Revisiting the “Revisionists”: The Rise and Fall of the Japanese Economic Model

July 31, 1998 • Trade Policy Analysis No. 3

After the collapse of Soviet‐​style communism, the “Japan, Inc.” economic model stood as the world’s only real alternative to Western free‐​market capitalism. Its leading American supporters–who became known as “revisionists”–argued in the late 1980s and early 1990s that the United States could not compete with Japan’s unique form of state‐​directed insider capitalism. Unless Washington adopted Japanese‐​style policies and abandoned free markets in favor of “managed trade,” they said, America would become an economic colony of Japan.

Today, the verdict is in: the revisionists were dead wrong, both in their assessment of the Japanese “threat” and in their recommendations for U.S. policy. Japan has not attained worldwide dominance; on the contrary, it has suffered a “lost decade” of economic stagnation. The “Japan, Inc.” model has not eclipsed Western‐​style capitalism; instead, there is an emerging consensus on both sides of the Pacific that the Japanese model has failed. Countries up and down the Pacific Rim are embracing market‐​oriented reforms in the wake of an economic crisis blamed widely on Japanese‐​style “crony capitalism.” Meanwhile, the United States, far from declining, is enjoying record‐​setting prosperity because it largely ignored the revisionists’ advice.

Japan’s problems are now obvious. To revive its fortunes, it must move to a system under which capital is allocated, not according to established relationships or government policy, but in response to clear and undistorted market signals. In sum, Japan needs to abandon the very elements of its system that the revisionists singled out as its greatest strengths.

The revisionists’ big mistake was to believe that a handful of government planners could outthink millions of private decisionmakers–could pick “strategic” industries, allocate capital in defiance of market signals, and prop up the stock market and real estate values. Only a few short years were needed to burst their bubble.


Ten years ago, the United States was going through a period of agonized debate about its relationship with Japan. Major American industries–automobiles, consumer electronics, semiconductors, and steel–were giving way to Japanese competition. U.S. “trophy” assets, from Rockefeller Center on one coast to Pebble Beach Golf Course on the other, were falling into Japanese hands. The large U.S. trade deficit with Japan would not succumb even in the face of a dramatic appreciation of the yen. Many believed that a rising Japan and a declining United States were “trading places.”

Leading the chorus of doom was a group of commentators that Bob Neff of Business Week dubbed the “revisionists.“1 Four figures in particular stand out: political scientist Chalmers Johnson, whose 1982 book MITI and the Japanese Miracle laid much of the intellectual groundwork for later writers; former Reagan administration trade negotiator Clyde Prestowitz, who authored Trading Places: How We Are Giving Our Future to Japan and How to Reclaim It and later founded the Economic Strategy Institute to advance the revisionist viewpoint; former U.S. News & World Report editor James Fallows, whose 1989 article “Containing Japan” in the Atlantic Monthly cast U.S.-Japan relations in Cold War terms; and Dutch journalist Karel van Wolferen, author of The Enigma of Japanese Power. These men influenced many others–including novelist Michael Crichton, whose 1992 jingoistic thriller Rising Sun became a number‐​one bestseller.

The revisionists asserted that, in contrast to the open‐​market capitalism of the “Anglo‐​American” model, Japan practiced a unique form of state‐​directed insider capitalism. Under that model, close relationships among business executives, bankers, and government officials strongly influence economic outcomes. By strategically allocating capital through a tightly controlled banking system, they argued, Japan would drive foreign competitors out of sector after sector, leading eventually to world economic domination.

Revisionists also maintained that because Japan was not playing by the normal rules of Western capitalism, it was useless to employ rules‐​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 trade imbalance. Beyond that, they proposed elements of a Japanese‐​style industrial policy as a means of improving U.S. economic performance.

Today, the verdict is in: the revisionists were dead wrong, both in their assessment of the Japanese “threat” and in their recommendations for U.S. policy. Japan has not attained worldwide dominance; on the contrary, it has suffered a “lost decade” of economic stagnation. The “Japan, Inc.” model has not eclipsed Western‐​style capitalism; instead, there is an emerging consensus on both sides of the Pacific that the Japanese model has failed. Countries up and down the Pacific Rim are embracing market‐​oriented reforms in the wake of an economic crisis blamed widely on Japanese‐​style “crony capitalism.” Meanwhile, the United States, far from declining, is enjoying record‐​setting prosperity, despite the fact that at most it only dabbled in the managed trade and industrial policy nostrums that the revisionists were pushing.

Japan’s Troubled Economy

In his book, Trading Places, Clyde Prestowitz wrote:

The power behind the Japanese juggernaut is much greater than most Americans suspect, and the juggernaut cannot stop of its own volition, 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 Japanese stock and real estate values during the late 1980s. That phenomenon is now known as the “bubble economy,” and its collapse has left Japan economically crippled. The magnitude of the fall is startling: Tokyo’s stock market is off 60 percent from its 1989 high, and real estate prices have fallen by as much as 80 percent.3 That crash in asset values left Japanese banks with staggering levels of bad debt. Late last year the Ministry of Finance estimated that problem loans totaled 76.7 trillion yen ($568 billion at 135 yen to the dollar), or 15 percent of gross domestic product.4 In addition, a senior ministry official has warned that the true level of nonperforming loans could be 30 percent higher, measured against a more stringent standard the Federation of Bankers’ Associations of Japan plans to adopt.5

The effect of the bad debt crisis has been to paralyze Japan’s financial sector, and with it the larger economy. The Japanese government spent some 75 trillion yen ($556 billion) on “pump‐​priming” public works projects between 1992 and 1995,6 and interest rates have dropped to historic lows–the current short‐​term interest rate is only 0.62 percent–but still economic activity remains anemic.7 From 1992 to 1997 economic growth in Japan averaged only around 1 percent a year, compared with 2.9 percent in the United States and just below 3 percent for the world.8 The economy actually shrank 0.7 percent in 1997, and with two consecutive quarters of negative growth, Japan is now officially in a recession for the first time since 1975.9

Other statistics paint an equally bleak picture. Corporate bankruptcies were up 37.5 percent in May 1998 over the same month the previous year, and personal bankruptcies may exceed 100,000 this year, compared with 70,000 last year. The yen slid to an eight‐​year low against the dollar in June 1998, prompting official government intervention in the currency markets.10

Unemployment–historically low in Japan–has reached its highest point in decades. It hit 4.1 percent in June 1998, according to the Japanese government.11 “I expect it to continue to get worse,” said Robert Alan Feldman, an economist with the brokerage firm Morgan Stanley.12

Unofficial estimates put the Japanese jobless rate much higher. Japan’s official figures exclude many people who want jobs, but are not registered as job seekers (women, for example, are often excluded from unemployment statistics). A survey done by the government’s Management and Coordination Agency suggested that Japan’s unemployment rate was 8.9 percent in February 1994, measured under a broader definition. Because Japan’s official unemployment has risen considerably since then, the broad rate may now be over 10 percent.13

Japan is also facing serious fiscal problems. Its budget deficit this year is approaching a massive 7 percent of GDP, while the public debt has climbed to over 100 percent of GDP.14 In the long run the fiscal problem is even worse because of demographic trends. Morgan Stanley estimates that the dependency ratio–the number of pensioners supported by workers–will reach 56 percent by 2010, the highest ratio among the Group of Seven industrial democracies.15 Without serious restructuring, Japan’s public pension system will collapse under that unsustainable burden.

The torrent of bad news has led prominent voices in Japan to sound the alarm. Norio Ohga, chairman and chief executive of Sony, warned in April 1998 that the Japanese economy is on the verge of collapse and compared then Prime Minister Hashimoto to Herbert Hoover.16

Akio Mikuni, who set up Japan’s first independent credit‐​rating agency in the 1980s in the face of Finance Ministry opposition (he was told credit ratings were “un‐​Japanese”), agrees that the next few years will be difficult ones. “When the pressure from the magma of contradictions in Japan’s economic and financial systems explodes into view,” Mikuni predicts, “10 percent of Japan’s public companies–some 300 companies, including ten to 15 banks–will either fail or be taken over.“17

Popular discontent over government handling of the economy is also increasingly apparent. Voters rejected the ruling Liberal Democratic Party in July elections for the upper house of the Japanese Parliament. The LDP won just 44 seats out of the 126 contested, prompting Hashimoto to announce his resignation almost immediately.

The Boys Who Cried Wolf

Japan’s current economic problems contrast sharply with the vision of Japan articulated by the revisionists during the 1980s and early 1990s. That vision was popularized for a mass audience in Michael Crichton’s 1992 hit novel, Rising Sun. In an earnest afterword to the techno‐​thriller, Crichton wrote:

Sooner or later, the United States must come to grips with the fact that Japan has become the leading industrial nation in the world. The Japanese have the longest lifespan. They have the highest employment, the highest literacy, the smallest gap between rich and poor. Their manufacturing products have the highest quality.…

But they haven’t succeeded by doing things our way. Japan is not a Western industrial state; it is organized quite differently. And the Japanese have invented a new kind of trade–adversarial trade, trade like war, trade intended to wipe out the competition–which America has failed to understand for several decades. The United States keeps insisting the Japanese do things our way. But increasingly, their response is to ask, why should we change? We’re doing better than you are. And indeed they are.18

Perhaps Crichton can be forgiven his dramatic license, but the fact is that he accurately summarized the revisionists’ viewpoint. In numerous books, articles, and commentaries, they praised the virtues of Asian‐​style capitalism and dismissed the U.S. adherence to relatively free‐​market policies as hopelessly naive. As James Fallows put it in 1989: “Japan and its acolytes, such as Taiwan and Korea, have demonstrated that in head‐​on industrial competition between free‐​trading societies and capitalist developmental states, the free traders will eventually lose.“19

The United States’ failure to mimic the Japanese model was rendering us, in Prestowitz’s words, “a colony‐​in‐​the‐​making.“20 Prestowitz also said:

In 1981, the United States, although less dominant than previously, was still the world leader in industry, technology, and finance as well as in military power. In 1987, it was the leader only in military power, and even there was facing the necessity of reducing commitments. In other areas, the United States, which had played the role first of occupier and then of protector and mentor, had traded places with its former protégé–Japan.21

Chalmers Johnson was more succinct. “The Cold War is over,” he wrote, “and Japan won.“22

As in the case of Mark Twain’s death, reports of the United States’ demise were greatly exaggerated. Indeed, the United States is now closing in on the longest peacetime expansion in its history, with inflation under control and unemployment at its lowest levels in decades. As to Japan, Prestowitz himself recently admitted: “If the criticism is that I did not accurately forecast the future of the Japanese economy, mea culpa, and I have a lot of company.“23

Japan’s Financial System: Patience as Virtue or Vice?

Revisionists thought that the heart of the Japanese system’s superiority was its long‐​term focus. The Japanese financial system allocated capital, not to achieve a high short‐​term return on investment, but to gain market share in strategic industries and thus, supposedly, to maximize long‐​term returns.

Japan achieved that different orientation by giving corporate managers access to “patient capital.” First, banks rather than equity markets played the central role in supplying funds. That situation 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 of GDP, while bank loans amount to only 50 percent.24 The dominance of banks allowed capital to be allocated according to government policy or long‐​standing corporate relationships rather than strictly market‐​based criteria.

Another key feature of the Japanese system was cross‐​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 estimated that 70 percent of the stock listed on the Tokyo Stock Exchange was owned by Japanese corporations and rarely traded.25

Access to “patient capital” took pressure off managers to achieve short‐​term profitability and freed them to concentrate on market share. And from the revisionists’ perspective, market share is to economic warfare what captured territory is to conventional warfare: whoever controls it wins the war. Accordingly, the revisionists believed that the elevation of market share over profits gave Japanese companies a tremendous competitive advantage.

In Zaibatsu America: How Japanese Firms Are Colonizing Vital U.S. Industries, then Economic Strategy Institute fellow Robert L. Kearns expressed that belief:

Toshiba and other major Japanese corporations can go flat out for market share and ignore short‐​term financial considerations because they face little or no risk. There will be no takeovers, no greenmail, no LBOs, and no white knights, because two‐​thirds of the shares of a Toshiba, or a Sony, or a Toyota are in the hands of other corporations and institutions that are in turn owned on a reciprocal basis. The corporations own each other and are operated not to maximize returns to shareholders, but to minimize risk and thus to maximize long‐​term earnings. Indeed, there are guarantees against risk.26

Or as Chalmers Johnson put it:

Japan is dynamic because its managers devote themselves to competing with other companies at home and abroad, without having to serve the parasitic interests of shareholders or the passive interests of workers who have no stake in the viability of the company.27

The U.S. system, with its emphasis on equity markets over bank lending and the ever‐​present threat of takeover because of a highly developed market for corporate control, was supposedly hobbled by a chronic short‐​term focus. In the revisionist view, American companies were therefore congenitally incapable of going toe‐​to‐​toe with Japanese competition. As Prestowitz stated:

The single greatest weakness of U.S. industry in competing with Japan is lack not of management effort but rather of financial staying power. Our capital is both too expensive and too impatient.28

Revisionists were so impressed by the Japanese system that they viewed the bubble economy’s escalation of stock and real estate values not as speculative excess but as a deliberately engineered turbo‐​charging of Japan’s export machine. In 1989, just a year before the bubble burst, Karel van Wolferen pooh‐​poohed fears of an impending collapse:

In a Western setting the speculative activities in which Japanese firms have been engaged would have brought the doom‐​sayers out in crowds. A few did appear in Japan, predicting “a bursting of the bubble” or “the bottom falling out” at some point in the near future. But short‐ and medium‐​term pessimists overlook a critical factor: that the absence of a clear division between the public and private sectors in Japan, the co‐​operation (or collusion as it would normally be termed in this context) among the administrators and the ease with which economic processes can be politically controlled all add up to a situation radically different from that in the other capitalist countries, whence such theories of bursting soap bubbles originally came.29

In the revisionist view, soaring asset values gave Japanese companies the ability to tap into apparently limitless amounts of no‐​questions‐​asked capital. The bubble was the “automatic wealth machine” that Prestowitz referred to, and it made the Japanese predatory threat seemingly unstoppable.

In response to that threat, the revisionists urged the overhaul of U.S. financial markets along Japanese lines. Prestowitz advocated encouraging patient capital through “rules on corporate takeovers that are much more restrictive, as well as through high taxation of short‐​term capital gains.“30 James Fallows suggested changing the security and exchange laws “so that corporations would have to file detailed profit‐​and‐​loss reports once a year, not every three months.” Such a change, he said, would “diminish the notorious American obsession with quarterly profit rates and would send a signal about the direction in which we’d like our business to head.“31

Short‐​Term Focus or Market Discipline?

Illuminated by the persistent woes of the Japanese financial sector throughout this decade, not to mention the more recent crises gripping other East Asian economies, the shortcomings of the “patient capital” model have become obvious to most observers. As Robert Denham, former chairman of Salomon Inc., explained: “The risk is that long‐​term orientation becomes an excuse for not focusing on profits at all. You can always excuse bad results by saying, ‘Oh, we’re building for the future. ’ ”32

The risk that Denham spoke of has come to pass in Japan. Even with the precipitous drop in Japanese stock market values, dividend yield has remained below 1 percent. 33 More broadly, rate of return on capital in the business sector has fallen below that in the European Union and is now less than half the U.S. rate.34 Japan is the most inefficient deployer of capital in the developed world.

This is a far cry from what revisionists were forecasting only a few years ago. In 1992 Robert Kearns confidently predicted that “Tokyo, with seven of the world’s ten largest banks, the world’s largest stock market and the world’s richest security firms, is on the way to becoming the financial center of the world.“35 But a recent Financial Times article described a very different reality: “While London and New York have surged, the volume of trading in Tokyo is now only about half of what it was in 1989 and the value is less than that.“36 And between 1992 and 1995, Tokyo was the only big financial center whose share of global foreign‐​exchange trading actually shrank.37

Second‐​guessing of the old financial model can now be heard throughout the Japanese business community. Junichi Ujie, the new CEO of Nomura Securities, recently called into question the cross‐​shareholding that lies at the core of the old system: “We have a bunch of bank shares. Is this really a strategic portfolio for an investment bank? I kind of doubt it.“38 And Yoichi Morishita, president of Matsushita Electric Co., the world’s largest consumer electronics company, conceded that “shareholder‐​oriented management has become very important internationally.“39

Picking Winners–And Losers

In predicting Japan’s relentless rise, the revisionists looked not only at the “patient capital” system but also at the state promotion of specific “strategic” industries with the aim of enhancing international competitiveness. They heaped praise upon Japan’s Ministry of International Trade and Industry, or MITI, and its industrial policy of direct subsidies, trade protection, and “administrative guidance.”

In Trading Places, Prestowitz described MITI’s philosophy as follows:

A key objective in any economy … is to create an industry that produces technologically sophisticated products with high income elasticity (that is, the higher a person’s income, the more one buys of those products) and a rapid growth rate (for example, VCRs). That objective … cannot be achieved without government intervention.40

The revisionists argued forcefully that the United States should adopt aspects of Japanese industrial policy. They urged an active role for Washington in promoting key industries and firms whose health they considered vital to the welfare of the economy as a whole. In particular, Johnson suggested that the United States think seriously about adopting its own “pilot agency,” similar to MITI, to guide industrial development.41 For his part, Prestowitz founded the Economic Strategy Institute to advocate Japanese‐​style policies. “The Economic Strategy Institute believes that America’s future as a great power and a land of opportunity depend [sic] not only on how much we produce, but equally on what we produce,” states ESI’s Web site.42

Fortunately, the United States largely failed to take the revisionists’ advice. Apart from a few relatively small projects–including the Pentagon‐​funded Sematech consortium and the Commerce Department’s Advanced Technology Program–the United States has done little to target and promote “strategic” industries.43 The Clinton administration came into office with promises of a more ambitious agenda, but Congress mostly refused to go along.44

Nevertheless, U.S. economic performance during the 1990s has been exceptional. And in the area of particular concern to the revisionists, U.S. companies remain strong in such “strategic” high‐​tech sectors as microprocessors, disk drives, personal computers, and software. In particular, U.S. companies dominate the Internet–a “strategic” sector that neither the revisionists nor other industrial policy enthusiasts even foresaw.

Meanwhile, the supposedly unstoppable Japanese progression up the “food chain” of technological leadership has stalled. Japanese companies have failed to parlay their strengths in commodity memory chips, semiconductor manufacturing equipment, and flat panel displays into domination of the larger computer industry–despite such industrial policy programs as the Fifth Generation Computer Project.45 Similarly, the much‐​ballyhooed Japanese initiative on high‐​definition television (HDTV) foundered on its mistaken commitment to analog technology.46

Notably, Prestowitz cited HDTV as an “example of the widening U.S. lag” in high technology. “There are not even any Americans involved in this struggle,” he lamented in 1988.47 Again, Prestowitz was dead wrong. American firms leapfrogged their Japanese rivals and produced a more technically advanced version of HDTV using digital technology. In December 1996, the FCC approved an HDTV standard developed by a so‐​called Grand Alliance of U.S. and European producers; Japan wasn’t even in the running.48

The Managed Trade Solution

Confronting what they thought to be a new and superior form of capitalism, the revisionists believed that the old rules of international trade did not apply. While free trade might be mutually beneficial among Western‐​style economies, it was supposedly a ticket to oblivion where Japan was concerned. “The United States must either begin to compete with Japan,” warned Johnson, “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 no sense to adhere to the established rules of free trade, since they only facilitated Japan’s relentless drive for worldwide market share. Likewise, there was no point in trying to force Japan to live by those rules, since they were fundamentally inconsistent with the Japanese system. The only solution was to decide on results–i.e., degrees of mutual market penetration–that both sides could live with.

In a chapter that opens with the gloomy hypothetical, “If we become a kind of fourth‐​world country with all our assets owned abroad … ‚” Prestowitz laid out the revisionist blueprint for U.S. trade policy:

For the United States, the first step is to discard the belief that the Japanese market is like that of the United States, and that it can be opened and made to operate similarly if only the Japanese will stop being unfair. The mentality of the Japanese and the structure of their society and economy exist. Neither fair nor unfair, they need to be handled as they are, with a clear understanding of their likely effects. It is counterproductive to continue to act the missionary toward Japan in the matter of trade and economics. We must get away from the stereotyped free‐​trade versus protectionist debate.50

In particular, Prestowitz singled out the web of government restrictions on international air transport as a model of successfully managed trade.51

James Fallows concurred, noting that “America’s interest in process, and Japan’s in result, have an important bearing on trade problems. They explain why the U.S. negotiating strategy has generally failed.” America, he wrote, “should focus on results, not rules.“52

In a similar vein, Johnson argued that “a policy of pressuring Japan to alter its economic system to make it look like the American system is doomed to fail.“53 A new approach is necessary, he maintained: “GATT rules are irrelevant and policies tailor‐​made for Japan will be required.“54 He made clear what kind of policies he had in mind: “Most examples of trade that is mutually beneficial belong to the category of managed trade.“55

The revisionists’ advocacy of managed trade rested on two assumptions. First, they believed that “patient capital” and industrial policy gave Japanese companies an unfair advantage in foreign markets. The experience of the past few years, though, has discredited that belief. Meanwhile, the revisionists thought that the Japanese market was structurally closed to foreign companies. Although that point of view remains widely held, it is likewise at odds with the facts. It is true that Japan, like other countries, has its share of overt protectionist barriers; it is also true that the Japanese system of political economy is distinctly different from the U.S. model. Nevertheless, in the absence of overt restrictions, foreign companies can and do achieve competitive success in Japan. In this regard, a study by James Abegglen and Peter Kirby of Gemini Consulting has documented that the 100 largest foreign‐​owned companies in Japan controlled $155 billion in sales in 1994.56 That figure does not even count the sales of companies like Boeing and Weyerhauser that export directly and not through Japanese subsidiaries. The existence of such success stories is simply not compatible with the stereotype of a closed Japan that the revisionists advanced.

Fortunately, as with industrial policy, the United States only flirted with the revisionists’ trade policy recommendations. It did impose quantitative restrictions on major Japanese imports–the so‐​called voluntary restraint agreements on automobiles, steel, and machine tools. And in the case of semiconductors, it negotiated a “voluntary export expansion” agreement in which Japan agreed to an explicit 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 Framework Agreement, but the Japanese government steadfastly refused to agree to further market share targets. In a final showdown over automobiles in June 1995, the United States ultimately decided to back down rather than impose sanctions against Japan. Since that time, U.S. demands for market share commitments have more or less ceased.

Despite a few dalliances, the United States stuck with its basic commitment to rules‐​based trade. It allowed the voluntary restraint agreements to expire. It led the Uruguay Round of trade talks that gave birth to the new World Trade Organization. Indeed, the prospect of losing its case at the WTO was a major factor behind the U.S. decision not to impose sanctions in the autos dispute. Meanwhile, the United States has prospered from its refusal to follow the revisionists’ advice.

“Third Way” to Nowhere

The revisionists’ predictions went so badly astray because they fundamentally misinterpreted Japan’s economic system. In particular, they believed they had discovered in Japan a new and superior form of capitalism: the so‐​called capitalist developmental state.57

According to the revisionists, the capitalist developmental state represented a “third way” in which the government sets broad societal goals but uses market mechanisms to achieve them. Private ownership of property and free exchange exist, but government planning and resource manipulation are also essential. As James Fallows wrote in Looking at the Sun, his in‐​depth analysis of the Asian economic model:

The Asian‐​style system deeply mistrusts markets. It sees competition as a useful tool for keeping companies on their toes but not as a way to resolve any of the big questions of life–how a society should be run, in what direction its economy should unfold.58

Specifically, the government attempts to foster economic development through market intervention aimed at helping specific companies improve their prospects of success. Intervention includes direct subsidies, import protection, and directing the flow of private capital toward promising industries.

Chalmers Johnson described MITI as the “pilot agency” primarily responsible for translating the government’s goals into substantive industrial policy. Its job was to identify the industries to be developed, formulate a high‐​growth strategy for those industries, and supervise competition so as to guarantee economic health and effectiveness.59

Revisionists thought that the apparent success of the capitalist developmental state signaled the end of orthodox free‐​market economics. Japan, not the United States, would serve as the model for the rest of the world to follow. By contrast, America’s supposed attachment to laissez‐​faire ideology had blinded it to the fact that the rules of international competition had changed: “If the United States were a well‐​run country,” Johnson told Fallows in 1989, “neoclassical economists would be hanging from the Capitol dome.“60

Johnson continued to praise the capitalist developmental state until at least as recently as 1995. “Japan’s combination of a strong state, industrial policy, producer economics and managerial autonomy,” he said, “seems destined to lie at the center, rather than the periphery, of what economists will teach their students in the next century.“61

Like so many earlier candidates, however, the revisionists’ claimed “third way” failed to live up to expectations. The revisionists recognized correctly that the Japanese system of political economy differs in important respects from American practice. Among its distinctive features are the close and informal ties between industry and government, stable cross‐​shareholding and heavy reliance on relationship‐​based bank financing rather than impatient capital markets, keiretsu alliances with suppliers and distributors, and lifetime employment arrangements. Furthermore, it is true that particular Japanese industries have achieved some spectacular competitive successes and that until recently Japan as a whole was growing much faster than the United States. Where the revisionists erred, though, was in thinking that Japan’s distinctive political economy accounted for its superior economic performance.

What was really happening? First, Japanese companies had developed new and superior manufacturing techniques, including such innovations as continuous improvement and just‐​in‐​time inventory. These innovations were sufficiently important that they distinguished a new system of so‐​called lean production from traditional mass production.62 Armed with these superior techniques, Japanese companies did indeed pose a formidable competitive challenge in selected industries, although certainly not across the board.

Second, Japan as a whole was experiencing continuing high growth and rapid advancement because it was playing technological catch‐​up with the West. It is much easier to grow and improve productivity quickly by adopting and adapting technologies invented elsewhere than by developing those new technologies internally.63 Furthermore, Japan was playing catch‐​up in a business‐​friendly policy environment of low taxes and low government spending.64 Thus, Japan’s rapid ascent was a tribute primarily to private sector innovation and good old‐​fashioned market forces, not some MITI‐​masterminded interventionist industrial policy.

And those very same market forces, not interventionist trade policies, were ultimately responsible for making the dire predictions of an unstoppable Japanese juggernaut look foolish in retrospect. With often painful restructuring, U.S. companies adopted the new lean production manufacturing techniques and regained their competitiveness. At the same time, Japan’s economic performance naturally slowed as the country reached the technological frontier.

And what about the interventionist elements of the Japanese system so beloved by the revisionists? It turns out that “Japan, Inc.” was much better suited to playing catch‐​up than it is to fostering growth at the cutting edge. Even Clyde Prestowitz now recognizes this fact:

As a catch‐​up machine, this model was unparalleled. But once Japan caught up … problems began to arise. While the model was good at concentrating resources to hit targets already set by the pattern of Western development, it performed poorly at selecting new directions.65

In particular, the clubby, relationship‐​based system of allocating capital–until recently praised by Prestowitz and his colleagues for its long‐​term focus–now looks dreadfully wasteful and inefficient. It is impossible to determine which “new directions” are worth pursuing in the absence of a financial system that directs capital toward its highest return.

Ultimately, the blame for Japan’s current problems lies with its failure to make the transition from capitalist developmental state to a mature economy at the technological frontier. Instead of making that transition, Japan first faked prosperity by inflating the 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 fester and worsen. This rot at the core of things has crippled the whole economy. The recent “Big Bang” reforms suggest a hopeful change of course, but it is too early to tell how far that course will be followed.66

To revive its fortunes, Japan needs to move to a system in which capital is allocated, not according to established relationships or government policy, but in response to clear and undistorted market signals. In sum, Japan needs to abandon the very elements of the old “Japan, Inc.” system that the revisionists singled out as its greatest strengths.

Where Are They Now?

The facts of the 1990s have been cruel to the revisionists. How have they reacted?

Some have trudged on bravely, minimizing Japan’s current problems and continuing to trumpet the superiority of the “Japan, Inc.” model. A particular standout in this regard is journalist Eamonn Fingleton, author of the 1995 book Blindside: Why Japan Is Still on Track to Overtake the U.S. by the Year 2000. Fingleton is no crank: he was formerly an editor at Forbes and Financial Times, and his book was named one of Business Week’s top 10 business books of 1995. But now, three years later, the book contains howlers that take the breath away.

As Japan was stumbling through year after year of subpar performance, Fingleton wrote:

Most of the Japanese financial disasters the Western press reported in the early 1990s were merely symbol‐​economy losses that had few if any negative implications for the real economy.67

About the heart of the problem, Japan’s inefficient and badly debt riddled banking system, he had this to say: “In fact, there is probably no other major Japanese industry that has such an efficiency 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 new leap forward with the help of powerful Keynesian economic stimulation via increased public spending. Keynesianism has, of course, been out of fashion in the West for decades, where its side effects such as inflation, increased government borrowing, and a rise in imports are deemed intolerable. These side effects have hardly been a concern in Japan, where wage increases are tightly contained, the national budget is in surplus most years, and various natural and artificial barriers to imports ensure that the benefits of budgetary stimulation do not leak abroad.

In short, while American observers continued to dwell on the illusory gloom of the past few years, the Japanese were focusing on a bright future. Just how bright this future is we will now see.69

Three years and trillions of yen in “powerful Keynesian economic stimulation” later, Fingleton’s “bright future” has yet to emerge. But even as evidence of Japan’s problems mounted, Fingleton remained optimistic: “The Japanese economy is like a young cyclist peddling uphill,” he said in a speech in 1996. “The strain is showing on his face, but it’s a healthy strain.“70 Of course, Fingleton declared only a year before that Japan was “triumphantly on track” to overtake the United States to become the world’s largest economy by the year 2000.71 With the U.S. economy still nearly twice as large as Japan’s and growing faster, the odds don’t look good.72

Like Fingleton, James Fallows stuck to his revisionist guns well into the 1990s. Indeed, he had high praise for Fingleton’s analyis. “A generation from now,” Fallows wrote, “readers will recognize Blindside as having offered crucial and prescient guidance.“73

East Asia’s financial crisis, though, seems to have been the straw that broke the camel’s back for Fallows. Writing as the crisis deepened in November 1997, he admitted that the Asian model that once so impressed him has “tragic flaws”:

The case against the Asian model is obvious. The effort to discourage consumption denies people the full fruits of their labor; guidance by bureaucrats invites corruption and seems ham‐​fisted in a world of instant capital flows and breakneck development in info‐​tech.74

Of course, none of these flaws were “obvious” to Fallows only a couple of years earlier. And still, Fallows tries his best to accentuate the positive:

But the soundness of parts of the model remain underappreciated in the English‐​speaking world.… In major manufacturing categories, Japanese, Korean, and Chinese manufacturers have held or expanded world market share even as banks collapse around them. … During seven years of unremitting distress for its financial system, Japan’s manufacturers have accumulated trade surpluses of more than $700 billion.75

As economist Paul Krugman commented recently on Fallows’s observation: “Shouldn’t this make him wonder whether trade surpluses are such a good thing?“76

As recently as 1995, Chalmers Johnson was still using his line about Japan’s winning the Cold War. Now, however, he is trying to cover his tracks. At a speech delivered before the Economic Strategy Institute this March, for example, he said: “The disaster of 1997 did not refute revisionism but rather confirmed the essence of the revisionists’ message–there are differences among capitalist systems that are not trivial and that under the right circumstances 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 the revisionists stood for:

During the early eighties, when Japan’s trade surpluses with the United States set new records every month and came close to destroying much of the manufacturing base of the U.S. economy, a group of foreign analysts (myself included) attempted to call attention to the differences between East Asian and American capitalism.… And we advocated using the full market power of the United States–which was, and still is, the main market for all the East Asian economies–to force them to make international trade mutually beneficial by opening their markets.78

He expanded upon this account in a posting on the “Dead Fukuzawa Society” email listserv:

Our policy answer … was to use the full power of the American market to force open the Japanese market. We called for a trade war. The intent was to force Japan into a domestic‐​demand‐​led economic strategy by selectively weaning it from the American market.…What was wrong with the so‐​called revisionists’ strategy is that the Cold War was still on and there were many fools in the U.S. who still thought Japan might either go communist or socialist or neutralist and that we should care. The reforms that are now promised in Japan were needed c. 1985.79

If forcing Japan into a domestic‐​demand‐​led economic strategy was always Johnson’s intent, it was easy to miss it. Recall that he wrote: “A policy of pressuring Japan to alter its economic system to make it look like the American system is doomed to fail.“80 And the notion that his or his colleagues’ goal was to pressure Japan to become more like us hardly squares with this vintage Johnson endorsement of other countries’ becoming more like Japan:

In order to meet the competition of Japan, other countries must copy or match Japan’s keiretsu-type company structures, its mercantilist industrial and trade policies, its ability to make capital available on a preferred basis to strategic industries, and its managerial incentives that impose long‐​term perspectives on company operations. Neoclassical economic theory is not only irrelevant to this challenge, it is downright misleading.81

Of all the revisionists, Clyde Prestowitz has reacted most dramatically to Japan’s current problems. Without explicitly renouncing his former views, he has nonetheless turned them on their head.

Prestowitz now regards the Japanese economy as in need of fundamental reform:

[I]n the present state of the Japanese economy, all the standard stimulus packages, be they public works spending, tax cuts or some combination thereof, are a bit like giving a blood transfusion to a man who needs a heart transplant. They may be necessary to keep the patient alive, but they won’t restore him to health.82

Indeed, according to Prestowitz, the whole Asian model–once the supposed wave of the future–must be scrapped, and the sooner the better: “With much of Asia now on life support, it is time to recognize that the Asian brand of capitalism is dangerous to the world economy’s health and that it must be abandoned, particularly by Japan.“83

Prestowitz once wrote that “it is counterproductive to continue to act the missionary toward Japan in the matter of trade and economics.“84 Now, however, he calls for a forced conversion of Japan at a special World Trade Organization inquisition:

To ensure that Japan takes these or other recommendations seriously, it might be necessary for world leaders to convene an extraordinary session of the World Trade Organization. It was John Maynard Keynes who proposed in the 1940s that a world trade body should have emergency measures for handling threats to the world trading system arising from chronic surpluses as well as from excessive deficits. Perhaps it is time for the WTO to come to grips with this long‐​recognized problem in a way that would encourage Japan seriously to consider a thorough opening of its market to both domestic and foreign enterprises.85

While Prestowitz’s disillusionment with the Japanese model is better late than never, his proposal of a WTO remedy for Japan’s troubles is wrongheaded. Japan’s economic woes are not a trade problem and should not be treated as such.86 Trade disputes should deal exclusively with government policies that discriminate against goods or services of foreign origin. The dysfunctional Japanese policies at issue do not fit that description. Punitive tax rates on corporate and personal income do not discriminate against foreigners; neither does the failure to clean up banks’ bad debts; neither does the hopeless attempt to fake economic vitality with wasteful public works spending.

The argument made by Prestowitz and others is that if Japan reforms its economy and returns to a healthy growth path, it could import more and take up the slack for the ailing economies of the Pacific Rim. Perhaps, but how does that distinguish Japan from other countries around the world? Surely Europe could grow faster and absorb more imports if it weren’t hobbled by chronic double‐​digit unemployment. If every economic underachiever were hauled to the dock, there would be no end of WTO tribunals.


The revisionists claimed to have discovered a new and superior form of capitalism: the Japanese capitalist developmental state. Today, however, the Japanese model is better known as “crony capitalism,” and its manifest failures are causing economic pain and political turmoil up and down the Pacific Rim. The revisionists argued that the United States was doomed as a leading economic power unless it adopted Japanese‐​style practices. It didn’t and is now enjoying spectacular and unrivaled prosperity.

In short, the revisionists’ doom‐​and‐​gloom prophecies could not have been more wrong. All their errors trace back to a common source: an inability to understand and appreciate the power of free markets. Suffering from what Nobel Prize‐​winning economist F. A. Hayek termed the “fatal conceit,“87 they believed that a handful of government planners could outthink millions of private decisionmakers–could pick “strategic” industries, allocate capital in defiance of market signals, and prop up the stock market and real estate values. Like so many others before them, they prided themselves as sophisticated realists, yet in fact their faith in bureaucratic miracles was hopelessly naive. Only a few short years were 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 Our Future to Japan and How to Reclaim It (New York: Basic Books, 1993), p. 72. This book was orginally published in 1988 and reissued 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 of 15,827.02. Real estate price decline figure is taken from “The Japan Puzzle,” The Economist, March 21, 1998, p. 22.

4. Reported in Peter Landers, “Japan: Time of Troubles,” Far Eastern Economic Review, February 26, 1998, p. 54.

5. “Japan MOF Official/​Bad Loans,” Dow Jones News Service, May 11, 1998.

6. Figure taken from “The Japan Puzzle,” p. 22.

7. Three‐​month money market rate taken from “Financial Indicators,” The Economist, July 4, 1998, p. 101.

8. U.S. data from Bureau of Economic Analysis, Revisions to Percent Change in GDP, Real GDP, and Price Indexes, http://​www​.bea​.doc​.gov/​b​e​a/an/ 0897niw/table4.htm. Other data available 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 As March,” Dow Jones Newswires, June 16, 1998, http://interactive.wsj .com/archive/retrieve.cgi?id=DI-CO-19980616–001758.djml.

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/​i​n​v​w​e​e​k​/​M​A​RKETS /october/20markgi.htm, or “Japan Cabinet Approves This FY Y4.646 Tln Extra Budget,” Dow Jones Newswire, May 11, 1998.

15. Paul Abrahams, “Ageing Cohort Needs Faster Growth, Higher Returns,” 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,” Atlantic Monthly, 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: Fans of Industrial Policy Suffer Unrequited Love,” Investor’s Business Daily, April 29, 1998.

24. Alan Murray, “Asia’s Financial Foibles Make American Way Look 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: Kodansha International, 1991), p. 24.

26. Robert L. Kearns, Zaibatsu America: How Japanese Firms Are 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: People and Politics in a Stateless Nation (London: Macmillan, 1989), p. 400.

30. Prestowitz, Trading Places, p. 519.

31. James Fallows, “Getting Along with Japan,” Atlantic Monthly, December 1989, pp. 54–55.

32. Quoted in Murray.

33. Abrahams.

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. Text available from authors by request.

35. Kearns, p. 6.

36. Gillian Tett, “A Bang or a Whimper?” Financial Times, April 1, 1998.

37. “Bang, Pop or Sputter?” The Economist: A Survey of Financial Centers (insert), May 9, 1998, p. 29.

38. Rohwer, p. 84.

39. James Grant, “Why Japan Is Undervalued,” Wall Street Journal, 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​.econ​strat​.org/ Inside.htm, on May 26, 1998.

43. For more on the failure of U.S. industrial policy, see Brink Lindsey, “DRAM SCAM: How the United States Built an Industrial Policy on Sand,” Reason, February 1992; or T. J. Rodgers, “Silicon Valley versus Corporate Welfare,” Cato Institute Briefing Paper no. 37, April 27, 1998.

44. The core of U.S. high‐​tech industrial policy is the Advanced Technology Program (ATP), which had a 1997 appropriation of $225 million. ATP was zeroed out by Congress in the 1996 budget cycle, although President Clinton vetoed that bill and secured a compromise that allowed ATP to survive with a 49 percent budget cut. In 1997, ATP’s budget was expanded by only 2 percent.

45. Jeffrey Batholet, “Dimming the Sun: the Alliance of Japanese Bureaucrats and Businessmen Doesn’t Work So Well Anymore,” Newsweek, March 17, 1998, p. 38.

46. David P. Hamilton, “Japan Appears Set to Abandon Its Analog HDTV,” 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​.cur​rent​.org/​a​t​v​1​.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.

51. Ibid.

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 Institute Policy Analysis no. 252, April 15, 1996, p. 34.

57. Johnson, Japan, p. 67.

58. James Fallows, Looking at the Sun: The Rise of the New East Asian Economic and Political System (New York: Pantheon Books, 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 the automobile industry is provided in James P. Womack, Daniel T. Jones, and Daniel Roos, The Machine That Changed the World, (New York: Macmillan, 1990).

63. Federal Reserve Board chairman Alan Greenspan made this point recently in congressional testimony on the Asian financial crisis. See Alan Greenspan, Testimony before the Committee on Foreign Relations, U.S. Senate, February 12, 1998, http://​www​.bog​.frb​.fed​.us/​b​o​a​r​d​d​o​c​s​/​t​e​s​t​i​m​o​n​y​/​1​9​9​8​0​2​1​2.htm.

64. Economist Alan Reynolds makes this point in “Toward Meaningful Tax Reform in Japan,” 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,–6-98.html.

65. Clyde Prestowitz, “Retooling Japan Is the Only Way to Rescue Asia Now,” Washington Post, December 14, 1997.

66. Tett.

67. Eamonn Fingleton, Blindside: Why Japan Is Still on Track to 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 statistics available at http://​www​.oecd​.org/std/ gdp.htm.

73. Quoted at http://​www​.ama​zon​.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.

75. Ibid.

76. Paul Krugman, “I Told You So,” New York Times Magazine, May 5, 1998.

77. Chalmers Johnson, “Asia’s Financial Meltdown: What Caused It and What Does It Mean?” Remarks delivered before the Economic Strategy Institute, March 24, 1998, http://​www​.econ​strat​.org/​E​C​O​N​S​T​R​A​T​/​j​o​h​n​s​o​n.htm.

78. Chalmers Johnson, “Cold War Economics Melt Asia,” Nation, February 23, 1998, p. 16.

79. Chalmers Johnson, posted on the Dead Fukuzawa Society listserv, aprox. December 1997. Text available from authors by request.

80. Johnson, Japan, p. 13.

81. Ibid., p. 83.

82. Clyde Prestowitz, “Going Down with Japan,” Far Eastern Economic Review, April 16, 1998, p. 15.

83. Prestowitz, “Retooling Japan Is the Only Way to Rescue Asia Now.”

84. Prestowitz, Trading Places, p. 514.

85. Clyde Prestowitz, “A Plan for Japan,” Washington Post, April 7, 1998.

86. Brink Lindsey, “Japan’s Weakness Is No Threat,” Journal of Commerce, May 29, 1998.

87. F. A. Hayek, The Fatal Conceit (Chicago: University of Chicago Press, 1989).

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