After the collapse of Soviet‐style communism, the “Japan, Inc.“economic model stood as the world’s only real alternative toWestern free‐market capitalism. Its leading Americansupporters – who became known as “revisionists” – argued in the late1980s and early 1990s that the United States could not compete withJapan’s unique form of state‐directed insider capitalism. UnlessWashington adopted Japanese‐style policies and abandoned freemarkets in favor of “managed trade,” they said, America wouldbecome an economic colony of Japan.
Today, the verdict is in: the revisionists were dead wrong, bothin their assessment of the Japanese “threat” and in theirrecommendations for U.S. policy. Japan has not attained worldwidedominance; on the contrary, it has suffered a “lost decade” ofeconomic stagnation. The “Japan, Inc.” model has not eclipsedWestern‐style capitalism; instead, there is an emerging consensuson both sides of the Pacific that the Japanese model has failed.Countries up and down the Pacific Rim are embracing market‐orientedreforms in the wake of an economic crisis blamed widely onJapanese‐style “crony capitalism.” Meanwhile, the United States,far from declining, is enjoying record‐setting prosperity becauseit largely ignored the revisionists’ advice.
Japan’s problems are now obvious. To revive its fortunes, itmust move to a system under which capital is allocated, notaccording to established relationships or government policy, but inresponse to clear and undistorted market signals. In sum, Japanneeds to abandon the very elements of its system that therevisionists singled out as its greatest strengths.
The revisionists’ big mistake was to believe that a handful ofgovernment planners could outthink millions of privatedecisionmakers – could pick “strategic” industries, allocate capitalin defiance of market signals, and prop up the stock market andreal estate values. Only a few short years were needed to bursttheir bubble.
Ten years ago, the United States was going through a period ofagonized debate about its relationship with Japan. Major Americanindustries – automobiles, consumer electronics, semiconductors, andsteel – were giving way to Japanese competition. U.S. “trophy“assets, from Rockefeller Center on one coast to Pebble Beach GolfCourse on the other, were falling into Japanese hands. The largeU.S. trade deficit with Japan would not succumb even in the face ofa dramatic appreciation of the yen. Many believed that a risingJapan and a declining United States were “trading places.”
Leading the chorus of doom was a group of commentators that BobNeff of Business Week dubbed the“revisionists.“1 Four figures in particular stand out:political scientist Chalmers Johnson, whose 1982 book MITI andthe Japanese Miracle laid much of the intellectual groundworkfor later writers; former Reagan administration trade negotiatorClyde Prestowitz, who authored Trading Places: How We AreGiving Our Future to Japan and How to Reclaim It and laterfounded the Economic Strategy Institute to advance the revisionistviewpoint; former U.S. News & World Report editorJames Fallows, whose 1989 article “Containing Japan” in theAtlantic Monthly cast U.S.-Japan relations in Cold Warterms; and Dutch journalist Karel van Wolferen, author of TheEnigma of Japanese Power. These men influenced manyothers – including novelist Michael Crichton, whose 1992 jingoisticthriller Rising Sun became a number‐one bestseller.
The revisionists asserted that, in contrast to the open‐marketcapitalism of the “Anglo‐American” model, Japan practiced a uniqueform of state‐directed insider capitalism. Under that model, closerelationships among business executives, bankers, and governmentofficials strongly influence economic outcomes. By strategicallyallocating capital through a tightly controlled banking system,they argued, Japan would drive foreign competitors out of sectorafter sector, leading eventually to world economic domination.
Revisionists also maintained that because Japan was not playingby the normal rules of Western capitalism, it was useless to employrules‐based trade negotiations to open the Japanese market.Instead, they advocated “results‐based” or “managed trade“agreements as the only realistic way to reduce the U.S.-Japan tradeimbalance. Beyond that, they proposed elements of a Japanese‐styleindustrial policy as a means of improving U.S. economicperformance.
Today, the verdict is in: the revisionists were dead wrong, bothin their assessment of the Japanese “threat” and in theirrecommendations for U.S. policy. Japan has not attained worldwidedominance; on the contrary, it has suffered a “lost decade” ofeconomic stagnation. The “Japan, Inc.” model has not eclipsedWestern‐style capitalism; instead, there is an emerging consensuson both sides of the Pacific that the Japanese model has failed.Countries up and down the Pacific Rim are embracing market‐orientedreforms in the wake of an economic crisis blamed widely onJapanese‐style “crony capitalism.” Meanwhile, the United States,far from declining, is enjoying record‐setting prosperity, despitethe fact that at most it only dabbled in the managed trade andindustrial policy nostrums that the revisionists were pushing.
Japan’s Troubled Economy
In his book, Trading Places, Clyde Prestowitzwrote:
The power behind the Japanese juggernaut is much greater thanmost Americans suspect, and the juggernaut cannot stop of its ownvolition, for Japan has created a kind of automatic wealth machine,perhaps the first since King Midas.2
Perhaps Prestowitz forgot that Midas met an unhappy end. So,too, did the Japanese “wealth machine.”
Prestowitz was referring to the gravity‐defying rise of Japanesestock and real estate values during the late 1980s. That phenomenonis now known as the “bubble economy,” and its collapse has leftJapan economically crippled. The magnitude of the fall isstartling: Tokyo’s stock market is off 60 percent from its 1989high, and real estate prices have fallen by as much as 80percent.3 That crash in asset values left Japanese bankswith staggering levels of bad debt. Late last year the Ministry ofFinance estimated that problem loans totaled 76.7 trillion yen($568 billion at 135 yen to the dollar), or 15 percent of grossdomestic product.4 In addition, a senior ministryofficial has warned that the true level of nonperforming loanscould be 30 percent higher, measured against a more stringentstandard the Federation of Bankers’ Associations of Japan plans toadopt.5
The effect of the bad debt crisis has been to paralyze Japan’sfinancial sector, and with it the larger economy. The Japanesegovernment spent some 75 trillion yen ($556 billion) on“pump-priming” public works projects between 1992 and1995,6 and interest rates have dropped to historiclows – the current short‐term interest rate is only 0.62percent – but still economic activity remains anemic.7From 1992 to 1997 economic growth in Japan averaged only around 1percent a year, compared with 2.9 percent in the United States andjust below 3 percent for the world.8 The economyactually shrank 0.7 percent in 1997, and with two consecutivequarters of negative growth, Japan is now officially in a recessionfor the first time since 1975.9
Other statistics paint an equally bleak picture. Corporatebankruptcies were up 37.5 percent in May 1998 over the same monththe previous year, and personal bankruptcies may exceed 100,000this year, compared with 70,000 last year. The yen slid to aneight‐year low against the dollar in June 1998, prompting officialgovernment intervention in the currency markets.10
Unemployment – historically low in Japan – has reached its highestpoint in decades. It hit 4.1 percent in June 1998, according to theJapanese government.11 “I expect it to continue to getworse,” said Robert Alan Feldman, an economist with the brokeragefirm Morgan Stanley.12
Unofficial estimates put the Japanese jobless rate much higher.Japan’s official figures exclude many people who want jobs, but arenot registered as job seekers (women, for example, are oftenexcluded from unemployment statistics). A survey done by thegovernment’s Management and Coordination Agency suggested thatJapan’s unemployment rate was 8.9 percent in February 1994,measured under a broader definition. Because Japan’s officialunemployment has risen considerably since then, the broad rate maynow be over 10 percent.13
Japan is also facing serious fiscal problems. Its budget deficitthis year is approaching a massive 7 percent of GDP, while thepublic debt has climbed to over 100 percent of GDP.14 Inthe long run the fiscal problem is even worse because ofdemographic trends. Morgan Stanley estimates that the dependencyratio – the number of pensioners supported by workers – will reach 56percent by 2010, the highest ratio among the Group of Sevenindustrial democracies.15 Without serious restructuring,Japan’s public pension system will collapse under thatunsustainable burden.
The torrent of bad news has led prominent voices in Japan tosound the alarm. Norio Ohga, chairman and chief executive of Sony,warned in April 1998 that the Japanese economy is on the verge ofcollapse and compared then Prime Minister Hashimoto to HerbertHoover.16
Akio Mikuni, who set up Japan’s first independent credit‐ratingagency in the 1980s in the face of Finance Ministry opposition (hewas told credit ratings were “un‐Japanese”), agrees that the nextfew years will be difficult ones. “When the pressure from the magmaof contradictions in Japan’s economic and financial systemsexplodes into view,” Mikuni predicts, “10 percent of Japan’s publiccompanies – some 300 companies, including ten to 15 banks – willeither fail or be taken over.“17
Popular discontent over government handling of the economy isalso increasingly apparent. Voters rejected the ruling LiberalDemocratic Party in July elections for the upper house of theJapanese Parliament. The LDP won just 44 seats out of the 126contested, prompting Hashimoto to announce his resignation almostimmediately.
The Boys Who Cried Wolf
Japan’s current economic problems contrast sharply with thevision of Japan articulated by the revisionists during the 1980sand early 1990s. That vision was popularized for a mass audience inMichael Crichton’s 1992 hit novel, Rising Sun. In anearnest afterword to the techno‐thriller, Crichton wrote:
Sooner or later, the United States must come to grips with thefact that Japan has become the leading industrial nation in theworld. The Japanese have the longest lifespan. They have thehighest employment, the highest literacy, the smallest gap betweenrich and poor. Their manufacturing products have the highestquality.…
But they haven’t succeeded by doing things our way. Japan is nota Western industrial state; it is organized quite differently. Andthe Japanese have invented a new kind of trade – adversarial trade,trade like war, trade intended to wipe out the competition – whichAmerica has failed to understand for several decades. The UnitedStates keeps insisting the Japanese do things our way. Butincreasingly, their response is to ask, why should wechange? We’re doing better than you are. And indeed theyare.18
Perhaps Crichton can be forgiven his dramatic license, but thefact is that he accurately summarized the revisionists’ viewpoint.In numerous books, articles, and commentaries, they praised thevirtues of Asian‐style capitalism and dismissed the U.S. adherenceto relatively free‐market policies as hopelessly naive. As JamesFallows put it in 1989: “Japan and its acolytes, such as Taiwan andKorea, have demonstrated that in head‐on industrial competitionbetween free‐trading societies and capitalist developmental states,the free traders will eventually lose.“19
The United States’ failure to mimic the Japanese model wasrendering us, in Prestowitz’s words, “acolony‐in‐the‐making.“20 Prestowitz also said:
In 1981, the United States, although less dominant thanpreviously, was still the world leader in industry, technology, andfinance as well as in military power. In 1987, it was the leaderonly in military power, and even there was facing the necessity ofreducing commitments. In other areas, the United States, which hadplayed the role first of occupier and then of protector and mentor,had traded places with its formerprotégé – Japan.21
Chalmers Johnson was more succinct. “The Cold War is over,” hewrote, “and Japan won.“22
As in the case of Mark Twain’s death, reports of the UnitedStates’ demise were greatly exaggerated. Indeed, the United Statesis now closing in on the longest peacetime expansion in itshistory, with inflation under control and unemployment at itslowest levels in decades. As to Japan, Prestowitz himself recentlyadmitted: “If the criticism is that I did not accurately forecastthe future of the Japanese economy, mea culpa, and I have a lot ofcompany.“23
Japan’s Financial System: Patience as Virtue or Vice?
Revisionists thought that the heart of the Japanese system’ssuperiority was its long‐term focus. The Japanese financial systemallocated capital, not to achieve a high short‐term return oninvestment, but to gain market share in strategic industries andthus, supposedly, to maximize long‐term returns.
Japan achieved that different orientation by giving corporatemanagers access to “patient capital.” First, banks rather thanequity markets played the central role in supplying funds. Thatsituation still holds today: bank loans equal 150 percent of GDP,while the bond market totals just 75 percent. In the United States,the situation is reversed: the bond market equals 110 percent ofGDP, while bank loans amount to only 50 percent.24 Thedominance of banks allowed capital to be allocated according togovernment policy or long‐standing corporate relationships ratherthan strictly market‐based criteria.
Another key feature of the Japanese system wascross‐shareholding. Because companies and banks owned each other,Japanese firms weren’t constrained by the need to please“impatient” shareholders. In 1991, for example, it was estimatedthat 70 percent of the stock listed on the Tokyo Stock Exchange wasowned by Japanese corporations and rarely traded.25
Access to “patient capital” took pressure off managers toachieve short‐term profitability and freed them to concentrate onmarket share. And from the revisionists’ perspective, market shareis to economic warfare what captured territory is to conventionalwarfare: whoever controls it wins the war. Accordingly, therevisionists believed that the elevation of market share overprofits gave Japanese companies a tremendous competitiveadvantage.
In Zaibatsu America: How Japanese Firms Are Colonizing VitalU.S. Industries, then Economic Strategy Institute fellowRobert L. Kearns expressed that belief:
Toshiba and other major Japanese corporations can go flat outfor market share and ignore short‐term financial considerationsbecause they face little or no risk. There will be no takeovers, nogreenmail, no LBOs, and no white knights, because two‐thirds of theshares of a Toshiba, or a Sony, or a Toyota are in the hands ofother corporations and institutions that are in turn owned on areciprocal basis. The corporations own each other and are operatednot to maximize returns to shareholders, but to minimize risk andthus to maximize long‐term earnings. Indeed, there are guaranteesagainst risk.26
Or as Chalmers Johnson put it:
Japan is dynamic because its managers devote themselves tocompeting with other companies at home and abroad, without havingto serve the parasitic interests of shareholders or the passiveinterests of workers who have no stake in the viability of thecompany.27
The U.S. system, with its emphasis on equity markets over banklending and the ever‐present threat of takeover because of a highlydeveloped market for corporate control, was supposedly hobbled by achronic short‐term focus. In the revisionist view, Americancompanies were therefore congenitally incapable of going toe‐to‐toewith Japanese competition. As Prestowitz stated:
The single greatest weakness of U.S. industry in competing withJapan is lack not of management effort but rather of financialstaying power. Our capital is both too expensive and tooimpatient.28
Revisionists were so impressed by the Japanese system that theyviewed the bubble economy’s escalation of stock and real estatevalues not as speculative excess but as a deliberately engineeredturbo‐charging of Japan’s export machine. In 1989, just a yearbefore the bubble burst, Karel van Wolferen pooh‐poohed fears of animpending collapse:
In a Western setting the speculative activities in whichJapanese firms have been engaged would have brought the doom‐sayersout in crowds. A few did appear in Japan, predicting “a bursting ofthe bubble” or “the bottom falling out” at some point in the nearfuture. But short‐ and medium‐term pessimists overlook a criticalfactor: that the absence of a clear division between the public andprivate sectors in Japan, the co‐operation (or collusion as itwould normally be termed in this context) among the administratorsand the ease with which economic processes can be politicallycontrolled all add up to a situation radically different from thatin the other capitalist countries, whence such theories of burstingsoap bubbles originally came.29
In the revisionist view, soaring asset values gave Japanesecompanies the ability to tap into apparently limitless amounts ofno‐questions‐asked capital. The bubble was the “automatic wealthmachine” that Prestowitz referred to, and it made the Japanesepredatory threat seemingly unstoppable.
In response to that threat, the revisionists urged the overhaulof U.S. financial markets along Japanese lines. Prestowitzadvocated encouraging patient capital through “rules on corporatetakeovers that are much more restrictive, as well as through hightaxation of short‐term capital gains.“30 James Fallowssuggested changing the security and exchange laws “so thatcorporations would have to file detailed profit‐and‐loss reportsonce a year, not every three months.” Such a change, he said, would“diminish the notorious American obsession with quarterly profitrates and would send a signal about the direction in which we’dlike our business to head.“31
Short‐Term Focus or Market Discipline?
Illuminated by the persistent woes of the Japanese financialsector throughout this decade, not to mention the more recentcrises gripping other East Asian economies, the shortcomings of the“patient capital” model have become obvious to most observers. AsRobert Denham, former chairman of Salomon Inc., explained: “Therisk is that long‐term orientation becomes an excuse for notfocusing on profits at all. You can always excuse bad results bysaying, ‘Oh, we’re building for the future. ’ ”32
The risk that Denham spoke of has come to pass in Japan. Evenwith the precipitous drop in Japanese stock market values, dividendyield has remained below 1 percent. 33 More broadly,rate of return on capital in the business sector has fallen belowthat in the European Union and is now less than half the U.S.rate.34 Japan is the most inefficient deployer ofcapital in the developed world.
This is a far cry from what revisionists were forecasting only afew years ago. In 1992 Robert Kearns confidently predicted that“Tokyo, with seven of the world’s ten largest banks, the world’slargest stock market and the world’s richest security firms, is onthe way to becoming the financial center of theworld.“35 But a recent Financial Times articledescribed a very different reality: “While London and New York havesurged, the volume of trading in Tokyo is now only about half ofwhat it was in 1989 and the value is less than that.“36And between 1992 and 1995, Tokyo was the only big financial centerwhose share of global foreign‐exchange trading actuallyshrank.37
Second‐guessing of the old financial model can now be heardthroughout the Japanese business community. Junichi Ujie, the newCEO of Nomura Securities, recently called into question thecross‐shareholding that lies at the core of the old system: “Wehave a bunch of bank shares. Is this really a strategic portfoliofor an investment bank? I kind of doubt it.“38 AndYoichi Morishita, president of Matsushita Electric Co., the world’slargest consumer electronics company, conceded that“shareholder-oriented management has become very importantinternationally.“39
Picking Winners – And Losers
In predicting Japan’s relentless rise, the revisionists lookednot only at the “patient capital” system but also at the statepromotion of specific “strategic” industries with the aim ofenhancing international competitiveness. They heaped praise uponJapan’s Ministry of International Trade and Industry, or MITI, andits industrial policy of direct subsidies, trade protection, and“administrative guidance.”
In Trading Places, Prestowitz described MITI’sphilosophy as follows:
A key objective in any economy … is to create an industrythat produces technologically sophisticated products with highincome elasticity (that is, the higher a person’s income, the moreone buys of those products) and a rapid growth rate (for example,VCRs). That objective … cannot be achieved without governmentintervention.40
The revisionists argued forcefully that the United States shouldadopt aspects of Japanese industrial policy. They urged an activerole for Washington in promoting key industries and firms whosehealth they considered vital to the welfare of the economy as awhole. In particular, Johnson suggested that the United Statesthink seriously about adopting its own “pilot agency,” similar toMITI, to guide industrial development.41 For his part,Prestowitz founded the Economic Strategy Institute to advocateJapanese‐style policies. “The Economic Strategy Institute believesthat America’s future as a great power and a land of opportunitydepend [sic] not only on how much we produce, but equally on whatwe produce,” states ESI’s Web site.42
Fortunately, the United States largely failed to take therevisionists’ advice. Apart from a few relatively smallprojects – including the Pentagon‐funded Sematech consortium and theCommerce Department’s Advanced Technology Program – the UnitedStates has done little to target and promote “strategic“industries.43 The Clinton administration came intooffice with promises of a more ambitious agenda, but Congressmostly refused to go along.44
Nevertheless, U.S. economic performance during the 1990s hasbeen exceptional. And in the area of particular concern to therevisionists, U.S. companies remain strong in such “strategic“high-tech sectors as microprocessors, disk drives, personalcomputers, and software. In particular, U.S. companies dominate theInternet – a “strategic” sector that neither the revisionists norother industrial policy enthusiasts even foresaw.
Meanwhile, the supposedly unstoppable Japanese progression upthe “food chain” of technological leadership has stalled. Japanesecompanies have failed to parlay their strengths in commodity memorychips, semiconductor manufacturing equipment, and flat paneldisplays into domination of the larger computer industry – despitesuch industrial policy programs as the Fifth Generation ComputerProject.45 Similarly, the much‐ballyhooed Japaneseinitiative on high‐definition television (HDTV) foundered on itsmistaken commitment to analog technology.46
Notably, Prestowitz cited HDTV as an “example of the wideningU.S. lag” in high technology. “There are not even any Americansinvolved in this struggle,” he lamented in 1988.47Again, Prestowitz was dead wrong. American firms leapfrogged theirJapanese rivals and produced a more technically advanced version ofHDTV using digital technology. In December 1996, the FCC approvedan HDTV standard developed by a so‐called Grand Alliance of U.S.and European producers; Japan wasn’t even in therunning.48
The Managed Trade Solution
Confronting what they thought to be a new and superior form ofcapitalism, the revisionists believed that the old rules ofinternational trade did not apply. While free trade might bemutually beneficial among Western‐style economies, it wassupposedly a ticket to oblivion where Japan was concerned. “TheUnited States must either begin to compete with Japan,” warnedJohnson, “or go the way of the USSR.“49
Specifically, revisionists urged an abandonment of “rules-based“trade in favor of “results‐based” or “managed trade.” It made nosense to adhere to the established rules of free trade, since theyonly facilitated Japan’s relentless drive for worldwide marketshare. Likewise, there was no point in trying to force Japan tolive by those rules, since they were fundamentally inconsistentwith the Japanese system. The only solution was to decide onresults – i.e., degrees of mutual market penetration – that bothsides could live with.
In a chapter that opens with the gloomy hypothetical, “If webecome a kind of fourth‐world country with all our assets ownedabroad … ‚” Prestowitz laid out the revisionist blueprint forU.S. trade policy:
For the United States, the first step is to discard the beliefthat the Japanese market is like that of the United States, andthat it can be opened and made to operate similarly if only theJapanese will stop being unfair. The mentality of the Japanese andthe structure of their society and economy exist. Neither fair norunfair, they need to be handled as they are, with a clearunderstanding of their likely effects. It is counterproductive tocontinue to act the missionary toward Japan in the matter of tradeand economics. We must get away from the stereotyped free‐tradeversus protectionist debate.50
In particular, Prestowitz singled out the web of governmentrestrictions on international air transport as a model ofsuccessfully managed trade.51
James Fallows concurred, noting that “America’s interest inprocess, and Japan’s in result, have an important bearing on tradeproblems. They explain why the U.S. negotiating strategy hasgenerally failed.” America, he wrote, “should focus on results, notrules.“52
In a similar vein, Johnson argued that “a policy of pressuringJapan to alter its economic system to make it look like theAmerican system is doomed to fail.“53 A new approach isnecessary, he maintained: “GATT rules are irrelevant and policiestailor‐made for Japan will be required.“54 He made clearwhat kind of policies he had in mind: “Most examples of trade thatis mutually beneficial belong to the category of managedtrade.“55
The revisionists’ advocacy of managed trade rested on twoassumptions. First, they believed that “patient capital” andindustrial policy gave Japanese companies an unfair advantage inforeign markets. The experience of the past few years, though, hasdiscredited that belief. Meanwhile, the revisionists thought thatthe Japanese market was structurally closed to foreign companies.Although that point of view remains widely held, it is likewise atodds with the facts. It is true that Japan, like other countries,has its share of overt protectionist barriers; it is also true thatthe Japanese system of political economy is distinctly differentfrom the U.S. model. Nevertheless, in the absence of overtrestrictions, foreign companies can and do achieve competitivesuccess in Japan. In this regard, a study by James Abegglen andPeter Kirby of Gemini Consulting has documented that the 100largest foreign‐owned companies in Japan controlled $155 billion insales in 1994.56 That figure does not even count thesales of companies like Boeing and Weyerhauser that export directlyand not through Japanese subsidiaries. The existence of suchsuccess stories is simply not compatible with the stereotype of aclosed Japan that the revisionists advanced.
Fortunately, as with industrial policy, the United States onlyflirted with the revisionists’ trade policy recommendations. It didimpose quantitative restrictions on major Japanese imports – theso‐called voluntary restraint agreements on automobiles, steel, andmachine tools. And in the case of semiconductors, it negotiated a“voluntary export expansion” agreement in which Japan agreed to anexplicit 20 percent market share target for foreign suppliers.
The Clinton administration sought to apply a “results-based“approach more broadly, under the 1993 U.S.-Japan FrameworkAgreement, but the Japanese government steadfastly refused to agreeto further market share targets. In a final showdown overautomobiles in June 1995, the United States ultimately decided toback down rather than impose sanctions against Japan. Since thattime, U.S. demands for market share commitments have more or lessceased.
Despite a few dalliances, the United States stuck with its basiccommitment to rules‐based trade. It allowed the voluntary restraintagreements to expire. It led the Uruguay Round of trade talks thatgave birth to the new World Trade Organization. Indeed, theprospect of losing its case at the WTO was a major factor behindthe U.S. decision not to impose sanctions in the autos dispute.Meanwhile, the United States has prospered from its refusal tofollow the revisionists’ advice.
“Third Way” to Nowhere
The revisionists’ predictions went so badly astray because theyfundamentally misinterpreted Japan’s economic system. Inparticular, they believed they had discovered in Japan a new andsuperior form of capitalism: the so‐called capitalist developmentalstate.57
According to the revisionists, the capitalist developmentalstate represented a “third way” in which the government sets broadsocietal goals but uses market mechanisms to achieve them. Privateownership of property and free exchange exist, but governmentplanning and resource manipulation are also essential. As JamesFallows wrote in Looking at the Sun, his in‐depth analysisof the Asian economic model:
The Asian‐style system deeply mistrusts markets. It seescompetition as a useful tool for keeping companies on their toesbut not as a way to resolve any of the big questions of life – how asociety should be run, in what direction its economy shouldunfold.58
Specifically, the government attempts to foster economicdevelopment through market intervention aimed at helping specificcompanies improve their prospects of success. Intervention includesdirect subsidies, import protection, and directing the flow ofprivate capital toward promising industries.
Chalmers Johnson described MITI as the “pilot agency” primarilyresponsible for translating the government’s goals into substantiveindustrial policy. Its job was to identify the industries to bedeveloped, formulate a high‐growth strategy for those industries,and supervise competition so as to guarantee economic health andeffectiveness.59
Revisionists thought that the apparent success of the capitalistdevelopmental state signaled the end of orthodox free‐marketeconomics. Japan, not the United States, would serve as the modelfor the rest of the world to follow. By contrast, America’ssupposed attachment to laissez‐faire ideology had blinded it to thefact that the rules of international competition had changed: “Ifthe United States were a well‐run country,” Johnson told Fallows in1989, “neoclassical economists would be hanging from the Capitoldome.“60
Johnson continued to praise the capitalist developmental stateuntil at least as recently as 1995. “Japan’s combination of astrong state, industrial policy, producer economics and managerialautonomy,” he said, “seems destined to lie at the center, ratherthan the periphery, of what economists will teach their students inthe next century.“61
Like so many earlier candidates, however, the revisionists’claimed “third way” failed to live up to expectations. Therevisionists recognized correctly that the Japanese system ofpolitical economy differs in important respects from Americanpractice. Among its distinctive features are the close and informalties between industry and government, stable cross‐shareholding andheavy reliance on relationship‐based bank financing rather thanimpatient capital markets, keiretsu alliances withsuppliers and distributors, and lifetime employment arrangements.Furthermore, it is true that particular Japanese industries haveachieved some spectacular competitive successes and that untilrecently Japan as a whole was growing much faster than the UnitedStates. Where the revisionists erred, though, was in thinking thatJapan’s distinctive political economy accounted for its superioreconomic performance.
What was really happening? First, Japanese companies haddeveloped new and superior manufacturing techniques, including suchinnovations as continuous improvement and just‐in‐time inventory.These innovations were sufficiently important that theydistinguished a new system of so‐called lean production fromtraditional mass production.62 Armed with these superiortechniques, Japanese companies did indeed pose a formidablecompetitive challenge in selected industries, although certainlynot across the board.
Second, Japan as a whole was experiencing continuing high growthand rapid advancement because it was playing technological catch‐upwith the West. It is much easier to grow and improve productivityquickly by adopting and adapting technologies invented elsewherethan by developing those new technologies internally.63Furthermore, Japan was playing catch‐up in a business‐friendlypolicy environment of low taxes and low governmentspending.64 Thus, Japan’s rapid ascent was a tributeprimarily to private sector innovation and good old‐fashionedmarket forces, not some MITI‐masterminded interventionistindustrial policy.
And those very same market forces, not interventionist tradepolicies, were ultimately responsible for making the direpredictions of an unstoppable Japanese juggernaut look foolish inretrospect. With often painful restructuring, U.S. companiesadopted the new lean production manufacturing techniques andregained their competitiveness. At the same time, Japan’s economicperformance naturally slowed as the country reached thetechnological frontier.
And what about the interventionist elements of the Japanesesystem so beloved by the revisionists? It turns out that “Japan,Inc.” was much better suited to playing catch‐up than it is tofostering growth at the cutting edge. Even Clyde Prestowitz nowrecognizes this fact:
As a catch‐up machine, this model was unparalleled. But onceJapan caught up … problems began to arise. While the model wasgood at concentrating resources to hit targets already set by thepattern of Western development, it performed poorly at selectingnew directions.65
In particular, the clubby, relationship‐based system ofallocating capital – until recently praised by Prestowitz and hiscolleagues for its long‐term focus – now looks dreadfully wastefuland inefficient. It is impossible to determine which “newdirections” are worth pursuing in the absence of a financial systemthat directs capital toward its highest return.
Ultimately, the blame for Japan’s current problems lies with itsfailure to make the transition from capitalist developmental stateto a mature economy at the technological frontier. Instead ofmaking that transition, Japan first faked prosperity by inflatingthe bubble economy in the late 1980s; then, after the bubble burst,it refused to introduce market accountability into the system.Rather, the Japanese authorities let the bad debt problem festerand worsen. This rot at the core of things has crippled the wholeeconomy. The recent “Big Bang” reforms suggest a hopeful change ofcourse, but it is too early to tell how far that course will befollowed.66
To revive its fortunes, Japan needs to move to a system in whichcapital is allocated, not according to established relationships orgovernment policy, but in response to clear and undistorted marketsignals. In sum, Japan needs to abandon the very elements of theold “Japan, Inc.” system that the revisionists singled out as itsgreatest strengths.
Where Are They Now?
The facts of the 1990s have been cruel to the revisionists. Howhave they reacted?
Some have trudged on bravely, minimizing Japan’s currentproblems and continuing to trumpet the superiority of the “Japan,Inc.” model. A particular standout in this regard is journalistEamonn Fingleton, author of the 1995 book Blindside: Why JapanIs Still on Track to Overtake the U.S. by the Year 2000.Fingleton is no crank: he was formerly an editor at Forbesand Financial Times, and his book was named one ofBusiness Week’s top 10 business books of 1995. But now,three years later, the book contains howlers that take the breathaway.
As Japan was stumbling through year after year of subparperformance, Fingleton wrote:
Most of the Japanese financial disasters the Western pressreported in the early 1990s were merely symbol‐economy losses thathad few if any negative implications for the realeconomy.67
About the heart of the problem, Japan’s inefficient and badlydebt riddled banking system, he had this to say: “In fact, there isprobably no other major Japanese industry that has such anefficiency lead over the Americans as banking!“68
Fingleton then laid out Japan’s master strategy for“blindsiding” the United States:
By 1994, it was apparent that Japan was girding itself for a newleap forward with the help of powerful Keynesian economicstimulation via increased public spending. Keynesianism has, ofcourse, been out of fashion in the West for decades, where its sideeffects such as inflation, increased government borrowing, and arise in imports are deemed intolerable. These side effects havehardly been a concern in Japan, where wage increases are tightlycontained, the national budget is in surplus most years, andvarious natural and artificial barriers to imports ensure that thebenefits of budgetary stimulation do not leak abroad.
In short, while American observers continued to dwell on theillusory gloom of the past few years, the Japanese were focusing ona bright future. Just how bright this future is we will nowsee.69
Three years and trillions of yen in “powerful Keynesian economicstimulation” later, Fingleton’s “bright future” has yet to emerge.But even as evidence of Japan’s problems mounted, Fingletonremained optimistic: “The Japanese economy is like a young cyclistpeddling uphill,” he said in a speech in 1996. “The strain isshowing on his face, but it’s a healthy strain.“70 Ofcourse, Fingleton declared only a year before that Japan was“triumphantly on track” to overtake the United States to become theworld’s largest economy by the year 2000.71 With theU.S. economy still nearly twice as large as Japan’s and growingfaster, the odds don’t look good.72
Like Fingleton, James Fallows stuck to his revisionist guns wellinto the 1990s. Indeed, he had high praise for Fingleton’s analyis.“A generation from now,” Fallows wrote, “readers will recognizeBlindside as having offered crucial and prescientguidance.“73
East Asia’s financial crisis, though, seems to have been thestraw that broke the camel’s back for Fallows. Writing as thecrisis deepened in November 1997, he admitted that the Asian modelthat once so impressed him has “tragic flaws”:
The case against the Asian model is obvious. The effort todiscourage consumption denies people the full fruits of theirlabor; guidance by bureaucrats invites corruption and seemsham‐fisted in a world of instant capital flows and breakneckdevelopment in info‐tech.74
Of course, none of these flaws were “obvious” to Fallows only acouple of years earlier. And still, Fallows tries his best toaccentuate the positive:
But the soundness of parts of the model remain underappreciatedin the English‐speaking world.… In major manufacturingcategories, Japanese, Korean, and Chinese manufacturers have heldor expanded world market share even as banks collapse around them.… During seven years of unremitting distress for its financialsystem, Japan’s manufacturers have accumulated trade surpluses ofmore than $700 billion.75
As economist Paul Krugman commented recently on Fallows’sobservation: “Shouldn’t this make him wonder whether tradesurpluses are such a good thing?“76
As recently as 1995, Chalmers Johnson was still using his lineabout Japan’s winning the Cold War. Now, however, he is trying tocover his tracks. At a speech delivered before the EconomicStrategy Institute this March, for example, he said: “The disasterof 1997 did not refute revisionism but rather confirmed the essenceof the revisionists’ message – there are differences amongcapitalist systems that are not trivial and that under the rightcircumstances can blow the system apart.“77 Of course,that statement fails to mention that it was the U.S.system that was supposed to have blown apart.
Johnson now presents a revisionist picture of what therevisionists stood for:
During the early eighties, when Japan’s trade surpluses with theUnited States set new records every month and came close todestroying much of the manufacturing base of the U.S. economy, agroup of foreign analysts (myself included) attempted to callattention to the differences between East Asian and Americancapitalism.… And we advocated using the full market power ofthe United States – which was, and still is, the main market for allthe East Asian economies – to force them to make international trademutually beneficial by opening their markets.78
He expanded upon this account in a posting on the “Dead FukuzawaSociety” email listserv:
Our policy answer … was to use the full power of theAmerican market to force open the Japanese market. We called for atrade war. The intent was to force Japan into a domestic‐demand‐ledeconomic strategy by selectively weaning it from the Americanmarket.…What was wrong with the so‐called revisionists’strategy is that the Cold War was still on and there were manyfools in the U.S. who still thought Japan might either go communistor socialist or neutralist and that we should care. The reformsthat are now promised in Japan were needed c.1985.79
If forcing Japan into a domestic‐demand‐led economic strategywas always Johnson’s intent, it was easy to miss it. Recall that hewrote: “A policy of pressuring Japan to alter its economic systemto make it look like the American system is doomed tofail.“80 And the notion that his or his colleagues’ goalwas to pressure Japan to become more like us hardly squares withthis vintage Johnson endorsement of other countries’ becoming morelike Japan:
In order to meet the competition of Japan, other countries mustcopy or match Japan’s keiretsu-type company structures,its mercantilist industrial and trade policies, its ability to makecapital available on a preferred basis to strategic industries, andits managerial incentives that impose long‐term perspectives oncompany operations. Neoclassical economic theory is not onlyirrelevant to this challenge, it is downrightmisleading.81
Of all the revisionists, Clyde Prestowitz has reacted mostdramatically to Japan’s current problems. Without explicitlyrenouncing his former views, he has nonetheless turned them ontheir head.
Prestowitz now regards the Japanese economy as in need offundamental reform:
[I]n the present state of the Japanese economy, all the standardstimulus packages, be they public works spending, tax cuts or somecombination thereof, are a bit like giving a blood transfusion to aman who needs a heart transplant. They may be necessary to keep thepatient alive, but they won’t restore him tohealth.82
Indeed, according to Prestowitz, the whole Asian model – once thesupposed wave of the future – must be scrapped, and the sooner thebetter: “With much of Asia now on life support, it is time torecognize that the Asian brand of capitalism is dangerous to theworld economy’s health and that it must be abandoned, particularlyby Japan.“83
Prestowitz once wrote that “it is counterproductive to continueto act the missionary toward Japan in the matter of trade andeconomics.“84 Now, however, he calls for a forcedconversion of Japan at a special World Trade Organizationinquisition:
To ensure that Japan takes these or other recommendationsseriously, it might be necessary for world leaders to convene anextraordinary session of the World Trade Organization. It was JohnMaynard Keynes who proposed in the 1940s that a world trade bodyshould have emergency measures for handling threats to the worldtrading system arising from chronic surpluses as well as fromexcessive deficits. Perhaps it is time for the WTO to come to gripswith this long‐recognized problem in a way that would encourageJapan seriously to consider a thorough opening of its market toboth domestic and foreign enterprises.85
While Prestowitz’s disillusionment with the Japanese model isbetter late than never, his proposal of a WTO remedy for Japan’stroubles is wrongheaded. Japan’s economic woes are not a tradeproblem and should not be treated as such.86 Tradedisputes should deal exclusively with government policies thatdiscriminate against goods or services of foreign origin. Thedysfunctional Japanese policies at issue do not fit thatdescription. Punitive tax rates on corporate and personal income donot discriminate against foreigners; neither does the failure toclean up banks’ bad debts; neither does the hopeless attempt tofake economic vitality with wasteful public works spending.
The argument made by Prestowitz and others is that if Japanreforms its economy and returns to a healthy growth path, it couldimport more and take up the slack for the ailing economies of thePacific Rim. Perhaps, but how does that distinguish Japan fromother countries around the world? Surely Europe could grow fasterand absorb more imports if it weren’t hobbled by chronicdouble‐digit unemployment. If every economic underachiever werehauled to the dock, there would be no end of WTO tribunals.
The revisionists claimed to have discovered a new and superiorform of capitalism: the Japanese capitalist developmental state.Today, however, the Japanese model is better known as “cronycapitalism,” and its manifest failures are causing economic painand political turmoil up and down the Pacific Rim. The revisionistsargued that the United States was doomed as a leading economicpower unless it adopted Japanese‐style practices. It didn’t and isnow enjoying spectacular and unrivaled prosperity.
In short, the revisionists’ doom‐and‐gloom prophecies could nothave been more wrong. All their errors trace back to a commonsource: an inability to understand and appreciate the power of freemarkets. Suffering from what Nobel Prize‐winning economist F. A.Hayek termed the “fatal conceit,“87 they believed that ahandful of government planners could outthink millions of privatedecisionmakers – could pick “strategic” industries, allocate capitalin defiance of market signals, and prop up the stock market andreal estate values. Like so many others before them, they pridedthemselves as sophisticated realists, yet in fact their faith inbureaucratic miracles was hopelessly naive. Only a few short yearswere needed to burst their bubble.
1. Robert Neff, “Rethinking Japan,” Business Week,August 7, 1989, p. 44.
2. Clyde Prestowitz, Trading Places: How We Are Giving OurFuture to Japan and How to Reclaim It (New York: Basic Books,1993), p. 72. This book was orginally published in 1988 andreissued in 1993 with a new introduction.
3. Stock market percentage decline is based on authors’calculation of Nikkei 225 prices with a historic high of 38,915.87(set at the end of 1989) and a June 30, 1998 closing price of15,827.02. Real estate price decline figure is taken from “TheJapan Puzzle,” The Economist, March 21, 1998, p. 22.
4. Reported in Peter Landers, “Japan: Time of Troubles,” FarEastern Economic Review, February 26, 1998, p. 54.
5. “Japan MOF Official/Bad Loans,” Dow Jones NewsService, May 11, 1998.
6. Figure taken from “The Japan Puzzle,” p. 22.
7. Three‐month money market rate taken from “FinancialIndicators,” The Economist, July 4, 1998, p. 101.
8. U.S. data from Bureau of Economic Analysis, Revisions toPercent Change in GDP, Real GDP, and Price Indexes,http://www.bea.doc.gov/bea/an/ 0897niw/table4.htm. Other dataavailable at http:// www.oecd.org.
9. Sandra Sugawara, “Officials Confirm Japan Is in Recession,“Washington Post, June 13, 1998.
10. Paul Blustein, “U.S., Japan Move to Boost Yen,“Washington Post, June 18, 1998.
11. “CORRECT: E.U.-11 April Unemployment Rate 11.3%, Same AsMarch,” Dow Jones Newswires, June 16, 1998,http://interactive.wsj.com/archive/retrieve.cgi?id=DI-CO-19980616 – 00175….
12. Quoted in Sugawara.
13. “One in Ten?” The Economist, July 1, 1995, p.26.
14. Rupert Thompson, “Japanese Government Bonds to Rise,“Investment Week, October 20, 1997,http://www.invweek.co.uk/invweek/MARKETS /october/20markgi.htm, or“Japan Cabinet Approves This FY Y4.646 Tln Extra Budget,” DowJones Newswire, May 11, 1998.
15. Paul Abrahams, “Ageing Cohort Needs Faster Growth, HigherReturns,” Financial Times, March 26, 1998.
16. “Sony Chief Says Japan’s Economy Faces Collapse,“Financial Times, April 3, 1998.
17. Jim Rohwer, “Japan’s Quiet Corporate Revolution,“Fortune, March 30, 1998, p. 83.
18. Michael Crichton, Rising Sun (New York: Knopf,1992), p. 349.
19. James Fallows, “Containing Japan,” AtlanticMonthly, May 1989, p. 40.
20. Prestowitz, Trading Places, p. 493.
21. Ibid., p. 94.
22. Chalmers Johnson, Japan: Who Governs? (New York:W.W. Norton & Company, 1995), p. 9.
23. Quoted in John Berlau, “Romancing the Japanese Model: Fansof Industrial Policy Suffer Unrequited Love,” Investor’sBusiness Daily, April 29, 1998.
24. Alan Murray, “Asia’s Financial Foibles Make American WayLook Like a Winner,” Wall Street Journal, December 8,1997.
25. Robert Zielinski and Nigel Holloway, Unequal Equities:Power and Risk in Japan’s Stock Market (New York: KodanshaInternational, 1991), p. 24.
26. Robert L. Kearns, Zaibatsu America: How Japanese FirmsAre Colonizing Vital U.S. Industries (New York: Free Press,1992), p. xi.
27. Johnson, Japan, p. 63.
28. Prestowitz, Trading Places, p. 519.
29. Karel van Wolferen, The Enigma of Japanese Power: Peopleand Politics in a Stateless Nation (London: Macmillan, 1989),p. 400.
30. Prestowitz, Trading Places, p. 519.
31. James Fallows, “Getting Along with Japan,” AtlanticMonthly, December 1989, pp. 54 – 55.
32. Quoted in Murray.
34. Jesper Koll, “The ‘Big Bang’ of Financial Market Reform,“Remarks delivered at “Deregulation in the Global Marketplace:Challenges for Japan and the United States in the 21st Century,“Cato Institute‐Keidanren Symposium, Tokyo, April 6, 1998. Textavailable from authors by request.
35. Kearns, p. 6.
36. Gillian Tett, “A Bang or a Whimper?” FinancialTimes, April 1, 1998.
37. “Bang, Pop or Sputter?” The Economist: A Survey ofFinancial Centers (insert), May 9, 1998, p. 29.
38. Rohwer, p. 84.
39. James Grant, “Why Japan Is Undervalued,” Wall StreetJournal, April 17, 1998.
40. Prestowitz, Trading Places, p. 256.
41. Chalmers Johnson, MITI and the Japanese Miracle,1925 – 1975 (Stanford, Calif.: Stanford University Press, 1982),p. 323.
42. “The ESI FAQ, http://www.econstrat.org/ Inside.htm, on May26, 1998.
43. For more on the failure of U.S. industrial policy, see BrinkLindsey, “DRAM SCAM: How the United States Built an IndustrialPolicy on Sand,” Reason, February 1992; or T. J. Rodgers,“Silicon Valley versus Corporate Welfare,” Cato Institute BriefingPaper no. 37, April 27, 1998.
44. The core of U.S. high‐tech industrial policy is the AdvancedTechnology Program (ATP), which had a 1997 appropriation of $225million. ATP was zeroed out by Congress in the 1996 budget cycle,although President Clinton vetoed that bill and secured acompromise that allowed ATP to survive with a 49 percent budgetcut. In 1997, ATP’s budget was expanded by only 2 percent.
45. Jeffrey Batholet, “Dimming the Sun: the Alliance of JapaneseBureaucrats and Businessmen Doesn’t Work So Well Anymore,“Newsweek, March 17, 1998, p. 38.
46. David P. Hamilton, “Japan Appears Set to Abandon Its AnalogHDTV,” Wall Street Journal, March 3, 1997.
47. Prestowitz, Trading Places, pp. 491 – 92.
48. “Public TV and the Transition to Digital Broadcasting,“Current Online, May 4, 1998, http://www.current.org/atv1.html. The“Grand-Alliance” consists of AT&T, General Instrument, MIT,Philips, Sarnoff, Thomson, and Zenith.
49. Johnson, Japan, p. 95.
50. Prestowitz, Trading Places, p. 514.
52. Fallows, “Getting Along with Japan,” p. 62.
53. Johnson, Japan, p. 13.
54. Ibid., p. 89.
55. Ibid., p. 55.
56. Cited in Scott Latham, “Market Opening or Corporate Welfare?‘Results-Oriented’ Trade Policy toward Japan,” Cato InstitutePolicy Analysis no. 252, April 15, 1996, p. 34.
57. Johnson, Japan, p. 67.
58. James Fallows, Looking at the Sun: The Rise of the NewEast Asian Economic and Political System (New York: PantheonBooks, 1994), p. 208.
59. Johnson, MITI and the Japanese Miracle, p. 315.
60. Quoted in Fallows, “Containing Japan,” p. 40.
61. Johnson, Japan, p. 68.
62. An analysis of Japanese “lean production” techniques in theautomobile industry is provided in James P. Womack, Daniel T.Jones, and Daniel Roos, The Machine That Changed theWorld, (New York: Macmillan, 1990).
63. Federal Reserve Board chairman Alan Greenspan made thispoint recently in congressional testimony on the Asian financialcrisis. See Alan Greenspan, Testimony before the Committee onForeign Relations, U.S. Senate, February 12, 1998,http://www.bog.frb.fed.us/boarddocs/testimony/19980212.htm.
64. Economist Alan Reynolds makes this point in “TowardMeaningful Tax Reform in Japan,” Remarks delivered at “Deregulationin the Global Marketplace: Challenges for Japan and the UnitedStates in the 21st Century,” Cato Institute‐Keidanren Symposium,Tokyo, April 6, 1998,http://www.freetrade.org/pubs/speeches/ar‑4 – 6‑98.html.
65. Clyde Prestowitz, “Retooling Japan Is the Only Way to RescueAsia Now,” Washington Post, December 14, 1997.
67. Eamonn Fingleton, Blindside: Why Japan Is Still on Trackto Overtake the U.S. by the Year 2000 (New York: Buttonwood,1995), p. 290.
68. Ibid., p. 61.
69. Ibid., p. 294.
70. Eamonn Fingleton, “The Great Recession: Real or Fabricated?“American Chamber of Commerce in Japan Journal, April 1,1997.
71. Fingleton, Blindside, p. 6.
72. Based on the OECD’s gross domestic product statisticsavailable at http://www.oecd.org/std/ gdp.htm.
73. Quoted at http://www.amazon.com/ exec/obidos/ASIN/0395633168/o/002 – 9089057-0751229.
74. James Fallows, “How the Far East Was Won,” U.S. News& World Report, December 8, 1997, p. 11.
76. Paul Krugman, “I Told You So,” New York TimesMagazine, May 5, 1998.
77. Chalmers Johnson, “Asia’s Financial Meltdown: What Caused Itand What Does It Mean?” Remarks delivered before the EconomicStrategy Institute, March 24, 1998,http://www.econstrat.org/ECONSTRAT/johnson.htm.
78. Chalmers Johnson, “Cold War Economics Melt Asia,“Nation, February 23, 1998, p. 16.
79. Chalmers Johnson, posted on the Dead Fukuzawa Societylistserv, aprox. December 1997. Text available from authors byrequest.
80. Johnson, Japan, p. 13.
81. Ibid., p. 83.
82. Clyde Prestowitz, “Going Down with Japan,” Far EasternEconomic Review, April 16, 1998, p. 15.
83. Prestowitz, “Retooling Japan Is the Only Way to Rescue AsiaNow.”
84. Prestowitz, Trading Places, p. 514.
85. Clyde Prestowitz, “A Plan for Japan,” WashingtonPost, April 7, 1998.
86. Brink Lindsey, “Japan’s Weakness Is No Threat,” Journalof Commerce, May 29, 1998.
87. F. A. Hayek, The Fatal Conceit (Chicago: Universityof Chicago Press, 1989).