Japanese Market Economy System

Its strengths and weakness

Book by Tsuru Kotaro

Article and Review by GlobalMacroForex

While this book was written in 1994, it is still very educational for someone new to business practices in Japan and gives a great starting point for understanding their more modern business practices.

Written by a member of the Economic Planning Agency, the book has a fairly pro-government interventionist bias.  However, there are very few actual policy suggestions promoted, and it has a far more educational tone on the general Japanese system.  Let’s learn some of the basics on what makes this economy so unique…

Lifetime Employment 

Japan has a unique employment system that highlights the vertical hierarchical nature of their culture.  Typically an employee stays at the same firm for their entire lives, moving up only within a single organization.  Also as he (or she) ages, his pay increases, regardless of merit. 

Kotaro highlights how this differs from western nations and gives us some of the benefits of this system, which are job security and low unemployment.  But some of the negatives could potentially be unseen as newer younger employees are not given the chance to advance based on merit.

Keiretsu

Keiretsu are large interlocking business relationships between multiple (technically) separate companies that often involve cross-shareholding.  There are multiple types of keiretsu, including both vertical and horizontal structures.  Under a vertical keiretsu, a larger brand company controls various smaller supply companies who provide key goods or services to the larger brand, while still preserving some of their independence. 

For example, Toyota has a variety of parts suppliers who manufacture or assemble a given piece before selling those pieces up the vertical chain.  Vertical keiretsu are more similar to American large corporations’ supply chains.

Horizontal keiretsu are unique to Japan, and there is no equivalent in America.  In this system, a large commercial bank (typically called a “core bank”) leads a group of unrelated businesses.  The unique feature of this keiretsu structure is cross-shareholding whereby each firm within the group holds equity positions in the others and even in the bank itself.  The bank, in turn, lends to those companies and also buys equity in them.

Kotaro notes a few of the advantages of this system, including better access to information, well-aligned interests, and the ability to avoid hostile takeover attempts.  Because the bank typically also provides basic financial services, accounting, and planning to the various companies in the structure, it has all the information it needs to make loan decisions.  By also owning equity in the firm, the bank is incentivized to not overcharge on the loans because it would hurt the company’s profits.  In addition, by cross-shareholding, these firms all avoid outsiders from taking over the company.  Typically keiretsu never sell their cross-shareholdings.

Kotaro notes how one of the main disadvantages of keiretsu is monopolies and occasionally inefficient practices due to competitors having a cheaper product than the suppliers in the keiretsu networks.  By having both vertical and horizontal keiretsu, it makes it difficult for new manufacturers to enter the scene, especially when the producer and store are within the same keiretsu.  Most keiretsu firms are unlikely to give a new manufacturer a chance (even if it offers a better product) because within its existing business relationships there are large sunk costs.

Changing Role of the Government

Kotaro highlights some of the ways that the attitude and policy of the Japanese government have changed from before the bubble in the 1970s to after the bubble in the 1990s.  In general, the government has pursued fewer policies that gave particular keiretsu extreme monopolistic advantages.  Prior to the 1980s, the Japanese government created a large amount of legislation to protect certain “strategic sectors,” and that environment helped to foster these large vertical keiretsu.

Now Kotaro believes that Japanese firms are consolidating, and there are fewer monopolies today than in the past.  (This book was written in 1994.)  In his view, monopolies have the potential to create inefficiencies in the market, but they are breaking apart on their own through market forces.

Conclusion

Tsuru Kotaro provides a general overview of the pros and cons of the Japanese system.  This book is an excellent introduction to any reader new to the ideas of keiretsu, lifetime employment, and the role of the Japanese government in the economy.