JPRI Working Paper No. 80, September 2001
Whatever Happened to the Japanese Miracle?
by Marie Anchordoguy

Japan is the world's second largest economy, yet we still have little understanding of the nature of its capitalist system. Just as students of Japan had identified some of the key mechanisms that drove the economy toward rapid growth and industrial competitiveness over the past century, the system stopped performing. Did scholars and other analysts fail to identify correctly the key factors in Japan's success, or has the environment changed?

Some studies argue that Japan's development was driven largely by a strong and effective developmental state. If this is true, why has the state not been effective since the 1990s? Others argue that the state has essentially carried out the orders of businessmen and politicians and that market forces have been the primary impetus for Japan's industrial development. This "market" argument is made by those who believe that state policy has at best followed market forces and by economists who, professionally and deductively, contend that Japan's industries would have grown even faster had they not been subject to the state's targeting policies. These views simply beg the question of how market forces allegedly worked so well to promote development from the 1950s through the 1980s but went awry starting in the 1990s.

Still a third school focuses on state-business networks, keiretsu (conglomerates of diverse industries), the main bank governance system, and trade associations. This school argues that Japan's economic development came about because of what it calls variously a "network state," "alliance capitalism," or a system of cartels and restrained trade. But why did these networks and associations function well in the past but not in the 1990s and the early 2000s?

Communitarian Capitalism

I believe that Japan has a system of communitarian capitalism that both helps to explain the rise of the Japanese economy in the 20th century and that is a critical contributor to its current stagnation. Capitalism, at its core, involves private ownership of property and the pursuit of profit. In Japan, however, because of broad public and communitarian goals, firms have constrained their drive for profits. Call it quasi-socialist. Although Japan has all the trappings of private property and profit-making institutions, priority has been placed on stability, predictability, national autonomy, order, and survival. Effectiveness at reaching these goals has been deemed more important than efficiency or profit. While risk-taking has sometimes been rewarded with increased status, risk-takers have rarely received economic returns commensurate with their risks. The difference between communitarian and market-based systems does not lie in the degree of state intervention per se; it lies in how the state intervenes and for what purpose.

By communitarian capitalism I do not mean to suggest a cultural or genetic explanation for the proclivities of Japanese people toward consensus decision-making, low returns on investment, cross-shareholding, a relatively small salary gap, the convoy (goso-sendan soshiki) and dango (bid-rigging) systems, and other anti-market practices. I do not support the notion that benevolence and goodwill drive Japan's system. Nor is mine an argument that a strong society somehow has veto power over the bureaucratic and corporate elite. In fact, communitarian capitalism is not necessarily good for all in the society. In the 1920s the system sacrificed farmers; in the 1960s and 1970s it discriminated against consumers; since the 1990s it has disadvantaged savers and wage earners via low interest rates, shrinking pensions, and stagnant wages.

What characterizes the system best is the dominant role of the state in a capitalist system. However, in Japan the state's legitimacy is contingent on maintaining social stability by preventing large corporate failures, socializing risks, and maintaining high levels of employment. The Japanese state is "strong" but it is not unconstrained; the society requires that the state administer the economy in order to achieve communitarian and egalitarian goals or risk withdrawal of consent. The capitalist system that evolved in this context helped promote industrial development under the set of political, economic, and technological conditions, domestic and international, that existed up until the 1980s. However, when the environment started to change dramatically in the late 1980s, the system of communitarian capitalism became a hindrance to further industrial development and contributed to political and economic paralysis. Yet the state and firms, locked into a set of institutions and policies for socializing risk and fearing the social instability that might come from radical restructuring, continued to cling to the old system.

Japan's system of capitalism is, of course, the result of its particular past. Japan's late developer status, its legacy of feudalism, the threat of colonization by western powers, and a strong national consciousness and identity due in part to its two centuries as a closed country all contributed to the emergence of a strong activist state embedded in social relations. Since at least the Meiji period (1868-1912), Japan's elite and its citizens, due to their particular history, ideology of national uniqueness, geopolitical realities, view of technological independence as the key to security, and late stage in economic development, chose the mix of states, markets, and firms they deemed optimal-- a mix I call communitarian capitalism.

Japan's system of communitarian capitalism includes the key elements of the capitalist developmental state, such as a strong state bureaucracy, close government-business relations, weak law, a centralized financial system, keiretsu groups, priority given to producers over consumers, emphasis on results over process, and the state as promoter not regulator. However, the developmental state is just one, though a very important, part of communitarian capitalism. Although one can delineate the rise of the developmental state in the late 1920s and 1930s and its decline since the 1990s, communitarian capitalism existed before the developmental state, and its basic foundations remain strong today. These bedrock values include a strong emphasis on social stability, order, socialization of risk so that high risks are not compensated by high returns, and national self-sufficiency. These orientations are rooted in Japan's past. Clearly, the village mentality still so strong in communitarian capitalism today reflects the mura shakai (village society) of the Tokugawa era (1603-1867).

I posit that a comprehensive explanation of the rise of Japan's economy and its recent stagnation requires bringing "society" and "technology," especially the nature of technological change, back into the analysis. Japan's system of communitarian capitalism on the whole worked well over the past century under a certain set of discrete circumstances, including such things as being in the followership stage, enjoying a positive international environment characterized in part by stable and predictable technological change, and having the ability to legally reverse-engineer foreign products. However, once Japanese firms caught up with their reference economies, primarily the United States and Germany, in manufacturing and when the nature of technological change shifted toward ideas and standards rather than tangible products that can be reverse-engineered, some of these same institutions and social values became truly counterproductive.

Four Characteristics

Because of the way Japan's capitalist system is embedded in societal norms, it has at least four key, somewhat interrelated, characteristics that distinguish it from market-based capitalist systems. First, the state refuses to play the objective umpire role necessary to create and maintain markets. That is, Japan essentially has no neutral competition policy; its markets are managed. Second, in part because of the lack of an objective competition policy, there is no functioning mechanism for penalizing failure other than gaiatsu (foreign pressure). The process of "creative destruction" that economic theorists such as Joseph Schumpeter (1883-1950) saw as critical to technological change and economic development does not exist in Japan. Third, competition, though it can be fierce, is also cooperative, as reflected in the prevalence of very old companies, yokonarabi kyoso (more or less uniform competitive strategies), yokonarabi kenkyu (similar research agendas, including multiple-company research consortia), and other forms of cooperatively competitive behavior, including the convoy system in finance (strong banks protecting weak ones) and the dango system (covert collusion among firms) in the telecommunications and construction industries. Fourth, this cooperative competition leads to what the Japanese call kato kyoso or excessive competition. Kato kyoso results in relatively low profits and low returns on investment. In export-oriented industries sensitive to economies of scale in production, it shifts cutthroat price competition from domestic to foreign markets.

Let me comment briefly on each of these four characteristics. Japan's system of communitarian capitalism is characterized by an activist state but that state has not been willing to enforce the antimonopoly law or other neutral competition policies that would encourage and maintain active markets. This unwillingness to play the role of an objective umpire is due to the way in which state policies are dependent on social acceptance for legitimacy. In a community where stability, predictability, order, and survival are prized, risk must be shared or, in more technical terms, "socialized." Thus, while the state uses market forces for specific purposes, it is not willing to rely on them fully because of the social instability and stigma that would result from corporate and individual failure.

This desire to prevent large losers (and the loss in status and face this involves) and thereby maintain social stability and order is only one reason, though an important one, why the state and firms manage markets. Another is to create comparative advantages. Managing markets was a key tool in nurturing industrial development during the catch-up stage, when the state could control the domestic environment, the technological trajectory was clear, products could be reverse-engineered, and there were no other late developers to compete with. At this stage, promoting effectiveness over economic efficiency contributed to industrial development. Guaranteeing stability, predictability, and order by managing markets provided firms with a safe haven free from short-term shareholder pressures and takeovers. This protection allowed the state and firms to invest heavily, plan development, and focus on incremental product advances through ever-improving manufacturing techniques. However, when domestic conditions (the finance system, protection of the market, ability to reverse-engineer foreign products legally) could no longer be tightly controlled and technological change became more rapid and unpredictable, state management of markets not only became very difficult, it actually hindered competitiveness in some cases.

A second key characteristic of Japan's system of communitarian capitalism is the absence of a vibrant mechanism for creative destruction. In market-based capitalist systems where returns are correlated with risk, the struggles for corporate control (shareholder power) and competitive labor and capital markets (including venture capital markets) help sweep away incompetent management, old ideas, and obsolete institutions and nurture new ones. In Japan, few firms have ever exited from industries, and the system has nurtured very few new firms except at the initial emergence of a market. Except for the consumer electronics industry, the telecommunications, computer hardware, computer software, and semiconductor industries that I discuss below are all dominated by the same firms, and these firms all have roots in the Meiji period. Even in consumer electronics, there have been few new entrants since the industry's initial takeoff in the 1950s. In essence, communitarian capitalism, because it socializes risk to promote stability, order, and survival, is designed to promote winners and therefore gives great advantages to existing firms. The system works to prevent losers in all but the most extreme cases because it is a part of the social contract and is explicitly incorporated into the country's labor laws, which make it difficult to lay off workers. "Learning from one's mistakes" is not an experience valued in Japanese society. If you fail once, you will be stigmatized for life. This stigma, along with the lack of economic rewards for risk-taking, has serious implications for individuals' willingness to start new companies, fund new companies, join small, volatile firms, attempt risky ventures and similar activities.

Oxymoron though it surely is, cooperative competition is a third key element of communitarian capitalism. By cooperative competition, I mean risk-sharing behavior whereby firms in an industry compete although in a controlled and predictable manner. This behavior, which promotes stability and minimizes conflict and failure, protects weaker firms at the expense of the strong. Japanese firms do not want to take on unusually high risks; they prefer to operate in an orderly and cooperative manner and be blamed collectively if mistakes are made. As a consequence, the top set of firms in the various electronics (and other) industries all follow similar strategies. They tend to offer relatively similar products at similar prices; when one puts out a new product, they all tend to jump into the market; when one goes overseas, all tend to follow.

Japanese firms, backed by (until recently) strong banks and free from serious discipline from the financial markets, are driven to expand market share to survive. As a result, they are willing to cut prices even below costs, resulting in what seems like another contradiction in terms, "excessive competition." Kato kyoso has at least two effects. First, it reduces profit margins and returns because of collective overinvestment. These low returns are accepted as a trade-off for increased stability and predictability. Second, it shifts the fiercest competition Japanese firms face from the domestic market to overseas markets. Because of the community's strong taboo against creating domestic losers-- i.e., bankrupting domestic competitors-- market share and profits are to be gained as much as possible at the expense of foreign firms, which are not part of Japan's community.

As Yoshitaka Kurosawa, a former Japan Development Bank official and now a professor at Nihon University, explained to me on March 31, 1993, "Since the Edo period we have had a saying: Ôcompete but do not defeat.' We will compete with each other but in the end will not defeat-- bankrupt-- each other. We will compromise. If a firm has problems, someone will help it. Look at the village model. Everyone compromises to provide everyone a minimum standard of living. With foreigners, you can compete and defeat them because they are not part of our family."

Risk-sharing behavior has led to excess capacity and dumping abroad in some industries. Because cooperative competition aims to prevent domestic losers yet is driven by a desire to survive through market-share expansion, it tends to stimulate heavy investment in export-oriented industries with strong sensitivities to production economies of scale. Dumping becomes a viable policy because managed markets make Japanese consumers pay high prices at home, essentially subsidizing below-cost exports. However, during periods of rapid and discontinuous technological change, which occurred in the electronics industries in the 1990s when competition started to revolve around software standards rather than manufacturing expertise, Japan's normal procedures meant that all the firms had the same products as well as the same research, labor, and marketing strategies and all were operating on relatively thin margins. There were no actors even on the fringes poised to respond quickly to emerging opportunities in the new economy.

While various studies have focused on either the strengths or the weaknesses of the Japanese state, I believe that there have always been cases of successes and failures in state intervention. The effectiveness of state policies depends on how they support or hinder the requirements of a specific industry at a given developmental stage. By demonstrating how effectiveness has been contingent on certain conditions, one can see that it is the new environment since the 1990s, more than problems of state intervention per se, that is responsible for the system's stagnation.

To gain insight into the state's role, I want to put forth several propositions regarding the conditions under which the state has intervened in a given industry and been effective. I will then examine these conditions in each of five industries during the period from the 1950s up until the 1980s and the period from the 1980s to the present. Dividing the periods in this way provides a comparative snapshot of the industries before they hit major challenges in the 1980s and 1990s.

Eleven Propositions

The first proposition is that the state will be stronger and more effective when an industry is in the catch-up mode than when it is not. This does notmean the catch-up stage is a sufficient factor, but rather that it is necessary for effective state targeting policies.

The second proposition is that state targeting will be more effective when the industry has a stable technological trajectory than when technologicalchange is unpredictable or discontinuous. By a stable technological trajectory I mean, for example, the clear-cut advances in integrated circuits from 4k to 16k to 64k and so on. This is not to suggest that the state will decide to intervene in all industries with stable technological trajectories; rather, where it decides to intervene, effectiveness will be facilitated by this condition. This proposition overlaps somewhat with the first in that many, though not all, industries in which a nation is trying to catch up, will, by their nature of being in follower positions, have stable technological trajectories. I posit this as a necessary though not sufficient condition for effective state intervention.

The third proposition is that the state will be more effective in nurturing industries that exhibit decreasing returns to scale -- that is, manufacturing industries in which competition revolves around price and quality and detailed planning can reduce costs and risks. The state will be less effective in industries characterized by increasing returns, ones in which competition centers around new ideas, concepts, and emerging or already dominant standards that enjoy network externalities. Let me open a brief parenthesis here and explain this proposition in somewhat greater detail.

Economists used to assume that industries primarily exhibited decreasing returns to scale-- as a firm produced more products, at some point it would reach a limit to making more money per extra unit and start making less profit per extra unit. There are various causes for diminishing returns, such as the difficulty in managing an increasingly complex manufacturing process and problems of acquiring adequate supplies of raw materials and parts. Competition in industries characterized by diminishing returns revolves around price and quality. Technological change tends to be relatively slow, stable, and incremental in these industries, allowing bureaucrats and corporate managers to plan activities and gain efficiencies by routinizing the production process without taking on huge new risks.

With the rise of advanced high technology industries in the last two decades, economists started to notice that many of these new industries exhibit increasing returns to scale. Competition in these industries revolves around ideas, strategies, and standards. When firms in these industries increaseproduction, they make more money by producing an extra product rather than less profit per extra unit. As firms in these industries produce more, they tend to get further ahead of their competitors.

Firms that produce more get stronger because of network externalities, often called network or bandwagon effects, and the way these effects lock users into standards.

The Windows software standard for PCs is a good example. Users choose the Windows platform to gain the compatibility needed to communicate with one another and have access to a broad library of software applications. As more people use Windows, software makers increase production of a wide range of applications because they see the standard as dominating the market. This provides users with continuously expanding although not permanent benefits. Firms that control these standards get stronger by locking users into their products. Schumpeter called these "temporary monopolies" and saw them as critical to innovation. Winners in these industries gain a strong market share and reap huge profits until the next round of creative destruction forces them to change or die. For further analysis, see, e.g., W. Brian Arthur, "Competing Technologies, Increasing Returns, and Lock-in by Historical Events," The Economic Journal, vol. 99 (1989): 116-31; W. Brian Arthur, "Increasing Returns and the New World of Business," Harvard Business Review, July-August 1996, pp. 100-109; and Paul M. Romer, "Increasing Returns and Long-Run Growth," Journal of Political Economy, vol. 94, no. 5 (1986): 1002-37.

To return to my list of eleven propositions, number four is that state targeting will be effective only if business itself is willing to invest heavily in an industry over the long-term. Heavy state investment is not enough to build comparative advantage in an industry.

Fifth, the effectiveness of state targeting will depend heavily on the intellectual property regime of a given industry. It will be most effective in industries where products can be legally reverse-engineered-- where ideas and standards are not legally protected or are difficult to protect.

Sixth, the state will be more likely to target an industry and be effective when barriers to entry are high. That is, the state will be most effective when there are heavy start-up costs, long product life cycles, and slow profit turnaround and other barriers, such as foreign first-movers. The state will be much less likely to intervene in industries where barriers to entry are low, and when it does, its capacity and effectiveness will be limited.

The seventh proposition is related to the size and nature of the state's budget for a specific industry and its regulatory power over that industry. I posit that the state will be more effective in targeting industries when it has enough funds and regulatory clout to induce specific corporate actions but not so large a budget or regulatory power as to attract political and corporate corruption.

Eighth, state capacity and effectiveness will be enhanced when there is core agreement-- consensus-- among the key state players (the various ministries and politicians) regarding the importance of the targeted industry to the nation and how to use the industry to pursue state objectives. When there is disagreement, the state will be reluctant to intervene to change the industry's trajectory, fearing that intervention will increase social instability and conflict. In cases where the state does intervene, its coherence and effectiveness will be diminished.

Ninth, the state will be more likely to intervene and be more effective when the industry has a few, relatively large players than when the industry has many firms, including small firms.

Tenth, the state will be more likely to target and be effective when the industry faces a positive rather than negative global environment. By a positive global environment, I mean having easy and relatively cheap access to foreign technology, a ready market abroad for products, and the ability to protect the home market from severe foreign competition. For this reason, one must assess just how important the international system was and is to the development of targeted industries.

Finally, the state is likely to be more effective when it intervenes in a market-conforming manner, by which I mean aiding firms on the condition that they meet performance criteria. The effectiveness of state aid will be enhanced when it is structured in ways that require the recipient firms to make advances as a quid pro quo for assistance.

Delineating the conditions that help explain the effectiveness of state targeting shows that since the 1990s there has been a preponderance of conditions under which the state historically has not been effective at intervention. These include rapid and discontinuous technological change, a more hostile international environment, and an intellectual property regime that makes it impossible to legally reverse-engineer the types of products necessary to sustain a rising standard of living. In short, many of the key conditions under which Japan's activist state effectively nurtured industrial development have turned negative since the 1990s. Consequently, many of the institutions involved in helping Japanese firms catch up in these industries in the past are no longer effective. They are reaching their limitations and in many cases are hindering competitiveness.

The activist state was quite effective at targeting industries when the technological trajectory was clear, products could be reverse-engineered, andthere was a strong consensus on how to use the industry for the national interest. The centralized financial system worked well in an era when it could be insulated from global markets and when firms and individuals accepted low returns in exchange for social stability and lower risks. Keiretsu groups and the main-bank system of corporate governance functioned as insurance mechanisms, protecting firms from short-term shareholder pressures and foreign takeovers. Huge, vertically integrated firms with organizational capacities suited to low-risk, incremental innovation and constant improvement in manufacturing skills helped Japanese firms become the world's most efficient, high quality manufacturers. Institutions and policies that provided employment stability and acceptable salary gaps prevented the massive social upheaval that most nations experience during a period of such rapid economic growth.

However, under different conditions, these strengths have become weaknesses. In an era of rapid, sometimes discontinuous technological change, a system that socializes risks-- that refuses to provide higher returns for higher risks-- hinders the emergence of risk-takers, be they politicians, corporate leaders, entrepreneurs, or scientists. The norms of working collectively contribute to order and social stability, but do so increasingly at the expense of industrial development and economic growth.

Other major changes in the competitive environment of Japanese electronics firms are the yen's rise in value, Japan's emergence as a global economic power in the last few decades, and the emergence of other successful follower nations such as South Korea and Taiwan. These altered conditions make it impossible for Japanese firms to sustain increasing standards of living producing the commodity products that the catch-up system nurtured. To be profitable at their current stage of development, with their hefty weight in the global economy and high wages, Japanese firms need to become more competitive in industries characterized by increasing returns-- areas where technological change is rapid and discontinuous and planning is difficult at best. Yet, their corporate structures-- large, centralized, and hierarchical-- are organized to rely on foreign breakthroughs and to compete on incremental changes and manufacturing skills. Their incentive systems-- largely seniority-based wages and the practice of companies rather than individuals obtaining patent rights-- impede radical innovation in these types of industries.

Even without Japan's current financial problems, I believe Japanese firms would be facing technological limitations. Japan's electronics firms would be struggling to compete because the institutions of catch-up and their corporate organizational capacities, including their focus on manufacturing skills rather than ideas/concepts and standards, are increasingly obsolete. Obviously, the serious economic problems the nation faces in the 2000s greatly exacerbate the difficulties involved in making the transition from a controlled, centralized, hierarchical, and risk-sharing system dominated by large firms to one that is more decentralized, flexible, and supportive of entrepreneurs, inventors, independent small and medium-sized firms, and new entrants.

I would take a further step and suggest that the very success of Japan's institutions and past policies is contributing to its economic crisis since the 1990s. The lack of an objective umpire and mechanism for the "creative destruction" of industries, the tendency toward cooperative, risk-sharing competition, and the unwillingness to promote efficiency and economic growth if the cost is sharply increased social instability have locked Japan into a set of outdated policies and institutions. Inherent in this lock-in is a negative feedback loop making the problems worse. Consequently, the Japanese state and firms are having grave difficulties adapting to the requisites of a new era.

I argue that institutions Japan developed in the past and that are deeply tied to social norms regarding risk and the appropriate role of the state are no longer working under current conditions. This is essentially an argument for nonconvergence of Japan's economy with those of its North American and European competitors. Japanese firms are converging with them in terms of moving toward internationally accepted technical standards; and corporate and state institutions, policies, and practices have become much more market-oriented since the 1990s. However, the system remains communitarian, not market-based. As long as this continues, the system cannot be viewed as fundamentally converging with market-based systems.

Five Industries

From the early Meiji period to the late 1970s, Japan's activist state built up a stable, reliable telecommunications industry. The state's effectiveness was highly contingent on a clear, stable technological trajectory, the ability to reverse-engineer foreign products, an exceptionally positive global environment, corporate willingness to invest heavily, the lack of an active mechanism for creative destruction, and the willingness of firms and citizens to accept low returns in exchange for social stability, low risk, and order. In this type of stable, controllable environment, the state and firms could plan effective strategies for creating a reliable communications infrastructure. Nippon Telegraph and Telephone Company (NTT), though politicized, was able to insulate itself from extreme political interference due to a strong state, business, and societal consensus on the importance of the industry for the nation's long-term economic development. The NTT family system, which involved risk-sharing dango and cooperative competition, helped nurture a strong family of firms that became competitive in international markets by the 1970s. During this initial catch-up stage, favorable economic, political, and technological conditions allowed the state, through NTT, to be effective. The state's unwillingness to play an objective umpire role and the lack of a mechanism for creative destruction provided the firms with a safe harbor within which to develop.

From the early 1980s to the present, major international and domestic political, economic, and technological changes occurred in the telecommunications industry that led to much less effective state policies. In the 1990s and early 2000s industry competitiveness was hindered by the state's unwillingness to play a neutral umpire role, the lack of a creative destruction mechanism, and telecommunications policies deeply rooted in societal norms related to stable employment, maintenance of close inter-corporate ties, and low returns in exchange for low risks. The state's consensus on how to use NTT for the national purpose eroded in the 1980s, leading to detrimental politicization of NTT. The Ministry of Posts and Telecommunications (MPT), which gained vast regulatory powers when NTT was partially privatized in the mid-1980s, remains unwilling to create a competitive market in telecommunications. This unwillingness, combined with the lack of a mechanism for providing high returns to compensate for high risks and the minimal forces of creative destruction beyond gaiatsu, has made the industry slow to shift from reverse-engineering foreign products and improving upon them to creating new technologies and services based on internationally accepted standards. MPT remains strong, but, due to the deep embeddedness of its policies in the norms of communitarian capitalism, it is now stifling the industry's development.

In the case of computer hardware, an active, effective state played a critical role in building up the industry through the 1980s. However, since the 1990s negative side effects of the communitarian capitalist system have undercut the industry's competitiveness. Huge Japanese computer incumbents, locked into risk-sharing behavior and heavily focused on one part of the market, their manufacturing expertise, and a set of obsolete computer standards were unable to adapt quickly in the 1980s and 1990s to rapid and discontinuous technological change. The lack of a mechanism for creative destruction and other pressures on firms to restructure meant they stuck to their risk-sharing strategies long after it was clear they were obsolete.

The computer software industry is an equally important negative case study. The state, burdened with building up the hardware side of the industry, decided initially not to use its capacity to intervene heavily in the software industry. Nor did it play an objective umpire role to help create a competitive market for software. Instead, it allowed the firms to manage competition in the industry. The firms, following their short-term interest, locked the nation into fragmented, closed standards. This strategy, by protecting the market, helped the firms initially to survive. However, once they needed to compete internationally, this lock-in, the lack of mechanism for creative destruction, and the absence of a system for providing rewards commensurate to risks greatly hindered their ability to become competitive. While state support of the computer hardware industry was key to Japan's ability to create a software industry, specific state policies targeting software have been ineffective. The industry also provides a good example of how, absent a strong state, firms managed competition in ways that worked to their own detriment.

The semiconductor industry is another example of how the activist state played a critical role in the birth of an industry by heavily protecting it and supporting the manufacture of high-quality memory chips. However, the tendency of all the chip firms to minimize risk by following the same strategy of manufacturing commodity memory chips contributed to overinvestment, excess competition, and dumping abroad in ways that helped Japanese firms at the expense of their U.S. counterparts. The focus on manufacturing DRAMS also meant that firms were not taking diverse paths and thus were not prepared to deal with rapid and discontinuous technological change and the emergence of other memory chip competitors starting in the 1990s. The case shows how, when the global environment changes dramatically and firms have caught up and need to become inventors rather than followers, strengths can quickly deteriorate into weaknesses, especially when there is no vigorous mechanism for creative destruction.

Japan's consumer electronics industry provides a case study of an industry that became internationally competitive yet was not heavily promoted by the state. Consumer electronics is also an example of an industry that is highly exposed to market forces and primarily market driven. However, even in this relatively market-oriented industry, firms managed competition in tune with the norms of communitarian capitalism. Elaborate risk-sharing production and price discrimination agreements helped promote domestic actors, even weak ones, in part by driving foreign firms out of the market. Firms have maintained their employees during the long recession, and despite turmoil in the industry, there have been few new entrants and exits. Thus, even in industries where the state has not been heavily involved and where the winds of international competition blow hard, the norms of communitarian capitalism help explain corporate behavior. Still, the most economically successful firms in this industry are those least embedded in the norms of communitarian capitalism.

Japan is facing a crisis in its communitarian capitalism. The system worked well to promote economic development for a century but is now a serious drag on competitiveness. The nation still has the ingredients for being very competitive-- lots of money, a highly educated population, and a relatively strong though outmoded system of innovation. Yet these advantages are slowly being eroded. Japan needs to move toward a more decentralized, market-based, entrepreneur- and inventor-friendly system if it is to compete in the twenty-first century.

MARIE ANCHORDOGUY is a professor in the Henry M. Jackson School of International Studies at the University of Washington and a member of JPRI's Board of Advisers. She is the author of many works on Japanese industrial policy, including Computers, Inc.: Japan's Challenge to IBM (Harvard University Press, 1989); "Japanese-American Trade Conflict and Supercomputers," Political Science Quarterly 109:1 (1994):35-80; and"Japan at a Technological Crossroads: Does Change Support Convergence Theory?" Journal of Japanese Studies, 23:2 (1997): 363-97. This paper is excerpted without reference notes from her forthcoming book tentatively titled The Japanese Dilemma: A Crisis in Communitarian Capitalism.

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