Japan: A Rising Sun?

M. Diana Helweg

From Foreign Affairs, July/August 2000

Article preview: first 500 of 4,589 words total.

Summary:  The Japanese economy of old -- coddled by an overbearing government and riddled with corruption -- is dying. Today Japan is undergoing nothing short of an economic revolution. No longer able to count on bailouts, banks are restructuring. Companies are putting profits ahead of personal loyalties. Reforms are breathing life into decayed industries. And the climate for foreign investment is better than ever. The most important force for change is the wave of small, creative, high-tech companies that have built Japan's very own Silicon Valley. The government's lackluster economic stewardship is no longer important. The state is not driving today's revolution; business is.

M. Diana Helweg is Project Director of the Council on Foreign Relations' Task Force on the Japanese Economy and Research Fellow at the John Tower Center for Political Studies, Southern Methodist University. The opinions expressed herein are her personal views.

THE THIRD WAY AND PROSPERITY

As Japan enters the twenty-first century, it sits on the brink of the biggest transformation in its history. Some observers want to write off Japan as stuck in a cycle of debt and deflation, but today's structural reforms in the Japanese financial system are quietly setting the stage for an economic revolution. Although rebuilding the Japanese economy will be no easier now than it was during the Meiji Restoration or after World War II, the present changes are more fundamental than anything the country has ever seen. Japan's revolutionary path will utterly transform it from the state-run industrial powerhouse of the twentieth century toward an innovation-driven, globalized economy of the twenty-first.

This transformation, however, is not necessarily synonymous with economic recovery. In fact, an overhaul of this magnitude is likely to shrink the economy as Japan initially encounters higher unemployment, lower capital investment, and other deflationary problems. But these downturns are temporary. Japan's financial sector is being reformed -- forcibly changing the way companies do business. As it develops, this new financial system is sowing the seeds for an entirely new Japanese economy -- one driven by innovation and competition among small and medium-sized enterprises and high-tech companies. The old economic guard of Japan still receives most of the world's attention. But the real action is taking place in the smaller, newer, more creative enterprises that will bring twenty-first-century prosperity to Japan.

THE EMPEROR'S LAST STAND

The spark that ignited Japan's economic revolution was cast by the collapse of the nation's financial system in the late 1990s. Until that collapse, Japan preferred that the government have nearly total control of the economy. While other modern democracies relied on free-market competition to distribute capital, Japan spent the last century perfecting a financial system that allocated capital according to government criteria. In fact, the recent affinity for state-directed economic policies began much earlier. When Japan isolated itself from the rest of the world during the Tokugawa era (1603-1867), the shogunate tightly controlled all domestic activity, from transportation to commerce.

Unsurprisingly, when a few outlying samurai families decided to replace the Tokugawa shogunate with Emperor Meiji and begin crafting Japan's first modern economic system in 1868, they continued to emphasize the state's control of capital. The self-appointed reformers who shaped the Meiji government wanted a modern economy that could support industrial growth at a pace necessary to catch up with Western countries. To achieve such rapid-fire industrialization, the Japanese government -- rather than individuals -- took the risks and footed the bills. Some of the wealthy merchants who had made their fortunes during the Tokugawa period led and partially funded the new enterprises, but they worked in tandem with the state, not as independent entrepreneurs. Most merchants became political actors collaborating with the central government, and many started the government-supported, family-run companies and banking houses (zaibatsu) that fueled much of Japan's growth in the first half of the twentieth century.

Japan steadfastly resisted a short-lived effort by ...

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