The Japanese Model

One of the most interesting economic phenomena of the past sixty years has been the emergence of Asian economic superpowers.  The most successful of them have all studied the development of post-WWII Japan and imitated large parts of it.  This is my take on how the Japanese model works:

Japan found itself at the end of WWII with a lot of its industrial infrastructure destroyed and many of its young adult population killed in the war.  Not endowed with lots of industrial raw materials, its major remaining  tradable economic asset was its labor power.  It had other pluses.  It had strong political cohesiveness,  through the belief in the pivotalposition of Japan in the world order and in the role of the Japanese emperor as the sole global mediator between the human and the divine.  The pre-war industrial conglomerates (zaibatsu), although legally banned, survived in all but name in the now famous post-war keiretsu, so the country had experienced administrators.  In addition, Japan had American help during reconstruction.

The essentials

What are the essential elements of the Japanese model?

1.  first and foremost, a social and political commitment to making the sacrifices needed for rebuilding;

2.  an economic plan that featured:

a.  establishing a competitive advantage through low-cost labor;

b.  pegging the local currency to that of the major customer, in this case the US, in order to secure and maintain this labor-cost advantage;

c. focusing national resources on building industry, not on the consumer;

d.  serving export markets, not local ones, to generate hard currency;

e. discouraging consumption and routing national savings through the banks into low-cost industrial loans;

e.  commitment, at least for the first few decades, to the most advanced technology possible.

3.  the ability to transition from more labor-intensive to less labor- more capital-intensive activity as the need arose.

Two specifically Japanese characteristics

There are two related quirks to the Japan story.  In the Japanese case, the issue is reindustrialization, not industrialization for the first time.  So, although the country might have had to buy technological processes, it didn’t need to invite foreign corporations into Japan, so that locals could learn the basic principles of industrial organization.  An important part of the story of developing Asian nations, in contrast, is the role played by government policy in making the country an attractive destination for foreign direct investment, so that locals could learn management skills while working for others.

Also, to this day, Japan is not particularly interested in having non-Japanese people living inside the country.  For both reasons, I don’t think Japan has the history of inviting foreign corporations to set up shop in Japan on favorable terms, in order to receive technology transfer, in the way developing Asian countries have.

Social buy-in : the most important ingredient

At any rate, why would anyone agree to live the kind of existence this development plan implies?  Work long hours for little money, pay high prices for consumer goods, experience industrial pollution and live in a small apartment with poor sewage, electricity and other utility services?

Although the answer may be framed differently from country to country, the basic idea, I think is–yes, there’s nothing much in this for you.  You’ll have a pretty spartan life, but it will be better than if the country did nothing.  And your children and grandchildren will stand on this generation’s shoulders and have a chance to live full and comfortable lives as citizens of an advanced industrial country.

In my experience, buy-in to this idea is what separates the successful modernizers from the rest.  Without this belief, people will just give up when the going gets tough and demand that the government revert to unsound policies that offer temporary relief.

Typical industries for a country that intends to offer cheap labor power must be ones that lend themselves to labor-intensive operation, such as textiles, garments, molded plastic products and the like.  As these businesses become successful, they foster the development of local support firms, like basic chemicals refineries and import/export agents  (sometimes known as “trading” companies).

There are limits to very labor-intensive success

Success breeds the first real problems for the industrializing country.  To make matters simple, let’s assume the export-oriented workers make nothing but men’s shirts.  These workers earn, say, $.40/ hour (for a 60-hour work week) vs. maybe $25/hour for their industrialized country counterparts.  So, if the quality is good, the industrializing country will have demand for as many shirts as it can make.

Suppose  the country expands capacity until there are no more unemployed workers–and customers are still clamoring for more shirts.  The first instinct of company managers will be to try to lure workers away from other walks of life–the government, restaurants….  The only way to do this is to raise wages, which is the first step on the road to killing the goose that lays the golden eggs.

Other complications are also arising from initial success.  While the industrializing country shirt industry is small, it makes virtually no difference to competitors in the importing country how successful it is.  But as the flow of imported shirts expands, it begins to make dents in the profits of the higher-cost customer-country shirt industry.  This threatens jobs.  So calls from that country’s management and labor lobbying groups come to ban, or limit, or tax exports in order to save local jobs.

In addition, as more and more shirt orders come in, demand by foreigners for the local currency will continually go up.  There will be a tendency for the local currency to rise.  A more expensive currency also upsets the development applecart, since it tends to erode the developing country’s labor cost advantage.  The government can step in to hold down the currency, many times in ways that will tend to cause local inflation.  Also, the importing country will complain that this is unfair competition.

What to do?

The conclusion from all this?  The developing country can’t let the situation get to the point I’m describing.  It must not only have,but also enforce, a migration path for the economy toward higher value-added products.  This implies establishing not only a higher degree of capital intensity but also a better educated workforce.

This can be a real sticking point, since vested interests in the textile industry won’t want to see themselves supplanted by, say, shipbuilding, or automobile manufacture.  They also won’t want to see changes in wages or currency that force the labor-intensive business to find a less-developed, lower-cost, home. Although Japan made several transitions of this type seemingly without a hitch, Singapore and, more especially, Malaysia both had significant difficulty with such moves.

Don’t follow the model? = No Development

In Asia, the countries that haven’t adopted this development template have, by and large, not developed–or not developed in a way that global investors would want long-term equity exposure to.  There are two significant exceptions:  Hong Kong, which adopted its peg for political, not economic, reasons; and China, which is an exception because it is so large.

More about these and how to invest using the model in subsequent posts.