Success as the Source of Failure?: Competition and Cooperation in the Japanese Economy

The Clinton administration’s pressures on the Japanese government in 1995 to increase U.S. companies’ share in Japan’s automobile and auto parts markets and Eastman Kodak’s accusation that Fuji Film uses unfair competitive practices in the Japanese market are the latest in a long series of assertions that Japanese companies collude with each other and with the government to suppress competition. Those who make such assertions tend to focus on three elements — industrial policy, the keiretsu (enterprise groups), and lifetime employment — that suppress competition in the Japanese business system. U.S. negotiators’ view that Japan’s “closed” system fosters collusion and restricts competition also leads them to insist that their efforts to help U.S. firms in the Japanese market are also in the interests of Japanese consumers.

Given Americans’ insistence on the virtues of competition, it is surprising that so many people see no inconsistency in believing that Japan had nearly four decades of economic growth with a fundamentally collusive business system. A more compelling argument is that, in the 1970s and 1980s, Japan’s business system was fueled by competition, not collusion, and it was this competition that powered Japanese economic growth.

Today, however, the sustainability of the key features of Japan’s business system in the face of a five-year recession and the strong yen is in doubt. The prospects for change in the Japanese industrial system as a consequence of these forces are much stronger than any pressures that the U.S. government generates. In this article, I examine the nature of competition in Japan, the implications of its industrial policy, the keiretsu, and the Japanese employment system and assess the prospects for fundamental change in the near future.

Competition and Industry Structure

Traditional economic theory espouses the view that free competition is the source of sound economic development. It maximizes total social welfare and forces companies to be innovative and to price their goods and services competitively. In this view, monopolies threaten the efficiency of markets, reduce innovation, and slow economic growth. On the other hand, individual firms pursue strategies to reduce competition — to find “niches” where they have a monopoly or a commanding, dominant position and to drive competitors to the wall. Weak firms either go out of business (in the pure competition model) or are acquired by strong firms trying to increase their dominance. Therefore, most industrialized nations are in the uneasy position of trying to balance free competition and prevent monopolies.

Despite the pride many Americans exhibit in their antitrust laws and a widespread belief that more countries should emulate these laws, many U.S. industries are highly concentrated, and leading firms have long been able to establish dominant or monopolistic positions. IBM, Xerox, Boeing, and Eastman Kodak historically have had quasi-monopolies in their core businesses. When the airline industry was deregulated in the early 1980s, an initial period of fragmentation as new entrants joined the industry was followed by a wave of mergers and bankruptcies. By the end of the decade, the concentration ratio in the U.S. airline industry was higher than it was before the deregulation initiatives (eight airlines accounted for 91.7 percent of the market in 1987, compared to 80.4 percent in 1978).1

In Japan, however, there are virtually no firms that have been able to establish and keep monopoly positions. Whereas, in the United States, IBM maintained long-standing domination in mainframe computers, in Japan, Fujitsu, Hitachi, and NEC long battled for market share with IBM Japan. Even the photographic film industry, which has only one U.S. player —Eastman Kodak — has two competitors in Japan, which has a market half the size of that in the United States. There are ten auto manufacturers in Japan, five integrated steel companies, five major manufacturers of single-lens reflex cameras, and more than ten semiconductor manufacturers.2 Even when a Japanese firm creates a new industry, as Nintendo did with video games, it finds that other firms quickly challenge its position (as Sega and Sony have challenged Nintendo). In virtually every industry, approximately four to eight firms compete fiercely for market position, even in so-called mature industries like steel, aluminum, television sets, and chemicals. And individual firms rarely leave mature industries, through acquisition, bankruptcy, or voluntary exit. Japanese economist Hiroyuki Odagiri found that, between 1964 and 1982 (a highly volatile period for the Japanese economy with two oil crises and the end of the high-growth era), the survival rate of manufacturing firms listed on the Tokyo Stock Exchange was 87 percent, a much higher rate than in Britain or the United States.3

Another feature related to this pattern of competition has been a consistently lower level of profitability for leading firms in Japan, compared with those in the United States and Britain. In the early 1980s, Hiroyuki Itami analyzed the profitability of the top U.S. firm and its Japanese counterpart in several major industries and found that the Japanese firm was significantly lower in profitability.4 Itami used these data to question the quality of Japanese management at the same time U.S. managers were reading the first wave of books and articles praising its virtues. Later studies by Odagiri and by others5 have confirmed that, despite the problems in comparability caused by differences in accounting practices, major Japanese firms consistently exhibit lower levels of profitability, which Odagiri attributes in part to more intense competition.6

Therefore, Japan’s most successful industries exhibit a pattern of competition that has, as economic theory would predict, reduced profit levels, intensified national competitiveness, and stimulated technological innovation and improvements in productivity and quality.7 However, it has not produced a falling out of weaker firms by bankruptcy, acquisition, or voluntary exit that one might expect as a consequence of competition (and that has characterized industries in the United States). This pattern of fierce competition without losers has underpinned Japan’s economic and competitive success in the postwar period. It involves three important elements: industrial policy, the keiretsu system, and lifetime employment.

Japanese Industrial Policy

In 1982, Chalmers Johnson argued that the Japanese government, symbolized by the Ministry of International Trade and Industry (MITI), had successfully fostered a series of changes in Japan’s industrial structure through policies that guided firms into promising new industries and gradually phased out old industries in which Japan had lost competitive advantage.8 His analysis triggered an extensive debate about the role of industrial policy in Japan’s economic growth and the implications of the Japanese experience for other countries.

The MITI-sponsored project to develop VLSI semiconductor technology (from 1976 to 1980) is perhaps the most famous example of Japanese industrial policy for new industries. The project, jointly funded by government (¥30 billion) and industry (¥42 billion), was an important contribution to strengthening the semiconductor industry in Japan. But what is often overlooked in discussions of the cooperation involved in the project is the intense domestic competition that ensued. The project generated more than 1,000 patents on the VLSI process. These were held by the Japanese government, which subsequently licensed the technologies not only to the participating companies (NEC, Toshiba, Hitachi, Mitsubishi Electric, and Fujitsu) but also to the consumer electronics firms excluded from the project, such as Oki, Sony, and Sharp, “second tier” semiconductor manufacturers without sufficient resources to invest in VLSI technologies themselves. The project in effect equalized the technology base among Japanese companies, maintaining the competitive positions of smaller players like Sony and Oki that might have dropped out of the industry had they not been able to share the results of the project. As a result of this redistribution of technologies, Japan retained more than ten major semiconductor manufacturers, which competed fiercely with each other, especially in capital investment. Japan’s semiconductor industry soon was characterized by a number of world-leading semiconductor manufacturing facilities.

Another example is MITI’s role in administering the Voluntary Export Restraints (VERs) in autos. Japan has been setting VERs in automobile export since 1981. MITI and the U.S. government negotiated the total number of Japanese exports, and then MITI assigned export quotas to individual auto manufacturers, based approximately on their current export levels. In doing so, MITI intentionally gave relatively favorable quotas to the weaker auto companies. Mazda’s share in the Japanese domestic market in the 1980s was 7.2 percent, while its share in the total export quota was 9.4 percent. In Subaru’s case, its domestic share was 1.5 percent, but its export share was 4 percent. The quotas supported these relatively weaker players and prevented them from dropping out of the export market. MITI’s policy may well have been a factor in maintaining Japan’s ten auto manufacturers, which competed fiercely in the domestic market.

Both academic analysts and policy makers in other countries too often overlook the role of Japan’s industrial policy in sustaining strong domestic competition. Japan has eschewed the path of creating and supporting strong “national champions,” which has often characterized European and Latin American in dustrial policy, choosing instead to maintain a number of players in each industry and to foster competition among them. Japan has also insisted, as the VLSI project shows, that government subsidies for R&D be matched by contributions from the companies involved and, until recently, has insisted on owning the patents from such projects and making them available for wider licensing (a practice to which foreign companies participating in Japanese government-sponsored projects have vociferously objected).

Equally important have been MITI’s policies for declining industries such as coal mining and shipbuilding, which, in Japan as elsewhere, are heavily concentrated in certain regions of the country. By subsidizing a gradual reduction of operations in these industries and providing support for the companies involved, industrial policies helped avoid social turmoil and rapid increases in unemployment. When economists realized that MITI has given as much or more support to declining industries — or “losers” — as it has to emerging industries —“winners” —some proclaimed MITI’s policies a failure. As an article in The Economist put it, “Japan’s clever technocrats picked and supported losers.”9 But these policies were aimed not at “picking” industries targeted for future growth but at cushioning the decline of industries in trouble. Of course, they also helped weaker industries to survive, increasing competition both domestically and internationally, much to the irritation of some of Japan’s competitors.

The Keiretsu

For many Western businesspeople and scholars, keir-etsu symbolize Japan’s anticompetitive, collusive behavior.10 However, closer examination reveals how keiret-su work as a competitive mechanism. There are, in fact, two different kinds of keiretsu: the horizontal keiretsu (six large industrial groups that each cover a wide range of industries) and the vertical keiretsu (epitomized by the supplier assembler networks of the major manufacturers).

Horizontal Keiretsu as a Mutual Insurance System

The six horizontal keiretsu are four groups that are built on the companies of the four largest prewar industrial groups or zaibatsu (Mitsui, Mitsubishi, Sumi-tomo, and Fuyo) and the two major bank-centered groups, the Dai-Ichi Kangyo Bank Group and the Sanwa Group. Each keiretsu has a member company in each of Japan’s main industries, especially the growth-era heavy industries (steel, shipbuilding, chemicals, construction, trading companies, etc.). These groups are not conglomerates: central holding companies are illegal under Japan’s postwar commercial law. There is no central strategy; the companies are independent and publicly owned. Rather, these are loosely coordinated groups characterized by minority cross-shareholding, regular communication of top executives in the “Presidents’ Club” of each group, and general cooperation for mutual benefit in unstated “gentlemen’s agreements.”

A feature of these groups is cross-shareholding, which, in 1987, averaged 23.4 percent (slightly higher — about 30 percent — in the former zaibatsu).11 Expectations of dividends and returns on investment are not the motivation for owning these shares; rather, share ownership is a symbol of commitment and mutual obligation. Group companies commit to being stable owners, protecting member companies from hostile takeover and external pressure, and allowing company management a high level of autonomy.

Because the keiretsu bank is usually the lead bank for group companies and because the trading company usually assumes many of the trading transactions for group companies, the horizontal keiretsu are perceived as a symbol of Japan’s closed corporate society. However, the groups are far from closed. One analysis showed that fewer than 10 percent of the total contracts of keiretsu companies were within their group — except for the Mitsubishi group figure of 17 percent. More than 70 percent of contracts were with non-keiretsu independent companies, and the rest were with companies in another keiretsu.12 The horizontal keiretsu groups do not prevent the group’s companies from having external relationships; instead, as mutual shareholders and sources of financing and information resources, keiretsu companies are committed to maintaining each other’s prosperity and continued existence, thereby providing a mutual insurance system.

If a keiretsu company falls into financial trouble, group companies provide help. In one famous case, Mazda faced bankruptcy in the wake of the first oil crisis, because of its highly energy-inefficient rotary engine cars. The Sumitomo Bank, Mazda’s group bank, put one of its executives in charge of Mazda, provided generous financing, and encouraged group companies to support Mazda in various ways (e.g., encouraging employees to buy Mazda cars). And more recently, the Sumitomo Bank chairman was instrumental in getting Ford to raise its investment stake in Mazda to provide the troubled auto firm with much-needed capital for investment.13

The group aims to maintain a policy of having a member company as a competitor in each major industry. It therefore functions as a mutual insurance system that ensures the existence of at least six competitors in each industry sector (although the horizontal keiretsu are not active in all sectors). In part because of the continuing keiretsu support, a member company could never drop out of competition or be acquired by a company from another group.

Keiretsu group companies therefore have lower risk than independent companies, because the whole keiretsu group shares individual risks. Given this lower risk, keiretsu companies obtain lower interest rates from both keiretsu banks and other financial institutions. Japanese companies in the horizontal keiretsu therefore tend to have higher debt ratios than either independent Japanese companies or their U.S. counterparts.

The lead shareholders in keiretsu companies maintain their shares regardless of returns, enabling companies to provide lower returns on equity and lower dividends. A study comparing horizontal group companies with equivalent independent companies found that returns to shareholders were lower for horizontal group companies, although returns to employees were greater.14 Group companies therefore reinvested earnings into production and R&D and maintained their presence in their core industry even if their profitability and efficiency did not match the leading competitors. Moreover, keiretsu companies built large corporate assets in the form of land and the shares of other keiretsu companies. In the growing economy of the late 1970s and 1980s, the value of this asset base soared and enabled keiretsu companies to borrow even more extensively to finance capital investment, generating even tougher competition and enabling even the weak players to sustain the investment levels necessary to compete.

In summary, then, the horizontal keiretsu have been an important factor in maintaining strong domestic competition, keeping firms from dropping out of the older line industries where they have been most strongly represented, and making sure that member firms moved into new, higher-growth industries, even when such expansion intensified competition.

Vertical Keiretsu as a Way to Create Competitive Teams

Virtually the only aspect that vertical keiretsu share with horizontal keiretsu is the word keiretsu, which means “order” or “system.” Both are types of industrial groups held together primarily by complex relationships, but the relationships are very different. In the vertical keiretsu, as the name implies, a lead firm organizes the network, which is epitomized by the supplier networks of the large auto and electronics firms. Every large industrial firm, such as Toyota or Matsushita, is the parent firm in a complex, layered group of firms; some are suppliers and sub-suppliers, others are sales and distribution companies, and still others are spinoff firms engaged in related businesses.

Americans have focused attention on the supplier networks and portrayed them as a key element of Japanese competitive success.15 Americans see Toyota outsourcing more than 60 percent of its parts and subsystems or Canon outsourcing nearly 90 percent of the value added in its copiers and think it gives these firms flexibility, efficiency, and strategic focus. The keiretsu is the primary mechanism for just-intime production and lean manufacturing: the lead firm closely coordinates its activities in production and engineering with its suppliers and itself concentrates on high value-added activities. The vertical keiretsu is held together by a complex mix of people, financial resources, information, parts and products, and technology. Ownership is only a part of this linkage: most lead firms have minority shares in their suppliers, rather than what Americans would think of as a “controlling interest” of more than 50 percent.

But while the business press has analyzed the close cooperation that develops in the vertical keiretsu, it has paid much less attention to its intensely competitive nature. Most Japanese lead firms follow a multisupplier policy, avoiding reliance on a single source, even a member of the group: the ratio of single-sourced parts in the auto industry in Japan is only 12.1 percent, compared to as much as 69 percent in the U.S. industry.16 The lead firm buys, for example, 50 percent of its parts from a main supplier, 30 percent from a second supplier, and 20 percent from a third supplier. The first and even second supplier may be a vertical keiretsu member, but at least one supplier will be outside the group. The lead firm encourages the second or third supplier to match the first supplier’s cost and quality, often passing along important technical and process information on the first supplier’s operations. In doing this, the lead firm tries to encourage the weaker suppliers to improve and keeps competitive pressure on its lead supplier. The lead firm tries to avoid monopoly power in its network, thus stimulating all suppliers to be more efficient and price competitive. If a keiretsu supplier falls behind outside suppliers, the lead firm provides financial support and even technology and often takes extraordinary steps to revive its competitiveness. But if, over an extended period of time, the keiretsu supplier fails to meet the competitive standards, it will find its share of the lead firm’s business steadily declining and may eventually be replaced by an outside supplier that has become the preferred supplier. The lead firm’s purchase of some of the outside firm’s shares symbolizes the closer relationship.

Suppliers are encouraged to sell their products to other assemblers to expose them to different ways of doing business and to gain greater economies of scale. But the lead firm remains their single largest customer, and their destiny is dependent on it. One Japanese executive in a keiretsu supplier company described this dependency: “As soon as I succeeded in becoming such a supplier, I was considered part of its ‘family.’ I was expected to be loyal to that company no matter what the sacrifice.”17

Suppliers in the same keiretsu group compete with each other and with outside suppliers to excel in quality, delivery, reliability, and cost performance. But at the same time, they cooperate with their lead firm and even with competing suppliers in the same group to compete against other keiretsu groups. Suppliers know that their success is ultimately dependent on the competitiveness of their lead firm in the final product market. The lead firm carefully fosters this combination of cooperation and competition among suppliers and often establishes mechanisms for asserting the group identity and providing a forum for cooperation by having meetings of supplier executives, sharing group trademarks, and setting up joint social activities such as sports events. Toyota has established a first-tier suppliers’ group, the Kyoukoukai (176 companies); Nissan has its Takarakai (104 companies). Members of the vertical keiretsu have had little choice but to accept this combination of cooperation and competition.

Lifetime Employment

Nearly three decades ago, James Abegglen identified Japan’s human resource management system as a primary feature of its industrial companies.18 The other features are: (1) lifetime, or more accurately, permanent employment — a guarantee that the employer will find a position for the employee until retirement, usually at age sixty; (2) seniority-based promotion and salaries; (3) group-based organization rather than individual jobs; and (4) vaguely defined job descriptions. Many Westerners have concluded that the Japanese work environment is much more cooperative than in the United States, and that Japanese employees enjoy more comfortable, secure, and friendly workplaces. But this is not true.

Lifetime employment means that employees have few opportunities to change employers. The large Japanese companies that are the country’s preferred employers recruit new employees from the crop of fresh graduates (blue-collar workers from high schools, managerial recruits from bachelor’s programs, and R&D personnel from the master’s programs). Mid-career jobs are therefore rare; if an employee doesn’t fit into the company, he or she has few attractive alternatives. Subsequent employment possibilities are likely to bring lower wages, less security, and less status.

The seniority-based promotion system means that people wait years for promotion, even if they are outstanding performers. Vladimir Pucik’s twenty-five year analysis of the promotions of employees hired in 1955 at a large trading company shows the patterns found in virtually all Japan’s large firms.19 The trading company has five managerial levels, with predetermined minimum time periods for promotion to the next level. The best people are promoted first, but even they must wait many years before they reach general manager positions. In Pucik’s study, less than a quarter of the people hired in 1955 reached the fifth level; only a small number (6.1 percent) reached that level in less than twenty-five years. Gradually, the less highly evaluated employees stopped rising.

There is no fast track in the Japanese company, but there is a very long track. Because employees’ entire lives are devoted to one company, the race creates fears of lagging behind and being outperformed. Some people are left behind. They are not, however, thrown out; the permanent employment guarantee ensures that they are not “losers” in the sense of losing their jobs.

This fierce internal competition could have created a hostile, individualistic work environment were it not for the two other characteristics of Japanese human resource management: group-based organizations and vague job descriptions. Companies evaluate employees’ performance not only on individual performance but also on how well the person improved group performance. Usually that performance is evaluated relative to similar groups in the company, and, therefore, each worker must cooperate with colleagues to achieve the best results. Even the best individual performers will not succeed if their group performs badly.

Vague or imprecise job descriptions give Japanese workers much more scope in helping colleagues, making suggestions, and implementing improvements. Many studies of blue-collar workers in Japanese auto plants and studies of managers have observed this.20 Companies expect managers to define their own roles and find ways to contribute.21 A very important criterion for becoming a manager is demonstrating whether he or she can understand the general mission of the position and discover ways to realize it, in both the internal and the external environment. Lifetime employment and the seniority promotion system, which are usually associated with periodic job rotations, give managerial candidates the background and experience to develop capabilities to cope with open-ended missions. Such “self-job definition” easily leads people into intense work commitments, even over-commitments. Because people have no preset goals and because they are judged on the goals they set and how they achieve them, people naturally compete by setting higher and higher goals. The phenomenon of karoushi — death by excess work — symbolizes the stress this produces among managers. While the system is stressful for people, Japanese companies have benefited by getting the best performances from both individuals and teams.

The basic mechanisms of this system are very similar to those we have observed in industrial policy and in the keiretsu: getting full commitment from the players, engaging them in unending competition by providing few alternatives and by ensuring that weaker contenders continue in the system, and ensuring that cooperation is not overwhelmed by competition.

There is coexistence and indeed essential harmony between competition and cooperation in the Japanese system. With few or no alternatives available, individuals, groups, suppliers, and lead firms compete with each other, but, at the same time, they cooperate as a team to compete against outsiders. High-pressure competition is generated in each layer, but successful competition demands that the competitors also work together. (see Figure 1).

Because the system creates no clear losers, Japanese society avoids many social costs believed to be inherent in a market economy. The market economy by nature produces social losers as well as winners, and the wealth generated by the winners offsets the poverty of the losers because of social welfare programs for the redistribution of wealth. But Japanese capitalism embeds this redistribution process in the systems of lifetime employment, the keiretsu, and industrial policy. As a result, Japanese society has incurred relatively lower social costs and by far the lowest unemployment level among the highly developed countries, even after five years of continued recession. Japan’s unemployment rate remains approximately 3 percent. Economists argue that “hidden unemployment” raises the figure to around 7 percent; i.e., there are some people who continue to hold jobs at large corporations without having significant work. But this figure shows that the lifetime employment system functions as a substitute for governmental welfare programs.

Trade-offs in the System

As a result of this competitive system, Japan has become one of the world’s major economies in the five decades since the end of World War II. But it has not been without costs.

First, the severe competition among companies and the refusal of weak players to drop out or be absorbed by the strong has led to frequent overinvestment in production capacity, and what MITI calls “excessive competition.” The horizontal keiretsu system fostered almost unlimited credit lines and made persistence possible despite negligible returns, fueling the competition. Second, the competition has held down the operating profit levels of Japanese companies. Third, excessive competition has accelerated the speed of product development and shortened the life of many products. Automakers change models every three or four years. Consumer electronics firms introduce a stream of new products, which lowers the value of the previous year’s models substantially and encourages consumers to expect new models every year. The resource waste and the disposal of unwanted but still serviceable products is beginning to concern environmental groups in Japan and elsewhere. Human resources are also consumed in the process. One electronics company had ten equivalent teams competing to develop a new stereo headphone. Should so many talented engineers be competing within one company just to make one new product? Finally, the system is intensely stressful for those working in it.

In addition, the Japanese system has an effect beyond Japan. Now that many Japanese companies have globalized their competitive battleground, they have set the base levels of profitability and competition for non-Japanese companies as well. Japanese companies are able to survive in this intense competition because of the social insurance mechanisms I have described. However, many non-Japanese companies lack patient shareholders, committed suppliers, and employees with no alternative to intense commitment, and find it difficult to deal with Japanese-style competition. This leads to severe trade friction and generates the image of “unfair Japanese competition.”

The intensely competitive domestic market also raises the entry barriers for non-Japanese firms, and consequently, non-Japanese companies experience serious difficulties penetrating the Japanese market. This can, however, hardly be seen as a trade barrier in the normal sense, because even new Japanese entrants face an equally difficult challenge. In some industries, such as airlines and long-distance telecommunications services, the U.S. market has higher entry barriers in the form of intense domestic competition.

The Sustainability of the Japanese Business System

Economists in the 1980s almost unanimously portrayed the Japanese business system as having been produced by a long period of economic growth and superbly adapted to thrive in a growth environment. However, the strong yen, the collapse of the “bubble economy,” and the continued Japanese recession have led many observers to conclude that Japan is now facing an extended era of zero or near-zero economic growth. This raises the specter of three serious problems for the Japanese business system: the growing importance of operational profitability, the erosion of lifetime employment, and generational conflict.

• Operational Profitability. In the late 1980s, the lower profitability of Japanese companies was overridden by the spectacular growth of their assets. Between 1985 and 1991, total operational earnings of publicly traded Japanese companies grew by 44 percent, while earnings from stock sales and the disposal of land assets grew by 78 percent and 56 percent respectively. The Japanese Economic Planning Agency calculated that, in the 1980s, the total value of Japan’s stock and land property increased by ¥700 trillion and ¥1,600 trillion respectively. This asset value increase accounted for more than 70 percent of the total GDP growth generated in Japan during that period.22 The prosperity of Japanese companies rested to an unrecognized degree on the accumulation of wealth during the higher growth period in the past. With the collapse of the bubble economy, as much as ¥233 trillion of land asset value and ¥178 trillion of stock value was eradicated in 1992 alone. Japanese companies in the future must profit from their operations and justify their investment on the basis of projected future operating profits, not on continuous asset inflation due to growth in the economy as a whole.23
• Erosion of Lifetime Employment. The second trend that may affect the business system is the erosion of lifetime employment caused by the globalization of production. Japanese offshore manufacturing is currently only 5.7 percent of total GNP, while the figure for the United States in 1989 was 23.8 percent. The appreciation of the yen has stimulated many Japanese companies to significantly expand their production outside Japan, especially in Asia. And the past five years of recession saw a growing number of Japanese companies struggling to reduce costs by cutting back employment. Nissan reduced its employment by 6.7 percent between 1990 and 1993. The five major Japanese steel companies reduced the combined total of their employees by 23,000 between 1993 and 1995. And, as in the United States, much of this reduction is in the managerial and white-collar labor force. Moreover, some companies have announced plans to introduce new promotion systems focusing on individual performance rather than seniority. Lifetime employment and the seniority-based promotion system have begun to erode.
• Generational Conflict. Both trends in turn will bring more intense generational conflict to Japanese society. In the traditional system, young people with little seniority contributed to their companies with lower rewards than their productivity warranted. However, secure in the knowledge that they would be rewarded as they gained seniority and the company expanded, young people remained intensely committed. Now they are beginning to suspect that present sacrifices will not produce larger future rewards. As the growth rate of the economy and companies has leveled off, many middle managers are finding their careers truncated by early retirements and transfers to subsidiaries. Young employees see the sacrifices of the senior generation going unrewarded and may no longer tolerate the low level of their compensation relative to their contribution.

There has been virtually unprecedented criticism of the current top management in big Japanese corporations. As executives sell assets inherited from past management in order to maintain profitability on paper, they seem to be sacrificing the future. They seem reluctant to undertake the painful restructuring that many Japanese believe is necessary to remain competitive. For young managers, the actions — and inaction — of current management threatens their future. Restructuring the company to make it competitive in a high yen environment would be much more valuable to young employees than manipulating assets to hide or postpone problems. Young executives know that their lives will be much more difficult and their rewards far less than those of current senior executives.

What Should Japan Do?

The Japanese economy is now facing the prospect of fundamental transformation, not because of U.S. pressures on trade issues but because of the challenges in adjusting to a very low-growth era. The bursting of the bubble economy is evidence that the Japanese economic system, symbolized by industrial policies, the keiretsu, and lifetime employment cannot function without rapid real growth. Even if Japanese companies want to continue the old “no losers” domestic competition, they cannot.

It is inevitable that Japanese firms give up their traditional keiretsu linkages, lifetime employment, seniority-based promotion, and the myth that big corporations will not disappear. Instead, there will be an increase in corporate contracts based on an economic rationale, demanding and critical shareholders and debt-holders, performance-based promotion and wage systems, term-contract-based employment, and industrial consolidations, mergers, and acquisitions.

Shareholders have realized that they cannot automatically expect capital gains created by economic growth, so they will demand higher dividends; they will no longer be “silent” partners. Japanese banks cannot give low-interest loans to keiretsu companies; their positions are now too precarious to adopt any but sound economic rationales for loans. Mergers, acquisitions, and consolidation of companies are already increasing; witness the recent wave of large mergers in banking and in the paper industry. The asset base value of a company has become less important, and the flow base — that is, operating profits — is much more important.

In the future, individuals and companies will chase their own economic advantages, and the traditional mutual insurance system will disappear. Strong companies will gain, at the expense of weak companies. Can Japan continue to have ten auto companies, five integrated steel producers, and ten large-scale semiconductor manufacturers? The focus of government policy must change from helping to sustain weak companies to helping strong companies become stronger by allowing competitive forces to eliminate weak competitors. This is completely opposite to the government’s traditional role, and, instead of changing that role, the government may take a much less active one.

At least in the short term, increased unemployment in Japan is inevitable, as companies strive to lower costs and move production abroad. But the pain of the transformation can be reduced if the white-collar job market becomes more flexible. Under the traditional lifetime employment system, when mid-career managers lose their jobs, they cannot find new opportunities; there is no white-collar labor market in Japan. But as more and more people are unemployed, Japan must develop more flexible white-collar and blue-collar labor markets. First, companies must replace seniority-based promotion and wages with a merit system to avoid discriminating against employees with previous experience outside the company. Matsushita Electric, for example, recently announced that it would recruit mid-career scientists and engineers for a new R&D lab on a five-year contract basis at individually negotiated wages. Nissan has also decided to introduce a merit-based promotion system. In addition, the company-specific retirement bonus (which is linked to length of service and is not transferable if an employee moves to another company) must be replaced by a portable pension system.

As Japan follows the United States in the creation of strong, lean companies in the traditional manufacturing industries, it must also pay attention to the development of new ventures. But the barriers to entrepreneurship in Japan have been high. In 1989, there were 160,000 companies newly incorporated in Japan, while, in 1988, more than 690,000 were set up in the United States. New Japanese companies face the same difficulties in obtaining financing, attracting good workers, and breaking into markets that confront foreign companies in Japan. But, as the keiretsu structure weakens, as the employment system erodes, and as financing becomes less relationship-based, entrepreneurs will face fewer structural barriers. A sudden upsurge in Japanese entrepreneurship, however, after decades in which it was discouraged, is doubtful. Essential to a society that fosters new ventures are entrepreneurs who are willing to take risks. However, the strong Japanese mutual insurance system was designed to eliminate the risks of companies or individuals being “losers.” Business managers were protected by social risk sharing from facing real business risks. After so many decades of a “low risk, stable returns” environment, where will Japan find entrepreneurs who will face repeated failures before meeting with success?

As the Japanese business system changes, the shortage of risk takers will be its most serious challenge. Most Japanese companies are simply trying to endure the recession by taking identical measures such as cost reduction, moving production to other Asian countries, and outplacing employees. They are expecting the government to end the recession with fiscal stimulation and tax reduction. But these typical risk-reduction behaviors cannot be the main foundation for future competitiveness. Only risk takers can start successful new businesses.

Because Japan has utilized its traditional risk-sharing systems so well for so long, and because the system has produced one of the most successful economies in the world, the entire society has adapted to competition without losers. The people and the firms in this system have been unparalleled in producing high-quality automobiles and memory chips. But they are not the source of new businesses and future Silicon Valleys. The tragedy for Japan is that, as a result of adaptation to the Japanese business system, there are too few risk takers to revitalize the Japanese economy and generate workplaces for future generations. A traditional Chinese saying holds that “failure is the source of success.” Is success going to be the source of failure in Japan?