vis-a-vis other interest groups
like Big Business, opposition parties, eonsumers, labor, or environmentalists; the stronger the state the more effeetive the industrial
policy. Sueeessful development may paradoxieally depend, in
part, on the state deliberately leaving so me eeonomie seetors

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