Diversity and Transformations of Asian Capitalisms [1 ed.] 9781136651144, 9780415604406

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ROUTLEDGE STUDIES IN THE MODERN WORLD ECONOMY

Diversity and Transformations of Asian Capitalisms Edited by Robert Boyer, Hiroyasu Uemura and Akinori Isogai

Diversity and Transformations of Asian Capitalisms

Among a vast literature on the Asian economies, the book proposes a distinctive approach, inspired by régulation theory, to understand the current transformations of the Asian economies. Most scholars use a market-led capitalism as a benchmark to diagnose the many imperfections of the Japanese, Korean, or Chinese configurations when compared with the American one. By contrast, this book traces the specificities of the Asian economies back to the formation of their basic institutions after the Second World War which have been shaping each national economy. The book follows the Asian economies’ transformations after the 1997 Asian crisis until the subprime crisis. The book looks at the degree of competition and insertion into the world economy, the nature of labor market organization, the monetary and exchange rate regimes, and finally the style for State intervention via legislation, public spending, and tax. The book provides new findings and will help to shed light on a de facto regional economic integration which is taking place in Asia, and the unsolved past and present political conflicts which hinder the institutionalization of these interdependencies. Robert Boyer, Senior Economist at CEPREMAP (Centre pour la Recherche Economique et ses Applications), is currently fellow at the Wissenschaftskolleg zu Berlin (2010–11). He is a contributor to régulation theory, i.e. a research program which analyzes how economic institutions evolve in the long run and define diverse contemporary brands of capitalism. He has published extensively on labor institutions, technical change, institutional macroeconomics, economic history, financial crises, and European integration. These publications include Japanese Capitalism in Crisis: A Regulationist Interpretation, with T. Yamada, Routledge, 2000; Régulation Theory the State of the Art, with Y. Saillard, Routledge, 2001; and The Future of Economic Growth, Edward Elgar, 2004. Hiroyasu Uemura is Professor of Economics at Yokohama National University, Japan. He is a contributor to régulation theory, i.e. a research program which analyzes how economic institutions evolve in the long run and defines diverse contemporary brands of capitalism. He has published books and articles widely in

the field of institutional economics and macroeconomic analysis. These include The Institutional Analysis of Socio-economic Systems: Beyond Marx and Keynes, with A. Isogai and A. Ebizuka, Nagoya University Press, 2007. Furthermore, he contributed to chapters in Boyer, R. and Yamada, T. (eds), Japanese Capitalism in Crisis: A Regulationist Interpretation, Routledge, 2000. Akinori Isogai is Professor of Economics at Kyushu University in Japan. He has published books and articles widely in the field of the evolutionary and institutional economics and institutional analysis on the contemporary Japanese economy. His recent publications include The Frontier of Institutional Economics: Theory, Application and Policy, Minerva Shobo, 2004; and The Institutional Analysis of Socio-economic Systems: Beyond Marx and Keynes, with H. Uemura and A. Ebizuka, Nagoya University Press, 2007.

Routledge Studies in the Modern World Economy

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Interest Rates and Budget Deficits A study of the advanced economies Kanhaya L. Gupta and Bakhtiar Moazzami

7 Competition Policy in the Global Economy Modalities for co-operation Edited by Leonard Waverman, William S. Comanor and Akira Goto

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World Trade after the Uruguay Round Prospects and policy options for the twenty-first century Edited by Harald Sander and Andras ´ Inotai

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31 Capital Flows without Crisis Reconciling capital mobility and economic stability Edited by Dipak Dasgupta, Marc Uzan and Dominic Wilson

32 International Trade and National Welfare Murray C. Kemp 33 Global Trading Systems at Crossroads A post-Seattle perspective Dilip K. Das 34 The Economics and Management of Technological Diversification Edited by John Cantwell, Alfonso Gambardella and Ove Granstrand 35 Before and Beyond EMU Historical lessons and future prospects Edited by Patrick Crowley 36 Fiscal Decentralization Ehtisham Ahmad and Vito Tanzi 37 Regionalisation of Globalised Innovation Locations for advanced industrial development and disparities in participation Edited by Ulrich Hilpert 38 Gold and the Modern World Economy Edited by MoonJoong Tcha 39 Global Economic Institutions Willem Molle

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40 Global Governance and Financial Crises Edited by Meghnad Desai and Yahia Said

50 Working Time and Workers’ Preferences in Industrialized Countries Finding the balance Edited by Jon C. Messenger

41 Linking Local and Global Economies The ties that bind Edited by Carlo Pietrobelli and Arni Sverrisson

51 Tax Systems and Tax Reforms in New EU Members Edited by Luigi Bernardi, Mark Chandler and Luca Gandullia

52 Globalization and the Nation State The impact of the IMF and the World Bank Edited by Gustav Ranis, James Vreeland and Stephen Kosak 53 Macroeconomic Policies and Poverty Reduction Edited by Ashoka Mody and Catherine Pattillo 54 Regional Monetary Policy Carlos J. Rodr´iguez-Fuentez 55 Trade and Migration in the Modern World Carl Mosk 56 Globalisation and the Labour Market Trade, technology and less-skilled workers in Europe and the United States Edited by Robert Anderton, Paul Brenton and John Whalley 57 Financial Crises Socio-economic causes and institutional context Brenda Spotton Visano 58 Globalization and Self Determination Is the nation-state under siege? Edited by David R. Cameron, Gustav Ranis and Annalisa Zinn 59 Developing Countries and the Doha Development Round of the WTO Edited by Pitou van Dijck and Gerrit Faber 60 Immigrant Enterprise in Europe and the USA Prodromos Panayiotopoulos

61 Solving the Riddle of Globalization and Development ´ Edited by Manuel Agosin, David Bloom, George Chapelier and Jagdish Saigal 62 Foreign Direct Investment and the World Economy Ashoka Mody 63 The World Economy A global analysis Horst Siebert 64 Production Organizations in Japanese Economic Development Edited by Tetsuji Okazaki 65 The Economics of Language International analyses Edited by Barry R. Chiswick and Paul W. Miller 66 Street Entrepreneurs People, place and politics in local and global perspective Edited by John Cross and Alfonso Morales 67 Global Challenges and Local Responses The East Asian experience Edited by Jang-Sup Shin 68 Globalization and Regional Integration The origins, development and impact of the single European aviation market Alan Dobson 69 Russia Moves into the Global Economy Breaking out John M. Letiche

70 The European Economy in an American Mirror Barry Eichengreen, Michael Landesmann and Dieter Stiefel

78 Governing Rapid Growth in China Equity and institutions Edited by Ravi Kanbur and Xiaobo Zhang

71 Working Time Around the World Trends in working hours, laws, and policies in a global comparative perspective Jon C. Messenger, Sangheon Lee and Deidre McCann

79 The Indonesian Labour Market Shafiq Dhanani, Iyanatul Islam and Anis Chowdhury

72 International Water Treaties Negotiation and cooperation along transboundary rivers Shlomi Dinar 73 Economic Integration in the Americas Edited by Joseph A. McKinney and H. Stephen Gardner 74 Expanding Frontiers of Global Trade Rules The political economy dynamics of the international trading system Nitya Nanda 75 The Macroeconomics of Global Imbalances European and Asian perspectives Edited by Marc Uzan 76 China and Asia Economic and financial interactions Edited by Yin-Wong Cheung and Kar-Yiu Wong 77 Regional Inequality in China Trends, explanations and policy responses Edited by Shenggen Fan, Ravi Kanbur and Xiaobo Zhang

80 Cost-Benefit Analysis in Multi-level Government in Europe and the USA The case of EU cohesion policy and of US federal investment policies Alessandro Ferrara 81 The Economic Geography of Air Transportation Space, time, and the freedom of the sky John Bowen 82 Cartelization, Antitrust and Globalization in the US and Europe Mark LeClair 83 The Political Economy of Integration Jeffrey Cason 84 Critical Issues in Air Transport Economics and Business Rosario Macario and Eddy Van de Voorde 85 Financial Liberalisation and Economic Performance Luiz Fernando de Paula 86 A General Theory of Institutional Change Shiping Tang

87 The Dynamics of Asian Financial Integration Edited by Michael Devereux, Philip Lane, Park Cyn-Young and Wei Shang-Jin 88 Innovative Fiscal Policy and Economic Development in Transition Economies Aleksandr Gevorkyan 89 Foreign Direct Investments in Asia Edited by Chalongphob Sussangkarn, Yung Chul Park and Sung Jin Kang

92 Multilateralism and Regionalism in Global Economic Governance Trade, investment and finance Edited by Junji Nakagawa 93 Economic Growth and Income Inequality in China, India and Singapore Trends and policy implications Pundarik Mukhopadhaya, G. Shantakumar and Bhanoji Rao 94 Foreign Direct Investment in China Spillover effects on domestic enterprises Ziliang Deng

90 Time Zones, Communications Networks, and International Trade Toru Kikuchi

95 Enterprise Forms and Economic Efficiency Capitalist, cooperative and government firms Kazuhiko Mikami

91 Miraculous Growth and Stagnation in Post-War Japan Edited by Koichi Hamada Keijiro Otsuka, Gustav Ranis and Ken Togo

96 Diversity and Transformations of Asian Capitalisms Edited by Robert Boyer, Hiroyasu Uemura and Akinori Isogai

Diversity and Transformations of Asian Capitalisms

Edited by Robert Boyer, Hiroyasu Uemura and Akinori Isogai

First published 2012 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business c 2011 Robert Boyer, Hiroyasu Uemura and Akinori Isogai  The right of Robert Boyer, Hiroyasu Uemura and Akinori Isogai to be identified as editors of this work has been asserted by them in accordance with the Copyright, Designs and Patent Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Diversity and transformations of Asian capitalisms/edited by Boyer, Uemura, Isogai. Includes bibliographical references and index. 1. Asia–Economic conditions. 2. Capitalism–Asia. 3. Economic development–Asia. I. Boyer, Robert, 1943-II. Uemura, Hiroyasu, 1956-III. Isogai, Akinori, 1956– HC412.D55 2011 330.95–dc22 2011015113 ISBN: 978-0-415-60440-6 (hbk) ISBN: 978-0-203-80584-8 (ebk) Typeset in Times New Roman by Sunrise Setting Ltd, Torquay, UK

Contents

List of Figures List of tables List of contributors Acknowledgements Introduction: Asia: a social laboratory of contemporary capitalisms?

xiv xviii xxi xxiv

1

ROBERT BOYER, HIROYASU UEMURA AND AKINORI ISOGAI

PART I

Japanese capitalism: the companyism eroded by firms’ heterogeneity and the lack of new coordinating mechanisms

13

1 How has the Japanese mode of régulation changed?

15

TOSHIO YAMADA AND YASURO HIRANO

2 The transformation of the Japanese corporate system and the hierarchical nexus of institutions

31

AKINORI ISOGAI

3 The increasing heterogeneity of firms in Japanese capitalism: facts, causes, consequences, and implications

56

SÉBASTIEN LECHEVALIER

4 Labor and financial-market risks and welfare spending: a comparative study with a special emphasis on Japan

72

HIRONORI TOHYAMA

5 Increasing wage inequality in Japan since the end of the 1990s: an institutional explanation HIROYUKI UNI

90

xii Contents 6 Institutional changes and the transformations of the growth regime in the Japanese economy: facing the impact of the world economic crisis and Asian integration

107

HIROYASU UEMURA

PART II

Chinese and Korean capitalisms: two contrasted trajectories

129

China: export or investment-led growth regime? 7 Development mode and capability building in the age of modularization and regional integration: origins of structural adjustments of Chinese economy

131

LEI SONG

8 Chinese international production linkages and Japanese multinationals: evolving industrial interdependence and coordination

143

JIAN WANG, NAGENDRA SHRESTHA AND HIROYASU UEMURA

9 Analysis of the linkage effect in Chinese export-led growth: according to the subdivisions of Asian international input–output tables

165

CHENGNAN YAN

10 The Chinese growth regime and the world economy

184

ROBERT BOYER

Korea: major transformations but uncertain régulation modes 11 The Korean economy between two economic crises: hybridization or convergence towards a market-led economy?

209

WOOSEOK OK AND JUNHO YANG

12 The great transformations in the Korean economy since 1962: processes and consequences

229

HYUNGKEE KIM

PART III

Diversity of Asian capitalisms: from globalization to Asian integration? The impact of internationalization: distinctive national trajectories but a common domination of competition

241

Contents xiii 13 Asian capitalisms: institutional configurations and firm heterogeneity

243

YUJI HARADA AND HIRONORI TOHYAMA

14 The consequences of internationalization of trade and financial transactions on growth: combining an institutional hierarchy hypothesis with a Keynes–Minsky approach

264

HIROSHI NISHI

Analysing conditions for monetary integrations: Asia and Europe 15 Comparative analysis of conditions for monetary integration: Europe and Asia

287

HIROYUKI UNI

16 Given the heterogeneity of Asian countries, is a monetary integration or coordination possible?

308

SE-EUN JEONG, JACQUES MAZIER AND SOPHIE SAGLIO

Conclusion: the evolving diversity of Asian capitalisms, from the Asian crisis to the subprime crisis

330

ROBERT BOYER, HIROYASU UEMURA AND AKINORI ISOGAI

Bibliography Index

350 372

List of figures

1.1 1.2 1.3 2.1 2.2 2.3 2.4

Export-led growth regime and companyist régulation Elasticity of real wages to labour productivity Balance of payments Extended Scheme of the Hierarchical Market-Firm Nexus Trends in capital efficiencies (all industries: 1961–2008) Downward shift of corporate value frontier and moral hazard Trends in capital–asset ratio and debt–asset ratio (manufacturing, all sizes) 2.5 Trends in capital–asset ratio and –asset ratio (non-manufacturing, all sizes) 2.6 Trends in before-tax net profit (1980–2006) 2.7 Trends in the proportion of stable shareholding (market price base: 1987–2003) 2.8 Trends in the rate of net profit (manufacturing, one billion and over) 2.9 Dispersion in Shunto Wage Settlements (1971–2000) 2.10 Four patterns of HRMs 2.11 Trends in the ratio of breakeven points (1990Q1–2009Q4) 2.12 Most important factors in setting pay during Shunto 4.1 Social protection 1981–1990 4.2 Social protection 1991–2000 4.3 Welfare spending, labor, and financial market risks and institutions 4.4 Effects of fluctuating house prices on Japanese social spending in 1995 4.5 Effects of EPL on Japanese social spending 5.1 Views on the cause of the rising wage inequality in Japan 5.2 Adoption rate of the performance-based wage system by occupation and enterprise zone (the amount of capital stock) 5.3 Annual growth of per capita wage by enterprise size 6.1 Accumulation rate and profit rate 6.2 Real GDP growth rate and wage share

18 20 23 33 35 36 37 38 40 41 44 46 48 50 53 74 75 79 85 86 91 98 98 111 111

List of figures xv 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 6.12 6.13 6.14 6.15 6.16 6.17 7.1 7.2 7.3 8.1 8.2 8.3 8.4 8.5 8.6 8.7 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10

Output–capital ratio Profit rates (different industries) Accumulation rates (different industries) Firm-size differentials of ordinary profit–sales ratio (manufacturing) Contributions to real GDP growth rate Stock price and credit multiplier Investment and export quantities Export to regions Import from regions Japan’s FDI Growth of labor productivity (different industry) Firm-size differentials of value-added per worker (manufacturing) Changes in employment structure: de-industrialization Unemployment rate Real GDP after the world economic crisis Linkage of macro and micro complementarities Technology–organization complementarity: an architectural view Interorganizational architecture in the international market Evolution in East Asian regional interdependence (1990–1995–2000) Trade with East Asia and the import of intermediate goods from East Asia Exports of electrical machinery and transport equipment General trends in Japanese FDI and trade in China Trade collapse due to international production networks Sales of Japanese overseas affiliates in China (million JP) Local procurement ratios of Japanese overseas affiliates in China Local state corporatism hypothesis: a synoptic view Competition: the hierarchical institutional form in China Declining output capital ratio and profit share Long-term decline in wage share and household consumption Rising trend of investment share From the local to the national: the three major tools of the Central State Strong anti-cyclical credit policy of China in reaction to the subprime crisis (annual growth rate) Stopping the re-evaluation of the yuan in order to promote industrial recovery After 2008: still more investment and less consumption shares in GDP USA, China, and the rest of the world

112 114 114 115 116 116 117 117 118 118 119 120 121 121 125 135 137 137 145 146 147 151 153 154 154 189 194 195 195 196 197 198 199 200 201

xvi List of figures 10.11 Rising world market share of China . . . at the initiative of multinationals 11.1 Responsiveness of the corporate loans extended by commercial banks to the GDP fluctuations before and after the 1997 financial crisis 11.2 Banking assets and proportion of corporate loans 11.3 Correlation between the size of the bank assets and SME loans: 1997–2007 11.4 Standard deviation of exchange rate fluctuation 11.5 Relative monthly wages per employee according to firm size, 1993–2007 (large establishments = 100) 11.6 Relative job tenure of the SME workers, 2003–7 (large establishment workers = 100) 11.7 The incidence and proportion of nonregular workers according to firm size, 2003–7 11.8 Interaction of the two dualities 11.9 Employment adjustment during the two crises 12.1 Macroeconomic circuit of export-led regime and Fordism 12.2 Relations between economic growth and income distribution (1982–2009) 12.3 Knowledge investment and social expenditure of OECD countries (2001) 12.4 Labor-market flexibility and expenditure on labor-market policies (2001) 13.1 Relative positions of Asian and advanced economies in the mid 2000s 13.2 Effect of institutional domains on first two factors 13.3 Diversity within Asian economies in the mid 2000s 13.4 Effect of institutional domains on first two factors 13.5 Transition of economies from the mid 1990s to mid 2000s 13.6 Correlation between liberalization and economic stability: the 2000s 13.7 Volatilities of GDP growth in Asian economies and the financial stress index in the USA 14.1 Institutional structure in an open economy 14.2 Stable dynamics in case of low substitutes 14.3 Unstable dynamics in case of close substitutes 14.4 Phillips curve and flexibility of employment adjustment 15.1 Ratios of export prices to wholesale prices in EU; 1995 = 1 15.2 Ratios of export prices to wholesale prices in East Asia; 1995 = 1 15.3 Export-biased productivity growth with inflation (Balassa–Samuelson type) 15.4 Export-biased productivity growth with cumulative trade imbalance

202

211 212 213 214 219 220 221 222 226 231 233 238 239 247 248 250 251 252 255 255 269 277 279 281 288 289 290 291

List of figures xvii 15.5 15.6 15.7 16.1 C1 C2 C3 C4 C5 C6 C7

Export-biased productivity growth under collectively managed floating system Korea’s exchange rate and ULCP Philippines’ exchange rate and ULCP Actual and equilibrium real effective and bilateral exchange rates of East Asian currencies (base 100 in 2000) GDP growth rates in Asian capitalisms Evolution of various capitalisms from the mid 1990s to mid 2000s Correlation between liberalization and stability: the 2000s Golden age: the synergy between reduced inequality and coherent modes of régulation The 1990s and 2000s: the vicious circle between increasing heterogeneity and incoherent and unstable configurations Regional monetary stability as a shield against the world financial crisis Optimistic scenario: Asian integration alleviates world unbalances

292 301 302 310 331 333 337 341 343 344 349

List of tables

1.1 Structure of financial transactions. All sectors. Fiscal year 2007 (unit: %) 2.1 Stylized features of the Japanese corporate system 2.2 Targets of management in Japanese firms (1980s and 1990s) 2.3 Transformation of the Japanese corporate system: summing up 2.4 Types of institutional change 2.5 Types of gradual change 4.1 Social security transfer. Economic risks and institutions 4.2 Elasticity of social security transfer 4.3 Social security transfers. Labour and financial market risks and institutions 5.1 Decomposition of the changes in the hourly wage inequality regarding education (Male regular workers, 1997–2002, Japan) 5.2 Decomposition of the changes in the hourly wage inequality regarding education (Male full-time workers, 1980–90, USA) 5.3 Decomposition of the changes in the hourly wage inequality regarding occupation (Male regular workers, 1997–2002, Japan) 5.4 Median years of tenure with current employer for university graduate workers (2006) 5.5 Decomposition of the changes in the hourly wage inequality regarding firm size (Male regular workers, 1997–2002, Japan) 6.1 Shifting growth regimes 7.1 International comparison of growth of labor productivity 7.2 Rate of profit of China’s manufacturing sector: IT and electronics industries 8.1 East Asia intraregional trade share, 1998 and 2008 (million US$ and %) 8.2 Trade intensity index of total trade in all goods, 1998 and 2007 8.3 Average growth rate of total manufactured goods, intermediate goods and final goods, 1998–2008 8.4 Trade pattern by stage of production, 1998–2008 8.5 Matrix of East Asia trade in 1995–2008

27 34 39 47 51 51 81 82 84 94 95 95 96 101 123 133 133 148 148 149 150 150

List of tables xix 8.6 Shares in Japanese exports and imports by countries/regions 8.7 Trend of US imports from East Asia (million US$) 8.8 Subtotals of column values in the Leontief inverse matrix – changes in final demand for JMNs 8.9 Relative contributions in terms of value added 8.10 Interpretation of international production linkages – from the institutional point of view 9.1 Sectoral dynamics in the 1990s (annual growth rate, unit: %) 9.2 Changes of intermediate goods supply (annual rate, million dollars) 9.3 Changes of backward linkage effect (data in the first line are the values for 1990; the second line is the change over 10 years) 9.4 Changes of forward linkage effect (data in the first line are the values for 1990; the second line is the change over 10 years) 10.1 The progressive emergence of the present competition-led accumulation regime 10.2 From a series of local corporatisms to Chinese macro dynamism 10.3 Some régulationist researches on China 10.4 The five institutional forms: the Chinese configuration 11.1 Estimated investment functions before and after the 1997 financial crisis 11.2 Annual growth rate of employment, SMEs versus large firms 11.3 Number of nonregular workers and the proportion of non-regular workers to total wage workers, 2002–2008 11.4 Simple correlation coefficients of employments with regard to the GDP fluctuations 12.1 Growth rates of real wages and real labor productivity in manufacturing industries 12.2 Estimation of equipment investment function: before and after the financial crisis 12.3 Estimation of consumption function: before and after the financial crisis 12.4 Change in hiring pattern after 1997 financial crisis in major companies 13.1 Typology of Asian firms 13.2 Diversity of Asian economies and the typology of Asian firms 14.1 Macroeconomic performance indicates institutional hierarchy 15.1 Changes in prices and trade deficits in Euro-area countries (unit: %) 15.2 Productivity, wages, and exchange rates in Central European Countries (1998–2003, unit: %) 15.3 Productivity, wages, and exchange rates in Asian countries (1990–5, unit: %)

152 152 158 159 161 166 168 175 177 186 187 191 193 215 217 218 225 233 235 235 236 257 258 282 288 295 298

xx List of tables 15.4 Productivity, wages, and exchange rates in Asian countries (1995–2000, unit: %) 16.1 Current account of East Asian countries (in % of GDP) 16.2 Intra-East Asia trade balance (in % of GDP) 16.3 Impact of US imbalances 16.4 Negative shock on internal demand 16.5 Loss of competitiveness 16.6 Undervaluation (e > 0 and r > 0) or overvaluation (e < 0 and r < 0) in bilateral (e) or real effective terms (r ) of the euro, yen, yuan and dollar (in %) 16.7 Undervaluation (e > 0 and r > 0) or overvaluation (e < 0 and r < 0) in bilateral (e) or real effective terms (r ) of East Asian currencies (in %) C1 Merits and difficulties of Asian monetary integration C2 Asian integration and emerging modes of ‘régulation’/growth regimes

300 312 312 315 319 321

328

329 345 346

List of contributors

Robert Boyer is Senior Economist at CEPREMAP (Centre pour la Recherche Economique et ses Applications) in France. He is a contributor to régulation theory, i.e. a research program that analyzes how economic institutions evolve in the long run and define diverse contemporary brands of capitalism. He has published extensively on labor institutions, technical change, institutional macroeconomics, economic history, financial crises, and European integration. Yuji Harada is Associate Professor of Economics at Fukuyama City University in Japan. He graduated from Nagoya University and obtained a Ph.D. in Economics from Nagoya University. He has published works on the diversity of industrial structural change in OECD countries and on the theory of institutions, especially régulation theory. Yasuro Hirano is Professor of Economics at Setsunan University in Japan. He has published books and articles on the contemporary Japanese economy from the viewpoint of labor and social policy. These include The Japanese Institutions and Economic Growth, Fujiwara Shoten, 1996. Akinori Isogai is Professor of Economics at Kyushu University in Japan. He has published books and articles widely in the field of the evolutionary and institutional economics and institutional analysis of the contemporary Japanese economy. These include The Institutional Analysis of Socio-economic Systems: Beyond Marx and Keynes, Nagoya University Press, 2007. Se-Eun Jeong is Professor of Economics at the Faculty of Economics, Chungnam National University in Korea. She obtained a Ph.D. in Economics from Paris-Nord, France, in 2003. She worked at LG Economic Research Institute and Seoul Development Institute before working at Chungnam National University from 2004. Her areas of interest include international economics, especially global imbalances, economic integration, and exchange rate policy. Hyungkee Kim is Professor of Economics at Kyungpook National University in Korea. He wrote many books and articles on political economy and labor economics. Major books include New Political Economy, 2001, and An Alternative Development Model: Beyond Neoliberalism, 2007. His most recent

xxii List of contributors article is ‘Capitalism after the Great Recession: Agenda for a New Progressive Development Model’, World Review of Political Economy, 1, no. 2 (2010). Sébastien Lechevalier is Associate Professor at École des Hautes Études en Sciences Sociales (EHESS) in France. He is a specialist of the innovation system and the labor market in the Japanese economy. His publications include ‘Why Some Firms Persistently Out-perform Others? Investigating the Interactions between Innovation and Exporting Strategies’, with K. Ito, Industrial and Corporate Change, 19, no. 6 (2010). Jacques Mazier is Professor of Economics at the University of Paris 13 in France since 1983 and researcher at CEPN-CNRS. He was previously Professor at the University of Rennes 1 and has worked at the Forecasting Department, Ministry of Finance, and at the French Planning Commission. His areas of interest include international macroeconomics, European economic policy, and regional integration. Hiroshi Nishi is Associate Professor of Economics at Hannan University in Japan. He has published articles in the field of macroeconomic and applied time series analysis. These include ‘Institutional Hierarchy Hypothesis, Multilayered Adjustment, and Economic Growth – A Post-Keynesian Dynamic Approach’, Evolutionary and Institutional Economics Review, 7, no. 1 (2010). Wooseok Ok is Associate Professor in the Division of International Trade at the University of Incheon in Korea, and former economist in Organization for the Economic Cooperation and Development (OECD). His main publications are related to economic growth, labor market, and East Asian economies. Sophie Saglio is Associate Professor of Economics at the University of Paris 8 in France since 2007 and researcher at LED from Paris 8. She obtained a Ph.D. in Economics from Paris 13 in 2004. Her areas of interest include European monetary integration, East Asian integration, and exchange rate regimes. Nagendra Shrestha is JSPS Postdoctoral Fellow at the Faculty of Economics, Yokohama National University in Japan. His research interests are the empirical studies of economic and monetary integration, exchange rate policies, and intraindustry trade dynamics in East Asia. He has published his paper in the World Economy. He previously worked in Japan Bank for International Cooperation. Lei Song is Associate Professor and the head of Department of Political Economy at Peking University in China, and holds a Ph.D. in Economics from Nagoya University. Before returning to Beijing, he conducted postdoctoral research at Kyoto University from 2002 to 2004. His research interests range from the Japanese economy, political economy of innovation to strategic management. He is currently working on two book-length studies about Japanese economy and developmental strategy.

List of contributors xxiii Hironori Tohyama is Professor of Economics at Shizuoka University in Japan. He has published books and articles in the field of the comparative political economy. He is the author of For Analyzing Varieties of Capitalism: An Interaction between Institutions and Economic Performance, Nakanishiya Press, 2010. Hiroyasu Uemura is Professor of Economics at Yokohama National University in Japan. He published books and articles widely in the field of institutional economics and macroeconomic analysis. These include The Institutional Analysis of Socio-economic Systems: Beyond Marx and Keynes, Nagoya University Press, 2007. Hiroyuki Uni is Professor of Economics at the Graduate School, Kyoto University in Japan. His main fields of research are economics of structural, institutional and technological change, Marxian economics, andthe Japanese economy. His recent publications include Economics of Institution and Régulation, Nakanishiya, 2009. Jian Wang is Research Fellow of Economics at Southern Cross University in Australia, and holds a Ph.D. in Economics from Yokohama National Univeristy. His diverse research interests include international trade and foreign direct investment in Asia and economic impact assessment, as well as large-scale infrastructure provision and transport policy. Toshio Yamada is Professor of Economics at Kyushu Sangyo University and Professor Emeritus at Nagoya University in Japan. He is a contributor to régulation theory, i.e. a research program that analyzes how economic institutions evolve in the long run and define diverse contemporary brands of capitalism. He has published extensively on economic theories, Japanese capitalism, and the contemporary world economy. Chengnan Yan is Associate Professor of Economics at Fukushima University in Japan. He was awarded Ph.D. in Economics from Kyoto University. His main research fields are growth regime and institutional changes in China, empirical analysis on international impact of China’s economy growth and industrial development. Junho Yang is Associate Professor of Economics at the University of Incheon in Korea, head in Institute of Sustainable Development (in Korea), and former chief economist in SAMSUNG Economic Research Institute (SERI). His main fields of research are the economics of institutions and macroeconomic dynamics, social enterprise and social economy, and the North-East Asian economy.

Acknowledgements

The authors gratefully acknowledge financial support from the project “The evolving diversity of firms and the dynamism of the industrial systems in the East Asian economic integration” (No. 22530219), funded by the Japan Society for the Promotion of Science. We are also grateful to the Chinese Social Science Fund (10zd&022) for supporting the research presented in Chapter 7. This book is the result of international collaborative research that has been supported by many French, Japanese, Chinese, and Korean colleagues for more than 20 years. Since the publication of the book, Boyer, R. and Yamada, T. (eds) Japanese Capitalism in Crisis: A Régulationist Interpretation (Routledge 2000), this international collegial network has developed extensively and has thus led to various collaborations in which not only the Japanese but also the Chinese and Korean economies have been studied. A logical extension has been a study of the diversity and transformations of Asian forms of capitalism, as a whole. The publication of this book is the outcome of this long-term international cooperation. The authors wish to thank the participants of a number of international conferences at the École des Hautes Études en Sciences Sociales (EHESS), Kyoto University, Kyushu University, and Yokohama National University. Special thanks are also extended to the participants of the following conferences: Japanese Capitalism Evolving with Asian Economic Integration, Maison Franco-Japonaise and Yokohama National University, August 2008; Japan within Asian Integration: Assessing Recent Transformation, EHESS in Paris, July 2009; The Diversity of Asian Capitalisms: Korea, China and Japan, Yokohama National University, August 2009; and The Diversity and Transformations of Asian Capitalisms, Yokohama National University, August 2010. On many occasions, the contributors have received useful comments and helpful suggestions or ideas from Bruno Amable, Benjamin Coriat, Donatella Gatti, Frederick Guy, Yuichi Hasebe, Simona Iammarino, Atsushi Ikeda, Young-Yong Kim, Midori Kizaki, Henri Nadel, Kazuhiro Okuma, Pascal Petit, Robert Rowthorn, Kiyotaka Sato, Noriyuki Tokumaru, Kengo Uchihashi, Hiroki Yokota, other members of the European Association for Evolutionary Political Economy and the Japan Association for Evolutionary Economics, and anonymous referees. We are grateful for the interest they have shown, and would like to declare the usual caveat

Acknowledgements xxv that none of them is held responsible for the final content of the book, or for any errors that remain. We must also thank Jacqueline Jean sincerely, who has supported our international collaboration wholeheartedly since we started it at the Centre pour La Recherche Economique et ses Applications (CEPREMAP), Paris more than two decades ago.

Introduction Asia: a social laboratory of contemporary capitalisms? Robert Boyer, Hiroyasu Uemura, and Akinori Isogai

The remarkable reactivity and resilience of China, India, and Brazil in response to the world crisis generated by the burst of the American real estate subprime bubble seem to have convinced most analysts that contemporary societies are entering a new, albeit unchartered, epoch in the history of capitalism. Mainstream economics was found powerless to explain such a major event, since it had, to date, adhered to the vision of a self-regulated market economy, a situation in which, they believed, the very interests and rationality of actors would lead to a stable equilibrium, devoid of any crisis. This world economic crisis is also the expression of the collective failure of a scientific community and its market economy paradigm. The purpose of this book is to show that an alternative approach, previously elaborated in order to understand post-World War II western capitalisms and their respective crises, can be extended and thus can highlight the dynamics of East Asian economies, their process of regional economic integration, and their possible role in the evolution of international relations.

Unexpected crises and a new great transformation: a challenge addressed to economic theorizing Since the 1990s, most economists had been convinced that the collapse of Soviettype societies pointed to the uncontested superiority of free-market mechanisms. Thus, financial innovations and globalization were assumed, in no uncertain terms, to contribute positively to efficiencies in allocating capital, as well as to world economic and financial stability. In any case, modern economic policies, it was held, were so sophisticated that they could mitigate any risk of depression and major crisis. Furthermore, the remarkable performance of the American economy converted it into the canonical model of modern capitalism, which other societies should emulate, thus supporting the idea of a progressive convergence of and homogeneity among previously diverse forms of capitalism. Major events in the last two decades of the world economy have shown the limits of this vision.

2 R. Boyer, H. Uemura and A. Isogai 1 The collapse of Soviet-type regimes was expected to trigger the smooth and prompt emergence of markets that would replace the exhausted and inefficient Gosplan. Other mechanisms that were more primitive and unfair prevailed, and the so-called markets allowed more predation than wealth creation, à la Adam Smith. Free-market economists had to recognize that no theory existed vis-à-vis how markets emerge and need to be socially constructed. 2 The 1997 Asian crisis was a second episode that was misinterpreted by most economists: the culprit of that crisis was the archaism of domestic financial systems, whereas the financial liberalization of external capital accounts played a de facto key role. Since then, the recurrence of twin banking and exchangerate crises has convinced a growing proportion of economists that financial globalization might be the source of these dramatic episodes. 3 The bursting of the Internet bubble in the early 2000s delivered a warning about the dangers of overestimating the rationality of financial markets: virtually all actors have thought that the timescale of radical innovations could be shortened to that of financial transactions on the stock market. John Maynard Keynes’ analysis of the impatience of financial markets and their instability in dealing with uncertainty should have replaced the “efficient market” hypothesis. A second message was also delivered: major innovations do not trigger a smooth transition from one equilibrium to another and superior one; rather, they generate first a boom and then speculation that ends in a downward adjustment, in order to compensate for previous, excessive investment. After all, is not Joseph Schumpeter’s vision of creative destruction more relevant than contemporary endogenous growth theory? 4 The subprime crisis and its international diffusion can be interpreted as “revenge” resulting from misunderstandings of the 1997 Asian crisis. On one hand, the massive inflow of Asian (and European) savings into the United States has favored the real-estate bubble and the dangerous relaxation of household credit constraints. On the other hand, the very modernity of the American financial system, far from preventing the collapse, has made it more probable and severe. The belief in the self and in the optimal organization of finance is becoming more and more difficult to support. Hyman Minsky’s model, which provides some convincing mechanisms at the core of financial instability, is again in vogue, since it has proven more pertinent than dynamic stochastic general equilibrium models. Do those models not assume that meteoric external shocks, such as a fall in productivity, caused the present crisis? 5 The emergence of new capitalisms might well be the more influential structural transformation that will shape international relations, but it also represents a reassessment of previous development theories. Have not the most successful “emerging economies” violated many of the principles put forward by the Washington Consensus? Their governments have been prudent about opening to international finance, they maintained a form of public control over domestic credit, and they have vigorous public interventions in the domains of innovation and industrial policy. China, India, and Brazil are clear outliers with respect to the conventional conception of a canonical free-market economy. Should

Introduction: Asia 3 not Andrew Shonfield’s analysis (1965) of mixed economies – where public interventions organize the smooth functioning of markets – replace the market fundamentalism that has triumphed until the present crisis? The collective failure of the economic profession (notwithstanding the dissenting voices that were present, but remained unheard) can be traced back to a basic flaw: it has been developing a theory of equilibrium related to a pure-market economy, wherein rational agents fully understand their mutual relationships, since they operate in a completely invariant environment, devoid of any historical innovation and unintended consequence. The divergence with the structural transformations and crises of the last two decades is impressive: massive errors on the part of the best-informed actors, the recurrence of completely unanticipated crises, and radical uncertainty about medium- and long-term trends. The present epoch calls for an aggiornamento in economics that should take as its starting point the fact that capitalism is a permanently evolving, contradictory, crisis-prone, and diverse socioeconomic regime.

Régulation theory is an analysis of the transformations and diversity of capitalism Such a research agenda has been explored since the end of the 1970s by an international network of economists who agree upon some key basic concepts, adopt the same historical and comparative methodologies, and share a series of results (Boyer and Saillard 1995). 1 The viability of a capitalist economy depends upon the ability of five institutional forms (i.e., its degree of competition, its insertion into the world economy, the nature of its labor organization, its monetary/financial regime, and its society/state of relations) to coalesce into an accumulation regime, monitored by an adequate régulation mode. This can be applied to East Asian capitalisms that have developed their own institutional configurations, and they show specific hierarchies among institutional forms. 2 Since these institutional forms are largely the outcome of social and political struggles, rather than of a typically economic pure rationality, several brands of capitalism may emerge from nationally embedded trajectories. The task of the analyst is to detect these configurations, using any method or technique available in the socioeconomist’s toolkit. In particular, each Asian capitalism has its own history, so its pattern of development will show a strong path-dependence. 3 Capitalism does not exhibit such a thing as a “steady state” or a long-term stable equilibrium. Competition permanently pushes firms and individuals to be innovative vis-à-vis their products, techniques, organizations, and institutions. Consequently, the purpose of any régulationist research is to substantiate and then theorize the emergence, maturation, aging, and crisis of any development mode in the era of globalization. Asian capitalisms show very specific patterns of evolution, from development to crisis and, subsequently, institutional reconfiguration.

4 R. Boyer, H. Uemura and A. Isogai 4 The diversity of capitalism is a pioneering aspect in the régulation theory, which has emphasized the several types of capitalism in the world economy (Amable 2003). Even within the East Asian region, the diversity of capitalisms can be seen in terms of their different institutional arrangements, and Asian capitalisms can be classified into several groups. Therefore, there is a good opportunity to develop an extended taxonomy of capitalisms – one that includes Asian capitalisms: Japan, China, Korea, Taiwan, Singapore, Hong Kong, Thailand, Malaysia, Indonesia, and the Philippines.

East Asia is a challenging social laboratory It can be argued that the East Asian economies have been anticipating many of the contemporary problems of mature economies in North America and Europe. However, the realities in East Asia are somehow more complex – in fact, a new form of integration among the East Asian economies is currently underway. It is no longer possible simply to juxtapose analyses of national trajectories, since they tend to be more interdependent in trade and international production networks. 1 The Japanese Lost Decade, which started in 1991, is a testament to how difficult and time-consuming it is to exit a phase of overaccumulation and excessive private debt under the threat of deflation. Even the economic recovery observed after 2002 was not sufficiently strong to support this exit, and the economy fell into another structural crisis when it was hit by the subprime crisis in 2008. The Japanese economy has experienced major and complex institutional changes that call for fresh analyses. What are the factors that block the emergence of a new socioeconomic regime? 2 The 1997 Asian crisis serves as evidence of structural instability, wrought by a complete lack of regulation in international finance and by a brutal stop to capital inflows. This had a strong effect on most Asian national economies, but especially on those in Thailand, Indonesia, Malaysia, and Korea, influencing domestic economic structures in different ways. Conversely, the realities of the 1997 Asian crisis suggest that capital controls might be required to preserve some autonomy in domestic policy. Could those controls be used as a catalyst for more resilient modes of development not only in Asia but also in Latin America? 3 The Chinese reform strategy is very much different from that of Russia, which triggered a long-lasting and severe depression. A completely different sequencing of reforms has been compatible with rapid and rather steady growth, and has even promoted it. China was hit by the 1997 and 2008 crises, but its growth has been only modestly affected. What can we learn from the emergence of this paradoxical and dynamic form of Chinese capitalism? It is an invitation to extend the spectrum of institutionalized compromises that implicitly govern virtually any brand of capitalism. 4 The Korean transformation of its financial and employment systems following the Asian financial crisis shows the degree to which international economic

Introduction: Asia 5 relations influence domestic institutional configurations. Do globalization and financial innovations assist in the emergence of an alternative growth regime, or do they produce quite hybrid and fragile configurations? This is an invitation to study, again, the complex process that shapes the “way out” of major economic crises, an issue that has been investigated with respect to the interwar Great Depression. 5 Globalization was meant to define a new world regime that would stabilize international relations and promote development via inflows of capital from rich to poor countries. Clearly the Asian countries – not only Japan, China, and Korea but also the ASEAN countries – have benefitted from opening their economies to trade and productive capital flows, and they have built impressive manufacturing capacities by developing international economic relations. However, some caveats have emerged in the last decade. First, those economies have become more vulnerable to financial crises that were generated elsewhere, but which immediately transmitted worldwide. Second, Asian trade surpluses have been invested in the world financial markets; they have de facto fed consumption and bubbles in the richest economies, especially the United States. Therefore, paradoxically, those economies contributed indirectly to the subprime crisis! Third, the fact that East Asia has become the manufacturer of the world implies a divergence between export-led growth and the development of domestic markets while satisfying pressing social needs in terms of education, health, and elderly care. This is especially true in China. The present crisis questions the long-term viability of these trends and opens some room for a strategic reorientation at both the national and regional levels, since interdependence among East Asian economies has become stronger on account of increases in trade and foreign direct investment (FDI). Can the de facto East Asian economic integration continue without more explicit coordinating mechanisms and some sort of institutional breakthrough? The urgent task of political economists is to craft a vision and an analytical framework that is sufficiently rich to provide a parsimonious explanation of these stylized facts.

Mixing historical, comparative, and statistical analyses: a collective research The authors of this book more or less share a common starting point, that is, a historical and institutionalist approach to the transformations of modern capitalisms, which is represented by the régulation theory. Most of the authors have already worked together to capture the specificity of Japanese capitalism and the nature of its crisis in the 1990s (Boyer and Yamada 2000). Furthermore, they have analyzed both the institutional changes that took place in the Japanese economy in the 1990s and its incomplete economic recovery after 2002. Other scholars have used the same concepts and methods with regard to the Korean and Chinese trajectories.

6 R. Boyer, H. Uemura and A. Isogai Thus, this book is the first project to apply this broad research framework to the evolution of Asian capitalisms as observed since the 1990s and to extend it in order to capture the specificity of each national trajectory, for example, the Chinese one. Furthermore, the unfolding of the 2008 crisis reveals new features that call for a re-evaluation of previous taxonomies of capitalism. The authors discuss three main issues, and mobilize various methods for this purpose. 1 How have East Asian capitalisms evolved since the 1997 crisis, and how have they reacted to the subprime collapse? The task of the various historical analyses of each national economy is to capture invariant and permanent structures, as well as their transformations. Historical analyses are conducted through the use of both institutional and statistical methods. 2 Do East Asian capitalisms differ from American and European ones, and do they share the same configuration? Conversely, can a significant diversity of East Asian capitalisms be identified? Echoing previous investigations restricted to OECD economies, a cross-national analysis extends them to a larger sample that includes as many Asian economies as possible, given the availability of comparable qualitative and quantitative data. An econometric analysis and a comparative institutional analysis are conducted complementarily. 3 How interdependent have East Asian capitalisms become? They are dynamic entities that interact with one another, but it is also important to assess how international trade and FDI in the East Asian region have affected domestic production and specialization within each nation state. Thus, some chapters use Asian International Input–Output Tables to analyze the interdependence of and structural changes among East Asian capitalisms.

Evolution, diversity, and interdependence in East Asian capitalisms: a summary of the book’s content There is a feature common to all the chapters herein: the economic structures and their dynamism of the Japanese, Chinese, and Korean economies, or those of the East Asian economy as a whole, are analyzed thoroughly from an institutionalist perspective. The first part of the book considers changes in the core institutions and transformations in the Japanese growth regime since the 1970s, including those in the Lost Decade (i.e., during the 1990s); it proposes future prospects with regards to the growth regime. Toshio Yamada and Yasuro Hirano (Chapter 1) investigate how the post-World War II Japanese mode of régulation, which they label as companyist, has changed during the last two decades. Companyist régulation once rested on two main pillars: a labor–management compromise on employment security and a company–bank compromise on management security. They point out that not only has the former radically changed, but that the latter has also changed. The dysfunction of companyism expresses itself at the macro level, particularly in the formation of weak domestic demand. The development of medical and social services, as well as of environmental protection activities, could

Introduction: Asia 7 serve as alternatives to the previous pattern of demand. Meanwhile, conventional companyism, as an organizational form, is still expected to survive, especially in export-oriented large companies; that is, because it is essential for securing good economic performance, including large productivity gains. Therefore, Yamada and Hirano conclude that Japan may today need a new type of régulation that combines the elements of both companyism and associative régulation, thus generating a virtuous complementarity. Akinori Isogai (Chapter 2) presents some stylized facts on the transformation of the Japanese corporate system since the 1990s, and discusses the resulting emergence of new hybrid organizational forms. He outlines two major findings. One is that changes have not proceeded uniformly, as they have been occurring unevenly across different groups of firms; consequently, the Japanese corporate system shows a far greater heterogeneity than has previously been seen. The other finding is of the emergence of a hybrid firm called the “new J -type firm,” which combines shareholder-oriented management styles and long-term employment practices. Finally, he makes an assessment concerning the future potential of the new J -type firm, in response to the subprime crisis; he does so, from the viewpoint of a comparative historical analysis of institutional change. Sébastien Lechevalier (Chapter 3) investigates the increasing heterogeneity of Japanese firms in terms of organization and productivity performance during the Lost Decade (1991–2002). He explores whether technical progress, internationalization, macro-level fluctuations, and deregulation could possibly explain this phenomenon. He then investigates its consequences and focuses on rising inequalities in Japan that have resulted from this increasing dispersion of productivity at the firm level. This analysis concludes that companyism no longer accurately describes the mode of régulation in Japan. Finally, the author suggests some directions for future régulationist research on Japanese capitalism: for identifying the nature of the post-companyist mode of régulation, a political economy analysis of coordination forms seems to be particularly promising. Hironori Tohyama (Chapter 4) investigates how the recent institutional changes in the Japanese labor market have influenced welfare spending, social protection, or the welfare state in a broad sense. To answer this question, econometric models are specified in which economic risks, institutions, and welfare expenditures are interrelated. Based on the models, he explores the relationship between economic risks and welfare spending in 15 advanced economies over the period from 1984 to 2000. The findings are that globalization has a negative effect on welfare spending, that de-industrialization has a positive effect. The third and most important finding is that a workers’ demand for welfare spending and insurance-oriented institutions may be complementary. The author concludes that a less stringent employment protection legislation is likely to give workers an incentive to refrain from demanding expanded welfare spending. Consequently, the institutional change in Japan is likely to result in less social protection and expose workers to more economic risks. Hiroyuki Uni (Chapter 5) investigates rising income inequalities observed in Japan since the end of the 1990s. Using factor decomposition of micro-level data,

8 R. Boyer, H. Uemura and A. Isogai he examines the validity of the skill-biased technological change and outsourcing hypotheses, both of which are offered as explanations for the continued rise in wage inequality within each age group. Statistical analysis unambiguously concludes that these two hypotheses are invalid. Instead, the author advances the “wage institution view,” showing that since the end of the 1990s, the most important cause of rising income inequality in Japan has been reforms in the wage system, including the introduction of a performance-based wage system and the weakening of the spring labor offensive system. Hiroyasu Uemura (Chapter 6) conducts a macroeconomic analysis that takes into account institutional coordinating mechanisms to govern investment, labor productivity, wages, and international trade. He then investigates the transformations of the Japanese economy’s growth pattern and finds that during the 1990s and the first half of the 2000s, investment patterns have changed on account of financial liberalization and increasing Japanese FDI in other Asian countries. Furthermore, the coordinating mechanisms of wages and employment have become more market-oriented, and industrial structures have shifted to the high-tech manufacturing and service sectors. During the post-2002 recovery process, the Japanese economy has experienced a new growth pattern, but the companyist mode of régulation has progressively eroded. Therefore, when the Japanese economy was hit by the subprime crisis in 2008, it fell into another structural crisis. The second part of the book considers transformations within the core institutions and the growth regimes of the Chinese and Korean economies, in close relation to the economic crises and de facto East Asian economic integration – the latter of which is under the impulse of multinational corporations. The Chinese economy has grown very rapidly and has come to be seen as a central manufacturing factory, not only in the East Asian region, but also at the world level. Lei Song (Chapter 7) investigates the origins of China’s structural adjustments and finds that they arise from a discontinuity of capability building in the age of modularization and regional integration. Cooperation between multinationals and Chinese corporations contributes much to the expansion of Chinese production capacity, but production organization is likely to become locked in a “modularization trap.” Due to the clear overlap between product architecture and interorganizational architecture – and because of their variations across different industries – the possibility for Chinese corporations to improve their technological capabilities through transactions with multinational firms differs between the consumer electronics and software-outsourcing industries. Jian Wang, Shrestha Nagendra, and Hiroyasu Uemura (Chapter 8) analyze the increasing interdependence among the East Asian economies, and the effect therein of the activities of the Japanese multinational firms. Those activities are a driving force of economic integration for both the Chinese and Japanese economies; this has been confirmed through the analysis of Asian International Input–Output Tables. In particular, the electrical-machinery and transportationequipment industries show different patterns with regard to component transactions, and thus the effect of international production linkages on the Chinese and the Japanese economies differs between those two industries. Production

Introduction: Asia 9 means within Japanese electrical-machinery firms are modularizing rapidly, while those within transportation-equipment firms are still integrated. This feature of transportation-equipment firms induces a flow of intermediate goods exportation from Japan to China. Chengnan Yan (Chapter 9) examines changes in domestic and international linkage effects in the Chinese economy; he analyzes the main causes of change in linkages in China’s export-led growth regime through the use of Asian International Input–output Tables. After the 1990s, Chinese international linkages expanded, mainly on account of increases in intermediate-goods imports. The growth rate of imports from the East Asian economies – especially those of Japan and Korean – has outpaced that of total imports. This shows the specificity of contemporary East Asian economic integration. Furthermore, he finds sector differences that are dependent on the capabilities inherent in the domestic intermediate goods supply chain, from upstream to downstream industries in China. Robert Boyer (Chapter 10) argues that the highly specific sociopolitical compromise in China explains not only the success of its development strategy, but also its growing influence in the evolution of the world economy. Local-state corporatism has progressively transformed into a society-wide compromise: the acceptance of the monopoly of the Communist party in the political domain, in exchange for a permanent increase in living standards via rapid and steady growth. Competition is leading accumulation, and it has a hierarchical position over the wage–labor nexus; the state, meanwhile, is the conductor of the permanent reorganization of the public and private sectors. This macroeconomic regime is specific to China, and its asymmetric insertion into the world economy is a compensatory mechanism against domestic structural imbalances. China’s trade surplus has been quite instrumental in correcting a major disequilibrium in domestic income distribution. The Korean economy also grew rapidly in the 1980s; since then, however, it has experienced some major transformations, largely in response to pressures exerted by the globalization of the economy and the impact of successive crises. Wooseok Ok and Junho Yang (Chapter 11) analyze the dramatic institutional changes seen in the financial and employment systems in the Korean economy, following the 1997 crisis. Furthermore, they consider whether the emerging institutional forms reveal an internal coherence and could sustain a new growth regime. In particular, changes in financial institutions and corporate governance and the increasingly dual nature of the product and labor markets with income inequality in the postcrisis Korean economy are investigated thoroughly, in relation to the stability of that country’s growth regime. Hyungkee Kim (Chapter 12) argues that a régulationist perspective pinpoints five turning points within the Korean economy after 1962. However, two great transformations had the strongest impact on the economic structures of Korea. The first one comprises a series of shifts: from a dictatorship regime to a democratic regime, from an export-led regime to a variant of Fordism, and from flexibility/homogenization in the labor market to rigidity/segmentation. The 1997

10 R. Boyer, H. Uemura and A. Isogai financial crisis caused the second great transformation, which was characterized by a transitioning from a developmental state to a neo-liberalist state. The third part analyzes the diversity and dynamics of Asian capitalisms, both theoretically and empirically; it also considers the prospect of a currency union in East Asia. Yuji Harada and Hironori Tohyama (Chapter 13) thoroughly investigate the diversity of Asian capitalisms and the determining factors of that diversity, through the use of institutional and quantitative methods. In particular, they conduct a statistical analysis to identify the typology of Asian capitalisms, using Principal Component and Cluster Analyses. They point out that there are five groups of capitalisms in East Asia: City Capitalism (Singapore and Hong Kong), Insular Semi-agrarian Capitalism (Indonesia and the Philippines), Innovationled Capitalism (Japan, Korea, and Taiwan), Trade-led Industrializing Capitalism (Malaysia and Thailand), and Continental Mixed Capitalism (China). These Asian capitalisms have specific characteristics in terms of institutional configurations and economic performance; consequently, they have had different reactions to external shocks, especially in response to the 1997 and 2008 crises. Hiroshi Nishi (Chapter 14) examines the macroeconomic dynamics of an open economy, in light of the institutional hierarchy hypothesis, that is, that a particular institutional form imposes its logic on the whole of the institutional architecture, and thus shapes the nature of macroeconomic adjustments and, ultimately, performance. The author analyzes the related growth pattern, dynamic stability, and a determination of wage and employment using a dynamic model inspired by Keynes and Minsky. As the internationalization of trade and financial transactions deepens, economic growth is determined primarily by external and financial factors, and employment/wage becomes the variable of adjustment. This is an expression of the subordination of the wage–labor nexus to insertion into the world economy. The possibility of establishing a monetary union in East Asia became a very important topic following the Asian financial crisis. Hiroyuki Uni (Chapter 15) investigates some of the structural conditions for monetary integration that relate to productivity growth in the export-goods and non-tradable-goods sectors; he then tests whether they can be found in both East Asia and the European Union (EU). One of the necessary conditions for the long-term viability of monetary integration is that the relative prices of export goods among the member countries of that monetary union are not likely to change too much. Therefore, the author proposes to institutionalize, at a multilateral level, the stability of the Asian currencies; this is done through the enforcement of adequate rules, which are presently being individually pursued by the Asian countries. Se-Eun Jeong, Jacques Mazier, and Sophie Saglio (Chapter 16) show that considerable effort has been devoted in the 2000s to improving monetary and financial cooperation in the East Asian region. However, results have been limited, mainly due to political issues, especially the underlying competition between China and Japan. The current financial crisis has driven new interest in monetary cooperation at the regional level. Using a macroeconomic model of East Asian interdependencies, the authors show the advantage of preserving an adjustable exchange-rate

Introduction: Asia 11 regime in East Asia. They also compare the different forms of monetary regimes that can be considered for East Asia: the Asian Currency Unit, the common currency basket, and the yen bloc. However, obstacles remain as a deterrent, along with a lack of political project and China’s will to preserve its autonomy. The concluding chapter derives from these findings some theoretical implications to be examined in further research. How should inquiries into the dynamics of capitalism be rejuvenated, especially as it is conceived as an evolving socioeconomic regime capable of generating rather diverse configurations? What are the implications of the interdependency between domestic institutional transformations and the evolution of the international regime for both macroeconomic analysis and international relations theory? Under which conditions can an economic regional integration succeed – given the growing heterogeneity wrought by the legacy of the last three decades of globalization – without a set of collectively agreed-upon rules? In any case, this conclusion also develops more practical implications concerning the strategies by which the present crisis can be overcome. Have not East Asian countries experienced a whole spectrum of policies and reforms in response to the first episode of structural crisis regarding financial globalization, that is, the 1997 Asian crisis? Is the Japanese Lost Decade a curiosity, or does it point to a real danger that both the United States and most European countries now face? Economic and political leaders alike should seriously ponder the lessons that East Asia delivers.

Part I

Japanese capitalism: the companyism eroded by firms’ heterogeneity and the lack of new coordinating mechanisms

1 How has the Japanese mode of régulation changed? The whereabouts of companyism Toshio Yamada and Yasuro Hirano

Introduction It seems that the last decade of the twentieth century turned out to be a great turning point for both the world economy and the Japanese economy. Nevertheless, it cannot be denied that the two economies have not necessarily been on the same page. While Japan suffered from a long period of stagnation after the burst of the Bubble Economy, the world economy surged into the phase of globalization that was powered especially by the finance-led growth of the USA and the so-called export-led industrialization of China. The trend of globalization, though having experienced a sort of setback by the economic crisis that hit the world economy after the autumn of 2008, will still prevail. Today at the beginning of the twenty-first century, the Japanese economy is experiencing greater changes and faces various problems. We will explain them below from the viewpoint of the contemporary change in the mode of régulation, and then we will prospect a mode of régulation suited to today’s Japan. However, before this, we very briefly point out some new economic environments that form the background of the changes in the Japanese economy and Japan’s mode of régulation. First, we can refer to “globalization” itself. In East Asia, following the lead of the newly industrialized economies (NIEs) and the Association of South East Asian Nations (ASEAN) countries, China and India initiated their industrialization efforts and are experiencing high economic growth. In the fields of trade and investments, Japan is very dependent on Asian countries. This hints towards the emergence of multinational enterprises and intense international competition. This also increases the urgency of solving the environmental problems that will further intensify because of the increased industrialization and higher energy demand. Second, the current wave of globalization is led largely by the USA and as such, financial liberalization was imposed on all countries. Consequently, the influence of the financial sector or the stock market was high in all countries, and firms could not neglect these in their management practices. Japan is no exception to the influence of “financialization” or “finance-led capitalism.” The negative consequences of this phenomenon are manifested in many aspects: increasing number

16 T. Yamada and Y. Hirano and proportion of nonregular workers, low wages, increasing unemployment, retrenchment of welfare, uneasiness of life, society with increasing inequality, etc. Financialization results in a social crisis. However, at the same time, Japan has accumulated, though this is less known, massive foreign financial assets, and the surplus in its balance on income (mainly, returns from foreign investment) is higher than the surplus in its trade balance. In this regard, it can be said that Japan is a financial power. Third, we look at “the rise of the tertiary sector.” In Japan, there is a dire need to improve the medical and social services sectors, given the fact that Japanese society is the most rapidly aging society in the world. Further, if, tomorrow, Japan faces a severe shortage of labor because of its declining population, it will have to increase its investments in education and training in order to promote technological innovations and facilitate the establishment of a knowledge-based economy. The shift from a goods-centered economy to a services-centered one will be a necessary evolution in Japan. Thus, globalization, including the economic integration of East Asia, financialization under which labor is subordinated, and the shift to a service economy with active social services and educational sectors, have formed the background of the recent changes. Further, these factors will continue to determine the economic scenario in Japan.

Contemporary changes in companyist Régulation Companyist régulation hypothesis Highly hinted at in the discussion on Fordism in the French régulation theory, we once proposed a hypothesis of “companyist régulation” as a mode of régulation that has characterized the postwar Japanese economy (Yamada 2000; Hanada and Hirano 2000).1 We have stressed the importance of the concept of “companyism,” especially to understand the original mode of régulation in post-1970s Japan that has become an economic power on the back of her export-led growth regime.2 However, the severe stagnation of the 1990s and the economic crisis of 2008 saw several changes being made to companyist régulation. Before explaining the details of the recent changes, we first briefly summarize the essentials of our companyist régulation hypothesis. Companyist régulation rests on two main pillars: labor–management compromise around employment security and company–bank compromise around management security. With regard to labor–management compromise, what had led the remarkable economic growth of postwar Japan was an employment compromise: workers’ acceptance of unlimited duties versus the provision of employment security by the management. This is in sharp contrast to the case of the USA in the Golden Age where a growth regime of mass production – mass consumption was led by a Fordist compromise: workers’ acceptance of Taylorist limited jobs versus the provision of productivity indexed wages by the management. In Japan, on the contrary, what the workers, especially the regular male workers in large

The Japanese mode of régulation 17 firms, have most seriously demanded in exchange for their devotion and loyalty to their company, is not a wage increase, but employment security or employment continuation in the very company to which they actually belong. After a number of trials and errors, this requirement of workers was accepted by the management, and the so-called “lifetime employment” became a rule of the game or a social norm between the management and workers (cf. Yamada 2000: 21). However, for a steadier realization of the wage–labor nexus centered on employment security, it is indispensable to secure the continuation of the firm – management security. For this purpose, a firm would like to obtain, in its time of managerial hardship or crisis, various relief measures such as additional finance, favorable interest rates, and dispatched executives from banks. In exchange for these possible relief measures, the company would fix a particular bank as its preferential business partner and shareholder. This finance compromise leads to the corporate governance by the bank, and in this way, the continuation of the firm is secured. This is the so-called main bank system. The main bank system is thus a core compromise between the firm and the bank for the management security of the firm. In addition, the cross-shareholdings or the keiretsu system in enterprise groups and the “convoy system” between the banks and the government have similarly evolved to ensure that the stability and the continuation of Japanese firms’ management is guaranteed. In this way, both employment security in the wage–labor nexus and management security in the finance and interfirm relations, making one another an institutional complementarity, have formed the kernel of the companyist régulation.3 In fact, the Japanese economy especially in the period from the Oil Shocks to the Bubble Economy, became an “economic power” by creating an export-led regime of growth supported by companyist régulation, as is shown in Figure 1.1. Collapse of management security: marketization of finance Globalization, which originated in the USA in the 1980s, has placed, by establishing finance in an advantageous position over labor, immense pressure on the Japanese economy by means of financial liberalization. In the 1990s stagnant Japan, various economic policies aiming at financial deregulation and marketization were implemented, and thus the financial structure of the firm was definitively changed. This change also resulted in the breakdown of the conventional firm– bank nexus, interfirm nexus, and bank–government nexus that together constituted an important pillar of the companyist régulation. In other words, this change resulted in the collapse of the management security system of Japanese firms. Let us examine this more precisely. As is well known, one can point out the following facts as the distinctive features of corporate finance in postwar Japan (Itoh 1995; Nabeshima 2000): 1 The ratio of external funds to internal funds is large. 2 The borrowing ratio is large and the proportion of securities in the external funds is small.

18 T. Yamada and Y. Hirano Productivity

Export

Investment

Production (=Demand)

Employment

Companyist régulation (employment and finance compromises)

Figure 1.1 Export-led growth regime and companyist régulation.

3 Nevertheless, with time, the ratio of internal funds has increased. 4 After the 1980s, while large firms have increased their ratio of internal funds and decreased their borrowing ratio (the separation or estrangement of the large firm from the bank), small and medium-sized firms still have a financial structure centered on borrowings from banks. With regard to the large firm’s separation (or estrangement) from the bank, the ratio of borrowings to total assets in the case of large and middle-standing enterprises4 has fallen sharply in the 2000s after a slow declining trend before and during the 1990s (Cabinet Office 2008: 137).5 These facts clearly signify that, particularly for large enterprises, corporate finance has recently changed from indirect (borrowings from bank) to direct finance (stock and bond) and that corporate finance is now mainly market-based. At the same time, the structure of stock holdings has changed drastically since the 1990s (ibid.: 138). The share of stock held by financial institutions (city banks, regional banks, etc.) has fallen sharply since the second half of the 1990s. The weight of stock held by non-financial incorporated enterprises has also decreased. The decrease in the weight of stock held by banks can be attributed to the following causes: (a) pressures to sell stocks because of sluggish stock prices that lead to depreciated asset values, (b) the Bank for International Settlements (BIS) banking regulation, which requires an equity ratio of more than 8 percent, and (c) the introduction of current value-based accounting. Furthermore, it is the foreign individuals and entities, particularly foreign institutional investors, that have overwhelmingly raised their share of stock holdings; the ratio of stocks held by foreign investors in value terms has increased drastically from less than 5 percent in 1990 to more than 25 percent in the mid 2000s. These hint towards the loosening of the bond between the enterprise and the bank and therefore a declining function of corporate governance by the main bank. The large enterprise no longer

The Japanese mode of régulation 19 considers the bank as a source of finance and the bank has also lost its will and ability to monitor and relieve large enterprises. Here, we can confirm a breakdown of the main bank system. The ratio of stock cross-holdings among enterprises has also dropped since the 1990s (see Chapter 2). We refer to financial institutions and non-financial enterprises as “stable stockholders,” and observe that the percentage of stable holdings has dropped from 43 percent in 1991 to 26 percent in 2002. As the foreign stockholders, whose numbers are consistently increasing, are, in general, short-term holders who only expect high stock prices and high yields, Japanese enterprises are experiencing increasing pressure to give serious thought to short-term profits and stockholders’ interests and at the same time, are no longer financially and managerially stable. The protective banking policies of the government, i.e., the so-called convoy system, have also been abandoned. In this way, the system of bank-guaranteed security of firm management that was an important part of the companyist régulation is no longer in force. Non-regularization of employees and endurance of limited employment security Finance, which has now occupied a superior position under the new environment of globalization, has begun radically to change labor. In short, the above-mentioned marketization of finance has forced the conventional wage–labor nexus to be transformed radically. How did the collapse of management security affect employment security within the companyist régulation, that included complementarity between management security and employment security? The greatest changes in the wage–labor nexus in the last 10 years are the non-regularization of employees and the discontinuation or suspension of wage increases. With regard to the non-regularization of workers, the number and proportion of regular workers have declined continuously since 1997, while those of precarious non-regular workers have increased rapidly. In fact, while only one fifth of the workers were non-regular workers in the first half of the 1990s, by the year 2005, this figure had increased to one third (Cabinet Office 2006: Figure 3-1-1). In this regard, we can say that there has been a change in both the industrial structure (the share of the service industry where the proportion of non-regular workers has always been high is increasing) and the employment strategy (all industries including manufacturing industry are increasing the number and proportion of non-regular workers in their ranks). Moreover, while in the 1990s, the increase in the number of non-regular workers was observed mainly in small and medium-sized enterprises, in the 2000s, the same was mainly seen in large enterprises. Furthermore, among non-regular workers, although there has been no increase in the proportion of part-time workers with short working hours, the proportion of dispatched workers with regular working hours has increased (ibid.: Figure 3-1-3, Appended Figure 3-1). This fact signifies that regular workers are now being replaced by non-regular workers even in large enterprises which are at the center of the Japanese economy (Uni 2009:

20 T. Yamada and Y. Hirano Ch. 4). In addition, we observe that once an enterprise increased the proportion of non-regular workers in its ranks, it did not hire regular workers even in the recovery phase of 2002–7 (Cabinet Office 2007: 176). This hints towards an obvious structural change in the firm’s behavior and labor institutions in Japan. In short, at present, the non-regularization of employees has become one of the characteristics of the wage–labor nexus in Japan.6 Another great transformation of the wage–labor nexus in the last 10 years is the discontinuation of wage increases. We can easily understand that the nonregularization of employees and the discontinuation of wage increases occurs simultaneously, because the primary reason why firms hire non-regular workers is to reduce wage costs. Moreover, recently in Japan, the traditional seniority-order wage system has been transformed into a performance-based wage system, and it is clear that firms have introduced the performance-based wage system not only to improve the work incentives but also to curb personnel expenditure. In fact, in the recovery phases before 1999, the increase in ordinary profit was accompanied by an increase in wages. However, since the recovery of 1999, the increase in corporate profit is not accompanied by an increase in wages. Moreover, after the recovery of 2002, wages began to decrease even though corporate profits increased drastically. As a result, a certain proportional relation between labor productivity and real wages that characterized the Japanese economy before 1990 (not to speak of the Fordist era in the USA), completely disappeared (Figure 1.2). Now Japan has been transformed into an economy with zero wage increases regardless of whether or not there is an increase in productivity. We can state several reasons as to why this transformation occurred. First, Japanese companies began to adopt a new distributive policy favorable to stockholders because of their increasing pressure owing to the marketization of

Annual Growth Rate of Real Wages

5.0 4.0 1975-1990

3.0 2.0

1991-2005

1.0 0.0 -1.0 -2.0 -2.0

-1.0

0.0

1.0

2.0

3.0

Annual Growth Rate of Labour Productivity

Figure 1.2 Elasticity of real wages to labour productivity. Source: Cabinet Office (2007).

4.0

5.0

The Japanese mode of régulation 21 corporate finance. Second, companies reduced wage costs and added the savings to their retained earnings in order to guard themselves against fierce international competition and the collapse of the management security offered by the main bank. Third, during the long-lasting stagnation of the 1990s, workers began to prefer employment stability to wage hikes owing to an increase in job dismissals (ibid.: 220–1). Thus, we have confirmed the non-regularization of employees and discontinuity of wage increases as elements that have greatly transformed the conventional wage–labor nexus. What needs to be questioned is how these facts have changed the employment security of regular male workers in large companies that has formed the core element of the companyist wage–labor nexus. According to some investigations, Japanese enterprises, particularly large enterprises, have hitherto retained their core employees for long periods of time, and intend to continue this hereafter. In short, Japanese companies are going to retain their core workers for as long as possible. For example, when we refer to the length-of-service by generation for the manufacturing and construction industries where the ratio of regular workers is relatively high, it has hardly changed between 1997 and 2007 – the trend of retaining regular workers for long period of time has been continued in principle (Cabinet Office 2008: 138). With regard to the future, guesses can be made from the results of questionnaires submitted to personnel managers (Japan Institute for Labor Policy and Training (ed) 2005) and top-level managers (Japan Business Federation 2006). According to the former one, about 90 percent of the firms who replied expressed their willingness to continue the long-term retention of employees in the future. According to the latter, more than 80 percent of firms gave either of the following replies: “Continuing long-term retention of employees in the future” and “Continuing long-term employees, but at the same time, also intending to increase the proportion of part-timers, dispatched workers, etc.” During these 10 years, the proportion of regular workers has decreased sharply to the extent that they now constitute only two-thirds of the labor force. Particularly in large enterprises, the proportion of non-regular workers has increased remarkably in recent years. Thus, the regular workers in large enterprises have been carefully segregated and accordingly reduced. Nevertheless, companies still seek long-term retention of the remaining regular workers and have expressed their willingness to continue this in the future. We refer to this as “endurance of limited employment security.” Companyist régulation’s one-engined flight With regard to the employment scene in recent years, we have confirmed a parallel, or rather complementary, evolution of apparently contradictory phenomena: the non-regularization of employees and the endurance of limited employment security. As a result of the marketization of corporate finance and the collapse of management security centered around the main bank system (finance compromise), we observed, in the field of employment, the non-regularization of

22 T. Yamada and Y. Hirano employees and the limited application of employment security. Nevertheless, Japanese enterprises do have the intention to endure employment security for the remaining core workers. Thus, the wage–labor nexus in Japan has, though having experienced great changes in its employment and wage systems, maintained the conventional source of productivity gains as an endurance of limited employment security. Or, to use the expression of the White Paper for Health, Labor and Welfare, Japanese companies today aim at “maintaining the long-term employment of regular employees by altering their wage system into a performance-based one and by making use of non-regular workers like part-time and dispatched workers” (Ministry of Health, Labor and Welfare 2008: 51). In brief, with regard to companyist régulation, the institutionalized corporate finance system (main bank system) has been marketized (direct finance system), and the firm-guaranteed employment security system (employment compromise) has been reduced and marketized. In other words, what we see today is employment security without management security by the main bank and decreasing numbers of workers with employment security accompanied by increasing numbers of non-regular workers without employment security. In short, the collapse of management security with financial institutions has been more or less compensated by a new wage–labor nexus within companyist régulation. Companyist régulation now continues on a dangerous trajectory as only one of its engines is working; simply put, companyist régulation is now very much dysfunctional. Furthermore, we can state that the following are the types of socio-economic problem that Japan is experiencing today as a result of this dysfunction: (a) poor conditions of non-regular workers and increasing inequality, (b) defective welfare and life security systems faced with the repercussions of an aging society, and (c) a vicious circle between life uneasiness and inactive domestic demand.

Perspective of the Japanese mode of régulation As mentioned above, in recent years, companyist régulation, which has been responsible for the growth of the Japanese economy in the past few decades, is failing. As such, without reforms, Japan may plunge into an economic deadlock with increasing inequality and minimal economic growth. Consequently, a new mode of régulation needs to be developed to deal with these new socioeconomic problems. It is certainly very difficult to predict the type of régulation that will emerge, but it is possible to have a perspective if we analyze the present problems. We can therefore get a perspective on the future of the Japanese mode of régulation by analyzing the problems plaguing the growth regime and the current mode of régulation in Japan. Shift in growth regime The Japanese growth regime shifted from the investment-led type to the exportled type in the second half of the 1970s. This growth regime was driven by

The Japanese mode of régulation 23 increasing productivity in the export goods industry, restrained wage increases, and dollar overestimation (Uni 1998). The Japanese economy fell into a long phase of stagnation in the 1990s at the macroeconomic level. At the same time, however, large firms in the manufacturing sector began to show growth by 1995. While the annual per capita growth rate of real GDP in these firms was around 0.9 percent for 1990–4, the corresponding figure for the years 1995–2008 was 7.5 percent. On the contrary, small and medium-sized firms and large non-manufacturing firms registered negative growth rates (Mizuno 2007). If we replace the per capita growth rate by total growth rate, we find that the differentials between large manufacturing firms and the small- and medium-sized firms and large non-manufacturing firms have been increasing since 2002. Around this time, the Japanese economy registered slow growth at the macroeconomic level. The economic growth of the large firms was fuelled by the development of production networks with the Asian economies. During this period, the trade balance always showed a surplus up until 2007. This growth regime can be referred to as an export-led growth regime with heterogeneous structures and regional integration (see Chapter 6).7 However, from here onwards, things changed for the worse. The surplus in the trade balance suddenly declined in 2008 (Figure 1.3). This was, of course, a result of the decrease in foreign demand arising from the global crisis caused by the credit crunch in the USA. This fall in demand does not seem to be temporary because it is not certain that the world economy will recover soon from this depression. Furthermore, it is not certain whether or not from a more long-term perspective the export-led growth regime with heterogeneous structures and regional integration is sustainable. This is because there seems to have emerged a price revolution 18,000 16,000

billions of yen

14,000 12,000 10,000 8,000 6,000 4,000 trade balance balance on income

2,000

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

0

year

Figure 1.3 Balance of payments. Source: Ministry of Finance (2010).

24 T. Yamada and Y. Hirano under which the prices of manufactured products fall on the one hand and the prices of raw materials or foodstuffs rise on the other. If this price revolution occurs, it will break the present Japanese growth regime that imports raw materials or food and exports manufactured goods.8 Although the prices of materials such as petroleum fluctuated greatly before and after the credit crunch, the price will tend to rise in the long term. As the Brazil–Russia–India–China (BRIC) economies continue to grow, with increasing production they will demand more raw materials for their manufactured products and foodstuffs for their labor force. As this trend will be irreversible, the export-led growth regime may not be sustainable in the medium-to-long term. There are two ways in which Japan could cope with this trend: one is to increase the value of its exports and the other is to expand its domestic demand. These measures will lead to a shift in the growth regime. New technologies such as organic electroluminescent displays and fuel cells will prove to be useful in increasing the value of exports.9 Technologies/measures/policies necessary to increase domestic demand will be discussed later in this section. It is anyway necessary to transform the mode of régulation in order to create a new growth regime, because it is very difficult to expand domestic demand through companyist régulation, though it is very possible to develop new technologies through the same. How should the companyist régulation be transformed in order to cope with the new trend? Continuity and discontinuity of companyist régulation Throughout history, no new institutions have emerged by breaking their links with the past; further, institutions have usually been path-dependent. The same can be said for the mode of régulation. Therefore, the new mode of régulation should continue appropriately and discontinue the policies adopted under companyist régulation. What are the shifts in the Japanese growth regime that are needed to transform Japan’s mode of régulation? We examine the previously mentioned two measures – the expansion of domestic demand and the increase in value of exports – individually. We first examine the expansion of domestic demand. Areas that are in urgent need of development are the medical and social services sectors that cater for the elderly, education, and research sectors that form the basis of technological and cultural development and environmental conservation. We can also include food production, as food prices are expected to increase. In the medical and social services sectors, effective demand cannot be increased without a reform of the redistribution system of income. In this sector, in Japan, social insurance contribution and tax income are the main financial resources. Increasing these resources results in the immediate expansion of demand. Therefore, political will is critical to expand the domestic demand in the sector. Furthermore, there are many legal regulations in agriculture and food production; here, too, political will has to precede the formation of domestic demand.

The Japanese mode of régulation 25 However, such demand cannot be formed through companyist régulation because it is inherently devoid of any political coordination. In addition, the recent changes in companyist régulation make domestic demand less plausible than before: there is immense pressure on demand owing to the discontinuity of wage increases along with the non-regularization of workers. This further strengthens the necessity of income redistribution. The new mode of régulation, therefore, should include discontinuity of companyist régulation. Companyist régulation has not only excluded demand formation where political will is necessary but also abandoned demand formation to a great extent. With regard to environmental conservation, companyist régulation can be an exceptional problem solver. Legislation has accumulated experience on how to cope with environmental problems between the late 1960s and the 1970s when the anti-pollution movement was at its peak. In addition, after the two oil shocks of the 1970s, companies have developed technologies that enable them to economize energy and protect the natural environment. In retrospect, it is probable that legislative regulation creates domestic demand and that companies supply proper goods. This is the continuity of companyist régulation. We now examine the increase in the value of exports. Technological enhancements are often needed to increase the value of exports. Japanese firms are at the forefront of developing technologies, especially in the field of “integral production” where the product is interdependently created using all of its constituent parts rather than in the field of “modular production” where the product can be divided into some independent modules (Fujimoto 2004).10 Therefore, exporters will be able to increase the value of their goods. This indicates that some continuous elements of companyist régulation should be necessary for restructuring the mode of régulation.11 Building a new system for investment New factors have to be included in companyist régulation in order to ensure some continuity so as to make the present Japanese mode of régulation capable of coping with the new growth regime. First, political will is necessary to arrive at a decision with regard to the increase in the contribution of social insurance and tax income to fund improvements in medical and social services sectors. Second, the recognition of a diverse set of values not only including economic efficiency but also social welfare, human rights, environmental conservation, and autonomy of non-profit organizations is very important. Third, it is necessary to increase domestic demand. To increase domestic demand and supply, it is necessary to invest domestically as investment itself creates demand and increases production capability. The nature of investment almost entirely determines the sectors that will experience productivity gains and thus grow. Investment that leads to the creation of domestic demand is the industrial investment that creates domestic production. Demand for products produced by these

26 T. Yamada and Y. Hirano industries is both internal and external. Demand within the nation is referred to as domestic/internal demand. Such investment is plausible when both financial assets and investment-friendly systems exist. We now analyze these two factors separately. First, financial assets include national and foreign funds. Foreign funds flow into Japan in the form of investment in Japanese firms. These will continue as long as Japanese firms yield profits. However, profits cannot be guaranteed, given that we are witnessing an historical transformation. National funds include the financial assets of natural Japanese citizens and domestic firms. These funds will be the main resource of future investment if there can be developed a system that would advance such investment in Japan (Table 1.1). We therefore analyze the second factor with regard to its investment potential. If there is a system that can use national financial assets as national investment, stable domestic demand would be created, and Japanese firms’ production capabilities would be strengthened. However, such a system would not come about spontaneously. In fact, in the fiscal year 2007, when there was no drastic change in financial transactions,12 80 percent of the financial assets in households were in the form of “currency and deposits” and “insurance and pension reserves.” In financial institutions, 46 percent of the money was used for lending purpose, 29 percent for “securities other than shares,” and 6.4 percent for “foreign investments in securities.” On the contrary, only 5.6 percent of the money was used for domestic investment. This distribution of financial assets where the share of domestic investment was low indicates that the current system is not new-business friendly. On comparing Japan with the USA and European countries, we find that systems that promote investments in community businesses are few and lacking in Japan (Tanimoto ed. 2007). This further reduces the prospects of stable and increasing domestic demand. As such, there is a need for the reform of the system for investment. In the medical and social services sector, which is among the sectors that constitute domestic demand, political will with regard to the decision of increasing the contribution of social insurance and tax income as a whole is absolutely essential. However, this alone will not suffice; entrepreneurship is very much necessary. Such enterprises will be realized not only by private businesses but also by nonprofit organizations. Further, such enterprises would be small- or medium-sized and localized. Note that localized, small- and medium-sized enterprises can exist not only in the medical and social services sectors, but also in the fields of applied technology where companies collaborate with local research centers, food processing, and hospitality (restaurants) where local materials are used, green business, etc. To establish a domestic-demand-led growth regime, it is necessary to establish a financial system that supplies money to new community businesses. In this regard, we can refer to the community development financial institutions in the USA and the UK. These institutions provide money to community businesses via diverse channels. In the USA, the Community Reinvestment Act of

Source: Bank of Japan (2009).

Currency and deposit B Loan C Securities other than shares D Shares and other equities Da Of which: shares E Financial derivatives F Insurance and pension reserves G Trade credits H Foreign direct investment I Foreign investment in securities J Others Y Difference between financial assets and liabilities Z Total

A

Non-financial institutions 2

Household 4

Government 3

Non-profit organizations 5 6

Foreigners

16.7 13.3

4.6

(1.8) 1.0

46.0 29.1

5.6

(3.6) 1.0

6.0 7.0

6.5 0.1

100.0

6.4

4.3

100.0

100.0

27.0 3.4

(10.0) 0.2

23.5

4.1 4.0

22.0

0.2 0.3

14.1

43.0

6.6

100.0

7.0 −45.8

21.7

(39.4) 0.3

61.4

41.3 9.2

100.0

18.4

22.2

0.1

(3.8)

18.4

5.2 27.0

8.0

100.0

3.4 −92.0

0.0

3.4

36.2 148.6

100.0

0.1

0.5

27.5

(5.2) 0.0

8.2

0.0 7.3

52.9

100.0

0.7 73.7

3.6

0.0

21.8

100.0

1.8

(0.2)

0.2

7.4 49.0

41.2

100.0

4.5 64.7

31.4

100.0

9.1

0.7

(33.1) 6.1

33.1

27.6 21.1

1.9

100.0

12.6 −71.0

104.4

1.8 12.3

5.3

29.9

4.5

Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities

Financial institutions 1

Table 1.1 Structure of financial transactions. All sectors. Fiscal year 2007 (unit: %)

28 T. Yamada and Y. Hirano 1977 obliged financial institutions to finance local enterprises to a certain extent. Community development financial institutions function within this tradition. In the UK, the Community Investment Tax Relief was legislated. This piece of legislation offers tax discounts when individuals, enterprises, or banks finance or invest in community development financial institutions. It is necessary to establish such institutions in Japan in order to establish a new mode of régulation that supports domestic-demand-led growth. Besides, it is also necessary to finance big firms so that they can research and develop new technologies. However, the present financial system can give large firms the chance to be financed at this point, as these companies are successfully developing new technologies. Towards a new model of foreign investment One might doubt whether Japan can fund its imports if it shifts from the export-led growth regime. Japan is resource-scarce and also, its food self-sufficiency ratio is low. Consequently, Japan relies on imports for raw materials and food. So, how will Japan fund its imports if it does not export? We will now answer this final question. The basis for the answer lies in the fact that the surplus in the balance on income has exceeded the surplus in the trade balance since 2005. Balance on income mainly includes the payment and receipt of the return on investment. The return on investment is divided into two: return on direct investment and return on securities. In Japan’s case, the latter greatly exceeds the former. This is inevitable, given the financial transactions in Japan (Table 1.1). At the macroeconomic level, Japan can pay for its imports by the surplus in the balance on income (Figure 1.3). So, even if Japan exports a lot less, it does not mean that Japan cannot pay for its imports. Japan will ultimately be able to pay using the return on investment if it maintains its foreign investments. Japanese multinational firms are expanding their production networks with Asian economies. This trend will continue in the long term as Asian economies, including China and India, emerge as the drivers of future economic growth. The behavior of Japanese multinational firms will lead to increasing foreign investment even if Japan shifts from export-led growth to domestic-demand-led growth. From this perspective, Japan may develop a new model of foreign investment that attaches importance to real investment or to investment with technical tie-ups rather than to securities, which are highly preferred in the USA.

Concluding remarks As seen above, in Japan today, the management security system has collapsed and the employment security system has barely survived with several limitations with regard to its applications. Now, under the wave of globalization, financialization, and aging society, the dysfunction of companyism has resulted in many problems: 1 It will be difficult to continue the export-led growth regime, but at the same time the shift to a domestic-demand-led growth regime proves to be very difficult.

The Japanese mode of régulation 29 2 The demand and supply systems of the medical and social services sectors that are increasingly needed in an aging society have become insufficient. 3 The conditions of non-regular workers deteriorate and inequality increases even more. These are questions that cannot be addressed appropriately within the traditional framework of companyist régulation. Above all, we have shown that in the fields of medical services, social services, and environment protection that have the potential to create domestic demand, relatively small community businesses that enjoy close relations with the locals are essential and will prove to be very efficient. We have also stressed the necessity of a new financial system that will promote investment and financial activity in these fields. However, the most important thing that is needed to create a demandand-supply system in these fields is political will on the parts of both the central and the local governments. Along with political will, highly active non-profitable organizations or associations are also required. In this respect, it is essential that Japan not only develops institutions and movements (party politics centered on policies, a non-expensive election system, etc.) that will help to adapt political will to the social needs but also to facilitate the creation of various associations and their networks that will be in the forefront of the new economic régulation. At the same time, conventional companyist régulation, though becoming small, is still expected to survive for the time being, especially in export-oriented large companies, as it is essential for securing the productivity gains of these entities. Furthermore, the formation of a global production network starting from these large export-oriented companies will augment the return on investment in the future and thus emerge as an important source for the payment of imports. We need to promote export industries and the development of foreign investments to the extent that we can pay for imports. Large export-oriented companies will still be at the center of the productive networks with Asian economies which will play increasingly important roles. Thus far, companyism, though dwindling, continues to be a part of the Japanese mode of régulation for the time being. In short, in Japan, the negative consequences resulting from the collapse of conventional companyism need to be balanced by an extensive development of associative activities synchronized with political will. Furthermore, at the same time, the positive aspects of productivity increase will be maintained in the future. Today, we may need a new type of régulation that employs the elements of both companyist and associative régulations in a virtuous complementarity.

Notes 1 This hypothesis has won more than a little backing. (Cf. Boyer and Juillard 2000; Tohyama 2002; Boyer 2004b.) 2 “Companyism” as a mode of régulation in postwar Japanese economy in the narrow sense means a particular mode of régulation that is observed mainly in large firms. However, in the broad sense, it also refers to an entire mode of régulation observed in Japan, i.e., the

30 T. Yamada and Y. Hirano

3

4

5 6 7

8

9 10

11

12

capital–labor compromise and firm–bank compromise in and around large enterprises that is at the heart of the Japanese economy and emerged as a dominant social value in postwar Japan. Although it is very important to point out that this companyism that is focussed on large firms has formed a structural compatibility with its indispensable and complementary counterparts (subcontracted small- and medium-sized enterprises, precarious non-regular workers, etc.) and that it has formed a structural compatibility with these counterparts (Isogai et al. 2000), we focus, because of the above-mentioned reason, upon the mode of régulation as focused on the large company. Our concept of companyist régulation does not refer to the field of industrial relations alone, nor to the micro-level as an individual firm, but, more broadly, to the meso-level of national economy. However, for a full-fledged meso-level analysis, it will be necessary, in addition to an analysis of the wage–labor nexus and finance relations, to comprehend interfirm relations (including international relations, because they are nowadays inseparable from the intra-Asian division of labor) and governmental policies, without which we cannot offer a realistic assessment. Middle-standing enterprise is the term that refers to the more developed and expanded form of medium-sized enterprises that have emerged during the time of high economic growth. And here, large and middle-standing enterprise refers to enterprises with a capital base of more than 100 million yen. While the ratio of borrowings was nearly 40 percent in 1975, it has fallen to 34 percent in the 1990s, and to 26 percent in the first half of the 2000s. If we can refer to the main change in the financial sector as the “marketization of fund raising,” this non-regularization of employees can very well be referred to as “marketization of labor procurement.” The relation between the large firms and the small- and medium-sized firms can be characterized as that of growing sector and stagnant sector as is shown in the differentials of growth rates. But if multinational large firms strengthen production networks with Asian economies, a part of the small- and medium-sized firms will participate in these networks. This will be a new interfirm relation. The variation of terms of trade (= export price/import price) between 2002 and 2006 is shown as −32.1 percent in Japan, −22.8 percent in South Korea, −6.6 percent in USA, −3.8 percent in Germany, −0.2 percent in France, and 7.1 percent in the UK (Mizuno 2008). If the Japanese terms of trade fall continuously, it will be difficult for the Japanese economy to maintain a surplus on the balance of trade. Cultural goods (design, art, amusement, etc.) can be included. This does not mean technological determinism of the production organization. The determination of production organization depends directly on the choice of the production management. It could be technological in a sense. But it depends ultimately on the choice of buyers. In the market, they choose some products by ‘integral production’ or others by ‘modular production’ as they like. The production organization, therefore, must be socially determined in this sense. As for cultural goods (design, art, amusement, etc.), the valorization has been realized rather by creativity of individuals or non-profit collectivities than by companies. The continuity or discontinuity of companyist régulation depends on the relation of the company with such individuals or collectivities. It is not suitable here that we look at the fresh data of fiscal year 2008. Because there was drastic change in financial transactions caused by the credit crunch in this year, we do not take a representative example of distribution of monetary assets from them.

2 The transformation of the Japanese corporate system and the hierarchical nexus of institutions Akinori Isogai

Introduction During “the Lost Decade,” after the bursting of the bubble economy in Japan, the core features of the Japanese corporate system, such as the main bank system, stakeholder-oriented model of corporate governance, lifetime employment system, and supplier network, had faced strong pressures to change and had actually undergone significant changes. Even though the existing systems had changed, the question we have to ask here is “what,” “when,” and “how” they had changed. More concretely, what had actually changed and what had not? Were the methods of coping with such changes appropriate? If we could not provide a proper response to the changes that were occurring, why was it so? On the contrary, did we attempt to change things that did not really need to be changed? The purpose of this chapter is to answer a series of such questions both by presenting some stylized facts on the transformation of the Japanese corporate system since the 1990s and by discussing the emergence of the new hybrid organizational forms as a consequence of this transformation. The remainder of this chapter is organized as follows. We begin by sketching out the nature of the Japanese corporate system. We then show that institutional attributes of the Japanese corporate system began to convert their functions during the bubble economy period and subsequently, in the first half of the post-bubble economy period. The next section provides empirical findings demonstrating that the core elements of the Japanese corporate system have changed significantly since the banking crisis in 1997. We go on to examine specifically changes in the domains of finance and employment. We then discuss the new hybrid organizational forms called the “new J-type firm,” as a consequence of the transformation. The penultimate section investigates the future potential of the new J-type firms in the face of a new global financial crisis after autumn 2008. Finally, we summarize our findings and their implications.

What is the Japanese corporate system? The “Japanese firm as a system” and the “hierarchical market-firm nexus” As many scholars pointed out, Japanese firms had entered into the long-term and continuous relationships on the basis of labor, product, and monetary transactions.

32 A. Isogai Before the bubble economy period, Japanese firms had long-term and growthoriented management targets; and they also had such structural traits as continuity in employment, trading, and ownership relations. This continuity brought about behavioral traits that allowed the Japanese firms to accumulate management resources over long periods of time, and, in turn, to grow using these accumulated resources. It was in the so-called Japanese corporate system, in which the firms had been entering into relationships, that the above three traits had been mutually reinforced. These characteristics of the Japanese corporate system are thus strongly linked to the more expansive Japanese model of capitalism that is characterized by a high degree of firm-specific investment supported by complementary institutions. From this standpoint, “The Japanese Firm as a System” by Aoki (1994) presented a pioneering work on Japanese firms. In order to understand a firm as a “system,” the following two points are of special importance. First, we must pay particular attention to the mutual interdependence among the elements constituting the Japanese corporate system. This conception of institutional complementarity is central to this kind of discussion. Institutional complementarity is defined as “the existence or the particular form taken by an institution in one area reinforcing the presence, functioning, or efficiency of another institution in another area” (Amable 2003: 60). This conception has an important implication. An examination of the effects of isolated institutions can be misleading, and therefore, economic or corporate systems should not be considered only as a collection of random institutional forms, but also as a set of complementarity relations between these institutions. Second, there exists more than one stable corporate system. Once we accept the idea of institutional complementarity, we find that the search for the “one best way” of organizing industrial relations and corporate governance can be misleading. If we understand the Japanese corporate system as a set of mutually complementary elements, we can identify another corporate system with coherent internal relations between its constituting elements other than the Japanese one. Thus, each different economic system has been evolving along its own particular historical path, and instead of looking at them from the viewpoint of specialty or universality, we should consider them as one of the various types of economic system. Furthermore, when we use the term “Japanese corporate system,” needless to say, it does not cover all firms in Japan. At this point, we would like to highlight that the characteristics of the corporate system of the large firm sector are at the core of the Japanese economy, which was established during the high-growth period as “the Japanese corporate system.” According to the discussion advanced by Japanese régulationist (Yamada 2000, and see also Chapter 3 of this book by Lechevalier), there exists the concept of “companyist régulation” that indicates the mode of régulation peculiar to the postwar Japanese economy. This companyist régulation has sought the features of the postwar Japanese mode of régulation in the structure of internal organizations in the large firm and in the form of organizing industrial relations within them. It is, of course, true that we seek the core features of the postwar Japanese economy in the organizational structures of large firms. However, we

The Japanese corporate system 33

Globalization of Economy Pressures of Liberalization and Deregulation

Economy of Speed; Severe Pressures of Competition

Financial System

Technological System

Financialization; Shareholder-oriented Corporate Governance

Firm Organization

Hierarchically Segmented Labor Market

Hirarchically Inter-firm Relations

Figure 2.1 Extended Scheme of the Hierarchical Market-Firm Nexus.

should take into account the close linkage between the labor market and interfirm relations on the one hand and firm organization on the other in order to discuss in further detail the specific organizational structures of large firms and their behavioral attributes. From this point of view, we proposed the theory of the “Hierarchical Market–firm Nexus” as a framework to explore interrelationships among the institutions of the Japanese economic system and their transformation (Isogai et al. 2000). However, despite past successes, Japan has faced strong pressures to change the traditional corporate system. Therefore, taking into account the pressures from the development of globalization and the advent of new information technology industries, therefore, we must revise our preceding scheme of the hierarchical market–firm nexus. The extended scheme of the hierarchical market–firm nexus is illustrated in Figure 2.1. Thus, the discussion in this chapter is based on the extended scheme of the hierarchical market–firm nexus. Stylized facts of the Japanese corporate system and its functions The postwar Japanese firm has long been noted for its unique organizational features or attributes, which are vastly different from Anglo-American firms. The stylized features of the Japanese corporate system can be summarized as in Table 2.1. We would like to have some supplemental reviews concerning Table 2.1. Corporate grouping, cross-shareholding, and stable shareholding provided an

34 A. Isogai Table 2.1 Stylized features of the Japanese corporate system Behavioral attributes

Functions

Institutional features

Maximizing Market Shares

• Risk Sharing

Growth-oriented

• Mitegation of Short-term Pressures from the Stock Market • Maintaining the Continuity of Business Management • Internalization of External Economies or Social Costs

Corporate Grouping Cross Shareholding and Stable Shareholding Correspondence of Operating Officers to Directors in the Board

Long-term Orientation

• Mitegation of Asymmetric Information • Preventing Over-liquidation of Corporate Business

Long-term Employment Practice Keiretsu Main Bank System

Source: Miyajima (2002), p. 10.

institutional foundation for growth-oriented firm behavior. Cross-shareholding and stable shareholding precluded hostile takeovers that threatened management stability, which mitigated short-term pressures on corporate management from the stock market. Cross-shareholding among firms lowered transaction costs such as marketing costs to economize ex post facto, and contributed to the stable longterm and continuous relationships between firms. Meanwhile, the formation of corporate grouping based on cross-shareholding had the function of ex-post risk sharing. In this sense, corporate grouping was an “insurance mechanism” peculiar to the postwar Japanese economy, which made it possible for the group-affiliated firms to remain insulated from the imperatives of market forces. Moreover, the main bank system provided the institutional foundation for corporate growth. There is an asymmetry of information between fund lenders and borrowers, in the sense that lenders have a great deal of information concerning the future revenues of investment projects. The main banks played an important role in mitigating this asymmetry and promoting corporate capital investment. According to Aoki’s concept of “contingent governance” in a critical corporatevalue state, the main banks had to decide whether to bail out and restructure the counterparty firm at its own cost or to liquidate it. This method of dealing with underperforming firms was in strong contrast to the US method and this prevented the over-liquidation of corporate businesses. In Japanese firms, employees were important stakeholders in corporate governance, reflected in a long-term orientation and implicit norm of lifetime employment in larger firms. Large firms have been trying to hoard excess labor within their own organizations to the maximum extent possible even during the period

The Japanese corporate system 35 of severe recession. This labor hoarding could be regarded as a mechanism of the internalization of social costs induced by mass unemployment, which would otherwise force the society as a whole to bear the burden of such social costs. The institutional features illustrated above in Table 2.1 were gradually consolidated and were fully establishment during the period from the late 1950s to the early 1980s (see also Isogai et al. 2000).

Initiation of changes in the Japanese corporate system In the 1980s, the Japanese model of capitalism was deeply admired for its economic success, and the features of the Japanese firms with strong growth orientation and high economic efficiencies attracted a great deal of attention both inside and outside Japan. However, in retrospect, it could be said that the conversion of the functions of the Japanese corporate system began the period when they gained a high reputation. In what follows, we will focus on both the problem of overaccumulation or excessive investment and changes in corporate finance that have occurred in the period between the bubble period of the late 1980s and the post-bubble period of the early 1990s. Problems of overaccumulation or excessive investment In the 1980s, behavioral attributes in the Japanese corporate system displayed a tendency toward overaccumulation or excessive investment as a result of growth orientation. This is clear from Figure 2.2, which shows the trend in capital efficiency measured by return on assets (ROA). Both operating profit on assets % 9 Operating Profit on Asset

Ordinary Profit on Asset

8 7 6 5 4 3 2 1

Fiscal year

Figure 2.2 Trends in capital efficiencies (all industries: 1961–2008). Source: Ministry of Finance, Statistical Survey of Business Corporations.

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

1971

1969

1967

1965

1963

1961

0

36 A. Isogai and ordinary profit on assets started to decrease, and even during the late 1980s, when the investment boom had emerged, their level declined below that of the late 1970s. For example, it is a well-known fact that some Japanese automobile companies made huge capital investments, and these investments were transformed into excessive production capacities in the 1990s. Furthermore, in this same period, mature manufacturing firms, which had lost their business opportunities in core business areas, made attempts to diversify into unrelated business areas, and construction, real estate, and distribution industries also attempted excessive land investments and facilitated new store development. Moreover, why did institutional features of the Japanese corporate system, which had been growth-promoting up to the mid 1980s, induce overaccumulation or excessive investment? On the basis of previous studies, we can identify the following reasons for this transformation. The first is that under long-term employmentoriented management, distressed firms were forced to diversify into unrelated business areas from their core business areas in order to maintain the employment, and consequently business reconstruction that was actually necessary was delayed. The second is developed using the corporate growth model based on “the growth maximizing hypothesis” proposed by Marris (1964). As illustrated in Figure 2.3, as the domestic economic activities in Japan reached maturity, business opportunities for Japanese firms declined, which resulted in the downward shift of the “corporate value (v–g) frontier.” In Figure 2.3, the bell-shaped curve is the v–g frontier. Moreover, the ratio of the market value of the firm to the book value of capital is called the valuation ratio (v) or Tobin’s q, and g denotes corporate growth rate. In the late 1980s, Japanese firms began requiring a greater investment cost than before in order to maintain the same corporate growth rate. As a result, the

Valuation ratio (v)

v* v * – v1 v1

v * – v2

v– g1

v2

v– g2

0

g*

g1

Growth rate (g)

Figure 2.3 Downward shift of corporate value frontier and moral hazard.

The Japanese corporate system 37 negative effect on corporate value became stronger than before, and this could be understood as the reason for the downward shift of the v–g frontier. In case the chosen growth rate is the same (for example, g1 ) as before, the divergence between the interests of shareholders and those of corporate insiders widens as such from v ∗ –v1 to v ∗ –v2 . It was highly likely that shareholders viewed this divergence in a negative light, because it seems that unlike before, the managers committed moral hazards; that is, managers pursued the corporate growth at the cost of shareholders’ interests. Thus, this mechanism appears to be the cause behind the occurrence of overaccumulation or excessive investment in the 1980s. Changes in corporate finance During the latter half of the 1970s to the 1980s, deregulation and liberalization of finance had created significant changes in the financing behavior of Japanese firms. The financial deregulation in the 1980s allowed for a shift toward bond finance, enabling the substitution of direct financing via banks. After this period, it became clear that large firms in the manufacturing sector had tried to shake off their reliance on borrowing. Meanwhile, small- and medium-sized firms in the manufacturing and non-manufacturing sectors still remained highly reliant on borrowing. This can be observed in the trends in the capital structure of Japanese firms. As is clear from Figure 2.4 (manufacturing) and Figure 2.5 (nonmanufacturing), the capital–asset ratio in the manufacturing sector rose rapidly after 1975 and its resistance to reliance on borrowing became clear. In contrast, the debt–asset ratio in the non-manufacturing sector continued to rise, and the sector’s reliance on borrowing was sustained until the end of the 1990s. % 45 Debt-to-Asset Ratio

Capital-to-Asset Ratio

40 35 30 25

2008

2006

1992 1994 1996 1998 2000 2002 2004

1982 1984 1986 1988 1990

1980

1974 1976 1978

1970 1972

1966 1968

1960

15

1962 1964

20

Figure 2.4 Trends in capital–asset ratio and debt–asset ratio (manufacturing, all sizes). Source: Ministry of Finance, Statistical Survey of Business Corporations.

38 A. Isogai 55 Debt-to-Asset Ratio

Capital-to-Asset Ratio

50 45 40 35 30 25 20 15 2006 2008

2002 2004

1992 1994 1996 1998 2000

1988 1990

1986

1982 1984

1980

1974 1976 1978

1970 1972

1966 1968

1962 1964

1960

10

Figure 2.5 Trends in capital–asset ratio and debt–asset ratio (non-manufacturing, all sizes). Source: Ministry of Finance, Statistical Survey of Business Corporations.

Thus, the rise of the capital–asset ratio enabled the blue-chip firms in the manufacturing sector to implement investment activities without depending on bank borrowing. Meanwhile, the pool of counterparty firms deteriorated in the case of banks. As a result, banks were forced to comply even with loan requests that would have been rejected previously. In the 1990s, it became obvious that many business areas extended by the diversification during the bubble period had not produced the desired profits. In order to eschew the conversion of bank loans into nonperforming loans, Japanese banks hesitated to deal with nonperforming loans and delayed the problem of their disposal by offering additional financing. Obviously, the main bank system, which had not only precluded the overliquidation of the counterparty firms but had also contributed to the maintenance of the formation of firm-specific skills within the system during the high-growth period, reversed its function and resorted to excessively bailing out underperforming firms. Therefore, overaccumulation or excessive investment has been a problem in the late 1980s, along with additional financing by banks. Thus, during the bubble economy period and subsequently, the first half in of the post-bubble economy period, the institutional features of the Japanese corporate system, which had been valid in the past, became dysfunctional.

Turning point in the Japanese corporate system: the year 1997 Changes in the management targets of Japanese firms An urgent issue that demanded the Japanese firm’s immediate attention in the 1990s was the restoration of corporate profitability. In fact, some questionnaire

The Japanese corporate system 39 Table 2.2 Targets of management in Japanese firms (1980s and 1990s) Kagono et al. (1983) Market share Return on investment (ROI) New products Rationalization of production and logistics systems Rationalization of product portfolio Equity ratio Good societal image of corporation Improvement of working condition Rise of share price

1.43 1.24 1.06 0.71

(0.73) (2.43) (0.21) (0.46)

0.68

(0.50)

0.59 0.20

(0.38) (0.05)

0.09

(0.04)

0.02

(1.14)

Questionnairing conducted by Nikkei Newspaper Inc. (1993)

(%)

Rise of profit Stable employment and employees’ welfare Philanthropy and enhancing societal evaluation Rise of sales Market share Rise of dividend rate and the return to shareholders Others No answers

68.7 8.7 8.0 3.6 2.9 1.6 6.0 0.7

Note: The questionnairing in Kagono et al. (1983) was conducted to top 1,000 corporations in the US and Japan. Figures are the average of ranking scores (The point of the first rank is three, the second is two, the third is one, and others are zero). Figures in parentheses are the average of ranking scores of the US corporations. The questionnairing by Nikkei Newspaper Inc. (1993) was conducted for top managers of 450 Japanese listed corporations. These are the part of questionnaire results on “Growth and Management of Japanese Corporations”.

researches summarized in Table 2.2 suggest that the management target of Japanese firms had significantly changed in the 1990s as compared to the 1980s. For example, in the questionnaire survey conducted in Kagono et al. (1983) for the top 1,000 corporations in the USA and Japan, market share ranked first in the Japanese firms’ management targets. Japanese firms obviously had longterm and growth-oriented targets until the 1980s. By contrast, in the questionnaire conducted by Nikkei Newspaper Inc. (1993) for the top managers of 450 Japanese listed corporations, nearly 70 percent of the top managers answered that the first target was the profit increase, whereas only 3 percent answered that market share was important. These facts show that the long-lasting recession after the bubble burst caused a substantial change in the growth-oriented strategies of Japanese firms. Simultaneous evolutions in labor, product, and monetary transactions As Figure 2.6 shows, after the before-tax net profit reached its peak in c.1990, it repeatedly and rapidly decreased, and corporate profitability plunged, making the bankruptcies of banks and large firms into a reality. In this period, the selection and concentration of business areas, which means the reorganization of the vertical and horizontal boundaries of firms, became an urgent issue that Japanese firms had to address. The selection and concentration in a vertical direction leads to the shortening of the vertical boundaries of firms. This can result from a decrease in

40 A. Isogai Trillion yen 30 Manufacturing

Non-manufacturing

25 20 15 10 5

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

0

Fiscal year

Figure 2.6 Trends in before-tax net profit (1980–2006). Source: Ministry of Finance, Statistical Survey of Business Corporations, for each year.

in-house production benefits not only because of a decrease in coordination cost caused by the development of information communication technology (ICT) but also because of an increase in the availability of outside specialized companies. Meanwhile, selection and concentration in a horizontal direction leads to a situation in which firms focus on their main business’ areas while withdrawing from less related businesses or disposing them. We can easily imagine that a comprehensive implementation of selection and concentration will lessen the validity of keiretsu, which is characterized by long-term and continuous product transactions. In fact, this situation has occurred in the past. A typical example is the selection of parts suppliers by Nissan, which had reduced the number of suppliers from 1,145 companies in 2000 to 595 companies in 2002. On studying the pattern of transactions by small- and medium-sized manufacturing firms since the late 1990s, we can see that the number of clients grew more rapidly than sales. This fact suggests that the number of businesses with a small number of large-volume clients has declined and that their transactions have become more dispersed. In short, there has been a shift in focus to business relations, which requires businesses to be conducted with a wider clientele. This is the situation of the “increasing fluidity of the subcontracting transaction structure” pointed out by Isogai et al. (2000).1 Simultaneously, assembly and processing operations began to be moved overseas, especially in East Asia. This movement was led by large firms and triggered a chain reaction as small- and medium-sized firms involved in related processes followed in their wake, creating gaps in the division of labor in manufacturing operations within Japan. This is a consequence of the fact that an increasing number of small- and medium-sized firms have been aiming to optimize

The Japanese corporate system 41

Ratio of Stable Holding (All)

Ratio of Stable Holding (Financial Institution)

Ratio of Stable Holding (Business Corpotation)

50 45 40 35 30

% 25 20 15 10

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

0

1987

5

Figure 2.7 Trends in the proportion of stable shareholding (market price base: 1987– 2003). Source: NLI Research Institute, Survey on Cross Shareholding, 2003.

their production systems, both in Japan and abroad, in the pursuit of survival and growth as well as limited benefits in the form of reduced labor costs since the late 1990s. Next, the long-term and continuous relationship between firms and financial backers such as the main bank system and cross-shareholding had also significantly changed. In fact, the decay of the main bank system had become obvious after the burst bubble caused a hiatus in the governance of the Japanese corporate system as a whole. Furthermore, the structure of shareholding in Japan underwent an immense change by c.1995. The proportion of stable shareholding is defined as the ratio of the sum of cross-shareholdings plus shareholdings of financial institutions and shareholdings of financial institutions by business corporations and of listed parent companies to the total issued shares of the listed corporations. As Figure 2.7 shows, this proportion showed a definite decline in 1995, and continued to decline after 1999. In particular, the stable shareholdings of banks have dramatically declined from 15 percent in the early 1990s to 6 percent in 2003. Correspondingly, the internal attributes of Japanese firms, such as lifetime employment practices, seniority-based pay systems, a board of directors comprising only insiders, and remuneration systems that are nonsensitive to corporate performances, significantly changed. Thus, with the banking crisis of October 1997 as a turning point, each of the long-term and continuous

42 A. Isogai relationships concerning labor, product, and monetary transactions that characterized the Japanese corporate system, faced strong pressures to change and actually underwent significant changes. As we stated at the beginning of this chapter, we should examine the reasons for these changes. In what follows, we would like to emphasize that such changes have not proceeded uniformly, and they have been occurring unevenly among firms, among industries, and even within the same industry. This is a problem concerning the “heterogeneity” of firms (Boyer 2004c; Lechevalier 2007; Yokota 2009). Therefore, deregulation and liberalization under economic globalization and the rapid development of ICT will never lead to the flat world phenomenon; namely, their producing impacts are diversified by firms or industries and the resulting changes proceed unevenly.

The heterogeneity of firms and unevenness of changes In this section, in terms of the heterogeneity of firms, we will specifically examine changes that have occurred in the domains of finance and employment, especially since the mid 1990s. Decay of the main bank system The main bank system played a leading role in corporate governance and information production in corporate finance, and financial deregulation led to the decrease of the dependence of Japanese firms on bank borrowing. Financial deregulation in the 1980s allowed for a shift towards bond finance, enabling the substitution of direct financing via banks. In the 1990s, when financial deregulation proceeded further, blue-chip firms did not require relief insurance by the main bank system any more, and their dependence on financing by corporate bonds further intensified. The banks and firms in this situation almost had an arm’s-length relationship, and the weakness in the corporate governance by a main bank became obvious. However, it should be noted that the dependence of Japanese firms on the capital market was not proceeding straightforwardly in the 1990s. From 1997 to 1999, the ratio of bank borrowing in the debt composition of Japanese firms increased again, reflecting the deterioration of corporate profitability and rising risk after the bubble burst. However, this increase of bank dependence does not mean that the positive disciplinary role performed by a main bank had been rehabilitated. As many works have suggested, the following two conditions must be satisfied for a main bank’s disciplinary functioning to work effectively: that rents should be secured in the banking sector; and that the composition of finance in banks should be sound and the banks’ threats to liquidate their client companies must be credible. In the 1990s, it was obvious that these two conditions could no longer be maintained. Financial deregulation since the 1980s caused the first requisite to be lost, and the second was also undermined by the worsening problem of the nonperforming loans held by Japanese banks. Thus, during the banking crisis of 1997, a main bank could not perform the leading role in corporate finance and corporate governance that it had in the past.

The Japanese corporate system 43 Unwinding of cross-shareholdings As we have described earlier, the structure of shareholding in Japan, which had once been extremely stable, showed a definite decline on reaching 1995. Accordingto the Survey on the Situation of Stock Distribution conducted by the Tokyo Stock Exchange, the proportion of shareholding by banks decreased from 16.4 percent in 1990 to 3.7 percent in 2007, and this decrease particularly accelerated after the banking crisis of 1997. Meanwhile, foreign investors owned 25.5 percent of stocks listed on the Tokyo Stock Exchange in 2007, compared to 4.2 percent in 1990. The traditional management style of Japanese firms, which had been to attempt to preclude pressures from shareholders on corporate management as much as possible by organizing stable shareholders or cross-shareholdings, was distinctly pressurized to transform from the mid 1990s. However, it should be noted here that the unwinding of cross-shareholdings also proceeded unevenly. Since the banking crisis of 1997, it is said that banks developed a tendency to avoid selling off their owned shares in client enterprises with which they had close ties in terms of bank borrowings; however, they were inclined to sell shares in enterprises whose profitability was expected to be high. In this regard, detailed analysis has been conducted by Miyajima et al. (2003). They found the following facts. Banks sell-off their shares in enterprises whose profitability is extremely low or relatively high; the banks’ borrowings decline, and the enterprises proceed to sell-off the relevant banks’ shares held by them. On the contrary, banks continue to hold shares in enterprises whose profitability is moderately low; the dependence on the bank borrowing of these enterprises is still high, and the enterprises’ inclination to sell-off the relevant banks’ shares held by them is low. Thus, in cases where cross-shareholdings exist between banks and firms, a polarized situation emerged; the unwinding of cross-shareholdings proceeded rapidly among some groups of firms while cross-shareholdings have been maintained among others. Incremental changes of employment systems Several factors such as the change from main bank-based indirect finance to capital market-based direct finance, the unwinding of stable shareholders and cross-shareholdings, and sharp increase in foreign investors pressurized Japanese firms to shift into the shareholder-oriented corporate governance. As is clear from Figure 2.8 (also from Figure 2.6), Japanese firms, particularly large firms in the manufacturing sector, accomplished the V-shape restoration of corporate profitability on reaching 2001; however, at the same time, dividends as well as internal reserves increased sharply. By contrast, wage share continued to decrease since 2001. Thus, in large Japanese firms, there has been a steady movement for the governance of shareholder value. Thus, the pressures of shortterm adjustment on wages and employment will be intensified further, provided that for the current term, shareholders’ returns are prioritized in governance for shareholder value over varying corporate profitability. As for wages, it has been proposed that it is necessary to change the seniority-based wage system or to

44 A. Isogai

Bonuses to Directors

Dividens

Rate of Net Profit (Left-side Scale)

% 5

Reserves

Wage Share (Right-side Scale)

4

% 80 75

3 70

2 1

65

0

60

–1 55

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

–3

1980

–2

50

FIscal Year

Figure 2.8 Trends in the rate of net profit (manufacturing, one billion and over). Note: Wages share is defined for all industries and all sizes. (Gross) Wage Share = Personell expense/(Personell expense + Operating profit + Depreciation) × 100. Personell expense = Employee salary + Director Salary. Source: The Ministry of Finance, Statical Survey of Business Corporations.

make wage costs more flexible. As for employment, it has been proposed that it is necessary to make employment adjustment more flexible by expanding nonregular employment or to make the dismissal rules more flexible. Adopting these measures would finally result in the discontinuance of the long-term employment practices. However, such a short-term adjustment in employment did not spread instantly throughout Japanese firms, nor have the long-term employment practices been abandoned (Miyamoto 2007; Jackson 2007). Some articles report the questionnaire result that more than 80 percent of Japanese firms are still maintaining long-term employment practices. Representative examples of this include such as Toyota and Canon. The norm of lifetime employment has remained robust in large firms, although the number of regular workers has gradually decreased since 1998. Meanwhile, the number of non-regular workers has consistently increased from the 1990s to the present. According to a survey examining firms’ preference to expand non-regular employment, the reasons of most of the firms in every industry are the reduction of wage costs. Some 80 percent of the firms in manufacturing, more than 90 percent in wholesale, retailing, and restaurant businesses, and more than 90 percent

The Japanese corporate system 45 in the service industry state this reason. Meanwhile, as for employment adjustment of the regular workers in large firms, it is highly likely that the large firms have been seeking to maintain the employment of these workers by transferring them to group companies. For example, in the case of NEC, which announced large-scale restructuring of employment in 1999, the number of employees on an unconsolidated basis decreased from 35,000 persons in 2000 to 23,000 persons in 2004. Meanwhile, the number of employees on a consolidated basis decreased from 150,000 persons in 2000 to 148,000 persons in 2004. Therefore, it seems that many large firms have maintained the long-term employment to the extent possible, utilizing the so-called “quasi internal labor market” among group-affiliated firms in the corporate group. In this way they have incrementally adapted to the changing economic environment. Contrary to the continued commitment to lifetime employment, the payment systems have changed significantly. Most of the firms have adopted the pay-forperformance system. This system’s aims are to attempt personnel cost-cutting through the utilization of non-regular workers on the one hand, and to attempt the improvement of individual workers’ performance on the other. Many questionnaire surveys have revealed that the introduction of the pay-for-performance system has begun to be steadily adopted.2 Furthermore, wage negotiation systems have also made a major shift since the late 1990s. Shunto, literally, “spring offensive,” which had worked quite well as the mechanism for equalizing wage increases on a nationwide and industry-wide scale, has significantly changed in the mid 1990s. It was from the year 1997 onward that Schunto lost its substance, and that its dysfunction became obvious. Figure 2.9 clearly demonstrates this. A gradual increase in the dispersion of wage settlements occurred in the 1990s, with a marked jump in the dispersion index since 1998. In the 2000s, therefore, Shunto was transformed into a quiet negotiating table in the name of labor–management cooperation for wage decreases and the maintenance of employment.3 Varieties of corporate governance reforms Since the late 1990s, when the decay of the main bank system had become obvious, Japanese firms started voluntarily to reform their business organizations. At the same time, corporate law reforms were implemented by the government in rapid succession. The first was the lifting of the holding company ban by the amendment to the Antimonopoly Act in 1997. The government has since implemented an amendment to the Commercial Code in stages. The amendment to the Commercial Code in 2002 introduced the American-style board of directors, called the “board with committees” as a second option alongside the traditional Japanese-style board with statutory auditors. Not many firms have adopted to the board with committees. In the manufacturing industry, firms in the electric machinery and electronics sectors with a larger share of overseas operations and many foreign shareholders selected the board with committees; in other industries, firms in the finance, securities, distribution service, leasing, and software development sectors also selected this type. In contrast, most other firms in the

46 A. Isogai 0. 7 Wage Level

Wage Increase

0. 6 0. 5 0. 4 0. 3 0. 2 0. 1 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

0. 0

Figure 2.9 Dispersion in Shunto Wage Settlements (1971–2000). Note: The 4th quartile dispersion index = (The 3rd quartile – The 1st quartile)/(2 × median). Source: The Ministry of Labour, Survey on Wage Increase, various years.

manufacturing industry selected the traditional board with statutory auditors, and under this condition, they are proceeding with the shareholder-oriented corporate governance reform. However, what both these boards had in common was the aim to separate day-to-day management and monitoring. In short, this made the board of director position a real seat for decision making, and simultaneously, promoted the acceleration of the decision-making process by limiting the number of board members. This type of reform was called the “executive officer system,” which has now been introduced by many publicly held companies. Thus, the past malfunctioning of corporate governance did not force Japanese firms immediately to shift to the American style of corporate governance; nor was the situation viewed as being inevitable. In this case, not only does there exist diversity in different systems coexisting within industries but also diversity in the form of different firms within the same industry. Lastly, Table 2.3 summaries the above discussions regarding the transformation of the Japanese corporate system after the banking crisis in 1997.

New hybridization between finance and employment Emergence of the hybrid firm The driving force behind the transformation of the Japanese corporate system was the significant changes in the domain of finance. The various corporate governance reforms began from here, and these reforms reflected pressures toward the pursuit of shareholder values and shareholder-oriented management. Such reforms, however, had not radically shifted the Japanese firms to the American style of corporate governance with the introduction of directors and stock options from outside

Institutional Complementarity

Decay

Main bank system

Unwinding, but, unequal development among firms

Functional deterioration of Shunto After the latter half of 90s: Debacle of wage coordination mechanism among industries and firms

Shunto as the mechanism of equalizing wage increases on a Nationwide and Industry-wide Scale

Cross-shareholding and stable shareholding

Prospect to formation of industry-specific skill is indeterminate

Maintenance of long-term employment by incremental adaptation, but, development of non-regularization of employment

Formation of firm-specific skill by in-house training system

Mutual Complementarity Relations

Introduction of pay-for-performance, but, various variants

Combination of seniority wage system and internal promotion system

Long-term employment practice

Transformation after 1997

Traditional Japanese Corporate System

Table 2.3 Transformation of the Japanese corporate system: summing up

Employment

Finance

48 A. Isogai Abandoning lifetime employment

Declining J-type Firm (12.2%)

A-type Firm (18.2%)

Not introducing pay for performance

Introducing pay for performance

New J-type Firm

(Traditional) J-type Firm (30.0%)

(39.7%)

Continued commitment to lifetime employment

Figure 2.10 Four Patterns of HRMs. Note: Numbers in brankets are the proportion of all answering firms (1280 firms) to questionnairing conducted by JILPT in 2005. Source: Author’s own adaptation from Miyamoto (2007).

the firm, because changes to the internal aspects of the corporate governance of Japanese firms had been more partial and more selective, depending on the firms’ various organizational factors. Similarly, the impacts of the various corporate governance reforms on the domain of employment were also diversified. There are some informative studies by Aoki et al. (2007), Jackson (2009), Miyajima (2009), Miyajima and Kasai (2010), and Miyamoto (2007) in this regard. We will pay special attention to Miyamoto (2007), in which he finds four patterns of the impacts of various corporate governance reforms on the domain of employment, as illustrated in Figure 2.10. Firms in the third quadrant are traditional Japanese-type firms. Traditional Jtype firms have thus been bifurcating into new J-type firms in the fourth quadrant and A-type firms in the first one. New J-type firms are mainly in the form of large-sized and blue-chip firms. Their recent business performances are relatively good, and these firms are distinguishable from the existing J-type firms in their strength of shareholder-oriented management. However, the shareholder-oriented management does not necessarily mean the abandonment of long-term employment practices. The new J-type firms, however, are realized with the introduction of the pay-for-performance system in order to maintain long-term employment practices, while their coverage firmly decreases in size. The A-type firms also strengthen the shareholder-oriented management and are, by contrast, distinguished from the traditional J-type firms in being forced to abandon long-term employment practices.

The Japanese corporate system 49 It could be said that the processes of the new J-type firms have emerged as those with incremental changes in the traditional Japanese corporate system. These incremental changes involve the processes of “institutional layering” (Mahoney and Thelen 2010; Thelen 2003, 2009, 2010) that works within the existing system by adding new rules on top of or alongside the old ones. In this sense, the emerging J-type firms are new hybrid organizational forms that consist of a combination of new and old elements. Two puzzling questions on the new J-type firms We can instantly raise two questions on the future or potential of the new J-type firms. The first question is whether this new hybrid organizational form can be sustained over a long period, or whether such a hybrid model represents only a transitional stage toward a more complete market-oriented model. The other is regarding the future of Japanese employment systems. Namely, under the institutional arrangements of the new J-type firms, will the traditional arrangement of the long-term formation of skill and competence on the basis of the in-house training system be sustained, or will the highly functional linkage between industrial relations, skill formation, and the productivity growth be likewise sustained?

The potential of new J-type firms: a more fundamental consideration The financial crisis caused by the subprime mortgage fiasco in the USA since the middle of 2007 exposed the limit of the business model driven by maximizing shareholder value. This crisis has caused a worldwide depression, immediately affecting the world economy. The economic recovery during the period 2002–7 in Japan has been led by business investment and export growth. Business investment has accounted for almost 40 percent of the rise in output during the five years since 2002, owing to an annual growth rate of more than 5 percent. The acceleration in export growth from less than 4 percent at the beginning of the decade in 1992 to nearly 10 percent during the five years until 2007 has boosted corporate profitability and created demand for additional capacity. Exports have been sustained by Japan’s increasing integration with Asian economies, which have accounted for more than half of Japan’s export growth during this expansion. In addition, the significant depreciation of the yen between 2005 and mid 2007 has supported export growth. In sum, the external sector has accounted for about one-third of the increased output during this recovery. However, after autumn 2008, the five-year run of expansion had eventually ended, and corporate profitability as well as business investment in the manufacturing industry plummeted (see Chapter 6 of this book by Uemura). Moreover, exports as well as industrial production decreased by c.40 percent in early 2009. In addition, as Figure 2.11 shows, the earning structure in the large firms of the manufacturing industry rapidly deteriorated from the end of 2008 to early 2009. In order to improve the earning structure, firms have had to either curtail fixed costs, reduce variable costs, or increase sales.

50 A. Isogai

Non-Manufacturing (One Billion and over)

Manufacturing (One Billion and over)

120 110 100 90 % 80 70 60 2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

50

Figure 2.11 Trends in the ratio of breakeven points (1990Q1–2009Q4). Note: Ratio of break-even point = {Fixed cost/(1 – Ratio of valuable cost)}/Sales × 100. Source: Ministry of Finance, Statistical Survey of Business Corporations.

Now, after the global financial crisis of 2008, in which direction will the transformation of the Japanese corporate system head? Each country will probably again adopt the policy of intensifying the regulation of financial markets. As a result, the pressures on corporate governance to prioritize maximization of shareholder values may be weakened. However, the long-term trend of the financialization of the economy since the 1980s will not be reversed. The trend in the proportion of shareholders by owners in Japan will also not revert to the state prior to the mid 1990s. It is thus unlikely that there will be no pressures on corporate management from shareholders, especially foreign investors. In what follows, seeking possible answers to the questions posed in “Two puzzling questions on the new J-type firms,” we will deal with the question of the direction that the transformation of the Japanese corporate system will take. The stance of the management in Japanese firms, which aims at controlling the increase in wage costs, will probably be continued or be further intensified, because this financial crisis has caused the rapid deterioration of the earning structure in large firms within the manufacturing sector to become a reality. This stance of the management has encouraged export-oriented firms facing a significant decline in sales, such as Toyota and Canon, to implement the prompt adjustment of employment in parallel with prompt production adjustment. This has resulted in the occurrence of the issue of “laid-off temporary workers (haken-giri)” such as the nonrenewal of a contract and the termination of a contract during the contract period at the end of 2008. Thus, the corporate behavior and corporate strategy of new J-type firms as

The Japanese corporate system 51 the hybrid model may promote the greater use of temporary workers in the name of greater numerical flexibility and wage cost reduction. In that case, can we even understand the laid-off temporary workers issue as an event displaying the instability of the new J-type firms as the hybrid model that has emerged exclusively in the employment or labor-market domain? This question raises a more fundamental, interesting point. It is the problem of how we understand institutional change under institutional arrangements that have caused the emergence of a hybrid organizational form such as the new J-type firm, rather than the manner in which we should approach the mechanism of institutional change itself. According to Deeg (2005, 2009), there are two basic approaches to institutional change, namely, “the equilibrium-functionalist approach” and “the historicalpolitical approach.” The former approach regards institutions as the self-enforcing equilibria that change as a result of exogenous shocks. This approach views institutional change as occurring through breakdown and replacement (“punctuated equilibrium” view). The latter approach regards institutions as continuously evolving in nontrivial ways. Thus, institutional equilibrium is not a normal state but an exception to the rule, which is the idea that has always been continuously articulated by the régulationist school. Regarding institutional change, this approach says that in many cases, smaller or gradual changes add up to major institutional transformation over time. In this chapter, we share perspectives on the latter approach, and pay special attention to contributions on institutional changes through comparative historical analysis.

Table 2.4 Types of institutional change Result of Change

Process of Change Incremental Abrupt

Continuity

Discontinuity

Reproduction by Adaptation Survival and Return

Gradual Transformation Breakdown and Replacement

Source: Streeck and Thelen (2005), p. 9.

Table 2.5 Types of gradual change

Removal of old rules Neglect of old rules Changed impact/enactment of old rules Introduction of new rules

Displacement

Layering

Drift

Conversion



× × ×

×  

× × 





×

×

Note:  indicates “Yes”. × indicates “No”. Source: Mahoney and Thelen (2010), p. 16.

52 A. Isogai Table 2.4, which was advanced by Streeck and Thelen (2005), shows four types of institutional change. Streeck and Thelen argue that the type of change with which we can properly conceptualize current developments in the capitalist economy is “gradual transformation.” In the work of Mahoney and Thelen (2010), four types of gradual change are proposed, as illustrated in Table 2.5. “Displacement,” “layering,” and “conversion” are important for us in the present context of the Japanese economy since the banking crisis in 1997 that caused the emergence of new J-type firms. Displacement occurs when existing rules are replaced by new ones. Layering is present when new rules are attached to existing ones, thereby changing the ways in which the original rules structure behavior. This does not introduce wholly new institutions or rules; rather, it involves amendments, revisions, or additions to existing rules. Layering can bring a substantial change if amendments alter the logic of the institution or compromise the stable reproduction of the original “core.” Meanwhile, conversion occurs when rules remain formally the same but are interpreted and enacted in new ways (Mahoney and Thelen 2010). Pieterse (1994) refers to hybridization as the “innovative recombination of elements,” but, laying aside the question of whether hybridization is innovative, the new J-type firm involves a combination of elements from the old Japanese model and the new and more Anglo-American practices. Japanese firms are adopting more diverse forms of finance, but still remaining homogeneous in terms of their employment pattern. Nevertheless, this naturally leads to more diversity between institutional domains; that is, the diversity may persist during the process of hybridization. The degree to which this diversity persists depends on how new and old rules or institutions are related to each other. This is equally true of the process of institutional layering. The likelihood that the layering of new and old institutions would depend on the degree of institutional diversity within a system persists over a long time without triggering a displacement of the old by the new. Further, using both the conceptions of conversion and layering, we will consider the labor market diversity since the late 1990s.4 As we have already stated, the dispersion of Shunto wage settlements have gradually increased in the 1990s, and the dispersion index has shown a marked increase since 1998 (see Figure 2.9). Figure 2.12 summarizes the results from another survey conducted by the Ministry of Health, Labor, and Welfare. It shows that the importance of “corporate performance” (i.e., the ability to pay) has gradually increased since 1992, while that of “social norm” (i.e., setting wages according to the going rate that is considered socially acceptable) has declined since the early 1990s. A comparison of Figure 2.9 and Figure 2.12 suggests a slow process of “conversion” of Shunto. Obviously, Shunto has converted its goals and functions from the coordinated wage increases into the mechanism for legitimizing wage restraint and dispersion. By contrast, the use of diverse forms of employment had started earlier, that is, from the mid 1980s. In 1986, the Worker Dispatch Law was enacted. According to this law, dispatched work was limited to 13 jobs that required expertise and skill. The amendment of this law in 1999 permitted the employment of dispatched workers for every job, except construction, security, harbor loading and

The Japanese corporate system 53

% 90

Company performance Securing and retaining workforce

Social norm Price inflation

80 70 60 50 40 30 20

0

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

10

Figure 2.12 Most important factors in setting pay during Shunto. Source: The Ministry of Finance, Survey on Wage Increase, Various years.

unloading, medical treatment, and manufacturing. From 2004, dispatched work was permitted in manufacturing work. These uses of non-regular workers had become layered onto the norm of lifetime employment. While in the past, nonregular workers were hired as buffers to cope with cyclical fluctuations in demand, a wider use of non-regular workers after the mid-1990s was encouraged by individual corporate strategies on a continuous basis in order to reduce personnel costs and to turn fixed costs into variable ones. The latter reflected significant changes in the Japanese firms’ management targets since the 1990s. Therefore, contingent or temporary works are portrayed as a case of “institutional layering” onto the norm of lifetime employment in the labor market. However, the process of this layering has not yet eroded the original core features of the Japanese employment system, because, even though the commitment to long-term employment practices by the management is relaxed or weakened, it will never be abandoned, especially in large firms. Unlike in the area of finance, in which short-term market pressures encouraged Japanese firms to adopt shareholder-oriented management, two different modes of institutional change, that is, “layering” and “conversion” in the domain of employment, will be further drawn out, and the coexistence of these two in the labor markets will continue to be for a long time in the future. Thus, at this point of time, it seems very difficult to predict precisely the stability or sustainability of the new J-type firm as a viable model of business organizations. It becomes obvious, however, that with the emergence of the new J-type firm, tensions are growing between corporate insiders and outsiders, such as between stable shareholders and foreign and institutional investors or between core and more peripheral groups of employees.

54 A. Isogai

Concluding remarks Our findings on the transformation of the Japanese corporate system and its impacts are very recent. Regarding the emerging hybrid model in the Japanese corporate system, there already exist some highly suggestive works. However, we can also present some implications and agendas for future research that should be explored both theoretically and empirically. First, the emergence of the new J-type firm as a hybrid model demonstrates that both the “strong” convergence view and the “strong” complementarity view are misleading. The strong convergence view claims that corporate convergence on a shareholder-oriented model is both desirable and inevitable (Hansmann and Kraakman 2001). Meanwhile, the strong complementarity view claims that systemic transformation is very unlikely. Two possible patterns of institutional change are allowed for. One is marginal institutional change, and the other is overall change in the system (Hall and Soskice 2001). The process of hybridization rejects both these ideas. Second, the emergence of the new J-type firm would naturally call us to reexamine the institutional complementarities between finance and employment theoretically as well as empirically, because the new J-type firm itself seems to show that the institutional complementarities between finance and employment may be less clear than was formerly assumed in theoretical models. A part of the complementarity relations among institutions, such as the complementarity between employment and finance, might not necessarily be a fixed relation, but, may be loose and modest. This reminds us of the significance of original ideas in the régulationist school. Identical reproduction is an exception to the rule. Institutional forms are always in a state of flux, sometimes changing gradually; other times rapidly. Complementarity is always accompanied by tensions, which rule out the idea of institutional configurations being in a static equilibrium state. Therefore, in dealing with a dynamic process such as institutional change, it is essential for us to reexamine or redefine the conception of institutional complementarity in a dynamic context. Last but not least, the question of whether the new J-type firms as new hybrid organizational forms can be sustained over a long-term period still remains open. The speed with which the new institution replaces the old depends on how the new and the old are related to each other. One possible avenue to explore might be how economic actors behave under these institutions, what reactions they display in the case of these institutions, and how their reactions interact. This is a topic for consideration studying the future.

Notes 1 The 2006 White Paper on Small and Medium Enterprises in Japan depicts a situation in which manufacturing small- to medium-sized enterprises (SMEs) become less intimately dependent on a small number of customers and develop thinner, broader, and multifaceted transactions with a larger number of clientele, with the “meshing” of the subcontracting transaction structure. However, this idea of meshing appears to be

The Japanese corporate system 55 somewhat controversial. Rather, at the domestic level, it would be more accurate to say that there is a shift away from dependence on certain enterprises, while the traditional subcontracting relations have been maintained. An upsurge in activity by SMEs entering local manufacturing networks in East Asia can be regarded as an extension of the subcontracting system at the East Asia level, creating divisions of labor in manufacturing that integrate the entire East Asia region. 2 According to the 2006 survey conducted by the Ministry of Health, Labor, and Welfare reports that 46 percent of the firms with varying members of employees, 83 percent of the firms with 1,000 employees and over, 72 percent of the firms with 300–999 employees, and 57 percent of the firms with 100–299 employees have already adopted this payment system. 3 For further details on the dysfunction of Schunto, see Chapter 5 of this book by Uni. 4 The following discussion owes a great deal to Sako (2007).

3 The increasing heterogeneity of firms in Japanese capitalism Facts, causes, consequences, and implications Sébastien Lechevalier Introduction Is the concept of “companyism,” introduced by the régulationist approach to describe the mode of régulation in Japan from the 1950s to the 1980s, still accurate to understand the Japanese economy in 2010? In this chapter, our answer is negative because of the following stylized fact: the increasing heterogeneity of Japanese firms during the Lost Decade (1991–2002). The critical point of our argument does not concern the static heterogeneity of firms but its evolution. Moreover, we emphasize that this increasing heterogeneity concerns performance and organization of firms of similar size and they belong to the same narrow sectors. It does not mean that the former companyist compromise completely disappeared: it still exists for core workers in some large firms as explained by Yamada and Hirano in Chapter 1. However, it is no longer possible to find companyist regularities at the micro level in order to define the mode of régulation in Japan. It is true that even in the 1970s, this compromise did not concern all Japanese firms, not even all large firms; however, the main difference between that time and the current period is that it was the norm. More importantly, this predominance had significant macro effects (e.g., for productivity dynamics). In this paper, we argue that the Japanese economy has reached a threshold beyond which the companyist compromise no longer plays its role at the macro level. Consequently, it does not help to define the Japanese mode of régulation. Therefore, we propose to go one step beyond the analysis of Yamada and Hirano in Chapter 1: companyist compromise is not only dysfunctional but has also lost its previous role at the macro level, which used to define the mode of régulation in Japan.1 Does this mean that it is impossible to define the nature of the Japanese capitalism? Some recent books, which emphasize the increasing diversity of Japanese firms, have indeed failed to provide an unambiguous definition of Japanese capitalism after the end of the Lost Decade (Aoki et al. 2007; Vogel 2006). Although the definition of the emerging mode of regulation of Japanese capitalism is beyond the scope of this chapter, we argue that it is possible to propose one, in taking into account the increasing heterogeneity of firms and in focusing on the forms of coordination of this heterogeneity, which will be defined hereafter. Another point concerns the nature of the dynamics and institutional change. This chapter basically agrees with the proposition of Boyer and Yamada (2000),

The heterogeneity of firms in Japanese capitalism 57 according to which the very success of the mode of régulation in Japan has led to its crisis. It means that the dynamics has been mainly endogenous. However, we add that it is necessary to take into account the political economy dynamics that, sometimes, anticipate the economic dynamics (Lechevalier 2011). More precisely, we argue that deregulation is the key factor to understanding institutional change in the Japanese economy since the early 1980s. Therefore, the neo-liberal policies that supported this process have to be studied in detail.2 In this chapter, we focus on the increasing heterogeneity of firms in keeping in the background the questions of the changing nature of Japanese capitalism and of institutional change in Japan. We first survey recent literature that has uncovered this stylized fact. The second section of this chapter is dedicated to an analysis of the causes of the increasing heterogeneity of firms. After having reviewed classical explanations – respective impacts of the technical progress, of the internationalization, and of the macro fluctuations – we propose an explanation that articulates organizational changes and institutional changes. More precisely, we argue that deregulation is also at the origin of the increasing heterogeneity of firms. The third section investigates some consequences of the increasing heterogeneity, namely the rising job insecurity and wage inequalities in Japan. In a fourth section, we propose some implications of the increasing heterogeneity of firms for the régulationist interpretation of the Japanese capitalism. We then introduce the concept of coordination, in trying to link it to other régulationist concepts. Finally, in conclusion, we suggest a research program to define the “new” Japanese capitalism and to analyze the institutional change in the Japanese economy.

The empirical evidence: the increasing heterogeneity of performance and organization of Japanese firms Some recent empirical works have shown that Japanese firms are increasingly heterogeneous. This first concerns the heterogeneity of performance, whatever the measure that is considered (productivity, profitability). It is also related to the organization of firms. Until now, these two dimensions of the heterogeneity of firms have been basically studied separately.3 Therefore, we introduce here these two strands of research consecutively. As for performance dimension, it would, of course, be misleading to consider that all firms necessarily perform poorly in a context of economic stagnation or crisis, such as the Lost Decade. However, what is surprising in the context of the late 1990s in Japan, in the midst of a macro downturn, is that companies such as Toyota or Canon, which were considered as archetypical of the J model, were not only not in crisis but were having record profits, whereas one observed, at the same time, a significant increase in the number of bankruptcies (Lechevalier 2007). More generally, a particular fact that has been uncovered by various studies is an increasing dispersion of productivity among Japanese firms during the Lost Decade (Fukao and Kwon 2006; Ito and Lechevalier 2009). Moreover, this heterogeneity is observed for firms of similar size and belonging to the same narrowly defined sectors. More precisely,

58 S. Lechevalier Ito and Lechevalier (2009) analyze the evolution of productivity dispersion for a panel of Japanese manufacturing and non-manufacturing firms during the period 1994–2003.4 They find that in both manufacturing and non-manufacturing, the dispersion of labor productivity has increased. This trend is a little more pronounced in the case of the manufacturing sector than in the non-manufacturing sector, but it started later in the former case than in the latter case. This increasing heterogeneity of firms concerns also their forms of organization and their strategies. For want of space, we focus here on human resource management (HRM) and corporate finance. The common picture regarding HRM is that the Japanese firms are moving away from the “traditional” practices of longterm employment and seniority wages. An oft-cited example concerns the rising share of “non-regular” workers (e.g., temporary and part-time workers), who today represent more than one third of the total workforce. However, some studies have shown that this overall increase in the use of non-regular workers does not concern all firms (Lechevalier 2007). Another employment-related dimension concerns the practice of downsizing. In the late 1990s to early 2000s, the simultaneous restructuring of firms in the electrical machinery sector was interpreted as a sign of the convergence towards US-style downsizing practices. However, Hurlin and Lechevalier (2003) compare two periods of restructuring, the late 1970s and the late 1990s, and show that the average speed of employment adjustment has been very stable, whereas the standard deviation of the individual speeds has increased. As for corporate finance and governance, the changes have been drastic since the beginning of the 1990s. However, they do not constitute a uniform switch towards the Anglo-Saxon model, but rather an increasing heterogeneity of the practices (Aoki et al. 2007). For example, in spite of the deregulation of the bond market in the mid 1980s, the overall dependence of firms on bank borrowing increased. Large firms lessened their ties with banks and began financing through bonds, but smaller listed firms continued borrowing from banks. In sum, size matters from this point of view. But this is not the only determinant: firms with already high levels of bank debt relied on their main bank for an increasing proportion of those loans. Finally, it is worth emphasizing that this increasing heterogeneity of organization concerns firms of similar size and belonging to the same narrowly defined sector, as in the case of performance. This growing diversity for each element of the firms’ organization and strategy makes it particularly difficult to define the competing “models” and therefore to check whether there is an emerging “model” that performs better than another. The underlying issue is, indeed, to know whether this heterogeneity is temporary and corresponds to the path towards a new equilibrium with one dominant model of firms, or if it is more structural and may last. This implies that, in looking for the roots of the competing models, we have to identify what makes them coherent. It can be found basically in the complementarities between the different elements of organization and strategy. This investigation regarding the complementarities has to be done in relation to the analysis of the micro-performance. The difficulty here is to conduct the analysis, without referring to any a-priori classification, such as small versus large firms.5

The heterogeneity of firms in Japanese capitalism 59 To achieve this research agenda, it is, indeed, necessary to determine preliminarily the nature of the line of cleavage among firms that has potentially evolved. One attractive tool of analysis is the cluster analysis (Aoki et al. 2007). A first advantage of this approach is to go beyond a-priori classification. Most previous studies in this field did not put into question the pertinence of criteria such as size or industry to categorize the firms, as they are implicitly influenced by the classical debates on dualism or segmentation of the Japanese economy. On the contrary, this approach potentially allows a renewal of the perspective by leaving a priori opened the question of the nature of the divide among firms. A second advantage is to test the persistence of complementarities between various dimensions of the firms’ organization (e.g., between HRM and corporate finance) and to leave open the possibility of a hybridization, which can be interpreted as a sign of a weakening of previous complementarities. What are the main findings of Aoki et al. (2007), who focus on corporate governance? Their cluster analysis of about 900 firms listed on the Tokyo Stock Exchange confirms that Japanese firms are increasingly diverse, forming three distinct clusters. The first one (67 percent of total employment but only 23 percent of firms, including Toyota and Canon) includes firms which combine market-based financing and long-term employment practices, in contradiction to predictions of the initial versions of Aoki’s theory. Most of them perform relatively well. The second cluster (21 percent of all firms and 10 percent of total employment) is comprised of firms that are resorting to relational financing and market-based employment practices. Most of these firms are newly established and led by founders. They also record relatively high levels of performance. The third cluster (26 percent of all firms and 11 percent of the workforce) encompasses traditional Japanese firms that combine relational financing with long-term employment practices. By comparison to the other two clusters, they perform relatively poorly. Finally, it is worth noting that the authors did not find any cluster corresponding to the A-type of firms (even if very few firms may have practices that conform to this model). To summarize, despite some methodological limitations of the cluster analysis, it is possible to find some emergent competing models. However, the complementarities that should be the theoretical basis for their definition seem to have weakened. To try to overcome the limitations of this last study, Ito and Lechevalier (2010) adopt a different perspective, which focuses on innovation and internationalization strategies of Japanese firms.6, 7 Their starting point is slightly different from Aoki et al.’s, but the implications are complementary. The initial question addressed by Ito and Lechevalier (2010) is, indeed, to understand the endogenous source of persistent differences of performance between firms. Economic models generally assume that performance differences are exogenous, making it difficult to explain how firms’ endogenous strategic choices interact. The basic idea of Ito and Lechevalier (2010) is that complementarities between strategic choices may help to define few possible strategies and explain why performance differences may be endogenous, structural, and therefore persistent. More precisely, the meaning of these complementarities is that a specific firm’s choice to invest in one activity is conditioned by another investment, especially if the effect of this particular

60 S. Lechevalier investment depends on previous investments. If these complementarities are significant, they may help to define coherent alternative productive models (Oï 1983). Of course, firms are not locked into any given productive model and may switch successfully from one to another. An important task is then to identify coherent and viable strategies. The basic result of Ito and Lechevalier (2010) is that innovation and internationalization investments are complementary rather than substitute.8 Beyond its initial concern, the results of this paper can be interpreted as follows: whereas it has been difficult to see complementarities between different dimensions of corporate governance, the complementarities between innovation and international engagement (at least, exports) seems to be more robust. Their results can also be mobilized in the context of the régulation theory. Boyer and Yamada (2000) have, indeed, shown that internationalization of Japanese firms played a key role in the institutional change of the Japanese economy from the 1970s to 1980s. Ito and Lechevalier (2010) show that only a minority of Japanese firms invests in R&D and in export: in 1994, 44 percent of the 11,604 manufacturing firms they analyzed were doing neither research and development (R&D) nor exports; 30 percent were doing only R&D, 5 percent were doing exports only, and 21 percent were doing both investments. Incidentally, it is worth noting that the share of R&D firms is much higher than the share of exporting firms.9 A final remark concerns whether or not the evolution observed in Japan is exceptional. As for the increasing dispersion of performance, a comparison between the results of Ito and Lechevalier (2009) and Faggio et al. (2010) shows that UK firms have also experienced increasing dispersion of productivity between 1984 and 2001. However, there are two differences. First, the most dramatic evolution concerns non-manufacturing firms in the UK whereas it concerns manufacturing firms in Japan, as seen above. Second, and more importantly, on average, the evolution is much more dramatic in Japan than in the UK. As for the increasing heterogeneity of organizational change, Jackson (2003) offers some insights from a comparison between Germany and Japan. In this case, it is very difficult to compare the intensity of organizational changes in both countries but it is possible to say that the trends are similar. To summarize, the increasing heterogeneity observed for Japanese firms seems to be far from exceptional in international comparison. However, because of the idiosyncrasy of the Japanese trajectory, the forms, the determinants, and the consequences of this trend are particular and deserve to be studied in detail.

Why did the heterogeneity of Japanese firms increase? The recognition of the increasing diversity of Japanese firms, both in terms of performance and organization, leads us to investigate the determinants of the evolving heterogeneity. The most advanced research concerns the analysis of the evolving dispersion of productivity. Among the various theoretical explanations, the impact of innovation is certainly the most popular. For example, Caselli (1999) built a model in which increasing productivity dispersion is generated by differences

The heterogeneity of firms in Japanese capitalism 61 in the rate of technology adoption. Other theoretical explanations focus on the impact of internationalization (Melitz 2003), market competition (Syverson 2004), or institutional factors (Aoki 2001b).10 Let us specify this last explanation, which concerns not only performance but also organization, and which has not yet been investigated by the mainstream literature. As emphasized by theories of comparative capitalisms, the institutional changes that occurred in the 1980s and 1990s have affected the organizational diversity of firms and, therefore, their performance dispersion (Deeg and Jackson 2007; Lechevalier 2007). More precisely, the process of liberalization in the most developed economies did not lead to the disappearance of rules but, rather, to the coexistence of old and new rules. This institutional layering has led to the differential adoption of old and new business practices according to firm-specific characteristics. On the empirical side, studies have tended to confirm the technology explanation (e.g., Dunne et al. (2004) for the case of the USA, and Faggio et al. (2010) for the case of the UK. However, as for the Japanese case, Ito and Lechevalier (2009) found that the introduction of information and communication technologies (ICT) decreased the within-industry labor productivity dispersion, while internationalization and the trend toward a more oligopolistic market structure in some industries increased it. What their empirical study shows is that internationalization played a key role in the increasing dispersion of productivity. Moreover, deregulation did not lead to an increase of competition; on the contrary, some industries (such as the car industry) have shifted towards more oligopolistic structures. At this stage, there is no comprehensive empirical analysis of the causes of the increasing heterogeneity of organizational forms. However, Aoki et al. (2007) suggest that the reason for the growing heterogeneity in corporate governance in Japan is that not all firms are equally exposed to pressure for change and that existing institutions also constrain change along particular trajectories. For example, foreign investors concentrate on some firms and this has a strong impact on their corporate governance: firms with a high foreign ownership ratio are more likely to adopt “Anglo-American”-style corporate reforms or modes of restructuring (although, as has been emphasized, no firm can be clearly characterized by this model). Finally, an empirical perspective that links the evolution of productivity dispersion to the evolution of organizational heterogeneity appears particularly promising, as it would further our understanding of the chain of causality. This is a possible direction for future research.

Rising inequalities as a consequence of the increasing heterogeneity of firms: a political economy perspective11 Rising inequalities are certainly the most important fact characterizing the Japanese economy from the early 1990s, in the sense that it constitutes a rupture by comparison to the previous characteristics of Japanese capitalism. First, although there was a debate on the dual nature of Japanese capitalism, one of

62 S. Lechevalier its characteristics during its postwar period of development is that it achieved a high degree of efficiency together with a containment of inequalities (Dore 1994). It means that Japanese capitalism did not face the typical tradeoff of capitalism: maintaining an acceptable level of inequalities through non-market mechanisms did not hinder the economic development; growth was achieved without a surge of inequalities, as is observed in China nowadays (Minami 2007). Second, it is possible to consider that the debate on inequalities was one of the major reasons for the dramatic political change in August 2009, with the electoral win of the Democratic Party of Japan (DPJ). It means that the neoliberal period has maybe reached its end in Japan (Lechevalier 2011). Back to the facts, there has been an academic debate on these rising inequalities.12 More precisely, until the report of the OECD in 2006, there was no consensus on whether income inequality widened during the 1990s and afterward. For example, Tachibanaki (2005) claimed that income inequality increased during the 1980s and 1990s. Conversely, Ohtake (2005) found that the increase in income inequality was partly due to the aging population. By focusing on the wage rate, Kambayashi et al. (2008) attempted to reconcile these two views. Employing the Dinardo et al. (1996) decomposition technique, they concluded the following: although simple aggregate statistics may give the impression that wage inequality did not change during the period, the decomposition analysis reveals that the seemingly steady trend is a product of two opposing trends: (1) declining between-group (defined by education, experience, tenure and firm/establishment size) wage inequality; and (2) increasing within-group inequality among male workers. As this trend of rising intra-group inequalities is similar to what has been found regarding the increasing heterogeneity of firms, it leads us to investigate the relationships between productivity dispersion and wage inequalities. In fact, this hypothesis has already been well analyzed for countries other than Japan. For example, in the case of the UK, Faggio et al. (2010) find that rising wage inequalities primarily concern workers with equivalent observable characteristics. To explain these rising within-group inequalities, they analyze its counterpart of increasing productivity dispersion across firms between and within sectors, and show a link between the two phenomena. In the case of Japan, although some studies (e.g., Kambayashi et al. 2008; Tachibanaki 2005) have considered the wage differential between firms of different sizes in Japan, there has been no recent investigation of between-firm wage dispersion in connection with productivity differentials. This is very surprising if one considers the particular fact that has been discussed in the first part of this chapter. One reason for the absence of this type of study is that a dominant concern has been the within-firm wage differential between regular and non-regular workers. However, Uni, in Chapter 5 of this book, shows this explanation to be insufficient. Another possible reason is that studies that have taken into account the firm size differential have found that it does not explain the increasing wage

The heterogeneity of firms in Japanese capitalism 63 gap (e.g., Kambayashi et al. 2008). Of course, the focus on wage differentials among firms of different sizes is understandable in a country that was (and still is, to a certain extent) characterized by a dual structure according to the size of the firm. However, if one aims to connect the evolution of productivity and wage differentials, one has to take into account the fact that the increasing productivity differentials since the mid 1990s mainly occurred in firms of similar size belonging to the same narrowly defined sectors. In this context, Gatti et al. (2010) analyze the trend of rising inequalities in Japan in introducing a theoretical framework that allows them to study its relations with productivity dispersion. More specifically, they construct an efficiency wage model with just one sector but two types of firm of similar size. The difference between the two types of firm is interpreted in terms of productive models, such as in Oi (1983). In using a rich employer–employee dataset, they get the following results. First, they confirm the existence of efficiency wages on average. Second, they divide the sample of firms into two groups using the unknown regime switching regression as in Ishikawa and Dejima (1994), and find that the primary sector, unlike the secondary, is characterized by efficiency wages. Finally, they run a simulation for the period 1981–2005 and find that a negative productivity shock at the aggregate level after 1991, similar to the one experienced by the Japanese economy during the Lost Decade (1991–2004), produces increasing productivity and wage differentials. Therefore, they confirm that rising wage inequalities can be related to increasing productivity dispersion among Japanese firms. To go a little beyond the conclusions of Gatti et al. (2010), it is possible to argue that the compromise on job security and the associated incentive mechanisms, as described by Yamada (2000) or Isogai et al. (2000), have changed. As recalled by Lechevalier (2012), among the possible modelings of internal rank hierarchy, rank-order tournaments better captured the essence of “permanent employment” by Japanese firms, as they did not use discharge as an enforcement mechanism. This situation changed in the 1990s, as the risk of layoffs substantially increased. In this case, the incentive mechanism may become closer to the one described by Shapiro and Stignlitz (1984). This is the meaning of the assumption by Gatti et al. (2010), according to which the incentive mechanism shifted from the seniority wage principle to the efficiency wage principle. Of course, this theory is much too simplistic, as practices at firm level are much more complex.13 However, the empirical confirmation of the existence of an efficiency wage mechanism for some firms in Gatti et al. (2010) constitutes a first step in the empirical investigation of the evolution of incentive mechanisms in Japanese capitalism. It should be confirmed by further studies using other datasets and other criteria to detect the existence of efficiency wages. Based on this assumption on the changing compromise on job security and associated incentives mechanism, the explanation of rising inequalities focusing on increasing firms’ heterogeneity can be connected to an institutionalist approach, as shown by Lechevalier (2011). In the same spirit, it is worth recalling the main result by Moriguchi and Saez (2008), according to which the changes in technology or tax policies alone cannot account for the comparative experience of

64 S. Lechevalier Japan and the USA. Instead, institutional factors such as internal labor markets and union structure are important determinants of wage income concentration. These results are perfectly compatible with the institutionalist perspective of Uni, who argues, in Chapter 5, that it is important to take into account the characteristics of the employment and wage systems in Japan to explain rising wage inequalities. More precisely, according to him, the most important causes are the reforms in the wage system, such as the introduction of a performance-based wage system (within-firm effect), and the weakening of the spring labor offensive system (between-firms effect). Uni concludes his analysis in arguing that the within-firm effect is dominating the between-firms effect. Lechevalier (2011) partially agree with this analysis proposed by Uni in Chapter 5. It confirms that the labor market is the matrix of inequalities in Japan. However, they do not specifically focus on the role of unions and propose the following political economy interpretation, inspired by Krugman (2007) in the case of the USA and by Dore (2000) and its comparison between “stock market capitalism” and “welfare capitalism.” Despite the fact that the process has been non-linear, it is possible to say that neoliberal policies have been dominant in Japan between the early 1980s and the turning point of 2009.14 To summarize, the first concrete acts of the neoliberal era in Japan have concerned financial deregulation – partly under the influence of the USA, partly under the pressure of domestic actors exporting manufacturing companies and banks – together with a direct fight against the influence of the trade unions (e.g., the privatization of JR and NTT). This era may have come to an end in 2009 with the electoral win of the DPJ, after a campaign during which the critics against neoliberal policies that led to rising inequalities have occupied a large place. Lechevalier (2011) then analyzes the direct impact of neoliberal policies on the labor market and their indirect impact that led to the increasing heterogeneity of firms. The starting point is the hypothesis of the “resegmentation of the Japanese labor market.” It describes an increase of inequalities, according to new lines of cleavages.15 It corresponds to the emergence of a new social compromise between the early 1980s and the late 2010s. The social compromise has been indeed deeply affected by neoliberal policies, which have evolved over the years and have concerned various fields, from the corporate governance, the education, to the labor market (Lechevalier 2011). In this context, the two major “losers” are the young, for whom it is more difficult to enter the job market, and the workers already on the labor market but who lose their job or have experienced a rupture in their career. For the first category, individual characteristics (such as education) matter (Tachibanaki 2010); for the second category, the firm’s characteristics are more important (Lechevalier 2011).

Implications for the régulationist interpretation of Japanese capitalism Most of this chapter has dealt with the empirical evidence on the increasing heterogeneity of Japanese firms. In this section, we would like to make some suggestions

The heterogeneity of firms in Japanese capitalism 65 regarding the theoretical implications of this empirical evidence, especially for the régulation approach to Japanese capitalism. The first point concerns the implication of the heterogeneity of firms for the theories of variety of capitalism. As well explained by Boyer (2005b), régulation theory adopts a macro perspective without any reference to a representative firm. In this sense, it does not follow the “variety of capitalism” (VOC) approach (Hall and Soskice 2001), or the comparative institutional analysis (CIA) approach (Aoki 2000), which, de facto, characterize national models of capitalism by a representative firm. However, the companyist hypothesis proposed by the régulationists in the case of Japan may be considered a little ambiguous from this point of view, as is evident in the following citation: “All the large firm-based institutions were constructed around fixed, long-term relationships” (Yamada 2000; 30). In this context, Lechevalier (2007) calls for an alternative theory of the firm that allows us to combine the variety of capitalism and the diversity of firms. Evolutionist theories of the firm may be good candidates. Indeed, they are fundamentally interested in discretionary differences across firms (Nelson 1991). The evolutionist approach appears to be attractive to conciliate the heterogeneity of firms and the diversity of capitalism. It is not by accident that the most recent work by Aoki has a more pronounced evolutionary flavour (Aoki 2010).16 This general problem typically appears in an analysis of Japanese capitalism. In proposing the companyist hypothesis, the régulation approach has exaggerated the homogeneity of the Japanese wage labor nexus, as emphasized by Isogai et al. (2000). In fact, it is possible to interpret the HMFN framework to go beyond the companyist interpretation of the Japanese mode of régulation. It means that there have already been various attempts to take into account the heterogeneity of firms in the régulationist analyses of the Japanese capitalism. Another promising road is the one opened by Boyer and Freyssenet (2002) in their analysis of the various productive models in the car industry. This approach may be potentially applied to other sectors. The increasing heterogeneity of firms does not mean that the research program defined by Yamada (2000) is inadequate, on the contrary: it is still pertinent to focus on the wage–labor nexus and the financial relations; moreover, as seen in the third section of this chapter, the companyist compromise focusing on employment security is still at the heart of the current changes, especially regarding the rising inequalities. However, we argue that the dynamic of the institutional change in Japan is explained less by the compatibility/incompatibility of these two institutional forms at the macro level than their weakening complementarity at the micro level. If this idea is correct, it has two important consequences. First, the analysis at the firm level should focus not only on corporate governance but also on strategic variables such as internationalization and innovation, whose complementarities make us able to define coherent and viable production modes (Ito and Lechevalier 2010). The former has been well analyzed in a régulationist perspective but this is not the case with the latter, with the important exception of Boyer (2003). We argue that the changes that affected the Japanese innovation system since the early

66 S. Lechevalier 1990s have to be central in the analysis of Japanese capitalism in transition. That is why Part I of this book, emphasizing innovation as one of the engines of the emerging growth regime is a first step, in continuity with former attempts of analyzing the social innovation systems with a régulationist flavor (Amable et al. 1997) that is particularly relevant. Second, it means that, in 2010, companyism is no longer relevant to describe the Japanese regulation mode, because large firms are much too diverse and they are no longer the center of social compromise. However, recognizing that Japanese firms are increasingly heterogeneous does not help to define the new mode of régulation in Japan. We need another concept to interpret this result at the macro level. More precisely, the issue is the articulation of macro, meso, and micro levels. The concept of coordination, introduced by Lechevalier (2007), is an attempt to take up this challenge. The main purpose of this chapter is not a discussion about this concept of coordination. Let us just recall that “the source of the coordination problem is neither the division of labor nor the structure of the game, but rather the fundamental heterogeneity of firms” (Lechevalier 2007). This concept of coordination is not without any relation to régulationist concepts. First of all, it is in strong continuity with the ambition of the HFMN approach “. . . to provide a bridge connecting the microeconomic analysis of institutions and individual behaviors with the macro-level analysis of economic dynamics” (Isogai et al. 2000: 33). It also shares with the HFMN approach a dynamic dimension, as the ambition is not only to aggregate static behaviors but to understand the interactions between institutional changes and organizational changes.17 Our concept of coordination is also directly related to two institutional forms: inter-firms relations and forms of the state, as private and public forms of coordination are considered. More precisely, in the case of Japanese capitalism, the decay of keiretsu, shunto, industrial policy, bureaupluralism, and the changes that have affected the subcontracting relations should be central in the analysis of the institutional changes during the Lost Decade. As for an understanding of the emerging mode of régulation in Japan, the increasing collaboration between competitors in the field of R&D, the revival of innovation policy (Lechevalier et al. 2010), and the fragmentation of production at the Asian level (Fukao et al. 2003) are crucial. It means that the concept of coordination is an attempt to broaden the perspective opened by the HFMN approach. First, if it follows the analysis by Isogai et al. (2000) who emphasize “the increasing fluidity and polarization in the subcontractor system” from the early 1990s, it goes beyond the subcontracting relations that cannot characterize alone the upper level of the heterogeneity of firms.18 It indeed includes the analysis of shunto, keiretsu, on the private side, and of bureaupluralism and industrial policy, on the public side. Moreover, from a functional perspective, it is possible to distinguish at least three dimensions of the coordination: • insurance function;19 • equalization, which was mainly done through shunto;

The heterogeneity of firms in Japanese capitalism 67 • various spillover effects, which concern not only the technology but also organizational innovation (e.g. diffusion of toyotism).20 Finally, we would like to make some suggestions based on this emphasis on micro-heterogeneity and coordination for the analysis of the Japanese capitalism. A first point concerns the definition of Japanese capitalism. As mentioned by Boyer (2005b), the opposition between liberal and coordinated capitalism proposed by the variety of capitalism approach is not fully satisfying. This is particularly true in the case of Japanese capitalism, which should be characterized by at least three dimensions: coordination, segmentation, and decentralization (Lechevalier 2007). These three characteristics are evolving over time and produce various results. For example, the Lost Decade can be interpreted as the result of the lack of coordination of an increasing heterogeneity of firms. If this idea is correct, the emerging mode of régulation in Japan cannot be characterized anymore by companyism alone. However, it is fair to recognize that we do not yet know how to define the “post-companyist” mode of regulation. We are facing here a difficulty similar to that experienced by regulationist analysts in trying to define a “post-Fordist” regime. In our attempt at definition, two levels have to be considered to analyse institutional change, in relation to organizational change: the heterogeneity of firms and the forms of coordination of this heterogeneity. To summarize, we argue that the major institutional change to characterize Japan since the early 1980s is deregulation.21 It has been accompanied by a decay of postwar forms of coordination, both public (industrial policy, bureaupluralism) and private (subcontracting, keiretsu, shunto). At the same time, until now, markettype coordination forms have performed very poorly. In our view, this double phenomenon is at the origin of the increasing differentials in the Japanese economy and of the poor macroeconomic performance. For example, there are some signs that, as a whole, spillover effects and positive externalities have decreased (Lechevalier 2011). To put it differently, the success of a firm such as Toyota has beneficiated the rest of the economy less in the 1990s than in the 1970s, especially because of its internationalization. As for the end of the Lost Decade, our interpretation is that it corresponds to the emergence of new forms of coordination (e.g. clusters, revival of innovation policy, and increasing collaboration between competitors in the field of R&D). This book emphasizes the idea that the emerging model of growth in Japan could be innovation- and Asian integration-led (see, especially, Chapter 6 by Uemura). We argue that it is possible to interpret these two engines of growth in terms of coordination. On the one hand, inter-firm collaboration together with public innovation policies are coordination devices that increase the spillover effects. On the other hand, the fragmentation of production that characterizes the Asian integration can be interpreted as an extension of the subcontracting system and therefore as a form of coordination led by Japanese multinationals (Fukao et al. 2003). Moreover, after the decay of shunto, the new welfare regime (as studied by Tohyama in Chapter 4 and as mentioned by Yamada and Hirano in Chapter 1) is

68 S. Lechevalier potentially another form of coordination that may turn into the domestic engine of a growth lying not only in innovation and internationalization.

As a matter of conclusion: defining a new research agenda on Japanese firms and capitalism In conclusion, the former J-model characterized by companyist arrangements is no more the norm; the number of Japanese firms that can be characterized as companyist has fallen under a threshold, below which it no longer produces the macro effects that were still observed in the 1990s. In the meantime, it is not yet possible to distinguish the emergence of a univocal new J-model. On the contrary, what is striking is the coexistence of different models, whose definitions depend on the criteria that are emphasized. This is a sign that former complementarities have weakened. Therefore, according to us, Japanese capitalism has been characterized since the early 1990s by an increasing heterogeneity of firms, in terms of organization and performance. Moreover, what is striking is that this heterogeneity is fundamentally discretionary: there are still some substantial differences in terms of size and sectors, but the novelty is the increasing heterogeneity of firms of similar size and belonging to the same narrowly defined sectors. Finally, we have shown some evidence that this fact does not correspond only to a transition process but is largely structural, as much as dualism was in the 1950s. Based on these results, we would like to introduce some proposals for the definition of a new research program on the Japanese economy in the diversity of capitalism. We first mention the necessity to generalize theories of the diversity of capitalism, which should directly address this issue of inter-firm heterogeneity within a given form of capitalism. This point has been developed elsewhere (Deeg and Jackson 2007; Lechevalier 2007). It is worth noting that it also has important implications for our understanding of institutional change, which should be microfounded in a specific way. The institutional change fundamentally depends on its mediation by firms and on the evolving composition of the economy in terms of “models” at the firm level. However, the relationship between organizational change and the institutional change is characterized by important non-linearities and is therefore far from being mechanical.22 The concept of coordination may provide a tool to analyze the complex process of dynamic aggregation and of articulation between the micro and the aggregate levels of change (Lechevalier 2007). This point should be further developed at both theoretical and empirical levels. Second, more empirical analyses have to be done in order to compare the dynamics of Japanese firms during the Lost Decade and before; to analyze the relationships between the productivity dispersion, the profitability dispersion, and the emergence of diverse models. The empirical results we introduced in this chapter should not lead us to hide that we are still very far from a complete understanding of the dynamics of firms (see also Dosi et al. 2010). Third, taking into account the heterogeneity of firms should make us unsatisfied with statements such as “the Japanese capitalism did not converge towards the

The heterogeneity of firms in Japanese capitalism 69 American or the European ones.” What is particularly important is to compare the evolving diversity of firms and its determinants within each form of capitalism. It may lead to interesting results regarding our understanding of the diversity of capitalism in general and within Asia in particular (Amable et al. 2011). Fourth and finally, to further develop our analysis of Japanese capitalism, it is necessary to propose a political economy analysis of its evolving forms of coordination. This is the proper way to define post-companyism. More precisely, what has to be done can find its inspiration in such historical analyses as the one proposed respectively by Gordon (1988) and Okazaki and Okuno-Fujiwara (1999). These books have, indeed, shown how complex has been the emergence of the postwar Japanese wage–labor nexus, with a mix of class struggles, American incidental policies, “traditional” paternalism, rational devices introduced by managers to stabilize the workforce in a context of labor shortage. The end of this companyist social compromise is itself complex, the consequence of American pressures, strategies of political entrepreneurs (Tiberghien 2007), ideological shift (Dore 2000). In following the analysis proposed by Aoki (1990) and Dore (2000), it is possible to say that Japan experienced during the neoliberal era a double shift of power: within the firm, the balance of power between workers and managers has been affected to the detriment of the former; outside the firm (or between the firm and its environment), the stockholders have gained more influence at the expense of the managers. In this process, we argued that neoliberal policies have played a major role. What has to be done further is to assess the impact of these policies on the evolving heterogeneity of firms and on inequalities (Lechevalier 2011). More generally speaking, the impact of neoliberalism on the diversity of capitalism has to be analyzed from a political economy perspective. In this context, the Japanese trajectory should be a particularly meaningful case study (Lechevalier 2011).

Notes 1 To put it differently, from our point of view, the two following propositions no longer hold in 2010: “All the large firm-based institutions were constructed around fixed, long-term relationships (. . .) It was through these relationships that collateralized management security and job security ultimately stimulated productivity rises” (Yamada 2000: 30); “The core argument of the “Companyism” hypothesis is that large firms are the centre of the mode of régulation and have strongly promoted social integration in Japanese society” (Isogai et al. 2000: 32). Moreover, the emergence of a new growth regime – defined by Uemura (in Chapter 6), based on the institutional changes that have characterized the Japanese economy during the Lost Decade – can also be interpreted as the consequence of the end of the predominance of the companyist comprise at the macro level. 2 The book by Cargill and Sakamoto (2008) constitutes an interesting attempt to analyze the evolution of the Japanese economy from the early 1980s, with an emphasis on financial deregulation, from both the economics and political economy points of view. However, according to us, it is a failure, because the authors leave aside institutionalist approaches, including the ones that take into account organizational changes at the micro level. For more detail, see our review of this book, published in Journal of Economics, 97, no. 1 (2009): 94–6.

70 S. Lechevalier 3 Two exceptions are Lee et al. (2009) for organizational dimensions and Ito and Lechevalier (2010) for strategic choices. 4 For lack of space, we focus here on labor productivity dispersion. Similar results have been obtained for total factor productivity (TFP) and profitabilities. As for profitabilities, see, for example, Nakamura (2002) and Dosi et al. (2010). 5 For a general discussion on the institutional complementarity hypothesis, see Boyer (2005a). 6 For the distinction between organization and strategy, see Lechevalier (2007). In Ito and Lechevalier (2010), R&D spending and exports are interpreted as two potentially inter-related but independent types of investment. The authors recognize, of course, that innovation is not limited to R&D spending and that exports do not capture all the dimensions of the international engagement of firms. However, both variables are considered as satisfying proxies for innovation and internationalization strategies. The attempt by Motohashi (1999) to analyze complementarities between innovation (namely, new technology adoption) and organizational change is also worth noting. 7 Another important difference to Aoki et al. (2007) concerns the data. Ito and Lechevalier (2010) do not focus on listed firms as did Aoki et al. (2007), but use the Basic Survey of Japanese Business Structure and Activities (BSBSA, or Kigyo Katsudo Kihon Chosa) for the years 1994–2003, a large-scale administrative survey conducted annually by METI that therefore includes SMEs. 8 It means that firms that invest in R&D have incentives to start exporting and vice versa. There are various explanations for this complementarity. For example, resource-based or endowment models help us to understand why firms that invest in innovation have incentives to export goods with high technological content. However, according to Ito and Lechevalier (2010), the most important explanations that can be found in the literature is the following: “As a whole, the presiding rationale for positive interactions between exporting and innovation is that both are potential channels for acquiring knowledge.” 9 This is not the case in Taiwan, for example: in the electrical machinery sector, Aw et al. (2005) report that slightly more than 50 percent of all firms have R&D expenditures while almost 75 percent participate in the export market. By comparison, Ito and Lechevalier (2010) get very similar results to the manufacturing sector as a whole for the Japanese electrical machinery sector, in contrast therefore with the Taiwanese case. 10 In an evolutionary perspective, Malerba (2004; 25, 29) also emphasizes the role of three mechanisms in the dynamics of the heterogeneity of firms: variety creation, imitation and selection. 11 Lechevalier (2007) mentions two consequences of the rising heterogeneity of firms, the macro-performance and the rising inequalities. As to our limited knowledge, no significant progress has been made concerning the analysis of the first point; we focus here on the relationships between the increasing diversity of firms and inequalities. However, let us recall the following points made by Lechevalier (2007) regarding the relationship between the increasing heterogeneity of firms and macro-performance: (1) The implicit assumption made by most evolutionary approaches, according to which the diversity of firms is good for the macro-performance of a given economy, fails to explain the Lost Decade, characterized by the poor macro-performance of the Japanese economy and increasing heterogeneity of firms. (2) Nevertheless, heterogeneity of firms is not necessarily detrimental to macro development as shown by the case of dualism in Japan in the 1950s. (3) What really matters is the coordination of the heterogeneity. (4) From this point of view, it is possible to explain the Lost Decade as a lack of coordination of an increasing micro-heterogeneity. 12 Due to lack of space, we do not introduce here a second academic debate, among sociologists, more precisely between Sato Toshiki and Seiyama Kazuo. See Seiyama Kazuo (2000), Chûryû hôkai wa monogatari ni suginai (The Fall of the Middle-class is a Myth) Chûô-kôron, November; Sato Toshiki (2000), Fubyôdô Shakai Nippon (Japan: An Egalitarian Society), Chûô-kôron, November.

The heterogeneity of firms in Japanese capitalism 71 13 In this sense, the description of the new performance-based wage system by Yamada and Hirano, in Chapter 1, may be closer to reality. However, the purpose of Gatti et al. (2010) is complementary as they aim to propose a theoretical framework to understand this change. 14 This non-linearity can be characterized as follows: neoliberal policies have been particularly active under Prime Ministers Nakasone, Hashimoto, Obuchi, and Koizumi, but have been much more moderate under other prime ministers. 15 It means that this interpretation is very close to the HMFN framework proposed by Isogai et al. (2000), in the sense that it is marked by “a refined concept of dualism.” However, it differs in that it does not focus on differentials according to the size of firms (even if this historical differential has far from disappeared). 16 However, it is also characterized by two drawbacks that are discussed in Lechevalier (2007): the uni-dimensional understanding of the determinants of the heterogeneity of firms, which is itself rooted in a restrictive vision of the firm, focusing almost exclusively on technology and innovation; and its simplistic normative evaluation of that heterogeneity. 17 As for the HMFN approach, it lies in the following principles: “(. . .) the specific ‘mode of régulation of the Japanese economy in the postwar period [is] generated by the coordinated structural effects of an ensemble of various institutions, aiming as a whole to establish ‘structural compatibility’ in the socio-economic system (Isogai et al. 2000: 32);” “(. . .) the HMFN plays a role as a dynamic coordinating mechanism in the process of capital accumulation (Isogai et al. 2000: 37).” 18 For example, Isogai et al. argue that “(. . .) inter-firms relations [are] the indispensable basis of structural compatibility of the HFMN (. . .) “What attract attention in Japanese inter-firm relations is the prevalence of subcontractor system” (Isogai et al. 2000: 35). 19 This idea is well expressed by Yamada (2000: 26): “This insurance relationship was not based upon company-based relationships alone. Interfirm relations in the form of crossshareholdings (within enterprise groups) performed management, security and insurance functions.” 20 This idea is well captured by Fukao and Kwon (2006): “Until the middle of the 1990s, large firms and many small firms were closely tied by sub-contracting and keiretsu relationships and it seems that through this network advanced technologies of assemblers and key-components producers were transferred to lower-tier small suppliers. But as large firms relocated their production abroad and rationalized their procurement processes, this technology transfer mechanism probably slowed down.” 21 Previous régulationist analyses (such as Boyer and Yamada 2000) have rather emphasized the role of internationalization. It is true that internationalization has led firms to introduce other forms of HRM and/or of financing their investments. Moreover, the internationalization of the Japanese economy has been one argument to promote deregulation, especially for the financial markets. However, Lechevalier (2011) shows that deregulation has been partly conducted for political reasons that have nothing to do with “economic” dynamics, such as internationalization. Furthermore, we now have enough distance to consider the continuity and the coherence between the early 1980s and the beginning of the neoliberal era in Japan and the political turning point of 2009. This is also what appears in the analysis of Cargill and Sakamoto (2008), although their emphasis is not on institutional change. 22 On the one hand, a given institutional change, such as deregulation, for example, will induce various rather than uniform organizational changes at the firm level, as shown by Jackson (2003). On the other hand, the predominance of norms or the existence of thresholds does not allow us to describe the institutional changes characterizing an economy based on the aggregation of organizational changes (such as the increasing fluidity of employment relationships).

4 Labor and financial-market risks and welfare spending A comparative study with a special emphasis on Japan Hironori Tohyama

Introduction Since the1980s, Japanese employers and government have begun to stress the need for deregulation in the labor market. They have begun the process of dismantling institutions, that had originally been designed for decoupling workers’ livelihoods from market outcomes. This institutional change supposedly resulted in reducing social protection against risks or periods of volatility in the markets. Japanese employees may be particularly vulnerable to such risks. The rapidly increasing number of non-permanent contract workers, as a result of this change, may cause an increase in economic insecurity among regular workers, as the latter are faced with a higher risk of losing their stable jobs and consequent loss of future income. The question we need to address in this chapter is whether this institutional change will drive Japanese workers to make greater demands on expanding welfare expenditure. To comprehend how the institutional changes can affect welfare expenditure, it is necessary to investigate the relationship between economic risks, institutions, and welfare expenditure. According to existing studies focusing on how economic shocks are related to welfare spending, the relationship between these factors can be explained as follows. When economic shocks cause a volatile economic situation, workers are exposed to increasing risks. This drives workers to make greater demands on welfare spending. In response, the government raises welfare expenditure. Therefore, economic risks are expected to have positive effects on welfare expenditure. This idea is based on the notion that economic risks lead to an increasing risk of job losses, and that workers’ demands for expanding welfare expenditure as an insurance against risks of income loss risks are caused by job losses. Labor market institutions can mitigate economic risks. Because those institutions are specific to each economy, workers in different economies can be confronted with different degrees of risk, resulting in different welfare spending demands. For instance, in economies where labor market institutions work as a means of a social insurance against economic risks (e.g., Agell 2002), welfare expenditure is less likely to increase, even though workers are confronted with increasing economic risks. In understanding how economic risks actually

A comparative study with an emphasis on Japan 73 influence welfare expenditure, labor market institutions are elements that need to be considered. What matters to workers is that they have a source from which they can steadily derive income in the future. It is true that a job is one of the primary sources of income. However, a financial asset can also be significant. Households in many advanced economies have begun to increase their financial assets since the1980s. Economic risks can create unemployment, followed by loss of income or reduced values of human capital assets. In addition, the risks can lead to a reduction in the value of financial assets. Financial assets can be instrumental in smoothing consumption over time in the face of economic risks and may mitigate against economic risks. However, it is likely that financial assets may be exposed to volatility in a financial market with deteriorating economic conditions. Workers may incur economic losses caused by the reduced value of financial assets in a financial market as well as job losses and depreciated human capital assets in a labor market. To the extent that economic loss increases due to job losses or depreciated financial assets, workers will expand their demands for social welfare spending as a means of social insurance. Therefore, it is important to bring the development of financial markets back into the relationship alongside economic risks, labor market institutions, and welfare spending. This chapter is organized as follows. The next section gives a comparative perspective on how social protection in Japan has evolved over the past 20 years. The third section shows how economic risks are related to welfare spending, extending the concept that economic risks derive, not only from unemployment and the consequent loss of income, but also by the reduced values of assets. Furthermore, it can be argued that the concept of assets covers financial assets as well as human capital and that volatile economic situations can expose financial assets and human capital to economic risks. From this point of view, the effects of economic risks on welfare spending should be investigated, not only in the labor market, but also in the financial market. Assuming the basic idea in the third section, in the fourth section an econometric model will be specified to estimate the effects of economic risks on welfare spending by using panel data for advanced countries, and the relationship between economic risks and welfare spending will be investigated. On the basis of the empirical results, we derive the implications for changing labor market institutions in Japan.

A brief view of social protection in Japan from a comparative perspective Advanced economies are categorized in terms of social protection. We refer to social protection as the institutions or policies that protect workers from losing their jobs, and the consequent loss of income and human capital asset values in volatile markets. Here, two variables can stand proxy for social security transfer as a percentage of GDP (SST) and employment protection legislation (EPL). Figure 4.1 shows the result of a cluster analysis that was applied to the averaged data in the period from 1981 to 1990. There advanced economies are grouped into two clusters, each of which is surrounded by a circle.

74 H. Tohyama

•Netherlands

Social security transfers as % of GDP

25

20 •Austria •Denmark

•France

•UK

•USA

10

•Sweden

•Germany

•Ireland •New zealand

15

•Belgium

•Italy •Finland

•Switzerland

•Spain

•Norway

•Portugal

•Japan

•Canada

•Australia

5

0

.25

.5

.75

1

1.25

1.5

Employment protection legislation

Figure 4.1 Social protection 1981–1990.

As can be seen in Figure 4.1, European countries such as Sweden or Germany show a higher level of SST and a stricter EPL, compared with Anglo-Saxon countries, which have a less strict EPL and lower level of SST. In this period, Japan was in the European cluster. However, social protection in Japan leaned on EPL, which prevented Japanese employers from firing workers. Individual companies are expected to protect Japanese workers from losing their jobs, and to provide so-called lifetime employment (Yamada 2000). It is likely that Japanese workers considered themselves safer in this period. However, in the 1990s, the Japanese economy departed from the European cluster (see Figure 4.2). It may be appropriate to think that the dramatic drop of SST was due to the long-term depression, and that the gradual removal of EPL had deleterious effects on social protection over this period. Therefore, social protection evolved so as to create an unfavorable environment for workers. Japanese workers were in more insecure situations or larger degrees of risk. This begs the question of whether an increasing degree of risk will drive workers to demand expanded welfare spending by the government. This chapter focuses on the ongoing institutional changes in the Japanese labor market, and the aim is to clarify what effects those changes will have on the evolution of the Japanese social protection system, or the welfare state in a broad sense. In the next section, the chapter specifies the model with which economic risks, institutions, and welfare expenditure are interrelated in order to assess the effects of the institutional changes.

A comparative study with an emphasis on Japan 75 22.5 •Finland

•Sweden

Social security transfers as % of GDP

20 •Denmark •Austria

17.5

•Netherlands •France •Germany •Italy •Belgium •Norway

15

•Spain

•UK •Canada

12.5

•USA

•Portugal Ireland • • Switzerland

10 •Japan

•Australia

7.5

5 0

.25

.5

.75

1

1.25

1.5

Employment protection legislation

Figure 4.2 Social protection 1991–2000.

A theoretical framework: welfare spending and economic risks Why do workers demand increasing welfare expenditure? The answer is that they want to insure themselves against economic risks that threaten their future income stream. Behind demands for welfare expenditure are social insurance motives;1 that is, motives for workers to gain a means to insure themselves. As Hans-Werner Sinn (1995) states, “the main advantage of welfare state is the insurance or risk reducing function of redistributive taxation” (Sinn 1995; 495–6). In other words, workers make demands for welfare expenditure, since it can be instrumental in decoupling their incomes from market outcomes. In order to comprehend how welfare expenditure as social insurance is related to economic risk, the risks need to be considered in more detail. Economic risks When economic shocks take place, workers will be confronted with economic risks. We now need to consider the nature of those risks. In this chapter, the risks refer to losing jobs, and the consequent loss of future income. It is true that if a human capital asset (a skill) that workers have is general, it may be much easier for them to find another job in a different industry or company, so the risk of losing their jobs is less likely to pose a grave threat on them. However, when their assets

76 H. Tohyama (skills) are specific to their industries or companies, the loss of the job can lead to reduced values of human capital assets, so reducing future income (see Iversen and Soskice 2001; Iversen 2005; Cusack et al. 2006). Thus, unemployment presents a great threat to workers whose skills are specific. To summarize, the economic risks facing workers stem from two sources; first, whether workers lose their current jobs. This is referred to as the risk of unemployment; second, how much income loss workers incur as a result of losing their current jobs. This can be called the size or cost of risk. This second source is subdivided into income loss as a consequence of job loss and potential devaluation of a human capital asset. In this theoretical framework, different types of economic risk, which come from de-industrialization or globalization, can be investigated simultaneously. Risk of unemployment: globalization and de-industrialization Some existing literature argues that globalization is a crucial force creating a greater economic risk (e.g., Rodrik 1998; Garret 1998). Globalization allegedly leads to greater labor market volatility. In a volatile economic situation, workers are faced with a higher risk of losing their jobs. An increase in risk exposure generates adjustment costs and enhances economic insecurity. In response to higher economic insecurity, workers demand greater welfare spending to offset the costs of increased trade exposure. Their empirical studies find that trade openness has a negative and significant effect on welfare spending.2 Whether market volatility poses a threat to workers is dependent on the costs they incur. Therefore, their different costs result in their different responses to increased market volatility. Workers with specific skills face higher costs as compared to those with more general skills. They are more likely to respond to globalization with demands for greater social spending. On the other hand, some scholars focus on de-industrialization (see Iversen 2001; Iversen and Cusack 2000). They argue that cross-national differences in economic insecurity in advanced economies are due to de-industrialization rather than globalization. De-industrialization presses workers to move from the manufacturing or agricultural sectors to the service sectors. It is more difficult if skills are not easily transferable. Therefore, de-industrialization particularly renders workers with specific skills more insecure. Those workers are more inclined to make greater demands for welfare spending. Size of risk: reduced income and value of assets The extent to which the risk of losing their jobs poses a threat to workers is dependent on how much their incomes decline in the event of job loss. This refers to the size of the risk rather than to the source of risk. The following two factors can affect the size of the risk: wage distribution and specificity of human capital assets. In terms of a wider wage distribution, workers may face a greater income loss if they fall into the bottom end. As a wage distribution becomes wider, workers

A comparative study with an emphasis on Japan 77 will face a higher degree of uncertainty about future income, as they become more uncertain about their future position in the distribution (see Agell 1999). If a worker loses a job, he or she faces a greater decline in future income as wage differentials become higher. Therefore, unemployment and the consequent loss of future income pose a great threat to the workers, leading them to make demands for the expansion of welfare expending or narrower wage distribution. Cusacket et al. (2006) show where the risk of unemployment comes from. Simultaneously, they suggest the extent to which the risk of unemployment poses a threat to the workers. As noted above, de-industrialization may expose workers to the risk of unemployment. It is more difficult for workers with specific skills to maintain the value of their human capital assets (i.e., specific skills) as specific skills are not marketable within the whole economy. The extent of devaluation of human capital assets and the consequent loss of an expected future income derived from the assets crucially hinges on the portfolio of the assets. In other words, a higher degree of specificity in human capital assets leads to greater loss of income due to unemployment. Because workers with specific skills have more to lose from unemployment as compared to those with general skills, they are expected to express a demand for expanding welfare spending as a means of insurance.3

Financial market developments: another potential source of risk For workers, employment is the main source of income. Undoubtedly, the most direct threat to this primary source is losing his or her job. Nevertheless, even in the event of job loss, if workers can receive a certain amount of income from financial assets, income loss can be decoupled from job loss. Nowadays, sources of income do not only consist of human capital assets. In financialized advanced economies, financial assets may also be significant sources of income even for workers. Financial market development can substitute for social policy designed for reducing the labor income risk (see Bertola 2007). Financial market developments provide workers with the tools to smooth consumption over time, even in the face of unexpected shocks. To the extent that this development allows workers to pool and offset risks, workers can reduce the negative effects of income uncertainty. Therefore, workers may mitigate the risk of income loss thanks to developments in financial market.4 The developments in the financial market can be instrumental in reducing risks due to the volatility of the labor market. However, a financial asset per se will be exposed to financial market volatility, and this will cause the asset to depreciate. As households shift the majority of their holdings of financial assets from safety assets such as deposits into relatively risky assets such as mutual fund shares and equities, a household’s financial asset becomes more vulnerable to volatility in the financial market (e.g., Glyn 2006). Economic shocks can cause financial assets to be depreciated, and workers may suffer from reduced income, even if they can continue to earn wages based on employment.

78 H. Tohyama Labor market institutions as social insurance Economic risks can be mitigated by labor market institutions. The extent to which economic risks influence a worker’s demand for welfare spending differs according to different institutional configurations. For most workers, human capital is the most important asset. Risky investments (i.e., investment in skills) may be occasionally made in order to build human capital. However, the private insurance market cannot overcome market failures such as underinvestment in skills because it will not accommodate their demands for protecting their assets against risks. In the context of missing insurance markets, the welfare state plays an important role in providing workers with insurance i.e., welfare spending against the uncertainties of the future. Alternatively, labor market institutions also provide insurance for workers. Properly designed institutions can insure workers against the risk of unemployment and encourage workers to undertake risky investments (see Agell 2002). As a means of social insurance, the labor market institution can be an alternative to welfare spending. In such a case, welfare spending is not expected to increase to insure workers against economic risks. It is important to identify how workers can be provided with the most effective social insurance, labor market institutions, or welfare spending. A theoretical framework In summing up the arguments in the preceding subsections, the relationship between welfare spending, economic risks, and labor market institutions is depicted in Figure 4.3. This conceptualized framework shows that in order to fully grasp the evolution of welfare expenditure in a financialized economy, economic risks should be considered not only in a labor market, but also in a financial market, and be investigated in terms of interaction with labor market institutions. Assuming this framework, as the risk of unemployment is greater, and the size of the risk is larger, workers are more inclined to express demands for expanding welfare spending as a means of insuring themselves against the risks. Since the risks are related to demands in welfare spending demand through labor market institutions, the relationships between them are attenuated or strengthened by institutions. Moreover, the risk of unemployment and the size of risks are influenced by globalization, de-industrialization, wage distribution, and periods of volatility in the financial market. Existing literature considering globalization as the primary risk for workers can be referred to as the product market-centered view, since this view concentrates on the risks which originate in greater international competition in the product market (e.g., Rodrik 1998; Garret 1998). As a contrast to this view, arguments linking the source of risks with de-industrialization can be referred to as the labor market-centered view because this argument is focused on the risks originating in unemployment and the consequent reduction of values in human capital assets, especially specific human capital assets (e.g., Iversen and Cusack 2000; Iversen 2001). However, the risks for workers do not emerge only in a product market, or

A comparative study with an emphasis on Japan 79

De-industrialization Globalization

Risk of Unemployment Welfare Spending Size of Risk

Specificity in Human Capital Asset

Wage Distribution

Labor Market Institutions

Financial Asset

Volatility in Financial Market

Figure 4.3 Welfare spending, labor, and financial market risks and institutions.

only in a labor market. This chapter tries to go beyond both views by creating the framework that includes the risks not only from the product and labor market, but also from the financial market. Based on this framework, the question that should be answered here is how economic risks are related to welfare spending. More specifically, it is necessary to examine how economic risks are interrelated with institutions in a labor market, how economic risks emerging from a financial market are related to welfare expenditure, and how institutional changes in the Japanese labor market affect workers’ welfare.

Empirical evidence A statistical model and methodology To assess the relevance of the conceptual framework explained in the previous section to the data, we can specify models relating economic risks to welfare spending. First, we can run a regression in this form: Yit = αi + β1 · Yi,t−1 + β2 · EconomicRiski,t−1 + β3 · LaborMarketInstitutionsi,t + β4 · FinancialStructurei,t + β5 · EconomicRiski,t−1 · LaborMarketInstitutionsi,t−1 + β6 · EconomicRisksi,t−1 · FinancialStructurei,t−1 + β7 · Controlsi,t + εi,t

(4.1)

where Yi,t indicates social security transfers as a percentage of GDP in country i during t. The model also includes country-specific fixed effects αi . β1 is the coefficient of lagged social security transfer.

80 H. Tohyama In estimating the above model, the annual data for each variable are used, and a lagged dependent variable and fixed effects are included. A lagged dependent variable is included since welfare spending is supposedly unable to absorb economic shocks in one period. The equation (4.1) also includes institutional variables as well as country fixed effects. Institutions may have time-invariant or slowly changing characteristics. This allegedly raises a problem: the inclusion of country fixed effects precludes the inclusion of time-invariant or slowly changing variables as independent variables (see Amable et al. 2007). To avoid this problem, a specific procedure, which is referred to as fixed effects vector decomposition (FEVD) as proposed by Plümper and Troeger (2007), is used here.5 Empirical results The data for the estimation of the models are from 15 OECD countries6 over the period from 1984 to 2000. Yet, data are not available for all years for all countries. The following briefly describes the variable used here. • Social security transfers. Social security transfers as a percentage of GDP7 consist of benefits for sickness, old age, family allowances, etc. and social assistance grants and welfare benefits paid by general government. • Economic risks.8 Regarding economic risks, five variables are used: the unemployment rate, de-industrialization, openness, the banking crisis, and standard deviations of house prices. The unemployment rate is the OECD standardized rate. De-industrialization is defined as 100 minus the sum of manufacturing and agricultural employment as a percentage of civilian employment. Openness is trade openness, defined as the sum of exports and imports as a percentage of GDP. A banking crisis is a year dummy variable that takes 1 if banking crisis occurs in the year and 0 otherwise. Alternatively, to capture volatility in a financial market, we use standard deviation of real house prices. • Financial market structure. As the financial market institutions used are: private credit by deposit money banks as a percentage of GDP, and also the arm’slength financial system index developed by Cardarelli et al. (2009), which summarizes the extent of the arm’s-length content of the financial system. • Labor market institutions. As with labor market institutions, EPL is used. EPL indicates the strictness of employment protection legislation. • Control variables. As control variables, the aged population (population 65 or over as a percentage of population) and an annual deficit (primary government balance) as a percentage of GDP are included. Table 4.1 shows the result of estimating the regression (4.1), using the FEVD procedure. As for control variables, those coefficients exhibited the expected signs. The size of the dependent population is shown to have a positive effect on spending. In response to the aging of the population, the government will be to increase examples of welfare spending such as health insurance and pensions. An annual

p < 0.05; ∗∗ p < 0.01; ∗∗∗ p < 0.001.

−0.115∗∗∗

−0.108∗∗∗

−0.0891∗∗∗

∗

0.0997∗∗

0.079∗

0.0231

−3.17∗∗∗

−0.633

−7.5∗∗∗

−8.95∗∗∗

0.151

−1.91∗∗∗

−1.74∗∗∗

0.127

−0.0119∗∗∗ 0.12∗∗∗ −0.132∗∗∗

−0.0198∗∗∗ 0.132∗∗∗ −0.144∗∗∗

−0.0302∗∗∗ 0.0811∗∗∗ −0.127∗∗∗

1.64∗∗∗

0.861∗∗∗

0.855∗∗∗

0.931∗∗∗

(3)

Social security transfer (t − 1) Economic risks Openness (t − 1) Deindustrialization (t − 1) Unemployment rate (−1) Control variables Population 65 and over as a % of poputlation Annual deficit (primary government balance) as a % of GDP Institutions EPL (Employment protection legislation) PC (Private credit by deposit money bank) ALF (Arm’s length financial system index) Economic risks, interacted with institutions EPL∗Openness (t − 1) EPL∗Dindustrialization (t − 1) EPL∗PC (t − 1) Deindustrialization∗PC (t − 1) ALF∗Openness (t − 1) ALF∗Deindustrialization (t − 1) Constant

(2)

(1)

Variable

Table 4.1 Social security transfer. Economic risks and institutions

−12∗∗∗

−0.00642 −0.0618∗∗∗

−8.3e-08

−2.27∗∗∗

9.57∗∗∗

−0.122∗∗∗

0.0575

−0.0351∗∗∗ 0.248∗∗∗ −0.135∗∗∗

0.838∗∗∗

(4)

3.06∗∗∗

−0.00927 0.103∗∗∗

−0.7∗∗∗

−6.83∗∗∗

0.602∗∗

−0.313∗∗∗ 0.199 −1.1

−8.26

−1.69∗∗∗

0.817∗∗

−0.112∗∗∗

0.117∗∗∗

−0.0203 −0.0655∗∗∗

0.124∗∗∗ 0.0278 −0.144∗∗∗

0.872∗∗∗

(6)

−0.0157∗∗∗ 0.0692∗∗∗ −0.173∗∗∗

0.892∗∗∗

(5)

−0.00562 −0.0739∗∗∗ −0.0117∗ 0.101∗∗∗ −0.116∗∗ −0.396∗∗∗ −4.59

−1.5e–07

−6.77∗∗∗

5.25∗∗∗

−0.0723∗∗∗

−0.0331

0.00455 0.394∗∗∗ −0.194∗∗∗

0.88∗∗∗

(7)

82 H. Tohyama deficit has a negative effect on spending, which would mean that a deteriorating budgetary position could pressure a government to cut budget. Trade openness is more likely to have a negative effect on welfare spending (except model 6). This result implicates that greater trade openness involves domestic firms and workers in increased international competition, which generates more pressures for reduction in government welfare spending, since the spending supposedly reduces the competitiveness. De-industrialization has a positive effect in all the models. If deindustrialization forces workers to move from manufacturing to services, the risk of losing his or her job in a particular branch of the economy, and having to find another job requiring very different skills will be heightened. It induces workers to express demands for expanding welfare spending as a means of a social insurance (e.g., Iversen and Cusack 2000; Iversen 2001). This argument is consistent with results estimated here. However, it seems that EPL reduces the risk of enforced labor movement due to de-industrialization. As models (4) and (7) show, an interaction between de-industrialization and EPL has a significant and negative effect on spending. Unemployment has a strong and negative effect on welfare spending as expected. For workers, unemployment is the most direct threat to the source of income. As the result indicates, an increase in the risk of unemployment presses workers to refrain from demand for expanding welfare spending. Yet, unemployment may be deteriorated by trade openness or de-industrialization and accordingly, the risk of unemployment can be a function of those two variables. To assess which risk is more influential, elasticity of welfare spending with regard to risk variables was computed at the point of means of the data, based on models (1) and (3). The results are shown in Table 4.2. As this simple technique implicates, unemployment is the most influential variable (−0.127 in model (8) and −0.132 in model (9)). As mentioned above, although unemployment is the most direct threat to the source of income, unemployment may be endogenously determined by globalization and de-industrialization. De-industrialization is a more influential factor than trade openness (0.0811 versus −0.0302 in model (8) and 0.12 versus −0.0119 in model (9)). This result is in favor of the argument that de-industrialization is the prime factor relating economic risks with workers’ insecurity and increasing welfare expenditure. Yet, openness is also influential.9 Table 4.2 Elasticity of social security transfer Variable

(8)

(9)

Economic risks Openness (t − 1) Deindustrialization (t − 1) Unemployment rate (t − 1)

−0.0302∗∗∗ 0.0811∗∗∗ −0.127∗∗∗

−0.0119∗∗∗ 0.12∗∗∗ −0.132∗∗∗

∗

p < 0.05; ∗∗ p < 0.01; ∗∗∗ p < 0.001.

A comparative study with an emphasis on Japan 83 As for labor market institutions, EPL is expected to protect workers from losing his or her job. In the economies where EPL is stricter and in favor of workers, it can be easier for workers to express greater demands for expanding welfare spending. The results exhibit positive effects, as expected. This result might be inconsistent with the idea that labor market institutions can be substituted for welfare spending. However, the fact that labor market institutions work as a social insurance does not contradict this. It may be more appropriate to think that institutions bolster up workers’ security in the market, leading to a greater demand for welfare spending. In other words, welfare spending and institutions are complementary in enhancing social protection. Financial market developments allegedly work as a social policy that decouples workers’ welfare from market outcomes (Bertola 2007). This argument seems to be plausible if attention is paid to a financial structure effect. This has a significant and negative effect on welfare spending. However, financial market development per se may have a deteriorating effect on workers’ welfare in the event of financial turmoil. In order to access whether heightened volatility in a financial market leads workers to express demands for increasing welfare spending, equation (4.1) will be revised in the following subsection. Volatility in a financial market To assess the effect of a financial market risk on welfare spending, a banking crisis dummy and, alternatively, a standard deviation of house prices are included. Equation (4.1) has been revised in the following form: Yit = αi + β1 · Yi,t−1 + β2 · EconomicRiski,t−1 + β3 · LaborMarketInstitutionsi,t + β4 · FinancialStructurei,t + β5 · FinancialMarketRisk + β6 · EconomicRiski,t−1 · LaborMarketInstitutionsi,t−1 + β7 · EconomicRisksi,t−1 · FinancialStructurei,t−1 + β8 · Controlsi,t + εi,t

(4.2)

We need to focus here on a financial market risk variable. Banking crisis and, alternatively, standard deviation in real house prices are used here. As mentioned above, the banking crisis is represented as a dummy variable. It takes 1 if a banking crisis takes place in the year and 0 otherwise.10 To calculate a standard deviation of real house prices, the percentage change of the previous year is used here. All other variables are the same as in equation (4.1). The result of estimating equation (4.2) is shown in Table 4.3. Model (10) is the base model for which the arm’s-length financial system index is used as a proxy for a financial structure. The effects of BankingCrisis on welfare spending are positive, as indicated in Model (12). However, this variable is

84 H. Tohyama Table 4.3 Social security transfers. Labour and financial market risks and institutions Variable Social security transfer (t − 1) Economic risks Openness (t − 1) Deindustrialization (t − 1) Unemployment rate (t − 1) Control variables Population 65 and over as a % of poputlation Annual deficit (primary government balance) as a % of GDP Institutions EPL (Employment protection legislation) ALF (Arm’s length financial system index) Financial volatility House price_std Banking crisis Constant ∗

(10)

(11)

(12)

0.931∗∗∗

0.924∗∗∗

0.933∗∗∗

−0.0302∗∗∗ 0.0811∗∗∗ −0.127∗∗∗

−0.0635∗∗∗ 0.117∗∗∗ −0.119∗∗∗

−0.0263∗∗∗ 0.0757∗∗∗ −0.124∗∗∗

0.0231 −0.0891∗∗∗

−0.0221 −0.0855∗∗∗

−0.0334 −0.0788∗∗∗

0.86∗∗ −3.85∗∗∗

2∗∗∗ −2.15

0.905∗∗ −3.64∗∗∗

0.233∗∗∗ −0.799

−3.88∗∗

0.028 −0.0661

p < 0.05; ∗∗ p < 0.01; ∗∗∗ p < 0.001.

not significant. In regard to the house price variable as a proxy for financial fluctuations, it shows a significant and positive effect (0.233 in Model (11)). This result can be interpreted as follows. The more that house prices fluctuate, the more households will be confronted with a higher risk of reduced financial assets. This heightened risk can induce households to demand that the government expand spending in order to offset income loss due to the reduction of the value of their financial assets. Over the period under investigation, fluctuations in real house prices – i.e., standard deviation – range from 1.48 in Germany to 7.31 in Sweden among countries which we took as samples for a counterfactual exercise. In order to see how fluctuation in a financial market would influence welfare spending in Japan, we conducted the exercise based on the following question: “What would happen to evolution of social security transfer if the Japanese economy were to be confronted with different countries’ levels of fluctuation in a financial market?” We used Model (11) in Table 4.3 to calculate the effects. The result is presented in Figure 4.4. As is shown, if the Japanese economy were to be confronted with a Swedish level of financial fluctuation, the social security transfer would be increased by 1.3 per cent. In contrast, the social security transfer would be reduced slightly if the standard deviation of house prices in the Japanese economy was at the German level. We can conjecture that workers become more sensitive to fluctuating house prices, and accordingly, more fluctuations in the financial market can put pressure on them to demand that government should expand welfare spending.

A comparative study with an emphasis on Japan 85

10.0857

10.0163 1995 11.3758

10.3549

8

9

11 10 Social security transfer as % of GDP

Japanese HousePrice Swedish HousePrice

12

German HousePrice USA HousePrice

Figure 4.4 Effects of fluctuating house prices on Japanese social spending in 1995.

A summing up Contrary to the existing views, such as those that are product market-centered and labor market-centered, we argue that all the risks need to be included in order to comprehend how welfare spending will evolve as workers demand welfare spending as a means of insuring themselves against the risks, irrespective of where those risks emerge. As empirical results clearly show, the risks originating in the financial market as well as in the product or labor market have a strong effect on the evolution of welfare spending. Labor market institutions (EPL) attenuate the effects of the risks on welfare spending. This implies that as EPL becomes stricter, workers find themselves being protected from job loss risks, and because of this institutional environment, it can be easier for workers to express greater demands for expanded welfare spending.

Implications for institutional changes in Japan The Japanese labor market is undergoing institutional changes. It has been alleged that these changes will lead to the creation of dualism in the labor market because of increasing non-regular workers (e.g., Jones 2007). It is likely that Japanese workers will be confronted with increased risks. The results of the empirical study above demonstrate that workers’ demands for welfare spending and insurance-oriented institutions are complementary. It

11 10 9 8 7 6 5

Social security transfer as a % of GDP

12

86 H. Tohyama

1991

1992

1993

1994

Japanese EPL Swedish EPL

1995

1996

German EPL USA EPL

Figure 4.5 Effects of EPL on Japanese social spending.

follows that ongoing institutional changes, i.e., reduced EPL, would induce workers to hold down their demands for expanding welfare spending. In order to visualize this prediction, we conducted a counterfactual exercise based on Model (11) in Table 4.3, which illustrates the likely evolution of social security transfers if the Japanese economy were to adopt a different level of EPL. Figure 4.5 shows how changes in EPL would have effects on levels of social security transfer. If the Japanese government were to remove EPL, resulting in Japan being at the level of the USA, the social security transfer would decrease by more than 1 per cent. On the contrary, if a German level of EPL were to be adopted, the social security transfer would be increased by approximately 1 per cent. This exercise postulates that removing EPL would result in a reduction in welfare spending. Therefore, Japanese workers would face a reduction in social protection, irrespective of whether this protection is provided by institutions or by government policies, since both EPL and welfare spending work as a means of insurance against risks in the labor market. To summarize, insurance-oriented institutions or policies are likely to function insufficiently if institutional changes in the Japanese labor market are launched near to a fully-fledged competitive market. The removal of such institutions has negative effects on welfare spending. It is more likely that institutional changes in the Japanese labor market result in less social protection and expose workers to greater risks than before (see Figure 4.2).

A comparative study with an emphasis on Japan 87

Concluding remarks How will the recent institutional changes in the Japanese labor market influence welfare spending, social protection, or the welfare state in a broad sense? To answer this question, models were specified earlier in this chapter in which economic risks, institutions, and welfare expenditure were interrelated. This chapter argued that the notion of where risks emerge should be extended to include where risks originated not only in product and labor markets, but also in financial markets, and how to investigate the risks interacted with labor market institutions. Following this, the relationship between economic risks and welfare spending in 15 advanced economies over the period from 1984 to 2000 was empirically investigated based on this framework. The findings were that globalization has a negative effect on welfare spending, and that de-industrialization has a positive effect. However, the effects are attenuated by an insurance-oriented labor market institution in the EPL. A financial market development can have a negative effect on welfare spending and can mitigate economic risks emerging from a labor market. However, volatilities in a financial market can cause workers’ welfare to deteriorate, and this can induce workers to express greater demands for expanding welfare spending. As the empirical results show, a worker’s demand for welfare spending and insurance-oriented institutions may be complementary. Assuming this to be true, it is likely that ongoing institutional changes in Japan have given workers an incentive to refrain from demanding expanded welfare spending. This infers a prediction that a less stringent EPL is likely to result in less social protection and expose workers to more economic risks. A couple of questions will have to be left for further research. While this chapter has shown how institutional changes in the Japanese labor market have had an influence on levels of social protection, the interaction between the political process and demands for welfare expenditure have been left aside. This chapter should be completed by exploring such political factors as a partisan effect for vote mechanisms (cf. Amable et al. 2006). Furthermore, the chapter is not concerned with subjective employment insecurity. Workers’ demands are usually assumed to be linked with such subjective insecurity. The relationship between these factors should be carefully explored in the future (cf. Anderson and Pontusson 2006).

Appendix: data sources Openness: Armingeon et al. (2006) Comparative Polical Data Set 1960–2004, Institute of Political Science, University of Berne. OECD standardized unemployment: Nickell, W. (2006) The CEP-OECD Institutional Data Set (1960–2004). De-industrialization: Nickell, W. (2006) The CEP-OECD Institutional Data Set (1960–2004).

88 H. Tohyama Employment protection legislation: Nickell, W. (2006) The CEP-OECD Institutional Data Set (1960–2004). House price: Girouard, N. et al. (2006). Private credit by deposit money banks/GDPAFBeck ˛ et al. (1999) A New Database on Financial Development and Structure. Undated data retrieved at the World Bank (accessed 6 June 2010). Banking Crises: Caprio et al. (2003) Banking Crises Database. Reinhart and Rogoff (2008) Banking Crises. Arm’s length financial market system index: IMF (2008). Population 65 and over as a percentage of population: Armingeon et al. (2006) Comparative Political Data Set, 1960–2004. Annual deficit as a percentage of GDP: Armingeon et al. (2006) Comparative Political Data Set, 1960–2004. Social security transfers as a percentage of GDP: Armingeon et al. (2006) Comparative Political Data Set, 1960–2004.

Notes 1 According to other ideas about motives for redistribution, workers are in favor of income redistribution because they expect to gain more from it when they see themselves as disadvantaged. However, there are some studies that show a negative relationship between inequality and social expenditure (e.g., Moene and Wallerstein (2001). This evidence suggests that workers’ demands for expanding social expenditure are less likely to be driven by a redistributive motive. Hence, I will focus in this chapter on the insurance motive. 2 Empirical evidence of the relationship between globalization and welfare spending is mixed. For example, Iversen (2001) investigates whether the output volatility of industries increases with export dependence, and whether such volatility translates into greater swings in industrial wages and employment. He concludes that there is no relationship between the export dependence of manufacturing and any of the volatility (see also Iversen and Cusack 2000). 3 Iversen and Soskice (2001) show that workers with specific skills are more inclined to support for social protection. 4 This idea is supported by some empirical studies. Catte et al. (2004) examines the effects of housing wealth on consumption and finds a positive relationship between them. Deroose ed. (2006) observes that there are larger wealth effects from housing and financial assets in the countries that have the most liberalized financial markets. 5 xtfevd for a FEVD procedure is available, which is an ado-file for Stata developed by Plümper and Troeger (2007). 6 The countries are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, Netherlands, Norway, Sweden, UK, and the USA. 7 It might be problematic to consider the size of welfare state in terms of this variable. Some scholars have cast doubt on the relevance of this variable as the size of welfare state (e.g., Korpi and Palme 2003; Starke 2006). However, in this chapter, social security transfers are recognized as a measure of social protection, rather than as a measure of the size of the welfare state.

A comparative study with an emphasis on Japan 89 8 In the previous section, wage distribution is also referred to as a factor that affects the size of economic risks in addition to these four risks. However, a wage distribution variable was not significant in any of the model specifications. Therefore, I ruled out this variable in terms of an empirical analysis. 9 As Iversen (2001) stressed, de-industrialization has the greatest effect on welfare spending. Yet, openness is also a significant factor. 10 Specifying crisis years is based on a research database “Episode of Systemic and Borderline Financial Crises” (see Caprio et al. 2003). Updated data can be retrieved from http://www1.worldbank.org/finance/html/database_sfd.html.

5 Increasing wage inequality in Japan since the end of the 1990s An institutional explanation Hiroyuki Uni

Introduction Income inequality has risen in the USA and UK since the 1980s. There are several views that emphasise that this situation is the outcome of institutional factors such as deregulation, privatisation, tax reform favourable to high-income earners, reform of the social security system, the decreasing income transfer and attack on trade unions (Freeman and Katz 1994; Pontusson 2005; Krugman 2007; Goldin and Katz 2007).1 However, the most popular view is the skill-biased technological change (SBTC) hypothesis wherein the main cause of the rising income inequality is the demand shift towards skilled labour through the diffusion of the ‘IT-related technique’ (Katz and Murphy 1992; Berman et al. 1994; Autor et al. 1998, 2008). As the SBTC hypothesis assumes that wages are determined chiefly by the supply–demand condition in the labour market, the demand shift towards skilled labour raises the wages of skilled workers. On the other hand, there are some studies that emphasise the influence of globalisation. This view is divided into two hypotheses. The first one emphasises the relocation (outsourcing) of non-skilled production to developing countries. As such outsourcing lowers the demand for non-skilled workers in developed countries, the relative demand for skilled labour increases, thus widening the wage gap between the two groups (Feenstra and Hanson 1996). According to the SBTC and the outsourcing hypotheses, the demand shift towards skilled labour occurs within each industry. The second hypothesis based on globalisation emphasises the factor price change in developed countries (an increase in the wages of skilled labour and a decrease in those of non-skilled labour) as an effect of trade in the Heckscher– Ohlin–Samuelson model (Wood 1994; Sachs and Shatz 1994).2 According to this hypothesis, the demand shift towards skilled labour is caused by the changes in the industrial structure that lead to the production specialisation for skilled labour-intensive goods in developed countries. In this chapter, using the factor decomposition of micro data,3 we examine the validity of the SBTC and outsourcing hypotheses regarding the continued rise in wage inequality within each age group that first emerged at the end of the 1990s in Japan. If the conclusion is presented in advance, these hypotheses are invalid. In Japan, the labour market liquidity is low and wages are chiefly determined

Increasing wage inequality in Japan 91

IT revolution

Population ageing

Skill-biased technological change Reforms of the wage system Uni (2008b)

Non-regularisation of employment Ota (2005)

Globalisation

Outsourcing

Demand shift towards skilled labour

Changes in relative factor prices by trade

Ohtake (2003) Sakurai (2000, 2004) Cabinet Office (2006)

Rise in income inequality

Figure 5.1 Views on the cause of the rising wage inequality in Japan.

on the basis of the wage system of each enterprise; although the demand shifts towards skilled labour owing to IT and globalisation, this shift is not likely to lead directly to the wage increase of skilled workers. The influence of IT and globalisation on wages is mainly reflected in the institutional reactions of enterprises. These institutional reactions are influenced not only by IT and globalisation, but also by various internal and external changes in the enterprise, such as ageing of the employees and deregulation. Moreover, the existing industrial relations and customary practices act as constraints to managerial decisions. As an alternative to the SBTC and outsourcing hypotheses, we present the following institutional hypothesis to explain the cause of rising income inequality since the end of the 1990s in Japan. The most important cause is the reforms in the wage system, such as the introduction of a performance-based wage system and the weakening of the spring labour offensive system. We examine the validity of this ‘wage institution view’ using the factor decomposition of micro data. The organisation of this chapter is as follows. The second section examines the validity of the SBTC and outsourcing hypotheses. The third section explains our ‘wage institution view’ and examines its validity. The fourth section presents the conclusion. In addition, Figure 5.1 illustrates the various views regarding the cause of the rising wage inequality in Japan. Two popular views in Japan are the ‘population ageing view’ and ‘non-regularization view’. A criticism of them is presented in Uni (2008c).

The influence of IT and globalisation As the wage differential between skilled and non-skilled workers based on educational background or profession was stable in Japan throughout the 1980s and 1990s, neither the SBTC nor outsourcing hypothesis became as popular in Japan, unlike in the USA and UK. However, there are a few studies related to the above

92 H. Uni hypotheses on Japan, such as Sakurai (2000, 2004), Sasaki and Sakura (2005), Ikenaga (2008) and Cabinet Office (2007).4 Sakurai (2004) and Sasaki and Sakura (2005) conducted the following three types of analysis. First, as the wage differential by educational background or profession has been almost constant in the aggregated data of the official wage statistics, they tried to determine the wage differential between skilled and nonskilled workers using the following procedures. They estimated the ‘Mincer-type’ wage function by taking into account the workers’ characteristics such as the duration of their schooling and working years. Using the estimation results, they quantitatively evaluated the hourly wage differentials among workers with different educational backgrounds after controlling for the workers’ characteristics. Both these studies found that the hourly wage differentials between university and non-university graduate workers increased in 1985–2000 or 1985–2003. Second, they decomposed the increase in the wage bill share of university graduates during this period into ‘within’ and ‘between’ shifts. The within shift denoted the increase in this share within each industry, which was consistent with the SBTC and outsourcing hypotheses. The between-shift represented the increase in this share through the changes in the industrial structure, which was consistent with the effect of trade in the Heckscher–Ohlin–Samuelson model. Both these studies found that the contribution rate of the within shift largely exceeded that of the between-shift and concluded that ‘the relative demand for university graduate workers within the same industry increased due to SBTC and the expansion of foreign outsourcing’. Third, they estimated the extent of influence of SBTC and outsourcing by using a regression analysis based on the panel data on Japan’s manufacturing sector by industry. The explained variable is the wage bill share of university graduates and the explaining variables are the research and development (R&D) expenditures ratio as an SBTC factor and the import ratio or the foreign production ratio as a globalisation (outsourcing) factor. Sasaki and Sakura (2005) mentioned that the sum of contribution ratios of both globalisation and SBTC factors is approximately equivalent to slightly less than 20 percent; and it can be said that the impact of a globalisation factor has been, at least, the same as, or more than, that of an SBTC factor. In a section of the Annual Report on the Japanese Economy and Public Finance 2007 (Cabinet Office 2007), the gap problem was analysed in line with the same report of the previous year (Cabinet Office 2006). In this section titled ‘The relation between economic growth and inequality’, the rising income inequality in the USA and UK since the 1980s was examined. In this context, the Cabinet Office (2007) commented on ‘the development of IT’, ‘deepening globalisation’ and ‘the ageing of the population’. With regard to the rising income inequality in Japan, the Cabinet Office (2007) stated – in keeping with the findings of the Cabinet Office (2006) – that, ‘the main cause of the recent rise in income inequality in Japan is the ageing of the population’. The new opinion added to the report of

Increasing wage inequality in Japan 93 the Cabinet Office (2006) is that ‘globalisation and IT partially contributed to the rising income inequality’. On the basis of a regression analysis similar to that in Sasaki and Sakura (2005), the Cabinet Office (2007) mentioned the following: the contribution ratio of globalisation factors is significantly larger than that of the technological change factor. These two factors explain only 10 per cent of the changes in the relative wage of university graduate workers. These results are similar to those of previous empirical studies. The above-mentioned studies attempt to measure the influence of SBTC and globalisation on wage inequality, focusing on the wage differential by educational background or profession. The results of the regression analyses conducted herein reveal that the amount of this influence – measured in terms of the contribution ratio to the wage bill share of university graduates – was 10–20 per cent in Japan. However, it would be premature to state, on the basis of these results, that ‘globalisation and IT partially contributed to the rising income inequality’. First, the wage bill is the product of the wages per capita and number of workers. Therefore, the increase in the wage bill share of university graduates can be decomposed into the rising wage differential by educational background and the increase in the number share of university graduate workers. As the latter is an obvious fact in Japan,5 the former would be considerably small. Therefore, the above-mentioned results of regression analyses are likely to indicate the contribution ratio of globalisation and IT to the number share of university graduate workers rather than to the relative wage of university graduate workers. Second, if a part of the abovementioned contribution ratio (10–20 per cent) pertained, to the relative wage of university graduate workers, answering the following question becomes necessary. How much weight did the increase in the relative wage of university graduate workers carry in the recent rise in income inequality in Japan? If it was on the smaller side, the influence of IT and globalisation on the rising income inequality would be negligible. The above-mentioned studies did not measure this weight. In the rest of this section, we measure this weight using micro data. From the anonymised micro data of the Employment Status Survey in 1997 and 2002, we calculate the hourly wages of regular male workers6 with 200 working days or more per year (see Uni 2008b; for more precise procedure). Thereafter, we decompose the changes in the log variance of the hourly wages in each age group into three factors: within-education effects (effects of wage disequalisation within each educational background group), between-education effects (effects of wage disequalisation between different educational background groups) and the effects of the change in workers’ distribution by educational background (effects of the popularisation of higher education). We conduct a similar decomposition in the case of professions (the method is presented in the Appendix). Table 5.1 shows the result of the decomposition by educational background. As shown in this table, the log variance of the hourly wages increased in all age groups in the period 1997–2002. Among the three above-mentioned factors, the within-education effects were the largest while the between-education effects and

94 H. Uni Table 5.1 Decomposition of the changes in the hourly wage inequality regarding education (Male regular workers, 1997–2002, Japan) Age

Change in log variance Within-education effects Between-education effects Effects of changes in educational structure

20–9

30–9

40–9

50–9

0.022 0.025 −0.002 −0.001

0.028 0.028 0.000 0.000

0.018 0.023 0.004 −0.009

0.030 0.031 0.000 −0.002

Note: The educational background groups are ‘elementary school or junior high school graduates’, ‘high school graduates’, ‘junior college or college of technology graduates’ and ‘university and graduate school graduates’. Source: The author calculated the above figures using the anonymised micro data of the Employment Status Survey of 1997 and 2002.

effects of the change in worker distribution by educational background were very small.7 The growth rates of the log variance in each educational background group were 13.5 per cent in the case of ‘elementary school or junior high school graduates’, 14.3 per cent in ‘high school graduates’, 17.0 per cent in ‘junior college or college of technology graduates’ and 12.4 per cent in ‘university and graduate school graduates’ (these figures are the averages of the four age groups). Thus, the wage inequality rose uniformly within all educational background groups. This uniform disequalisation within each educational background group and the nondisequalisation between different educational background groups contradicts the SBTC and outsourcing hypotheses. This pattern of disequalisation is consistent with the wage institution view that we will explain in the next section. Moreover, we examined the validity of the SBTC and outsourcing hypotheses regarding the rising wage inequality in male full-time workers8 in the USA using the above-mentioned factor decomposition. We used the micro data of the Current Population Survey, Merged Outgoing Rotation Groups of 1980, 1990 and 2000. Table 5.2 shows the result of the decomposition of the changes in the hourly wage inequality regarding education in 1980–90. In contrast to the result in Japan (Table 5.1), the between-education effects were as large as the within-education effects in the USA.9 The effects of the change in the workers’ distribution by educational background were very small, like in Japan. These two characteristics were also found in 1990–2000, although the size of effects were about half of the data in 1980–90.10 Thus, the disequalisation between different educational background groups contributed largely to the rising wage inequality in the United States. This pattern of disequalisation is consistent with the SBTC and outsourcing hypotheses. Table 5.3 shows the result of the decomposition by occupation in Japan. Similar to the decomposition by educational background, the rising inequality of hourly wages was chiefly caused by the within-occupation effects. The between-occupation effects and the effects of the change in the workers’

Increasing wage inequality in Japan 95 Table 5.2 Decomposition of the changes in the hourly wage inequality regarding education (Male full-time workers, 1980–90, USA) Age

Change in log variance Within-education effects Between-education effects Effects of changes in educational structure

20–9

30–9

40–9

50–9

0.044 0.024 0.019 0.001

0.060 0.034 0.030 −0.005

0.070 0.029 0.035 0.007

0.070 0.034 0.026 0.010

Note: The educational background groups are ‘high school dropout’, ‘high school graduate’, ‘some college’, ‘college graduate’ and ‘post college’. Except for hourly paid workers, an hourly wage rate is computed by dividing the usual weekly earnings by usual weekly hours of work. The top-coded weekly earnings number is multiplied by 1.4 just like Lemieux (2006). Source: The author calculated the above figures using the anonymised micro data of the National Bureau of Economic Research’s Current Population Survey, Merged Outgoing Rotation Groups of 1980 and 1990.

Table 5.3 Decomposition of the changes in the hourly wage inequality regarding occupation (Male regular workers, 1997–2002, Japan) Age

Change in log variance Within-occupation effects Between-occupation effects Effects of changes in occupational structure

20–9

30–9

40–9

50–9

0.021 0.019 0.000 0.003

0.028 0.023 0.004 0.001

0.018 0.018 0.003 −0.002

0.030 0.024 0.007 0.000

Note: The occupation groups are ‘specialist and technical workers’, ‘administrative and managerial workers’, ‘clerical workers’, ‘sales workers’, ‘service workers’, ‘security workers’, ‘agriculture, forestry and fishery workers’, ‘transport and communication workers’ and ‘production process and related workers’. Source: See Table 5.1.

distribution by occupation are very small. The uniform disequalisation within each occupation group and non-disequalisation between different occupation groups contradicts the SBTC and outsourcing hypotheses and is consistent with the wage institution view. According to the results of these two decompositions, the wage disequalisation between workers with different educational backgrounds or occupations did not really contribute to the recent rise in wage inequality in Japan. Measured on the basis of the hourly wages of each age group, these two types of wage disequalisation did not occur in 1997–2002.11 This fact can be confirmed by the uniform decrease in the average hourly wages of each educational background or occupation group. The decrease rates in these five years were 11.8 per cent in

96 H. Uni ‘elementary school or junior high school graduates’, 11.5 per cent in ‘high school graduates’, 14.5 per cent in ‘junior college or college of technology graduates’ and 11.6 per cent in ‘university and graduate school graduates’ (these figures were the averages of the four age groups). Therefore, even if IT and globalisation contributed slightly to the wage disequalisation between workers with different educational backgrounds, the influence of IT and globalisation on the rising income inequality was negligible. Consequently, the SBTC and the outsourcing hypotheses are hardly valid as an explanation for the recent rise in income inequality in Japan. The statement of the Cabinet Office (2007) that ‘globalisation and IT partially contributed to the rising income inequality’ is thus an unsubstantiated assertion.

The influence of the wage system reform As mentioned above, the wage inequality between workers with different educational backgrounds has been constant in Japan, although the share of university graduate workers has increased. This fact is not unnatural if we take into account the characteristics of the employment and wage systems in Japan. Table 5.4 shows the median years of tenure of university graduate workers with their current employers. In Japan, the years of tenure increase in parallel with the worker’s age. In other words, the majority of university graduate male workers work exclusively for one company in their lifetime. It means that so-called ‘lifetime employment system’ still exists. On the other hand, the short duration of tenure in the USA indicates that career change and mid-career hiring are widespread. The low mobility of university graduate male workers in Japan means that the adjustment of wages in correspondence with the supply–demand condition in the labour market is difficult to function. Such market coordination of wages is effected – to some extent – only in the case of new graduate workers. The other aspects of wage profiles are chiefly determined by the wage system that is institutionalised in each enterprise. This wage system has mid- and long-term stability and is not much influenced by a short-term fluctuation of the supply–demand condition in the labour market. Consequently, even if the demand shifts towards skilled labour due to IT and globalisation, it is unlikely that it will directly raise the wages of skilled labour.

Table 5.4 Median years of tenure with current employer for university graduate workers (2006) Age

USA Japan

25–34

35–44

45–54

55–64

3.0 5.5

5.2 13.3

8.8 20.3

11.1 22.0

Sources: Japan: The Ministry of Health, Labour and Welfare’s Basic Survey on Wage Structure in 2006, USA: The US Department of Labor’s Employee Tenure in 2006.

Increasing wage inequality in Japan 97 The influence, if any, of IT and globalisation on wages in Japan is reflected mainly in the reform of the wage system in each enterprise. This wage system reform is planned by not only taking into account IT and globalisation, but also the various internal and external changes in the enterprise, such as the ageing of the population and deregulation. Moreover, the existing harmonious industrial relations and numerous customary practices serve to constrain managerial decisions. In Japan, IT and globalisation not only caused a demand shift towards skilled labour in the 1990s, but also eroded the profitability of Japanese companies through factors such as intensified international competition. Many enterprises tried to reduce wage costs to recover their profitability. IT and globalisation were not the only factors that forced enterprises to reduce wage costs; the disposal of bad debt caused by the bursting of the bubble economy, the accelerating ageing12 of the workforce and the changes in the competitive environment caused by deregulation policies were also contributors. There are two ways to reduce wage costs: employment reduction and wage reduction. However, the former is constrained due to some factors in Japanese companies. The downsizing of the existing employees cannot be implemented easily, although it is possible to suspend or reduce recruitments. Although some companies solicited voluntary retirement as the last option towards reducing the number of employees in the 1990s, many companies tried to reduce wages. It was done through the introduction of a performance-based system and the weakening of the spring labour offensive system in addition to the control of the rate of wage increase. Until the 1960s, the seniority-based system was the dominant wage system in Japan. Under this system, the main basis for the wage level and promotions was the age of the employees. Since the 1970s, merit-based wage systems have been introduced on the basis of the initiatives of the Japan Federation of Employers’ Association that intended to strengthen the skill upgrading and incentive functions of the wage system. The merit-based wage system and competency assessment comprise the special Japanese personnel and wage system known as ‘the meritbased grade system’. Managers assess workers’ competency, referred to as ‘merit’. Subject to this assessment, workers are ranked on the basis of a merit grade that is linked with remuneration. However, the introduction of this merit-based wage system gave rise to a problem. As it was very difficult to quantify objectively a worker’s merit through this assessment, the managers often assigned a heavy weight to the worker’s seniority or years of experience. Such ‘senioritybased operation of the merit-based grade system’ contributed to reducing the wage inequality generated by the merit-based wage system (Kusuda 2002). In the long period of stagnation following the collapse of the bubble, the intensified international competition and rising wage costs due to the ageing of employees, Japanese companies were forced to reduce their wage costs.13 As shown in Figure 5.3, the annual wage growth slowed down drastically and the wage rise – excluding the regular wage increase based on seniority – ceased from the mid 1990s. In the 1990s, many enterprises introduced a performance-based wage system in which the link between wages and individual performance was strengthened by objectives management, self-assessment and interview systems.

98 H. Uni

under 1 billion yen

5 to 10 billon yen 10 billion yen and over

1 to 5 billion yen

100 80 60 (%) 40 20 Others

Production process and related workers

Clerical workers

Service workers

Specialist and technical workers

Sales workers

Administrative and managerial workers

0

Figure 5.2 Adoption rate of the performance-based wage system by occupation and enterprise zone (the amount of capital stock). Source: Cabinet Office, Economic and Social Research Institute (2005).

16 14

5,000 employees and over

12

100–299 employees

10 (%) 8 6 4 2 0 75

80

85

90

95

2000

2005

Figure 5.3 Annual growth of per capita wage by enterprise size. Source: The Ministry of Health, Labour and Welfare’s Survey on Wage Increase.

As the ‘seniority-based operation of the merit-based grade system’ was eliminated in the performance-based wage system, the wage gap between the employees within an enterprise widened. Actually, it was confirmed that wage inequality rose after the performance-based wage system was introduced.14 The most prominent performance-related wage system is the annual salary system. In 1996, about

Increasing wage inequality in Japan 99 10 per cent of Japanese enterprises had introduced the annual salary system for administrative jobs, and this figure increased to 40 per cent in 2002.15 Moreover, the Cabinet Office, Economic and Social Research Institute (2005) conducted a questionnaire survey on the adoption rate of the performance-based wage system. As shown in Figure 5.2, the larger the amount of capital stock of enterprises, the higher were their rates of adoption of the performance-based wage system.16 The wage-bargaining system also changed. The ‘spring labour offensive system’ plays an important role as an inter-firm wage standardisation mechanism in Japan, where intra-firm wage bargaining by enterprise unions is popular. In this system, the date for each wage bargaining session is set as follows. The enterprises which are comparatively more successful than the others are the first to conduct their bargaining sessions and they then become the pattern setters who develop the social standard of wage increase. Other enterprises schedule their bargaining sessions a few days after those of the comparatively more successful enterprises in order to follow the wage increase of the pattern setters as much as possible. From the mid 1990s, however, the pattern setter unions were often unable to achieve their wage demands. Moreover, in many cases, trade unions could not coordinate their wage demands in each industry. The spring labour offensive in 1995 marked a turning point (Takanashi 2002). The Great Hanshin Earthquake of 17 January 1995 especially affected the public utility sectors. The General Federation of Private Railway and Bus Workers Union of Japan could not schedule a strike. The union and the management of Nippon Telegraph and Telephone Corporation (NTT) reached an agreement earlier than scheduled. The centralised collective bargaining in the private railway sector that had continued since 1967 collapsed in 1995 and strikes in this sector became fewer after 1995. Although the public utility sectors had supported a wage rise during the recession, this function was lost under pressure of deregulation in the public utility sectors. In the spring labour offensive in 2000, the bargaining in NTT, electric power companies and private railway companies was settled without a wage increase, although the major metal and machinery companies responded with a wage increase of about 500 yen. Moreover, the bargaining in Toyota – a significant pattern setter which had been performing successfully since the 1990s – was also settled with no wage increase in 2001 and 2002. In 2003, the labour union in Toyota abandoned the demand for a wage increase. As far as the management perspective is concerned, managers attach low importance to the social standard of wages in wage determination.17 The Japan Federation of Employers’ Associations (1995), which served to guide the managers’ decisions, declared that managers’ should attach more importance to an intra-firm relationship rather than an industry-level relationship. ‘The intra-firm wage determination’ was arrived at in the spring labour offensive in 1997. The management of Toyota responded with a wage increase of about 700 yen, which exceeded the demand by the Confederation of Japan Automobile Workers’ Unions. Moreover, the continuing unified efforts of five steel major companies since 1957 failed in 2000. According to the Basic Survey on Labour Unions conducted by the Ministry of Health, Labour and Welfare, the unionisation rates in 2005 were 47.7 per cent

100 H. Uni in enterprises with 1,000 employees and more, 15.0 per cent in those with 100 to 999 employees and 1.2 per cent in those with less than 99 employees. In non-union enterprises, wages are likely to be determined at the discretion of the employers. Therefore, employers’ disregard of the social standard of wages widens the wage gaps within workers, especially in small-sized enterprises. Such a weakening of the spring labour offensive causes an increase in interfirm wage inequality. Figure 5.3 shows the annual growth rate of per capita wage by enterprise size. Large-sized enterprises (with 5,000 employees and over) and middle-sized enterprises (with 100–299 employees) had raised wages at approximately the same rate until the mid 1990s. However, a remarkable gap emerged between them in the period 1998–2004. On the basis of the Basic Survey on Wage Structure (Ministry of Health, Labour and Welfare), we can calculate the annual growth rate of the per capita wage in large-sized enterprises (with 1,000 employees and over) and small-sized enterprises (with 10–99 employees). The gap between them emerged in the mid 1990s. If a value of 100 is assigned to the wages in largesized enterprises, the value of the wages in small-sized enterprises was stable at approximately 78–80 until the mid 1990s, but decreased to 73 in 2006. Taking into account the above-mentioned facts regarding the performancebased wage system and the spring labour offensive system, we can set up the following hypotheses on the rising wage inequality. First, as shown in Figure 5.2, the larger the size of enterprises, the higher were their rates of adoption of the performance-based wage system. Therefore, an increase in wage inequality within an enterprise due to the performance-based wage system would be more remarkable in large-sized enterprises. Second, the weakening of the spring labour offensive would lead to the disregard of the social standard of wages by managers. This would cause the rising wage inequality within workers, especially in small-sized enterprises of which almost all are non-union companies. Third, as shown in Figure 5.3, the weakening of the spring labour offensive system would increase the wage differential between the large-sized, medium and small-sized enterprises. This would lead to a rise in wage inequality between enterprises of different sizes. After all, the introduction of the performance-based wage system causes wage inequality to rise chiefly in large-sized enterprises. The weakening of the spring labour offensive system chiefly causes an increase in wage inequality in the small-sized enterprises and between enterprises of different sizes. To affirm the above three hypotheses, we decomposed the changes in the wage inequality in each age group into the following three factors: (a) within-firm size effects (effects of wage disequalisation within each firm size group), (b) betweenfirm size effects (effects of wage disequalisation between different firm size groups), and (c) the effects of the change in the workers’ distribution by firm size. We used the same data set as in the second section: the hourly wages of male regular workers calculated from the anonymised micro data of the Employment Status Survey in 1997 and 2002. Table 5.5 shows the result of the decomposition. As shown in this table, the within-firm size effects were the largest, followed by the between-firm size effects. The effects of the change in worker distribution by firm size were very

Increasing wage inequality in Japan 101 Table 5.5 Decomposition of the changes in the hourly wage inequality regarding firm size (Male regular workers, 1997–2002, Japan) Age

Change in log variance Within-firm size effects Between-firm size effects Effects of changes in firm size structure

20–9

30–9

40–9

50–9

0.022 0.017 0.005 0.000

0.028 0.022 0.006 0.000

0.018 0.013 0.008 −0.003

0.030 0.021 0.010 −0.002

Note: The firm size groups are ‘1–29 employees’, ‘30–99 employees’, ‘100–299 employees’, ‘300–999 employees’, ‘1,000 employees and over’ and ‘government and other public offices’. Source: See Table 5.1.

small. As the rising wage inequality between different size enterprises can be regarded as the result of the weakening of the spring labour offensive system, it proves the third of the hypotheses mentioned above. The growth rates of the log variance in each firm size group were 15.2 per cent in ‘1–29 employees’, 3.9 per cent in ‘30–99 employees’, 10.7 per cent in ‘100–299 employees’, 9.6 per cent in ‘300–999 employees’, 16.0 per cent in ‘1,000 employees and over’ and 3.9 per cent in ‘government and other public offices’ (these figures are the averages of the four age groups). Although the wage inequality rose in all the firm sizes, it was remarkable in large-sized enterprises (with 1,000 employees and over) and small-sized enterprises (with 1–29 employees). As the rising wage inequality in large-sized enterprises can be regarded as the result of the introduction of the performance-based wage system, it proves the first hypothesis mentioned above.18 The rising wage inequality in small-sized enterprises proves the second hypothesis. Thus, the growth pattern of the wage inequality in each firm size group is consistent with the wage institution view. Moreover, taking into account the fact that the adoption rate of the performance-based wage system is low in the government and other public offices and the uniform wage rise is guaranteed for government employees by the recommendation of the National Personnel Authority, the slow rate of increase in the wage inequality in the government sector (3.9 per cent) is also consistent with the wage institution view. In addition, the point in time when the wage inequality in each age group started to rise is consistent with this view, taking into account the fact that both the introduction of the performance-based wage system and the weakening of the spring labour offensive system started in the mid 1990s.19 Furthermore, as mentioned in endnotes 6 and 7, the fact that the increase in the rate of wage inequality among female regular workers was smaller than that among male regular workers is also consistent with the wage institution view because of the following reason. In Japan, the percentage of female managerial staff is very low.20 Due to this strong gender segregation at work, the impact of the performance-based wage system on female wages is relatively small.

102 H. Uni

Conclusion In this chapter, we examined the validity of four hypotheses – the SBTC hypothesis, the outsourcing hypothesis, the trade effect view and the wage institution view – concerning the continued rise in the income inequality within each age group that first appeared at the end of the 1990s in Japan. As the wage bill share of university graduates increased mainly within each industry, the trade effect view is hardly valid. Furthermore, the increase in this share was caused chiefly by the increase in the number share of university graduate workers and the wage differential between university graduate and other workers was almost constant. Therefore, most of the rising wage inequality in recent Japan occurred within each educational background group. A similar result was obtained regarding occupation. The SBTC and outsourcing hypotheses that assume an increase in the relative wages of skilled workers are hardly valid as explanations for the recent rise in income inequality in Japan. Wage determination is a strongly institutionalised process within Japanese enterprises. If we take this characteristic of the Japanese wage system into account, it is not unnatural that the wage inequality between workers with different educational backgrounds has been constant despite the demand shift towards skilled labour. Paraphrased conversely, the remarkable rise in income inequality in the USA and UK might be due to their institutional character whereby the wage determination is only weakly institutionalised within enterprises. In Japan, even if the demand shifts towards the skilled labour because of IT and globalisation, its influence on wages is mainly reflected in the reform of the wage system in each enterprise. In the 1990s, this wage system reform was planned by taking into account not only IT and globalisation, but also other factors. The most important purpose of this reform was to reduce the wage costs in the wake of the bursting of the bubble economy, accelerating ageing and the changing competitive environment owing to deregulation and globalisation. Although there were several ways to reduce wage costs, many Japanese companies chose to introduce a performance-based wage system and weaken the spring labour offensive system. Consequently, the rise in wage inequality since the end of the 1990s appeared not between workers with different educational backgrounds or occupations, but within each educational background and occupation group. The wage institution view is also supported by the growth pattern of the wage inequality in each firm size group. The population ageing view was valid for the rise in income inequality until the 1990s. However, as mentioned in Uni (2008c), the rise in income inequality from the end of the 1990s cannot be explained only on the basis of the ageing of the population because the inequality in each age group showed an increase. In order to control wage costs, many enterprises reformed not only the wage system, but also the employment system. This relates to the view that the non-regularisation of employment was the main cause of wage disequalisation. As mentioned in Uni (2008c), contrary to this view, the effects of the non-regularisation of employment on the changes in wage inequality were small owing to the following reasons.21

Increasing wage inequality in Japan 103 First, the disequalisation of hourly wages occurred among regular workers, not among part-time workers. Second, the inequality of hourly wages between regular workers and non-regular workers was partly lowered by a decrease in regular workers’ wages. According to the wage institution view, managers were principally responsible for the rising wage inequality. Trade unions who agreed with the introduction of a performance-based wage system were also to blame. Some leaders of the national centre of trade unions have already recognised this responsibility. The wage institution view supports this recognition of union leaders. The rising wage inequality among regular workers stemmed from the lack of response by unions to the weakening of the spring labour offensive system and the introduction of a performance-based wage system. Paraphrased conversely, income inequality in Japan can be reduced through efforts to recover wage solidarity within industries or professions and to weaken the link between remuneration and individual performance. To back these efforts, reforms in the labour law towards strengthening the bargaining power of trade unions may be necessary.

Appendix: The method of decomposing the changes in inequality using log variance22 The log variance of income implies the variance of the logarithm value of income, as shown in the following equation. 1 LV = (lyi − μ)2 n n

i=1

Here, LV is the log variance, n is the the number of samples, μ is the the mean of log income, and lyi is the log-income of the i th sample. When there are m groups, the above-mentioned log variance is decomposed into within-group inequality (log variance) and between-group inequality (log variance). LV =

m 

si LVi +

i=1

m 

si (μi − μ)2

i=1

The first term on the right side is the within-group inequality and the second term is the between-group inequality. Here, LVi is the log variance of the i th group, m is the the number of groups, si is the share of the i th group, si = n i /n (n i is the the number of samples in the i th group), and μi is the the mean of log income in the i th group. In addition, an inter-temporal change in log variance (LV ) is deconstructed as follows. LV =

m  i=1

si LVi +

m  i=1

si (μi − μ)2 +

m  i=1

si LVi +

m  i=1

si (μi − μ)2

104 H. Uni The first term on the right side is the contribution of changes in the within-group inequality. The second term is the contribution of changes in the between-group inequality. The sum of the third and fourth terms is the contribution of changes in the composition. The third term is the contribution of different log variance by group and the fourth term is the contribution of the difference between the overall mean and the mean in each group. In the actual calculations, we used the mean values of the two time points as si , LVi and (μi − μ)2 .

Notes 1 These studies, which emphasised institutional factors, did not necessarily deny the influence of IT and globalisation on income inequality. They attached importance to institutional factors in order to explain the fact that the USA and UK were the only ones among the many countries similarly affected by IT and globalisation to experiencethe rising income inequality. Freeman and Katz (1994) called their own theory the ‘supply-demand-institutional (SDI) explanation’. 2 Krugman (1995b) criticised this hypothesis. 3 We used the anonymised micro data of the Employment Status Survey for 1997 and 2002 and the National Survey of Family Income and Expenditure for 1999 and 2004, both of which are conducted by the Ministry of Internal Affairs and Communications every five years. The sample of the former survey comprises household members aged 15 years or above from about 450,000 households. The sample of the latter survey comprises around 50,000 households. These micro data were provided by the Research Centre for Information and Statistics of Social Science, Institute of Economic Research, Hitotsubashi University. 4 Sakurai (2000) and Ikenaga (2008) make a distinction between skilled and non-skilled workers using the occupational classification. Sakurai (2004), Sasaki and Sakura (2005) and Cabinet Office (2007) regard university graduate workers as skilled workers. 5 On the basis of the Employment Status Survey in 1997 and 2002, the share of ‘university and graduate school graduates’ in the total regular male workers increased from 30.2 per cent to 34.1 per cent. As a control variable in the regression analysis, Sasaki and Sakura (2005) used such average share of university graduates in the whole economy, not in each industry. Therefore, their control of the number share is very insufficient. 6 As shown in Uni (2008b), the increase in the rates of inequality in hourly wages among female regular workers was smaller than that among male regular workers. Therefore, in this chapter, we focus on the wage inequality among male regular workers. 7 Regarding female regular workers in Japan, we obtained results similar to Table 5.1, although the change in log variance and the within-education effects were smaller than those in the result of male workers. For example, in the female regular workers aged 30–9, the change in log variance was 0.006, the within-education effects were 0.010, the between-education effects were 0.000 and the effects of changes in educational structure were −0.004. 8 As regards the female full-time workers in the United States, we obtained results similar to Table 5.2, although the between-education effects were slightly smaller than the within-education effects. For example, in the female full-time workers aged 30–39, the within-education effects were 0.052, the between-education effects were 0.037 and the effects of changes in educational structure were −0.007. 9 Juhn et al. (1993) obtained the results similar to ours using the March Current Population Survey in 1979–88. Although their method of factor decomposition was different

Increasing wage inequality in Japan 105

10 11

12

13

14

15

16

from ours, they showed that the between-education effects were as large as the withineducation effect and the effects of the change in the workers’ distribution by educational background were very small (p. 430, Table 4). According to Autor et al. (2008), the college plus/high school wage gaps grew rapidly during the 1980s and decelerated in the 1990s (p. 303, Figure 2). Nomura (2007) considers that the essence of Japanese-style employment practice is ‘the management order segmented by educational background and sex’. He mentions that the employment practice is not the dependent variable of economic and managerial conditions but the persistent social norms and values once they are established. He states that ‘the management order segmented by educational background is unlikely to change in the foreseeable future’ (p. 431). An increase in the ageing population raises the wage costs of enterprises in two ways. The first is through the seniority-based operation of the merit-based grade system; in fact, under this operation, the ageing of the labour force naturally leads to a rise in the total wage costs. The second way is by increasing the social security burden of employers (Uni 2008a). In order to chart a course of direction for reforms in the wage system, the Japan Federation of Employers’ Associations (1995) declared that enterprises should attach more importance to employee merit and performance rather than age and seniority. The national centre for trade unions opposed such a direction (RENGO 1995). However, in the questionnaire survey of leaders in enterprise unions (RENGO Research Institute for Advancement of Living Standards 1998), the option ‘performance should be given more importance as a determining factor for wages of university graduate workers’ constituted 33.8 per cent of the respondents’ replies, and the option ‘performance should be given more importance to some extent’ constituted 45.4 per cent. In total, most of the leaders in the enterprise unions agreed with the performance-based wage system, at least in 1998. This contributed to the rapid and widespread introduction of this system (the adoption rate in 2004 is shown in Figure 5.2). According to the Questionnaire Survey on Business Behavior (Cabinet Office, Economic and Social Research Institute 2005), the intra-firm wage inequality is greater and the rate of its increase is higher in the enterprises in which the weight of the performance-based wage is 50 per cent or more, compared with the other enterprises. The Japan Institute for Labour Policy and Training (2007) inquired of employees whether the wage differentials had expanded among their colleagues with similar seniority in 2002–5. In enterprises with a performance-based wage system in place, 43.2 per cent of the employees answered ‘yes’ and in enterprises without one, 15.7 per cent of the employees answered ‘yes’. Moreover, the SANRO Research Institute (1999) inquired of managers the manner in which they would like to change the wage differentials in university graduate male white-collar employees in the future. 20.7 per cent of enterprises answered that they would expand them greatly. 50.8 per cent of enterprises answered that they would expand them slightly and only 23.8 per cent answered that they would not change them. Japan Productivity Center for Socio-Economic Development conducted a Survey on Changes in the Japanese Personnel System. The adoption rate of the annual salary system for non-administrative jobs was below 10 per cent. The performance-based wage system for non-administrative jobs generally involves the following two methods on the basis of which wages are decided. First, a part of the wages is adjusted according to managers’ assessment of individual performance. Second, the annual wage increase is adjusted according to this assessment. The samples of Figure 5.2 are limited to the companies listed on the first and the second sections of the Tokyo, Osaka and Nagoya Stock Exchanges. 92 per cent of these samples are large-sized enterprises with over one billion yen in capital stock. In medium and small-sized enterprises, the adoption rates of the performance-based wage system seem to be smaller than shown in Figure 5.2.

106 H. Uni 17 According to the Survey on Wage Increase conducted by the Ministry of Health, Labour and Welfare, 25 per cent of Japanese enterprises attached importance to the social standard of wages in 1980–97 in wage determination. This ratio declined to 11 per cent in 1998–2006. On the other hand, the ratio of enterprises that attached importance to business performance increased from 62 to 75 per cent. 18 In order to identify the effect of the strict introduction of the performance-based pay system, it is necessary to decompose the increase in wage inequality within the large-sized enterprises group to the within-firm increase and between-firm increase. This decomposition is impossible because the micro data of the Employment Status Survey do not contain the name of the place of employment. However, according to the three surveys quoted in endnote 14, it is almost certain that there was a within-firm increase in wage inequality. 19 The Development Bank of Japan (2002) calculated the return on assets (ROA) of about 1,400 listed Japanese companies, and clarified the trend of the inter-company disparities of ROA measured by the coefficient of variation. These disparities of ROA were almost constant in the 1980s and increased from the beginning of the 1990s. On the other hand, the Survey on Productivity Model Wage undertaken by the Japan Productivity Center investigated about 1,200 companies’ normal wages by age, educational background, sex and occupation (clerical or technological staff and production worker). The intercompany disparities of wages were measured by the coefficient of variation in each category. There was no trend of increase in these wage disparities in any category in 1991–6. On the basis of this difference in trend between profitability disparities and wage disparities, we can understand that the increase in profitability disparities is not a sufficient condition for the increase in wage disparities, although it might be one of the necessary conditions. 20 According to the Basic Survey on Wage Structure in 2000 (Ministry of Health, Labour and Welfare), the percentage of female workers at the subsection chief level is 8.1 per cent, the percentage at the section chief level is 4.0 per cent and the percentage at the department manager level is 2.2 per cent. 21 Wage inequality between regular workers and non-regular workers is important not as a cause of the widening gap, but as a cause of the largeness of the gap. 22 Here, we follow the explanation of Ota (2005).

6 Institutional changes and the transformations of the growth regime in the Japanese economy Facing the impact of the world economic crisis and Asian integration Hiroyasu Uemura

Introduction The Japanese economy experienced institutional changes after the prolonged recession of the 1990s, and started to show a new growth pattern in recovery in the early 2000s, in the face of increasing international interdependence with other Asian economies.1 In particular, there have been changes in investment behaviors owing to financial liberalization and increasing Japanese foreign direct investment in Asian countries. The coordinating mechanism of wages has also changed to one that is more market-oriented. Furthermore, the industrial structures have shifted in favor of the high-tech manufacturing sector and the service sector, influenced by the development of the international division of labor and the increasing interdependence with other Asian economies. Subsequently, the Japanese economy was hit by the subprime crisis in 2008. In this chapter, we conduct a macroeconomic analysis that is closely linked to the institutional coordinating mechanisms of investment, labor productivity, wages, and international trade, and investigate changes in the growth pattern of the Japanese economy, in the light of the recent economic crisis and Asian economic integration. In particular, institutional changes and the transformations of the growth regime are examined from the viewpoint of régulation theory. The data on the profit rate, labor productivity, and employment at the industrial level are used to investigate changes in institutional coordinating mechanisms. The Japanese economy has experienced several shifts in its growth pattern over the last 30 years. In the first half of the 1980s, investment coupled with an undervalued yen led to the creation of excess capacity, and more excess capacity was created in the bubble boom in the second half of the 1980s. In the 1990s, the rapid depreciation and scrapping of capital stock occurred as the adjustment of excess capital that was accumulated in the late 1980s. In the prolonged recession of the 1990s, investment was very stagnant, influenced by excess capital stock and a

108 H. Uemura non-performing loan problem in the uncertain financial system. After excess capital stock was scrapped and the non-performing loan problem was resolved, the Japanese economy started to recover in 2002, taking on a new growth pattern in the recovery. As part of this process, increasing financial liberalization led to corporate finance becoming more dependent on market mechanisms. The employment system also evolved after the mid 1990s. In fact, in order to cope with labor-hoarding in large Japanese firms, the number of non-regular workers increased dramatically, and nominal wage growth was severely depressed. Wage share, which increased due to labor-hoarding in the 1990s, fell very sharply in the early 2000s, and the profit rates of large firms recovered considerably. Export came to play an important role again in demand formation in the Japanese economy. At the same time, fierce international competition with other Asian countries and the increasing foreign direct investment of Japanese multinational firms imposed a strong structural constraint on the Japanese economy. There are different approaches to the study of the prolonged recession of the 1990s and the recovery in the early 2000s. The neoclassical approach explains that the low growth rates were caused by a decrease in total factor productivity and labor input (Hayashi and Prescott 2002). According to this understanding, the way to realize higher economic growth is to eliminate low-productivity firms by strengthening the function of the market mechanisms with deregulation policies. Productivity slowdown is one of the major problems in the Japanese economy, but stronger competitive pressure in the market is not the exclusive way to promote productivity growth. From the evolutionary point of view, innovative activities in an adequate innovation system and sustainable demand formation may be more important in the long run. The Keynesian approach explains that the prolonged recession was caused by overinvestment in the second half of the 1980s and insufficient demand in the early 1990s (Yoshikawa 1998), as well as the sharp fall in stock prices after the collapse of the bubble boom (Miyazaki 1992). The non-performing loan problem and debt deflation in the uncertain financial system also exacerbated the recession in the 1990s. According to this approach, new investment opportunities and a wellorganized financial system should be created to realize stable economic growth. In this regard, reducing excess capacity and solving the bad debt problem were helpful in promoting the recovery process in the 2000s. The régulation approach has a more structural perspective, emphasizing institutional conditions and the stability of a growth regime. The analysis shows that the prolonged structural crisis of the Japanese economy in the 1990s was caused by coordination failures, in other words, the deterioration of the existing mode of régulation in the financial system and industrial dynamics (Boyer and Yamada eds. 2000; Uemura 2000; Boyer 2004b; Lechevalier 2007). In particular, in the structural crisis the expectation of socio-economic agents, workers, managers, and others, greatly deteriorated, and their activities shrank in terms of production and transaction. Furthermore, the structural compatibility that existed between firm organization, subcontracting networks, and the segmented labor market, which yielded more flexibility and increased productivity in the Japanese economy, was

The growth regime in the Japanese economy 109 weakened with the increasing heterogeneity of industries and firms after the late 1990s.2 In this context, the companyist mode of régulation was progressively eroded due to institutional changes resulting from the prolonged recession of the 1990s and even from the recovery process after 2002 (regarding companyist régulation, see Chapters 1–3 of this book). From this perspective, an adequate mode of régulation needed to be re-established in support of the structural compatibility of institutions, to realize a stable growth regime. Unfortunately, the Japanese economy had been hit by the world economic crisis of 2008 before a fully fledged mode of régulation could be firmly re-established. In this chapter, the régulationist understandings of the recession and the recovery are taken into account, as we consider the following problems. First, we investigate the major characteristics of the growth pattern during the structural crisis of the 1990s and following the recovery after 2002, as well as subsequent to the new economic crisis of 2008; we do so by analyzing such macroeconomic variables as the profit rate, the accumulation rate, wage share, the output–capital ratio, and employment structures. Second, we consider how institutional changes in the employment system and the financial system in the last 15 years have influenced the new growth pattern in the 2000s and the ongoing structural crisis after 2008. Third, in keeping with the régulationist point of view, some necessary conditions for establishing a new sustainable growth regime with stable demand formation and productivity growth, in the future, are considered.

Profit rate and capital accumulation Basic framework of the profit rate We propose the structuralist macroeconomic framework to investigate major macroeconomic variables. The structuralist macroeconomic theory seeks to synthesize Kalecki and Kaldor by analyzing the long-term evolution of institutional arrangements. In particular, there is a common perspective of attempting to build a framework of macroeconomic dynamics by synthesizing the logic of effective demand and the logic of distributional conflict under certain historical and institutional conditions. From this perspective, we will consider the determinants of the profit rate, capital accumulation, and income distribution. We will begin by considering the components of the profit rate, because the pursuit of profit is the driving force in the capitalist economy and the profit rate is a key category in analyzing the accumulation of capital. The basic formula for determining the profit rate is given by the national account, as follows.

r= =

px  pk K  Px  Y X X · · · ·  K pk Y X X

110 H. Uemura =π ·β ·u ·σ · p = (1 − ws ) · β · u · σ · p = [1 − (w/ px )/λn ] · β · u · σ · p The basic notations are as follows: r is the profit rate,  is the real profit, π is the  is the potential real output, Y is profit share, X is the real output (= real GDP), X the real national income (= real GDP – depreciation), K is the real capital stock, β is the national income–GDP ratio, u is the capacity utilization, σ is the potential output–capital ratio, px is the prices of output (= GDP deflator), pk is the prices of capital, p is the ratio of output prices to capital prices, ws is the wage share, w is nominal wage, and λn is net labor productivity (λn = Y/N; N: employment). The above equation is an identical equation at the macroeconomic level, but we can see several causal chains behind it. As Kalecki pointed out, investment is induced by the expected rate of profit, and, in turn, profit is realized by investment expenditure. Therefore, there is a dynamic interaction between investment and profit, and this determines the level of capacity utilization. As Bowles and Boyer pointed out, wages play a triple role, that is, as “a source of consumption demand, a component of unit labor costs and hence a deduction from profits, and as an instrument in capital’s labor-disciplining strategies” (Bowles and Boyer 1990). Therefore, the level of wages indirectly influences capacity utilization and labor productivity. The labor-disciplining effect is sometimes institutionalized in various forms, when the wage–labor nexus is highly institutionalized. The potential output–capital ratio is influenced by the technological and organizational conditions of the production process and industrial structures. Furthermore, productivity growth and demand growth interact in a cumulative way in the medium term, as pointed out by the régulation theory (Boyer 1988). All of these factors determine a specific pattern of capital accumulation, depending on institutional arrangements (Uemura 2000). Capital accumulation and the profit rate in the Japanese economy First of all, we will see long-term changes in the profit rate and the accumulation rate in the Japanese economy after the 1960s, in Figure 6.1.3 The profit rate The profit rate is calculated as net profits divided by the gross capital stock at current prices. As shown in Figure 6.1, it was quite high during the high economic growth period, and reached its peak in 1969. Since then, it has been falling. The Japanese economy has experienced two sharp falls in the profit rate in the postwar period. First, the profit rate started to fall at the beginning of the 1970s, that is, before the first oil shock, and then it fell sharply after it. Second, the profit rate fell in the late 1980s and the early 1990s. At the beginning of the 1970s, the decreases in profit share, capacity utilization, and potential output–capital ratio were the contributing factors, and the falls in profit share and capacity utilization

The growth regime in the Japanese economy 111

The accumuration rate

The profit rate

% 30 25 20 15 10 5 0 –5

60

65

70

75

80

85

90

95

00

05

Figure 6.1 Accumulation rate and profit rate. Source: Cabinet Office, Annual Report on National Accounts and Gross Capital Stock of Private Enterprises.

Real GDP growth rate

%8 7 6 5 4 3 2 1 0 –1 –2 80

Wage share

76 % 75 74 73 72 71 70 69 68 67 66 85

90

95

00

05

Figure 6.2 Real GDP growth rate and wage share. Source: Cabinet Office, Annual Report on National Accounts.

became marked in the downturn in the first half of the 1970s (Uemura 2000). The fall in the potential output–capital ratio contributed greatly to the fall in the profit rate around 1990, and both profit shares and capacity utilization fell sharply in the recession of the 1990s. The profitability of corporations was very low in the 1990s.4 This was caused by several factors. First, stagnant investment led to a low level of capacity utilization (see Figure 6.3). Second, potential output–capital ratio fell sharply because of the excess capital caused by “over-accumulation” (see Figure 6.3). Third, wage shares rose due to a sharp fall in labor productivity with “labor-hoarding” (see Figure 6.2). Furthermore, corporate profitability was under great pressure because of the bad debt problem. Another important feature is a profitability differential between large firms and small and medium-sized ones. This was caused by pressure on the subcontractor system, since parent companies decreased both the volume of orders and unit prices offered in pursuit of

112 H. Uemura

Output–capital ratio

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 80

85

90

Potential output–capital ratio

95

00

05

Figure 6.3 Output–capital ratio. Source: Cabinet Office, Annual Report on National Accounts.

the restructuring of the subcontractor network. The profit rate started to recover slightly due to decreasing wages and the retrenchment of many workers in the first half of the 2000s. However, there were great differentials in profitability between different-sized firms, as we will see later. The accumulation rate The accumulation rate is calculated on the basis of the percentage growth rate of the gross capital stock of private enterprises. As shown in Figure 6.1, the accumulation rate fluctuated in a very dynamic way, mostly following the profit rate with a one-year lag in the 1960s. The accumulation rate reached a peak in 1970 and then plummeted in the first half of the 1970s. It increased again in the second half of the 1980s during the bubble boom, although the profit rate gradually fell. Therefore, we see the “over-accumulation” of capital stock in the late 1980s. Then, it fell quite sharply at the beginning of the 1990s, and was at a very low level with the large amount of scrapping of capital stock in the prolonged recession. The accumulation rate did not recover well, at least at the aggregate level, in the 2000s. Then, when the world economic crisis struck the Japanese economy, the accumulation rate started to fall in 2008. Wage share fluctuating counter-cyclically We can see the long-term shifts in wage share after the 1980s, in Figure 6.2.5 Wage share is defined in terms of “employee incomes/(national incomes – unincorporated enterprises’ incomes).”6 According to Uemura (2000), wage share slightly decreased in the high growth period, rose considerably in the first half of the 1970s, and then stagnated again after 1975. This seems to have reflected structural shifts in institutional arrangements in wage bargaining. However, wage share was quite stable after the late 1970s. As for the cyclical movement of wage

The growth regime in the Japanese economy 113 share, it has been fluctuating counter-cyclically over the postwar period. This has manifested itself in terms of the following relations. Labor productivity fluctuates pro-cyclically, because the job security of core workers results in “labor-hoarding” during contractions and an easing of labor costs during expansions. Furthermore, the economy realizes “increasing returns to scale” in expansions. Therefore, the growth of product wages lags behind that of productivity during expansions, and the deceleration in productivity growth is much larger than that in product wages during contractions. Hence, wage share fluctuates counter-cyclically. As seen in Figure 6.2, wage share rose considerably due to “labor hoarding” in the recession of the 1990s. Then, wage share decreased very sharply due to decreasing wages and the mass retrenchment of workers in the first half of the 2000s. Eventually, wage share started to rise again during the recent world economic crisis. Capacity utilization and the decreasing potential output–capital ratio The fluctuations of capacity utilization are depicted as a gap between the potential output–capital ratio and the actual output–capital ratio in Figure 6.3. Capacity utilization went up to a very high level, and the output–capital ratio reached the potential level in the bubble boom during the second half of the 1980s, then fell very sharply in 1991. This reflected the fact that excess capital stocks had accumulated in the 1980s. After the scrapping of capital stock in the second half of the 1990s, capacity utilization started to rise in the recovery process after 2002. However, the potential output–capital ratio has been falling continuously. This trend may reflect the inefficient use of capital stock in the process of transforming the Japanese economy to a more high-technology-based one. Differentials of the profit rate and the accumulation rate between sectors One of the marked features of the Japanese economy since the 1980s has been the large differentials of the profit rate and the accumulation rate between industrial sectors, resulting from export-led, uneven development. As seen in Figure 6.4, in the early 1990s, the ordinary profit–total capital ratio fell steeply in the electrical machinery and automobile industries. The automobile industry recovered relatively earlier in the mid-1990s, but the electrical machinery industry experienced a sharp fall again in the IT recession of 2001 and showed a V-shape recovery due to mass retrenchments. The construction industry did not recover well even in the recovery process. Therefore, in the recovery process after 2002, the differentials of the ordinary profit–total capital ratio widened, as seen in Figure 6.4. Then, in 2008, when the Japanese economy was hit by the world economic crisis, the ordinary profit–capital ratio started to fall in all manufacturing industry sectors. Above all, the fall was most marked in the transportation machinery industry and the electrical machinery industry sectors. We can also see the increasing differentials of the accumulation rate in the recovery process, in Figure 6.5. Capital accumulation recovered strongly in the transportation machinery industry, while the electrical machinery industry and the

114 H. Uemura % 10 Manufacturing (average) Electrical Machinery Transportation Machinery Construction Services

9 8 7 6 5 4 3 2 1 0 80

85

90

95

00

05

Figure 6.4 Profit rates (different industries). Source: Ministry of Finance, Statistical Survey of Business Corporations.

% 20 Manufacturing (average)

15

Electorical Machinery

10

Transportation Machinery

5

Construction Services

0 –5 80

85

90

95

00

05

Figure 6.5 Accumulation rates (different industries). Source: Cabinet Office, Annual Report on National Accounts.

construction industry experienced a negative rate of capital accumulation because of large-scale scrapping. The accumulation rate recovered in the electrical machinery industry in the mid 2000s. The accumulation rates in the service industry have been relatively high since the 1980s. Then, with the onset of the world economic crisis, the accumulation rate fell very sharply in all industries. Differentials of the profit rates between different-sized firms In the Japanese economy, there has been a specific institutional arrangement that favored “structural compatibility” between large firms’ organization, subcontracting networks, and the segmented labor market; such compatibility

The growth regime in the Japanese economy 115

Over 1000 million yen capital fund

100 milllion yen–1000 million yen

10 million yen–100 million yen

Less than 10 million yen

%7 6 5 4 3 2 1 0 –1 –2 80

85

90

95

00

05

Figure 6.6 Firm-size differentials of ordinary profit–sales ratio (manufacturing). Source: Ministry of Finance, Statistical Survey of Business Corporations.

promotes productivity growth in the manufacturing sector.7 However, these institutional structures began transforming themselves after the recession in the 1990s. When we look at different-sized firms, profitability differentials have been more marked since the late 1990s, as seen in Figure 6.6. Profitability, which is measured by the ordinary profit–sales ratio, has increased in large firms, while it has remained at a very low level in small and medium-sized firms. Thus, only large firms benefited from the economic recovery in the first half of the 2000s. In other words, the very unequal recovery of profitability between different-sized firms shows that the growth pattern changed in the Japanese economy after the prolonged recession of the 1990s and the recovery process of the 2000s. Subsequently, when the Japanese economy was hit by the world economic crisis in 2008, the profitability of large firms fell steeply.

Pattern of demand formation Contribution to real GDP growth in the recovery process In the 2000s, demand formation in the recovery process of the Japanese economy has been characterized as follows. Exports contributed considerably to real GDP growth, so the Japanese economy continued to exhibit export-led growth in the recovery process of the 2000s, as seen in Figure 6.7. Above all, exports have increased very rapidly to Asian countries, especially China. Investment did not play a major role in the recovery process owing to the insufficient investment opportunities resulting from the restructuring of firms and the uncertain financial system. This was reflected in the fact that the credit multiplier remained at a very low level, as seen in Figure 6.8. Consumption has contributed less to GDP growth, compared with its percentage share. This was due to the dramatic decrease in wage share and increasing income

116 H. Uemura Inventory Private Investment

Net Exports Public Spending

Housing Private Consumption

%3 2 1 0 –1 –2 –3 –4 –5

00

01

02

03

04

05

06

07

08

09

Figure 6.7 Contributions to real GDP growth rate. Source: Cabinet Office, Annual Report on National Accounts.

Yen 40000 35000

Nikkei Average

Credit Multiplier

14 13 12 11 10 9 8 7 6

30000 25000 20000 15000 10000 5000 0 80

85

90

95

00

05

Figure 6.8 Stock price and credit multiplier. Note: Credit multiplier = (M2 + CD)/(Base money). Source: Nikkei Stock Index 225 and Bank of Japan, Monthly Report of Recent Economic and Financial Developments.

inequality among workers in the 2000s. In other words, the institutional changes in the “wage–labor nexus” have influenced demand formation. Public spending has been constrained by restrictive fiscal policies owing to the large fiscal deficit and neoliberalist policies such as “structural reform” and budget cutting. When the Japanese economy was hit by the world economic crisis, exports decreased very sharply, seriously hurting the Japanese economy. Export-led growth and the increasing importance of the Asian economies As seen in Figure 6.9, the close link between export and investment, which existed in the 1980s and disappeared in the 1990s, appeared again in the process of the economic recovery in the 2000s. In other words, investment followed export

The growth regime in the Japanese economy 117

Real Private Investment

Export Quantity

% 15 10 5 0 –5 –10 80

82

84

86

88

90

92

94

96

98

00

02

04

06

08

Figure 6.9 Investment and export quantities. Source: Ministry of Finance, Trade Statistics and Cabinet Office, Annual Report on National Accounts. US

EU

All Asian Countrie s

CHINA

Trillion yen

45 40 35 30 25 20 15 10 5 0 80

85

90

95

00

05

Figure 6.10 Export to regions. Source: Ministry of Finance, Trade Statistics.

quantity with a lag of a few quarters. This means that the typical export-led growth pattern was established again in the Japanese economy. As for international trade, Japan’s main trading partners changed from the USA to Asian countries in the 1990s, as seen in Figures 6.10 and 6.11. In particular, China became the biggest trading partner of Japan in the 2000s. Intermediate goods trade with Asian countries plays an increasingly important role in the development of international production linkages in the Asian region.8 In this context, Japanese multinational firms came to have more FDI in Asian countries than the USA, as seen in Figure 6.12. The shifting of production plants to Asian countries has greatly influenced investment behaviors and employment structures in the Japanese economy.

118 H. Uemura

US

EU

All Asian Countries

CHINA

35 30 Trillion yen

25 20 15 10 5 0 80

85

90

95

00

05

Figure 6.11 Import from regions.

1000 millions yen

Source: Ministry of Finance, Trade Statistics.

50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

North America China+Hong Kong Asia Europe

Figure 6.12 Japan’s FDI. Source: Ministry of Finance, Foreign Direct Investment.

Productivity growth differentials in the recovery process Productivity differentials between the industrial sectors Productivity differentials between industrial sectors are one of the marked structural characteristics of the Japanese economy. In particular, since the 1980s, productivity growth has been much higher in the export goods sector than in the non-export goods sector. During the recovery process of the 2000s, the productivity growth differentials between industries have been widening, as seen in Figure 6.13. Labor productivity rose very sharply due to mass retrenchments and innovations in the electrical machinery industry. This was the result of an institutional change in the employment system whereby managers no longer guaranteed employment security.

The growth regime in the Japanese economy 119

Manufacturing (average)

Textile

Chemical

Electorical machinery

Transportation Machinery

Finance and Insurance

Services

Manufacturing (average) (1980 = 100)

800 700 600 500 400 300 200 100 0 80

85

90

95

00

05

Figure 6.13 Growth of labor productivity (different industry). Source: Cabinet Office, Annual Report on National Accounts.

Productivity differentials between different-sized firms Since the 1990s, productivity growth differentials have also increased between large firms and small and medium-sized firms. Especially, the firm-sized differentials of value-added per worker have been markedly increasing in the recovery process after 2002 (Figure 6.14). As mentioned, “structural compatibility” between large firms, subcontracting networks, and the segmented labor market enhanced work incentives and promoted the flexibility of employment adjustment after the 1970s. However, this hierarchical socio-economic structure was gradually eroded due to the marked increase in the firm-size differentials and the reorganization of subcontracting networks after the late 1990s. In other words, the Japanese economy came to exhibit more heterogeneous structures between industries and firms, influenced greatly by its increasing interdependence with the Asian economies.

Changes in wage coordination and employment Institutional wage coordination eroded Nominal wage growth was sensitive to the decreasing unemployment rate accompanied by the “reserve army effect” in the high economic growth period, that is, in the 1960s, but was not so sensitive subsequently, even in the quasifull-employment situation in the late 1980s. This was the result of the more institutionalized wage coordinating mechanism established in the 1970s. Product wages increased almost in line with labor productivity during the 1980s, and this was compatible with the export-led growth at that time. The distributional pattern was brought about by the complex wage coordinating mechanisms, which

120 H. Uemura

Over 1000 million yen capital fund

100 million yen–1000 million yen

10 million yen–10 million yen

less than 10 million yen

16000

Thousand yen

14000 12000 10000 8000 6000 4000 2000 0 80

85

90

95

00

05

Figure 6.14 Firm-size differentials of value-added per worker (manufacturing). Source: Ministry of Finance, Statistical Survey of Business Corporations.

consist of a profit-sharing mechanism in large firms, Shunto (spring offensive), and the flexible determination of wages of non-regular workers on the basis of the hierarchical economic structures (Tsuru 1992; Ebizuka et al. 1997). In the severe recession of the 1990s, however, wage share rose considerably, because labor productivity fell very sharply due to “labor hoarding.” After 2002, during the recovery process, the wage spillover mechanism was weakened because Shunto as an institutionalized wage coordination mechanism almost broke down due to the declining bargaining power of trade unions, as we see in Chapter 2 of this book. Hence, even in the recovery process after 2002, wages were severely depressed. In turn, the low increase in wages due to the collapse of shunto depressed consumption demand during the recovery process, and the Japanese economy had to depend more on exports. Decline in manufacturing employment: de-industrialization Since the early 1990s, manufacturing employment has decreased at the absolute level, a form of “de-industrialization” in terms of employment (Rowthorn and Wells 1987; Petit 1988). In the Japanese economy, there is the diversity of shifting patterns of employment among industrial sectors. In particular, employment has been falling steeply in the electrical machinery industry and the textile industry, while it has remained relatively stable in the transportation machinery industry, as seen in Figure 6.15. In principle, the productivity growth differential between the manufacturing sector and the service sector causes a shift of employment from the manufacturing sector to the service sector, which is called “positive de-industrialization.” Furthermore, when demand for the manufacturing sector is stagnant in a recession, the share of

Thousand

The growth regime in the Japanese economy 121 18000 Manufacturing (total)

16000 Chemical

14000

Electrical machinery

12000

Transportation Machinery

10000

Textile

8000 6000 4000 2000 0 80

85

90

95

00

05

Figure 6.15 Changes in employment structure: de-industrialization. Source: Cabinet Office, Annual Report on National Accounts.

(Female)

(Male) % 12 10 8 6 4 2 0 80

% 10

15–24 years old

8

25–34 years old

6

35–44 years old

4

45–54 years old 55–64 years old over 65 years old

2 85

90

95

00

05

0 80

85

90

95

00

05

Figure 6.16 Unemployment rate. Source: Ministry of Internal Affairs and Communications, Statistic Bureau, Labor Force Survey.

manufacturing employment decreases. This shift in employment in a recession is called “negative de-industrialization” because it is brought about by stagnant manufacturing output rather than high productivity growth in the manufacturing sector (Rowthorn and Wells 1987). As a result, the relative share of employment in the service sector increases. In this sense, the Japanese economy experienced a kind of negative deindustrialization in the prolonged recession of the 1990s. From an institutional point of view, it should be pointed out that the increasing employment in the service sector increased the various kinds of non-regular jobs that lacked employment stability. In this context, more structural unemployment might be brought about through failure to coordinate the shift in employment from one industrial sector to another. In fact, the unemployment rate of younger and elderly workers rose sharply in the late 1990s, and has remained at a very high level in the 2000s, as seen in Figure 6.16.

122 H. Uemura

A Shift in the growth regime after the prolonged recession of the 1990s Institutional changes influencing the growth regime When we consider the shift in the growth regime of the Japanese economy after the prolonged recession of the 1990s, we should take into account several major institutional changes that seem to influence the characteristics of the growth regime. First, firm organizations were restructured to reduce various costs, and the employment system was transformed into a more flexible one after the late 1990s. In particular, job security for regular workers was weakened, and many workers were easily fired even from large companies. Furthermore, non-regular workers of various types rapidly increased as firms sought to reduce the total wage costs. Second, the wage-coordinating mechanism changed dramatically at both firm level and industry level. As we have already seen, shunto as an institutionalized wage-bargaining system broke down with the weakened bargaining power of trade unions at the beginning of the 2000s. In this context, the spillover mechanism of trade surplus and productivity gain from the export goods sector to the rest of the economy was gradually eroded, and economic differentials in the Japanese economy widened. Third, many foreign investors have entered the Japanese capital market, and the pressure they exerted on corporate governance and corporate strategies grew significantly. This caused a diversity of corporate strategy, depending on the relative share of foreign investors in firms’ shareholding. In this context, the heterogeneity of firms has become one of the most important features of the Japanese corporate system (Lechevalier 2007). Fourth, Japanese multinational firms have expanded their activities in the East Asian region, and they are promoting intermediate goods trade, FDI, and international production networks. In particular, the interdependence between Japan and China has recently strengthened, and this has had a strong influence on industrial structures in Japan (see Chapter 8). Major characteristics of the growth pattern after 2002 We can conclude on the basis of the institutional analysis, as well as the macroeconomic analysis of the Japanese economy after the 1980s, that the growth regime shifted before and after the prolonged recession of the 1990s. In fact, the Japanese economy showed a different growth pattern in the recovery process of the early 2000s, as we have seen in the previous sections. The marked features of the growth pattern are the greater heterogeneity of Japanese economic structures among different industries and different-sized firms and the tighter economic integration of the Japanese economy into the Asian economies. However, the extent of future innovation in the high-tech industry as the most important component of an emerging growth regime remains unpredictable, so the new growth pattern has not fully emerged. Furthermore, the companyist mode of régulation has been progressively eroded, though the appropriate mode of

The growth regime in the Japanese economy 123 Table 6.1 Shifting growth regimes The 80s: Export-led growth regime with structural compatibility

⇒ The 2000s: Export-led growth regime with heterogeneous structures and regional integration

⇒ About 2% ⇒ ASIA > US > EU, Increase in intermediate goods trade Profitability Relatively high with ⇒ High in large firms in the profitability differentials automobile industry, but very low in small and medium-size firms in genaral Spillover of The Spillover of trade surplus ⇒ Inter-industry wage differentials surplus by wage coordination and and weakening redistribution redistribution through the through the tax system tax system Industrial Strong manufacturing sector ⇒ The necessity of promoting Structures with high productivity innovation in the high-tec growth industry with the expansion of the service sector, resulting in de-industrialization International Increasing FDI in Asian ⇒ Stronger international production production countries and US linkages with Asian countries linkages and de-localisation of production The mode of The mode of régulation ⇒ The mode of régulation has not régulation supporting the stable been established. Weakening and structural growth regime. Structural structural compatibility and compatibility compatibility between firm shrinking core socio-economic organisation, subconstructures faced with the tracting networks and the international division of labour labour market supporting in East Asia export-led growth Growth rate Export to

About 4% US > ASIA > EU

régulation and the structural compatibility among institutions are the most crucial elements to predict the long-tem stability of the growth regime. The main characteristics of the regime pattern after 2002, which cannot be called a “growth regime” in its strict sense, are summarized in comparison with the previous growth regime, in Table 6.1. The new growth pattern reflected institutional changes and increasing economic heterogeneity in the 1990s and the early 2000s.

Onset of the world economic crisis: the Japanese economy suffers a structural crisis Falling stock prices in the subprime crisis The Japanese economy was hit by the subprime crisis that originated in the USA in September 2008. The world crisis undermined the incomplete growth regime

124 H. Uemura of the Japanese economy which had been emerging during the post-2002 recovery process. The world crisis was exogenous, but it made the Japanese economy fall into another endogenous structural crisis owing to the dysfunctional mode of régulation. Faced by the subprime crisis, the prices of shares and bonds fell very sharply on the Japanese stock market. In fact, the Nikkei stock index, which was about 12,000 yen just before the subprime crisis in September of 2008, fell to about 70,000 yen at the beginning of 2009. Although Japanese financial institutions did not have a large volume of subprime commodities, the sharp fall in stock prices in the Japanese market was brought about by the large amount of financial assets being sold by foreign investors. Furthermore, foreign banks, which became more active in the Japanese interbank market after 2006, decreased their demand for bank loans in Japan in the wake of the subprime crisis. Therefore, the Japanese financial market was deeply involved in the financial turmoil of the world crisis. Sharp fall in export and a decrease in investment and consumption Due to the world economic crisis, Japanese exports fell steeply. The financial crisis had a major impact on many national economies over the world, through international trade. In particular, the Japanese economy experienced a crisis with a sharp decrease in exports, not only to the USA but also to Asian countries, in terms of intermediate goods trade in the face of an appreciating yen. This had a very negative impact on Japanese companies in the automobile, electric machinery, and machinery industries, since these had international production networks with Asian countries. The decrease in exports caused a sharp fall in the profits of Japanese firms, and brought about a dramatic decrease in the activities of the Japanese economy, as seen in Figure 6.17. Investment decreased greatly, and retrenching not only non-regular workers but also regular workers exacerbated the unemployment problem and further stagnated consumption. In this context, the unemployment rate rose very sharply to more than 5 percent, which was not normal in the Japanese economy. Institutional changes and the fragile growth pattern Unfortunately for the Japanese economy, changes in institutional structures and growth patterns made the economy vulnerable to the world economic crisis of 2008, in the following ways. First, many foreign investors entered the Japanese financial market after “the Japanese financial big bang” in 1997 and 1998, and the international financial market came to exert a strong influence on the Japanese financial system. In this context, corporate governance became more influenced by the stock market. Accordingly, the Japanese financial system and the Japanese corporate system were very easily affected by the subprime crisis. Second, the growth pattern depended very much on exports, especially to Asian countries, in the recovery process after 2002. Therefore, the export goods industry was seriously affected by the sharp fall in demand from the USA and Asian

The growth regime in the Japanese economy 125

Seasonal adjusted, the quarterly growth rate converted to the annual growth rate Non-adjusted, the growth rate from the same quarter in the previos year

% 15 10 5 0 –5 –10 –15 85

90

95

00

05

Figure 6.17 Real GDP after the world economic crisis. Source: Cabinet Office, Annual Report on National Accounts.

countries. Third, economic inequality and the heterogeneity of economic organizations increased greatly among different industries and different-sized firms, and the Japanese economy lost its consistency and structural compatibility as a national economy. The mode of régulation to coordinate those structures was not established in this context. Therefore, it became very difficult for Japanese firms to reorganize the international networks of production and to coordinate effectively the transaction and subcontracting networks to maintain domestic production and employment levels. Therefore, small and mediumsized firms saw a significant decrease in their profitability. Fourth, the number of non-regular workers increased substantially, and even regular workers were threatened with dismissal. This rendered the Japanese employment system more unstable and the unemployment rate became much higher after the subprime crisis. In short, the companyist mode of régulation was eroded, even in the new growth pattern found in the recovery process after 2002, and the Japanese economy, being very vulnerable to the world economic crisis, underwent another structural crisis. In the context of this ongoing severe crisis, the re-establishment of the mode of régulation became more difficult.

Conclusions: the possibility of a new growth regime? The Japanese economy showed a new growth pattern during the recovery process after 2002, but the companyist mode of régulation has been continuously eroded so that it has become dysfunctional. Therefore, due to the difficulties caused by the subprime crisis, the Japanese economy underwent another structural crisis in 2008. Not only non-regular workers but also regular workers were threatened with dismissal by Japanese companies, and the unemployment rate rose very rapidly during the crisis.

126 H. Uemura In this context, the following urgent policy agendas are required. First, credible rules in relation to monetary and financial policies should be established to stabilize the Japanese financial market. Second, active fiscal policies targeting such important areas as education, social infrastructures, and social security should be implemented to lift the economy out of chronic deflation and to ensure sufficient profitability to Japanese firms, including small and medium-sized ones. Third, in the light of the increasing unemployment in a rapidly aging society, an effective safety net must be created and the social welfare system improved in order to protect the work and welfare of Japanese people. What can we say about the distinctive features of a possible future growth regime in Japan? Of course, there are impediments to a future new growth regime, because, until now, no solutions to the ongoing structural crisis have been found. However, the long-term possibility of a growth regime should be considered. For example, Robert Boyer suggests “innovation and regional integration-led growth” as the basis for a possible growth regime in Japan, in the future. This means a growth regime where high productivity and profitability are realized with active innovation in industries such as the electronics and telecommunication industry and other manufacturing industries. These industries will play a leading role in the international division of labor in the Asian integration process. In order to realize this growth regime, we should solve the structural problems, which have been caused by the export-oriented economic growth as well as by the heterogeneity of firms and industries. In this regard, a new mode of régulation should be established to coordinate effectively the behaviors of various agents and the dynamics of firms and industries. This implies that there would be new rules regarding employment security, continuous wage increases, adequate opportunity for skill formation by both regular and non-regular workers, as well as a continuous increase in workers’ consumption supported by these institutional conditions. Of course, several institutional and structural conditions should be satisfied to realize this growth regime. The pattern of demand formation We should realize a continuous increase in export demand as well as the stable formation of domestic demand. Asian countries, especially China, Korea, and ASEAN countries, will continue to be important trading partners with Japan. However, what we should pursue is not a simple export-led growth but a more sophisticated one in which we keep our competitiveness in the high-tech industry, while expanding international trade by effectively organizing intermediate goods trade through international transaction networks. A necessary condition to achieve this growth pattern is maintaining a stable exchange rate for the yen in relation to the other Asian currencies. As for the formation of domestic demand, it is necessary to stabilize the Japanese financial system by re-establishing a proper framework of financial regulations and promoting sufficient levels of investment. Furthermore, it is also necessary to encourage social demand for social welfare, elderly care, education, medical care, and environmental protection.

The growth regime in the Japanese economy 127 Profitability and the surplus spillover Profitability differentials should be decreased between industries and different-sized firms by new social coordinating mechanisms at both the industrial and firm levels because the profitability differentials have unfavorable effects on productivity growth and demand formation in the Japanese economy as a whole. Of course, trade surplus generated by a leading industry with high productivity is necessary for dynamic economic growth; but, at the same time, we should reconstruct a new surplus spillover by establishing a new wage-equalizing mechanism instead of the traditional shunto. Furthermore, the tax system should contribute to the transfer of incomes from large firms in the export goods sector to the rest of the Japanese economy.

Industrial structures and international production linkages A dynamic manufacturing industry that plays a leading role in the international division of labor in East Asian economies should be created. In the light of the deepening international economic relations with the Chinese and other Asian economies, de-industrialization in terms of manufacturing employment will inevitably occur in Japan, in the future. Therefore, in order to prevent the manufacturing industry from losing its competitiveness in the deindustrialization process, we should develop a new leading industry with strong dynamism and high productivity growth to support the growth of the Japanese economy as a whole, while effectively organizing international production linkages with the other Asian economies. Furthermore, as the domestic service sector expands in the deindustrialization process, high quality personal services in education, medical care, and elderly care should be developed.

Structural compatibility and the mode of régulation There was structural compatibility between the organization of large firms, hierarchical subcontracting systems, and the segmented labor market in the Japanese economy in the 1980s. Under these institutional arrangements, a competitive production system and a flexible coordination of wages and employment were effectively realized. However, the structural compatibility deteriorated, and the mode of régulation was eroded in the structural crisis of the 1990s. Corporate governance came to be influenced by the financial market, increasing the heterogeneity of firms’ organization. In the recovery process, after 2002, only large firms in the export goods industry enjoyed high profitability without being structurally compatible with other industries and small and medium-sized firms. Therefore, new structural compatibility is needed between the financial system, the company system, and the labor market based on a proper mode of régulation that covers not only large firms but also small and medium-sized firms and non-regular workers. This requires a new social consensus among the Japanese people.

128 H. Uemura The régulation theory emphasizes political factors and historical effects in institutional changes and in the transformations of the growth regime. Therefore, the necessary conditions shown here are only a rough sketch of a new growth regime, whereas the actual growth regime in Japan in the future will be decided by history.

Notes 1 As for the increasing interdependence among the East Asian economies, see the analysis of Asian International Input–Output Tables in Figure 8.1, in Chapter 8 of this book. 2 The institutional arrangements that have existed between firm organization, subcontracting networks, and the segmented labor market in Japan are called the “hierarchical market-firm nexus” (HMFN) in the studies by the régulation theory (Uemura and Ebizuka 1994; Isogai et al. 2000). These institutional arrangements have been complementary structures to the companyist mode of régulation in Japan (see Chapter 2 of this book). 3 The data sources and calculation procedures of the variables are as follows. The profit is calculated on the basis of data from the Cabinet Office, Annual Report on National Accounts, and the capital stocks of private enterprises are obtained from the Cabinet Office, Gross Capital Stock of Private Enterprises. The profit rate of private enterprises = (the incomes of private enterprises + interest + dividend)/the capital stock of private enterprises. In constructing the profit rate of all enterprises, the incomes of unincorporated enterprises are formally divided into profits and wages, following income distribution in enterprises. We obtain the accumulation rate as the growth rate of real capital stock, adjusting the data on gross capital stock in order to remove the effects of the privatization of the NTT and the Japan Tobacco Industry in 1985, and the Japan National Railway (JNR) in 1987, etc. 4 For more detailed information on the factors that influenced the changes in the profit rate from the 1960s to the 1990s, see Uemura (2000). 5 As for long-term shifts in wage share in the Japanese economy after the 1960s, see Uemura (2000). 6 In Figure 6.2, national incomes, employee incomes, and unincorporated enterprises’ incomes are obtained from the Cabinet Office, Annual Report on National Accounts. 7 The analysis in this part is closely related to the institutional analysis of the “hierarchical market–firm nexus” in the postwar Japanese economy. The nexus consists of firm organization based on “the competence-based grade system,” the hierarchically segmented labor market, and hierarchical inter-firm relations, which have resulted in complementary relations between large firms and small and medium-sized firms with various types of flexibility. It should be emphasized that these components had very dynamic “structural compatibility” in the Japanese economy of the 1980s. The concept of “structural compatibility” is, to a certain extent, similar to “institutional complementarity” (Aoki 2000a; Aoki and Dore 1994), but it is a more dynamic concept, taking account of mesolevel and macro-level stability based on the theoretical framework of the régulation theory. 8 Regarding the effects of the activities of Japanese multinational firms on intermediate goods trade and international production linkages between China and Japan, see Tables 8.8 and 8.9 in Chapter 8 of this book.

Part II

Chinese and Korean capitalisms: two contrasted trajectories China: export or investment-led growth regime?

7 Development mode and capability building in the age of modularization and regional integration Origins of structural adjustments of Chinese economy Lei Song

Introduction The last three decades have witnessed the dramatic growth of China as a manufacturing and trading powerhouse. China’s growth has been featured by heavy dependency on FDI and exports which can be attributed to regional cooperation to a large extent. However, China has been forced to undertake two kinds of structural adjustment in recent years: at the corporate level around the capability building, typically represented in the so-called indigenous innovation policy, and at the macro level around the change of development mode, that is accelerated by the onset of the subprime crisis. Most mainstream economists tend to discuss the two structural adjustments separately. In this chapter, we argue that the two structural adjustments relate to each other and both originate from the inherent limits of Chinese-style capitalism. The adjustment of development mode should be taken as an unavoidable result of the evolution of the “reform without long-term perspective,” rather than a simple crisis measure. Similarly, the structural adjustment towards innovation strategy at the corporate level should be taken as an indication of the fragility of the technological foundation of Chinese corporations. The purpose of this chapter is twofold. Primarily, it aims to investigate the origins of structural adjustments at the macro and corporate levels from the viewpoints of institutional economics and technological change. Secondly, it analyzes the relation between the origins of two structural adjustments and shows how the de facto regional integration shapes the capability building of Chinese corporations. This chapter is structured as follows. The second section outlines the stylized facts of China’s growth and sheds light on the necessity of structural adjustments. The third section investigates the origins of the structural adjustments of the Chinese economy through the lens of linkage of institutional complementarity and organizational–technological complementarity. Taking the relation between the origins of two structural adjustments into account, the fourth section

132 L. Song discusses how the de facto regional integration shapes Chinese corporations’ capability building in the age of modularization. The last section summarizes the main findings.

Structural adjustments and stylized facts of China’s growth China has been experiencing two structural adjustments in recent years. First, China eventually formed its national policy on “indigenous innovation” in 2006, after 28 years of reform. Second, the American financial crisis revealed China’s over-reliance on the international market. Consequently, China stepped into a strategic transition to domestic consumption-led growth. Gradualism has been taken as the most distinguishing characteristic of China’s development. Considering China’s particular circumstances (the combination of market economy and the one-party system), the gradualism hypothesis provides a powerful explanation to the “reform without losers” period (1978–95). However, the legitimacy of gradual reform became seriously jeopardized when the reform itself became “reform with losers” in the late half of the 1990s. Furthermore, the gradualism hypothesis does not have much to do with capability building at the corporation level. The aforementioned structural adjustments hit China’s reform is far from a sequent process. A self-consistent analytical framework which focuses on the discontinuity of China’s growth is needed to understand the logics of both rapid expansion and policy U-turns. East Asia has witnessed several economic miracles since the end of World War II. Compared to its counterparts, China’s economic growth is even more recondite. • Trade dependency. As a long-term trend, it is widely observed that there is a systematic association between the trade proportion and the size of GNP or population; that is, the trade proportion rises as GNP or population declines. In other words, the big country tends to have low-trade dependency (Kuznets 1964). However, since the end of the 1970s, China’s trade dependency has continued to rise and reached a level much higher even than that of Japan and Germany, the two most well-known export-led economies.1 • Change of mode of development. Since Kaldor first addressed the question of “why growth rates differ among economies” (Kaldor 1966), the mode of development has been one research topic of the post-Keynesian tradition. Based on the recognition that part of the difference of growth rates can be attributed to the performance of the export sector, he positioned the expansion of the export sector as an important means to achieve sustainable development. Actually, one core of Kaldor’s growth theory is to emphasize the possibility of realizing sustainable economic growth with full employment through “the change of the mode of development”. The point here is that in the long run, “change of the mode of development” refers to not only the change from domestic demand-led growth to export-led growth, but also the change from the latter to the former (Boyer 1992).

Origins of structural adjustments of Chinese economy 133 Table 7.1 International comparison of growth of labor productivity

Japan 1975–80 1980–5 Korea 1985–90 1990–5 China 1992–7 1997–02

Tradable goods

Domestic consumption goods

6.9 4.4 6.8 13.8 18.5 11.7

2.8 2.3 6.1 4.7 8.6 17.1

Source: Uni et al. (2004).

Table 7.2 Rate of profit of China’s manufacturing sector: IT and electronics industries

Manufacturing sector as a whole IT and electronics industries

Manufacturing sector as a whole IT and electronics industries

1995

1996

1997

1998

1999

2000

2001

3.81

3.05

3.17

2.35

3.42

5.56

5.35

5.75

5.49

6.83

5.00

5.79

7.16

5.40

2002

2003

2004

2005

2006

2007

2008

5.62

6.25

6.52

6.61

7.43

6.74

6.42

4.44

4.03

3.99

3.39

3.49

3.71

3.62

Source: Chinese Statistics Yearbook 1996–2009.

Considering the size of GNP and population, Japan is China’s comparable counterpart in this region. However, the change of China’s mode of development is quite different from that of Japan. Contrary to the popular theory prevailing in the mass media, it was from 1975 that Japan began its export-led growth. Before that, Japan’s high growth was motivated by domestic consumption (Uni 1995). An intriguing fact is that China entered its export-led growth period from the beginning of the 1990s when its domestic consumption-led growth was far from fulfilling the mission (Uni et al. 2004). • Deviation of growth of labor productivity and rate of profit. As Table 7.1 shows, China has been experiencing a high growth of labor productivity since the early 1990s, even higher than that of Japan’s and Korea’s export-led growth periods. However, Table 7.2 shows that, in some industries, the record-setting growth of labor productivity did not result in a reasonable rate of profit for most Chinese corporations. Up until 2001, the rate of profit of the manufacturing sector as a whole has been lower than that of export-oriented industries such as IT and the electronics industries. But that trend has been reversed since 2002. The computer and audio/video equipment industries, which are the two main

134 L. Song forces of China’s export sector, have shown a decline in the rate of profit since 2001 (Song 2008). • High growth rate of GDP and low R&D expenditure. The proportion of R&D expenditure to GDP has been fluctuating at around 1 percent. As a result, Chinese corporations have relied heavily on the import and spillover of foreign technology. • Rapid expansion of GDP and absence of world-class corporations. The high growth in Japan and Korea were inextricably linked to developmental processes in which newcomers (Sony, Honda, Samsung, LG, and many others) reached the technical frontier. China’s long-lasting rapid growth, however, did not include the appearance of world-class corporations. The above stylized facts reflect two characteristics of China’s growth: exportled growth at the macro level, and divergence of production capacity and technological capability at the corporate level. Growth of production capability, which can be attributed to the increase of FDI, to some extent, contributes to the expansion of the trade sector, which induces a growth of labor productivity through Kaldor’s law. Similarly, a sluggish advancement of technological capability gives rise to a declining rate of profit. In turn, the low R&D expenditure can be taken as the result of the low rate of profit.

Linkage of complementarities and origins of structural adjustments With the rebirth of institutional economics and the development of a resourcebased view of firms, the institutional and technical foundations of competitiveness have been discussed from viewpoints of economics and management. Among these studies, some authors have analyzed the institutional environment or institutional foundations of competitiveness (Aoki and Dore eds. 1994; Amable 2003) while others became aware of the technical foundation of competitiveness (Pavit 1984; Lall 1992; Mowery and Nelson eds. 1999). There is little doubt that these studies contribute much to our understanding of competitiveness. However, these studies fail to provide a fully applicable analytical framework and the origin and dynamics of competitiveness remain elusive. Taking the divergence of production capacity and technological capability into account, this section aims to rethink the formation of the competitiveness of Chinese corporations and the origins of structural adjustments by combining recent progress in institutional economics and strategic management. In practice, we try to deepen the technology–organization complementarity hypothesis by introducing an architecture-based analysis of competitiveness into the study of the Chinese economy. Linkage of micro and macro complementarities: starting point of analytical framework The study of the relation between organization and technology at the firm level has a long history. However, early previous studies concentrate mainly on finding

Origins of structural adjustments of Chinese economy 135 IC employment relationship

financial system IIO

IIO

technology TOC

IC

IC

organization

IIO

form of competition and cooperation in domestic and international markets

Figure 7.1 Linkage of macro and micro complementarities. Note: IC: institutional complementarity; TOC: technology-organization complementarity; IIO: isomorphism between institutions and organizations. Source: Boyer (2005) with modification.

out the decisive factor rather than studying the interrelated influence (Woodward 1960; Blauner 1964). In recent years, the relation between the two factors is expressed in an applicable way and linked to competitiveness.2 Among these studies, French régulationist’s analysis about the linkage of micro and macro complementarities that positions the firm at the center of analysis provides a starting point to systematically understand the relation between organization and technology (see Figure 7.1). Régulationists’ analysis originates from their study of the productive model which is defined in the international as well as domestic environments (Boyer and Freyssenent 2002). In their analysis, corporate strategy is taken as the result of micro and macro complementarities.3 Basically, the corporation is composed of capital, equipment, and labor force. Equipment is nothing but the form of materialization of technology and the process of labor takes place in the organization. In order to achieve sustainable growth, the capital has to be transferred to investments in technology and organization. Seen in this light, in the dynamic development, the corporation is actually composed of technology and organization and its performance can to a large extent be attributed to the technology–organization complementarity. Obviously, institutional arrangement at the macro level affects organization and technology at the corporate level.

136 L. Song International regime and architectures of product and organization: towards an applicable analytical framework Organization and technology have been discussed separately in different disciplines. As the result, we cannot analyze the two factors under the same framework until the architecture-based analysis of competitiveness appeared (Baldwin and Clark 2000). Product architecture refers to the scheme by which the function of a product is allocated to physical components (Ulrich 1995). Fujimoto (2004) argues that product architecture can be categorized as open modular, closed integral, and closed modular by function–component mapping and versatility of components. Consequently, modularization can be understood as a shift from a closed integral architecture to an open modular architecture. Taking into account the fact that an organization is a system composed of subsystems linked through interface to fulfil special functions, we can categorize organizational architecture in the light of a definition of product architecture.4 One point we should make is that “organization” here refers to not only the organizational form inside the firm, but also the inter-firm organizational form which occupies a central position in the process of capability building of China’s industries. A company with an integral organizational architecture permits the cross-sectoral exchange of information and employees, therefore the subsystems and employees are not simply replaceable. On the other hand, a company with a modular organizational architecture advocates the deepening of division of labor among sectors and employees. As a result, the employees are to some extent replaceable and the necessity of cross-sectoral exchange of information is reduced substantially. Similarly, at the inter-firm level, an inter-business relation with an integral organizational architecture tends to transact with specific partners in the long term, while an inter-business relation with a modular organizational architecture tends to deal with different partners in flux to maximize short-term profit. Some corporations with such an inter-business relation developed into virtual corporations. By defining the product and organization architectures in the above ways, it becomes possible to discuss the complementarity between two kinds of architecture.5 However, the complementarity types one and two shown in Figure 7.2 are static ones and the picture of the formation of competitiveness in the processes of technological and organizational changes is still not yet clear. Chesbrough (2003) developed a dynamic model of formation and change of competitiveness from the viewpoint of architectural change, and highlighted the dynamic complementarity between technological change and organizational evolution. Concretely, in the process of technological change, companies with rigid integral organizational architectures are likely to be locked in an “integrality trap” when the product architecture shifts from integral side to modular side, while the virtual companies face the danger of “modularization trap” when the product architecture changes to the opposite direction.6 Undoubtedly, Chesbrough’s cyclical model of architectural change is a crucial contribution to the literature of competitiveness and corporate strategy. However,

Origins of structural adjustments of Chinese economy 137

product architecture

organizational architecture in/between firms integral modular

modular

integral

complementarity type one

complementarity type two

Figure 7.2 Technology–organization complementarity: an architectural view.

Chinese corporation interorganization architecture type A

interorganizational architecture type B

foreign corporation

foreign corporation

Figure 7.3 Interorganizational architecture in the international market.

as with other previous studies, his work basically focuses on corporations in advanced countries rather than corporations in developing countries, for whom the key question is about both formation and the sustainability of competitiveness in the process of architectural change driven by advanced countries in the age of modularization. Along the lines of Bell and Pavitt (1993), we take “production capacity” and “technological capability” as the principal parts of a corporation’s competitiveness in developing countries and discuss how the international regime, specifically the regional cooperation or the inter-organizational architecture between Chinese and multinational firms affects the former’s competitiveness in the process of technological change. Considering the definition given above, as shown in Figure 7.3, inter-organizational architecture can be divided into type A and type B. In interorganization architecture type A, the transaction partners keep a distance from each other once the transaction ends; in inter-organization architecture type B,

138 L. Song the transaction partners interact closely with each other before and after the transaction. By introducing inter-organizational architecture into the analytical framework, we link the form of competition and cooperation in the international market to the technology and organization complementarity at the corporate level. Under such an analytical framework, we discuss how the international regime shapes Chinese corporations’ capability building and investigate the origins of structural adjustments that China is experiencing in the next section.

Regional cooperation and capability building of Chinese corporations: evidences from consumer electronics and software outsourcing industries On the basis of the fact that organizational and technological linkages with corporations from advanced industrial nations provide corporations in developing countries with the chance to catch up, we have the subsequent propositions in ceteris paribus terms. P ROPOSITION 1 The modularization triggered and dominated by corporations from advanced countries provides the latecomers in developing countries the chance to enter high-tech industries and expand the scale of production. As a result, the higher the degree of product modularization, the easier for the latecomers to improve its production capacity. P ROPOSITION 2 The higher the degree of overlapping between product and inter-organizational architectures, the less possible for the latecomers to benefit through technical spillover from an advanced industrial economy, or, in other words, the higher the degree of inter-organizational modularization, the less possible for the latecomers to improve its technological capability. Taking structural adjustments into consideration, we concentrate on the process of capability building of Chinese corporations by evaluating the evidences from consumer electronics and software outsourcing industries.7 Modularization of product architecture and latecomer’s production capacity Modularization can be understood as both the result and the process of product architecture change. The product architectural change towards modularity lowers entry barrier for newcomers in developing countries. In the consumer electronics industry, with the help of the open design rule and standardization of interface between components, complex products with integral architecture shift to the modular side, and production has become quite simple in recent years: purchasing key components and putting them together. It is the very reason why Chinese corporations have successfully entered the production of panel TV sets and DVD players when these newest electronics have only just been launched in Japan,

Origins of structural adjustments of Chinese economy 139 though the traditional product cycle hypothesis has it that it would take a long time for latecomers to master the skills to produce the newest product innovated by advanced countries (Vernon 1966; Akamatsu 1960). What is even more impressive is that although it took Chinese makers nearly 10 years to improve the quality of some electronics goods in the era of analogy technology, the product quality has improved dramatically when the product architecture has shifted to the modular side in recent years (Zhang 2004). Due to the complexity of the product being embodied in key components and the interface of the parts being well defined in modular architecture, it is not surprising to find that Chinese corporations successfully raised its production capacity, product quality, and labor productivity. At the same time, modularization lowers the economic value of vertical integration for incumbent enterprises in advanced industrial countries. Facing the pressure of high R&D costs, multinational enterprises have to distribute key components in the international market to decrease product price and spur demand (Sakakibara and Koyama 2006). This is why Japanese and Korean consumer electronics corporations that triggered the process of modularization have been providing key components to their Chinese rivals. Similarly, the positive correlation between modularization and production capacity also exists in China’s software outsourcing industry, which is strongly affected by its transactions with Japanese corporations.8 Modularization in the software outsourcing industry refers to (1) the segmentation of phases of product design, product development, and maintenance, and (2) the reuse of modules. Obviously, segmentation lowers entry barriers and makes it possible for latecomers to start production and reuse of modules means Kaldor’s law works in this industry. Modularization of inter-organizational architecture and latecomer’s technological capability Although it is obvious that regional cooperation contributes to the growth of latecomers’ production capacity, whether or not it induces the latecomer’s upgrade of technological capability is not free from doubts. In the literature of technology management, the discontinuous technical change has been taken as a chance for latecomers to catch up (Tushman and Anderson 1986; Henderson and Clark 1990). Some authors go further to argue that the discontinuous technical innovation provides the developing countries with the chance to catch up by implementing public policies aiming at trade flow, foreign investment, and structural adjustment of the domestic industry (Dosi 1982). Taking the literature of discontinuous innovation into account, it seems that we have sound reasons to expect modularization, a seemingly discontinuous innovation will open a “window of opportunity” (Perez and Soete 1988) for Chinese corporations. However, for latecomers, the effects of discontinuous innovation only come into being when latecomers’ technical learning is continuous: the “window of opportunity” only opens for the well prepared.

140 L. Song In some consumer electronics industries, technical change pushed by modularization shows obvious discontinuity, and technical learning of local corporations has been interrupted repeatedly. For instance, it took China’s TV-set industry one decade or longer to gradually accumulate Braun tube-related knowledge.9 However, the flat-screen TV has entirely different key components and the knowledge of the Braun tube cannot be transferred to produce or design liquid crystal or Plasma displays. What makes the Chinese TV set makers’ position even weaker is the rapid upgrade of liquid crystal display (LCD) panel skill. It took multinational corporations just five years to upgrade its production line from fifth generation to tenth generation. Furthermore, organic light-emitting display (OLED) is likely to replace LCD and plasma panel in the near future. If the OLED TV set becomes the new dominant design, the technical capacity accumulated in the period of LCD and Plasma will be disrupted once again. Another example concerns the chip. In the era of flat-screen TV, five chips used in CRT TV are condensed into two or one, which means the entry barrier of chip design moves upwards. The sophistication of key components brings about two interrelated effects on the inter-organizational architecture and technological learning. First, the change from Braun tube to flat panel is a kind of substitute of modules, and the change from 5 chips to one or two chips can be described as an integration of modules (Baldwin and Clark 2000). Both substitution and integration of modules create more sophisticated modules, which leads to the overlapping of product and inter-organizational architectures. The rising degree of overlapping of product and inter-organizational architectures decreases the necessity of information exchange between designer and taker of design rule, and also increases the difficulty for latecomers to master the knowledge embodied in these new modules. It is in this process that Chinese corporations are locked in the Chinese-style modularization trap. Unlike their Indian counterparts whose transactions are basically American/ Europe-oriented and relate to all the stages of design, China’s software outsourcing corporations have been relying on transactions with Japanese corporations for a long time. These transactions concentrate on coding and testing phases. Therefore, it is necessary to investigate whether or not the Chinese-style modularization trap appears in the software outsourcing industry once again. In order to answer this question, we conducted questionnaires and interviews in Dalian and Beijing to investigate if the transactions with Japanese corporations hinder Chinese corporations building their technological capability (Song 2010).10 Concretely, we compare the organizational and technological features of Chinese corporations whose main markets are Japan or America/Europe. The main findings of the questionnaires and interviews can be summarized as follows. First, contrary to the accepted wisdom, a client’s nationality is not a decisive variable for Chinese firms’ organizational pattern and technological feature. Although Japanese and American/European clients’ emphases on form of document file and CMM are different, the two kinds of Chinese corporation share both organizational and technological aspects in common.11 Second, different from the consumer electronics industry, the organizational boundary between

Origins of structural adjustments of Chinese economy 141 client and agent is less strict. The staff exchange, especially the detachment of the bridge engineer, is widely observed in both kinds of Chinese corporations. In other words, perfect overlapping between product architecture and inter-organizational architecture does not exist in China’s software outsourcing industry. Because information and technology are closely related to each other and exchange of information is necessary to conduct software outsourcing, the transaction unavoidably gives rise to technology transfer and contributes to the growth of technological capability of Chinese corporations.12, 13 To sum up, the relationship between Chinese and Japanese corporations in the consumer electronics industry and the software outsourcing industry correspond to inter-organizational architecture type A and type B separately. Different from inter-organizational architecture type A, inter-organizational architecture type B leaves room for Chinese corporations to build technological capability through production.

Tentative conclusions and research agenda In order to understand the origins of structural adjustments that China is facing, we built an analytical framework in which the linkage of macro and micro complementarities is put in the center. The analytical framework points in two potential directions: understanding the origin of structural adjustments by focusing on how the international regime (regional integration) shapes the technological foundation of the Chinese economy, and investigating how the wage–labour nexus affects the institutional foundation of the Chinese economy. This chapter did not touch the employment issues. However, considering the undergoing labor disputes, the researches about the technological and institutional foundations of the Chinese economy are equally important. From the technological point of view, we find structural adjustments come from the discontinuity of capability building in the age of regional integration and modularization. Unlike the analogy era, regional cooperation presents with much more complicated effects on the capability building of China’s industries in the age of modularization. The divergence of production capacity and technological capability features the process of China’s capability building in the age of modularization. Concretely, the cooperation between multinationals and Chinese corporations contributes much to the expansion of the latter’s production capacity; however, the modularization of inter-organizational architecture between corporations from developed and developing countries leaves the latter less room to improve their technological capability through “learning by doing” in some industries. This is the very reason why some Chinese corporations are locked into a so-called “Chinese-style modularization trap” and China has to carry out structural adjustments. However, due to the degree of perfect overlapping of product architecture and inter-organizational architecture varying in different industries, the possibility for Chinese corporations to improve technological capability through transactions with their multinational counterparts differs in the consumer electronics industry and the software outsourcing industry.

142 L. Song

Notes 1 Since 2005, the trade dependency has been over 60 percent. 2 Lazonick is among the economists who first discussed this issue thoroughly, but his studies lack a clear typology of technology (Lazonick 1990). Orlikowski and Barley (2001) analyzed the relationship between organization and technology, but the technology they discussed is IT-related and is just peripheral technology for most industries. 3 In his subsequent study, Boyer refined his analysis about the complementarity at the corporate level by introducing equipment to the analytical framework (Boyer 2005a). 4 Henderson and Clark (1990) discussed the typology of organizational architecture from the viewpoint of exchange of information inside the company. Sako (2003) defined organization architecture in a most comprehensive way by an analogy to product architecture. 5 Kusunoki and Chesbrough (2006) and Fujimoto (2004) all mentioned the complementarity between product architecture and organizational architecture, but they did not define the organizational architecture as clearly as Sako (2005) did. 6 See Kusunoki and Chesbrough (2001) for a detailed description of the two kinds of architectural trap. 7 The two industries are chosen for the following reasons. First, the consumer electronics industry has been the symbol of Chinese manufacturing industries’ growth and frustration, and considering the extensive application of software in the manufacturing sector, the software industry has been widely taken as the new source of the competitiveness in the Chinese economy. Second, the growth of the two industries benefits from the modularization of product architecture. Third, although the Sino-Japanese economic cooperation played crucial roles in the early stages of the growth of China’s two industries and will continue to affect their further development, capability building of the two industries evolves in different trajectories. 8 In the early stage of its development, nearly all orders came from Japanese corporations and nowadays the transactions with Japanese corporations still occupy more than 50 percent of the whole sales. 9 For how Chinese corporations accumulated the technological capacity in the era of the CRT TV set, see Shintaku et al. (2005). 10 Dalian has been the base of Japan-oriented software outsourcing and Beijing is becoming the base of America-oriented software outsourcing. We received replies from 22 corporations among which we interviewed five Japanese, three American and eight local corporations. 11 CMM is the abbreviation of Capability Maturity Model which is designed to promote the standardization and traceability of development of software. 12 For the relations between product decomposability and knowledge decomposability, see Dosi et al. (2003). 13 The findings are consistent with empirical study about the organizational boundary in European’s IT outsourcing industry (Miozzo and Grimshaw 2005).

8 Chinese international production linkages and Japanese multinationals Evolving industrial interdependence and coordination Jian Wang, Nagendra Shrestha, and Hiroyasu Uemura

Introduction After the 1990s, Asian capitalisms achieved extraordinarily fast growth in “international production sharing” (the splitting up of value-added chains). Multinational firms played an important role in the process of globalization and regional integration (Coriat et al. 2006).1 In particular, the Japanese multinational firms’ (JMNs) activities and foreign direct investments (FDI) have been instrumental in creating international production linkages, thus promoting economic integration in the East Asian region. Asian capitalisms have accomplished dynamic economic growth by participating in international production sharing in East Asia. However, the subprime crisis was the catalyst for a serious global economic downturn in 2008. Significant reduction in exports, resulting from the declining import demand from the USA and European countries, had a significant impact on the export-oriented East Asian economies. Although there is growing evidence that production and trade associated with FDI is the driving force behind increasing interdependence in the East Asian economies, especially in China, one can be less certain about the exact impact of the crisis on the economic integration process in East Asia. In this situation, JMNs are assisting in the tighter formation of international production linkages between Japan and Asian host countries. In this chapter, we investigate the increasing industrial interdependence among the East Asian economies in the economic integration process and analyze the effects of JMNs on the interdependence between Chinese and Japanese economies. We apply an international input–output (I–O) analysis to provide an appropriate framework for the analysis of complex international production linkages between China and Japan. Furthermore, we investigate the implication of increasing international production linkages promoted by the activities of JMNs in China from the production and transaction process viewpoint of heterogeneous JMNs. We follow four specific points. First, we investigate the increasing trend of international production linkages and regional interdependence in the East Asian region after the 1990s. We analyze the complex networks of intermediate goods

144 J. Wang, N. Shrestha and H. Uemura trade among the East Asian economies by utilizing Asian International Input– Output Tables (AIO) and other trade data in East Asia.2 The international I–O analysis has the clear advantage of taking into account the intermediate goods trade and international production linkages. Second, we examine the evolution of JMN activities in different industries in China over the past two decades. We analyze the dynamic effects of Japanese FDI and JMN activities on the Chinese economy, with a focus on the industrial specificities of Japanese FDI. Third, we conduct an international I–O analysis to investigate the international production linkages between JMNs and the Chinese economy. Yamada’s studies are considered as pioneering efforts to analyze the activities of JMNs in the framework of the international I–O analysis (Yamada 2001, 2002, 2004, 2007). Following his studies, we examine the changing impact of JMNs’ activities on the Chinese economy by comparing AIO tables for 1995 and 2000. Finally, we explore the evolution and coordination of international production linkages from the viewpoint of the heterogeneous behaviors and organizational structures of Japanese firms (see Chapter 3 by Lechevalier in this book). Regarding JMNs in the electrical machinery and transportation equipment industries in China, Fujimoto and Shintaku (2005) emphasized that the impact of component “modularization” in products on the local procurement differs between these industries (as for “capability” and “modularization,” also see Fujimoto (2007) and Chapter 7 by Song in this book). We also discuss recent structural changes in international production linkages that have been promoted by the activities of JMNs in China.

Increasing trend of regional interdependence in East Asian economies Increasing interdependence in Asian international I–O tables Regional trade linkages and interdependence in the East Asian region have increased significantly since the 1990s; however, diversity currently exists there in Asian capitalisms. The share of intra-regional trade amounted to about half of the total trade volume and intermediate goods trade accounted for 60 percent of intra-regional trade in 2005.3 The trade linkages clearly played a major role in promoting the flying geese pattern of economic development (Akamatsu 1962), but the pattern has been modified strongly by the increase in FDI and international production linkages in the economic integration in East Asia. Figure 8.1 shows the interdependence levels among 10 economies in 1990, 1995, and 2000 on the basis of the AIO Tables.4 The dependence of one country on another is defined as the ratio of inputs supplied from another country to the total inputs necessary for production. These bilateral dependencies are shown as off-diagonal elements. In a similar manner, the share of domestically supplied inputs to the total production inputs, termed as self-dependence, are presented as the diagonal elements in Figure 8.1.5 The interdependence level with magnitude of less than 1 percent has been shaded black to indicate either non- or exceptionally low interdependence. For example, for linkages on the demand side,

1990

In

Ma

Ph

Si

Indonesia

0.90

1

0.01

Malaysia

0.00 0.68 0.01

0.06

Th

Ch

Tw

Kr

Jp

US

0.01

Philippines 0.00 0.00 0.65 Singapore 0.00 0.04 0.02 0.34 0.03 Thailand China

0.00 1

Taiwan

0.00

0.00

0.01 0.01

0.01 0.61 0.03

0.02 0.90 0.00

0.02

0.03 0.03 0.03 0.02 0.02 0.02

0.00

0.00

0.00

0.67 0.01

0.00

0.00

0.01 0.70 0.00

0.00

Korea

0.01

0.01

Japan

0.02

0.11 0.10 0.21 0.12 0.02 0.13 0.11 0.93 0.02

USA

0.01 0.05 0.07 0.12 0.08 0.01 0.01 0.01 0.01 0.93

1

0.02

Hong Kong EU ROW

1995

0.04 0.06 0.05 0.13 0.07 0.02 0.07 0.06 0.03 0.04

In

Ma

Ph

Si

Th

Indonesia

0.86

0.01 0.02

Malaysia

0.00 0.54

0.01 0.05 0.02

Ch

Tw

Kr

Jp

US

0.01

Philippines 0.00 0.00 0.57 Singapore

1

0.04

0.02 0.39 0.03

0.01

0.03 0.56

Thailand China

0.02 0.02 0.02

0.02 0.87 0.02 0.03

Taiwan

0.02 0.04 0.02

0.02

0.02

0.03 0.04

0.58 0.01

0.02 0.01 0.02 0.66 0.01

Korea

0.01

Japan

0.03 0.17 0.10 0.22 0.15

0.01

USA

0.02 0.08 0.08 0.11 0.08 0.02 0.09 0.08 0.02 0.90

0.04 0.16 0.11 0.92 0.03

Hong Kong 0.00 0.00 0.01 0.00 0.00 0.01 EU

0.00

ROW

0.04 0.07

2000

In

0.00

Ma

0.00

0.00

0.00

0.06 0.07 0.06 0.03

0.07 0.06 0.02

Ph

Tw

Si

Th

Ch

Indonesia

0.81 0.01

Malaysia

0.01 0.40 0.02 0.07 0.03 0.40

Philippines 0.00

0.01 0.01

Kr

Jp

0.04

US

0.01 0.02

0.01

0.01 0.42

Singapore 0.01 0.07 0.03 0.39 0.03

0.02

0.02 0.01 0.02 0.51

Thailand China

0.02 0.03 0.02 0.04 0.04 0.84 0.03 0.03 0.01

Taiwan

0.01

Korea

0.01 0.03 0.05 0.03 0.03 0.02 0.04 0.63

0.01

0.04 0.04 0.02 0.03 0.02 0.56 0.02

Japan

0.04 0.15 0.17 0.17 0.14 0.04 0.15 0.10 0.90 0.03

USA

0.03 0.12

0.11 0.10 0.07 0.02 0.08 0.08 0.02 0.88

Hong Kong 0.00 0.01 0.01 0.01 0.00 EU

0.01 0.03 0.03 0.02 0.03 0.01

ROW

0.05 0.06 0.05 0.10 0.05 0.02 0.06 0.06 0.02 0.04

0.02 0.02

0.01 0.01

Figure 8.1 Evolution in East Asian regional interdependence (1990–1995–2000). Source: Shrestha (2009).

146 J. Wang, N. Shrestha and H. Uemura overall Chinese production requires 84 percent of domestic contribution, 4 percent from Japan, and 2 percent from the USA for production input in 2000. In that same year, the Japanese economy had 90 percent domestic and 10 percent foreign contribution. The USA and rest of the world (ROW), excluding the countries listed as sources in Figure 8.1, has contributed 2 percent to their total production. Figure 8.1 shows an obvious increase in regional interdependence among the East Asian economies from 1990 to 2000.6 Specifically, the dependence of East Asian economies on the Chinese economy has grown extensively during this period, therefore demonstrating that China became one of the important intermediate goods trade centers in East Asia. However, it is important to note that the degrees of interdependence among the regional economies are comparatively lower than their dependence on Japan and the USA. Although intra-regional cooperation has strengthened the economic integration in East Asia, the economies are still influenced significantly by powerful advanced economies such as the USA and Japan. It is not possible to state how the interdependence structures in the East Asian regions have transformed after the year 2000 because a new international I–O table for 2005 and beyond is not available. One may assume that this trend of East Asian intra-regional relationships has not decreased notably.

Recent trends for intermediate goods trade in East Asia Using trade data from the East Asian region, we can investigate the trends associated with intermediate goods trade up to 2008. Gray bars in Figure 8.2 represent the trade of China, East Asia,7 Japan, and the USA with the East Asian economies. Black bars represent these economies’ imports from the East Asian region. Intraregional trade increased from 274 billion US$ in 2000 to 626 billion US$ in 2008. China, Japan, and the USA also boosted their trade with the East Asian economies during the period. Although the intermediate goods supply from the East Asian

500 Trade

Import of intermediate goods

300 200

2000 2005 2008

China

2000 2005 2008

East Asia

197

56

55 257

75 44

284

45

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219

86

77

626

91

73

58

345

0

56

203

100

63

Billion US$

400

2000 2005 2008

2000 2005 2008

Japan

USA

Figure 8.2 Trade with East Asia and the import of intermediate goods from East Asia. Source: United Nations COMTRADE statistics.

Evolving industrial interdependence and coordination 147 200 China

Ja pa n

Korea

Billion US$

150

100

Electrical Machinery

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

2009

2008

2007

2006

2005

2004

2003

2002

2001

0

2000

50

Transport Equipment

Figure 8.3 Exports of electrical machinery and transport equipment. Source: United Nations COMTRADE statistics.

economies to Japan and the USA has declined slightly, China and the East Asian region experienced a minor rise in the East Asian supply of intermediate goods from 2005 through 2008. This may be attributed to a sharp decline in the Chinese, Japanese, and Korean export of electrical machinery and transport equipment commodities from 2008 to 2009, as seen in Figure 8.3. In recent years, the acceleration of regional trade, to include China, Japan, and Korea, suggests that regional interdependence has developed strongly among these East Asian economies. The Japanese multinationals and the US multinationals operating in the Asian economies have played a very important role in organizing and coordinating international production linkages in the economic integration of East Asia.

Japanese FDI trade network The East Asian share of world trade has increased sharply over the past two decades. A large portion of this increase is the result of booming intra-regional trade (Gaulier et al. 2007). Since the 1990s, the emergence of China as a new economic and commercial power has encouraged regional trade integration in East Asia and contributed to substantial growth in East Asian trade. Evolution of trade patterns in East Asia Two measures are typically cited to show trends in regional trade integration: the intra-regional trade share and trade intensity (Capannelli et al. 2009). As shown in Table 8.1, intra-East Asian trade increased slightly as a total share of trade between 1998 and 2008, changing from 46.6 percent to 49.1 percent. The trend

148 J. Wang, N. Shrestha and H. Uemura Table 8.1 East Asia intraregional trade share, 1998 and 2008 (million US$ and %) Partner

1998

China Japan Korea ASEAN East Asia ROW

237,976.3 245,146.3 88,519.0 316,017.5 1,122,169.6 1,284,168.9

2008 9.9 10.2 3.7 13.1 46.6 53.4

1,094,261.4 682,635.5 407,194.4 1,153,697.4 4,001,072.8 4,145,588.7

13.4 8.4 5.0 14.2 49.1 50.9

Notes: 1 ROW (rest of the world); 2 East Asian Countries are Japan, China, Hong Kong, Taiwan, Korea, Singapore, Thailand, Malaysia, the Philippines, Indonesia, Brunei, Cambodia, and Vietnam. Source: United Nations COMTRADE statistics and the Research Institute of Economy, Trade and Industry (RIETI).

Table 8.2 Trade intensity index of total trade in all goods, 1998 and 2007 Exporter

1998 China Japan Korea ASEAN 2007 China Japan Korea ASEAN

Importer China

Japan

Korea

ASEAN

– 1.77 2.83 1.2

3.81 – 1.94 2.72

2.54 2.98 – 2.04

1.17 2.59 2.25 –

– 3.12 4.6 1.95

2.01 – 1.71 2.45

2.16 3.59 – 1.78

1.37 2.31 1.79 –

Source: United Nations COMTRADE statistics.

and size of East Asia’s intra-regional trade share reflects its growing links with China and continued reliance upon outside partners. The intensity with which a region trades within its own boundaries, compared with world trade, is shown as “trade intensity index.” Table 8.2 presents calculations of the trade intensity indices for China, Japan, Korea, and ASEAN countries in 1998 and 2007.8 The table indicates that overall, intra-East Asian trade strength increased significantly over the past few decades and shows a high dependency on regional trade by all East Asian countries. China and Japan were the main source of imports to other East Asian economies in both 1998 and 2007. The importance of China as an import source country can be seen in 2007 especially. To examine the extent in which Japan and China specialize in the trade of final and intermediate goods, the value of exports and imports for each country is decomposed accordingly. Table 8.3 demonstrates the annual trade growth rate

Evolving industrial interdependence and coordination 149 Table 8.3 Average growth rate of total manufactured goods, intermediate goods and final goods, 1998–2008 Country/Area

China Japan East Asia World

Imports

Exports

Total

Intermediate goods

Final goods

Total

Intermediate goods

Final goods

22.9 10.2 13.2 10.8

19.7 10.6 13.0 10.5

20.3 5.4 8.8 8.7

18.3 6.8 11.9 10.8

22.5 7.6 12.7 10.5

16.4 5.8 10.7 8.7

Note: East Asian Countries are Japan, China, Hong Kong, Taiwan, Korea, Singapore, Thailand, Malaysia, the Philippines, Indonesia, Brunei, Cambodia, and Vietnam. Source: United Nations COMTRADE statistics and the Research Institute of Economy, Trade and Industry (RIETI).

in total manufactured goods and compares them with the trade rate in finished and intermediate goods. Compared to ROW, the growth rate in intermediate goods is much faster in China and East Asia for exports and imports. In particular, Chinese exports and imports of intermediate goods grew between 1998 and 2008, increasing from an average rate of 19.7 percent to 22.5 percent. This table provides strong evidence that intermediate goods trade, resulting from international production sharing, has been the engine driving China’s trade in recent years. Table 8.4 further distinguishes different types of intermediate goods, such as parts, components, and semi-finished goods. Finished goods are classified into consumption goods and capital goods and primary goods form the final category. This classification by different production stages is used to show how each nation of East Asia is involved in international production sharing. The most notable finding is the considerable variation in the trade patterns between China and Japan. China’s trade structure can be characterized by a large share of imported parts and components (22.1 percent in 1998 versus 22.4 percent in 2008), and by a large share of consumption goods exports (53.4 percent in 1998 versus 32 percent in 2008), in addition to capital goods (15.4 percent in 1998 versus 26.6 percent in 2008). This reflects China’s role in international production sharing as a processing and assembly base for finished products destined for the world market. One notable trend with final goods exports is the shift from consumption goods to capital goods. This development suggests that China has been moving up the value-added chain and is now supplying inputs for production in other countries of the region. Japan’s trade structure is quite a contrast to that of China. Japan is a larger supplier of parts and components, and this is reflected by Japanese industries turning to other countries of the region for assembly of these products. Table 8.4 also indicates that capital goods hold a large share of Japan’s exports (27.6 percent in 1998 versus 24.1 percent in 2008), which partially reflects large FDI outflows from Japan.

150 J. Wang, N. Shrestha and H. Uemura Table 8.4 Trade pattern by stage of production, 1998–2008 Import

1998 Consumption goods Capital goods Parts and components Semi-finished goods Primary goods 2008 Consumption goods Capital goods Parts and components Semi-finished goods Primary goods

Export

China

Japan

East Asia

China

Japan

East Asia

4.7 20.1 22.1 43.9 9.2

28.8 13.3 13.4 25.1 19.4

17.9 16.9 23.8 30.1 11.4

53.4 15.4 10.3 17.7 3.1

20.4 27.6 31.1 20.5 0.4

27.7 21.7 25.1 23.0 2.5

4.2 15.5 22.4 28.1 29.5

17.7 9.1 11.2 28.6 33.5

10.0 13.5 21.2 31.8 23.5

32.0 26.6 16.9 23.0 1.5

19.5 24.1 28.3 27.0 1.1

22.1 22.2 23.4 28.5 3.8

Note: East Asian Countries are Japan, China, Hong Kong, Taiwan, Korea, Singapore, Thailand, Malaysia, The Philippines, Indonesia, Brunei, Cambodia, and Vietnam. Source: United Nations COMTRADE statistics and the Research Institute of Economy, Trade and Industry (RIETI).

Table 8.5 Matrix of East Asia trade in 1995–2008 Exporter SITC

Importer China

Japan

1995 2000 2005 2008 1995 2000 2005 2008 China

Japan

7 (Machinery and transport equipment) 75–77 (IT products) 78 (Transport equipment) 7 (Machinery and transport equipment) 75–77 (IT products) 78 (Transport equipment)

–

–

–

–

15.4 23.3 37.1 38.9

– – – – 78.3 77.5 77.8 71.6 – – – – 6.3 5.9 6.7 7.3 54.3 50.8 51.1 50.4 – – – – 39.8 56.1 52.5 49.8 – 7.6 7.5 9.6 14.3 –

– –

– –

– –

Source: United Nations COMTRADE statistics.

The main contributors to the growth in Sino-Japanese bilateral trade are the parts and components of IT products and transport equipment. Table 8.5 employs the United Nations Standard International Trade Classification (SITC) trade statistics to highlight the composition and relative importance of individual component products in Sino-Japan trade. One interesting point evident from these statistics is that Sino-Japanese component trades concentrated on relatively few items. At an SITC 2-digit level, machinery and transport equipment accounted for 38.9 percent of China’s exports to Japan in 2008, representing a 23.5 percent increase

Evolving industrial interdependence and coordination 151 from 1995. Although machinery and transport equipment made up more than 50 percent of Japan’s total exports to China, both in 1995 and 2008, there were dramatic changes occurring with exports composition. IT products (SITC 75–7)9 and transport equipment (SITC 78) accounted for 49.8 percent and 14.3 percent of Japan’s machinery and transport equipment exports, respectively, to China in 2008, which represents a 10 percent and 6.7 percent increase, respectively, compared with 1995. This reflects a large volume of parts and components trade within the vertically integrated production networks between China and Japan.

International production sharing between China and Japan Recent decades have witnessed an increasing trend towards international production sharing between China and Japan, being driven strongly by JMNs that shifted from exports to offshore production and have reorganized their business activities in China. These firms have also built up cross-border production and trade networks that served to promote economic integration between China and Japan. Cross-border production and trade networks explain the rapid increase in both trade and FDI inflows between China and Japan (Figure 8.4). In terms of FDI, Japan is the second largest investor in China after Hong Kong. Japanese FDI has experienced rapid growth in China since the late 1980s, subject to considerable fluctuations at different periods. As shown in Figure 8.4, Japanese FDI has been an important component in the development of bilateral 100 million JP ¥ 8,000

Billion US$ 160

7,000

140 First boom

Export

120

Second boom

Third boom

Import FDI

Global Financial Crisis (2008)

100 Asian Financial Crisis (1997)

80

60

Plaza Accord (1985)

Tian’anmen Protest (1989)

6,000

5,000

WTO Accession (2001)

Deng’s Southern Tour of China (1992)

4,000

3,000

40

2,000

20

1,000

0

0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Figure 8.4 General trends in Japanese FDI and trade in China. Source: Adapted from Maruya (2008).

152 J. Wang, N. Shrestha and H. Uemura Table 8.6 Shares in Japanese exports and imports by countries/regions Exports

US EU 15 China East Asia

Imports

1995

2000

2005

2009

1995

2000

2005

2009

27.3 16.1 5.0 41.7

29.7 16.3 6.3 50.1

22.6 13.8 13.4 53.9

16.1 11.4 18.9 54.1

22.4 14.6 10.7 37.9

19.0 12.3 14.5 39.6

12.4 11.1 21.0 42.3

10.7 10.3 22.2 41.8

Source: Japan External Trade Organization (JETRO), various years.

Table 8.7 Trend of US imports from East Asia (million US$) 2005

2006

2007

2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2

China 243,740 287,774 321,443 72,729 81,517 96,150 87,377 64,810 68,629 Japan 138,004 148,181 145,463 37,267 36,434 34,174 31,388 21,768 20,943 East Asia 550,031 619,857 650,232 154,774 163,712 177,359 160,257 120,526 123,361 World 1,672,455 1,853,928 1,956,962 504,614 555,188 572,678 471,160 352,435 362,796

Source: United Nations COMTRADE statistics and Taiwan Directorate General of Customs.

trade between China and Japan. Japan’s trade with China, both in exports and imports, has also been overwhelmingly growing over the past decades. The global financial crisis prompted a sharp decline in shares of Japanese exports and imports to the USA and the EU. As a result, China is now Japan’s largest trading partner, as both imports and exports from China exceed those from the USA (Table 8.6). The collapse of US consumption demand, associated with the global financial crisis, induced a significant decline of Chinese and Japanese exports, furthering the decrease of China’s demand for intermediate inputs from neighboring East Asian countries, particularly Japan. The direct impact of the contraction of US import demand can be measured by changes in trade statistics. Table 8.7 shows the trend of US imports since 2005, which continually increased until the Lehman Shock in September 2008. A significant plunge can be observed from the third quarter of 2008, resulting in a marked decline of imports from China and Japan. Trade in Japan has declined at a much faster pace than in China.10 The fall in US demand had an amplified effect in Japan because the decline reduced Japanese net exports to the USA and net exports of intermediate goods to China, where they would have been assembled. The international production sharing networks account for the amplification of Japan’s drop in trade (see Figure 8.5). Figure 8.5 provides strong evidence that a trade collapse in Japan could result from a breakdown of vertical trade chains. JMNs established offshore production plants to specialize in the processing and assembly of imported intermediate goods with cheap labor and then finished products are exported to the USA. International production sharing has been greatly facilitated by JMNs and FDI, which has had a significant impact on exports from Japan to China. In 2005, they

Evolving industrial interdependence and coordination 153

CHINA

Parts and components Semi-finished goods

JAPAN/Other East Asia

Final consumption goods

US/EU

Figure 8.5 Trade collapse due to international production networks.

accounted for almost 70 percent of Japan’s total exports to China and 67 percent of China’s exports to Japan, compared to 59 percent and 39 percent, respectively, in 1995 (METI 2007). Investigating the evolution and diversity of the activities of JMNs in China, by industry sectors and historical periods would be useful. The next section is an overview of Japanese affiliate activities in China during the past few decades. Overview of Japanese affiliate activities in China One of the goals of JMNs investing in China is to utilize China as an export platform for the world market. The export-oriented nature of JMNs is reflected in their export destinations; however, domestic demand in China has grown rapidly in recent years. With a domestic market of 1.3 billion consumers, private consumption is expanding, especially in the urban areas along the coast, so the need for household electronics and automobiles is becoming much stronger. In this situation, many opportunities continue for JMNs in China, leading to an expansion of their domestic operations in recent years. On average, the manufacturing sector of overseas Japanese affiliate sales in China were not influenced by the East Asian crisis (see Figure 8.6). Sales in the transportation equipment sector have been growing ever since the mid 1990s, spurred by the expansion of Chinese domestic demand. Sales in the electrical machinery sector to China were less affected by the East Asian crisis than that in the other East Asian countries, but they dropped substantially in 2001 and 2002 due to the collapse of the IT boom. However, sales recovered quickly and a high volume has been maintained thereafter. The global financial turmoil in 2008 did not have a direct impact on JMNs’ sales in China in any of the three relevant industries.

154 J. Wang, N. Shrestha and H. Uemura 7000 6000

General Machinery

Electrical Machinery

Transportation Equipment

5000 4000 3000 2000 1000 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Figure 8.6 Sales of Japanese overseas affiliates in China (million JP). Source: Japan Ministry of Economy, Trade and Industry (METI), various years.

90 80 70 60 50 40 30 20 10 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 General Machinery Electronical Machinery Transportation Equipment

Figure 8.7 Local procurement ratios of Japanese overseas affiliates in China. Source: Japan Ministry of Economy, Trade and Industry (METI), various years.

Procurement localization is one of the most important factors in promoting international production linkages and transforming the “value-chain” of production and transaction processes. The local procurement ratios of Japanese manufacturing affiliates in China have steadily risen since 1995 and have shown some interesting patterns (see Figure 8.7).11 The local procurement ratios in the general machinery sector and the transportation equipment sector were relatively high in 1995 and have increased steadily since then (see Figure 8.7). Meanwhile, the electrical machinery sector rose from 18.7 percent in 1995 to 63 percent in 2008. Behind this change is the transformation of JMN value chains in the

Evolving industrial interdependence and coordination 155 electrical machinery sector and the growth of local Chinese suppliers. Above all, component modularization in promoted products the open procurement of Japanese electrical giants and lifted the local procurement of JMNs in the electrical machinery sector in China (Fujimoto and Shintaku 2005).

International production linkage of Japanese multinationals in China: an I–O analysis With the emergence of global production networks promoted by JMNs, trade and FDI data has became less accurate in capturing the role of JMNs by forming the economic interdependencies between China and Japan. One major limitation of trade and FDI statistics in describing economic integration is that they are unable to capture the sources of value that is added to production changes (i.e., to quantify the contribution of JMNs to the total value-added produced). Therefore, these statistics provide less accurate information about the dependence of each region’s production chains on external demand. One possible way to address this problem is to use AIO tables, which are compiled by the Institute of Developing Economics (IDE). These tables provide detailed information on trade and production linkages between nine economies in East Asia. The AIO tables contain information about these countries using a detailed trade matrix. To date, the AIO tables have been compiled for the years: 1985, 1990, 1995, and 2000. AIO tables can be used to analyze the industry structure and trade linkages in addition to inter-temporal changes with the interferences of the economies in East Asia. Conventional AIO tables are inadequate to describe the role of JMNs, because they do not provide information that can be used to separate JMNs and local firms in the analysis of inter-linkages between various sectors. For this reason, we recompile the AIO tables at the country level for 1995 and 2000 to include the activities of JMNs in China, and vice versa, to analyze the research questions posed in this chapter. Recompilation of the China–Japan I–O table In the recompilation of the China–Japan tables, we extracted data from AIO tables to include JMNs and analyzed the intermediate demand between China, JMNs, and Japan. We then formulated a new I–O table consisting of three parts: China, JMNs, and Japan. This basic framework of recompilation procedures was originally developed by Wang (2004). The main recompilation procedures are summarized as follows: 1 2 3 4 5

Compile 19 I–O table sectors for JMNs in 1995 and 2000; Estimate JMN I–O table structures; Estimate JMN value-added structures; Estimate JMN international freight and insurance; Compile JMN export vectors;

156 J. Wang, N. Shrestha and H. Uemura

Recompile and readjust the I–O table Data sources • The Asian International Input–Output Tables: The China–Japan tables (1995 and 2000) can be obtained from the Asian International Input–Output Tables by Institute of Developing Economies (IDE) in Japan. • METI, Basic Survey on Overseas Business Activities: This survey contains the most commonly cited statistics on the activities of Japanese overseas affiliates. The Ministry of Economy Trade and Industry (METI) provides data on investment position, sales, procurements, and profits of Japanese overseas affiliates by industry and host region.12 • Japan Finance Corporation for Small Business (JASME) also conducts a survey of Japanese business activities in China from 2000. JASME survey provides us with important information on the local purchases of Japanese subsidiaries in China by industries and origins of suppliers. Industrial classification In the METI, Basic Survey on Overseas Business Activities, data on the activities of Japanese overseas affiliates are aggregated into 12 industries in the manufacturing sector and six industries in the non-manufacturing sector. METI’s survey provides data for 18 sectors, so we use the 19-sector classification here. We integrate the original China–Japan tables into 19 sectors in our analysis. Analysis using the China–Japan I–O table The newly compiled 1995 and 2000 tables are used in two different analyses. We first calculate the “backward linkages” of production, to help us describe the inter-linkages of China, the JMNs, and Japan in the production process. Then, the relative value-added contributions of JMNs by regions and sectors are computed. Backward linkages of production In our study, the theoretical framework of I–O analysis, which was originally developed by Yamada (2001, 2002), is utilized to illustrate how production in the Chinese economy is stimulated by the production activities of JMNs located in China. An extended AIO table for JMNs is constructed with three parts: China, JMNs, and Japan, using the following notations: X 1 : Chinese production: X 2 : the production of JMNs, X 3 : Japanese production. A typical I–O model with these three parts can be written as follows: ⎡

A11

⎢ ⎢ A21 ⎣ A31

A12

A13

⎤⎡

X1

⎤

⎡

F11

⎤

⎡

F13

⎤

⎡

E1

⎤

⎡

X1

⎤

A22

⎥⎢ ⎥ ⎢ ⎥ ⎢ ⎥ ⎢ ⎥ ⎢ ⎥ ⎢ ⎥ ⎢ ⎥ ⎢ ⎥ ⎢ ⎥ ⎢ ⎥ A23 ⎥ ⎦ ⎣ X 2 ⎦ + ⎣ F21 ⎦ + ⎣ F23 ⎦ + ⎣ E 2 ⎦ = ⎣ X 2 ⎦

A32

A33

X3

F31

F33

E3

X3

(8.1)

Evolving industrial interdependence and coordination 157 where A12 , A22 , A32 , represent the input coefficient matrices of JMNs, A21 X 1 , A22 X 2 , A23 X 3 represent the sales of intermediate goods of JMNs respectively, F21 represents the sales of final goods of JMNs in Chinese markets, F23 represents the export of final goods from JMNs to Japan, and E 2 represents the export of JMN final goods to the other countries. Equation (8.1) can be written as: AX + Y = X

(8.2)

To determine how much production is needed to meet one unit of demand, the system of equations can be rewritten as: X = (I − A)−1 Y = BY

(8.3)

B is called the Leontief coefficient matrix. The Bi j element of the matrix indicates the number of production units needed in country i to produce one unit of value to country j . The Leontief coefficient matrix helps us to analyze production linkages between China, JMNs, and Japan via intermediate input trades. Production in the Chinese industries is induced by an increase in JMN final goods production in China, driven by the demand for the products of JMNs both domestically and internationally. JMNs increase their output because of direct effects, resulting in an increase in demand on their suppliers and continuing down the supply chain. To investigate backward linkage effects of unit changes in JMN final goods production for different industries in China, we calculated the Leontief inverse of the input matrices of the 1995 and 2000 AIO tables. The results of the production linkage analysis are summarized in Table 8.8, illustrating the Leontief coefficients of the 1995 and 2000 AIO tables. The degree that JMNs maintain backward supply chains provides an understanding of JMN capacity to stimulate economic activity across the borders between China and Japan. Three observations can be made from Table 8.8. First, JMN backward linkage effects on China in the general machinery, precision instruments, transportation equipment, textiles, and electrical machinery sectors became more significant in 2000 compared to the corresponding figures in 1995. Second, JMNs with higher backward linkage effects on the Chinese economy represent a cooperative purchasing relationship with local Chinese suppliers. In other words, JMNs have stimulated higher production from local Chinese suppliers in the precision instruments, electrical machinery, textiles, and general machinery sectors since 1995. Finally, and perhaps most importantly, the backward linkage effects of JMNs in the transportation equipment sector on the Japanese economy were very strong in both 1995 and 2000. This can be explained by the large amount of induced machinery goods exports and the transportation equipment components from Japan to China. The effect of JMN activities on exports from Japan to China, which is typically seen in the transportation equipment industry, is often called an “induced-export effect.”13

158 J. Wang, N. Shrestha and H. Uemura Table 8.8 Subtotals of column values in the Leontief inverse matrix – changes in final demand for JMNs

Final Goods Production of JMNs 1995 Food Textiles Wood and pulp Chemicals Petroleum and coal Non-ferrous metals Iron and steel General machinery Electrical machinery Transportation equipment Precision instruments Other manufacturing 2000 Food Textiles Wood and pulp Chemicals Petroleum and coal Non-ferrous metals Iron and Steel General machinery Electrical machinery Transportation equipment Precision instruments Other manufacturing

CHINA

JMNs

JAPAN

1.27 0.24 0.88 1.21 0.81 0.96 1.46 0.49 0.23 0.67 0.19 0.73

1.03 1.02 1.03 1.05 1.01 1.09 1.05 1.06 1.03 1.06 1.01 1.03

0.08 0.99 0.47 0.06 0.01 0.34 0.06 0.52 0.70 0.94 0.32 0.31

1.00 0.54 1.36 0.87 0.92 1.39 0.50 0.86 0.52 0.82 0.84 0.67

1.02 1.05 1.02 1.05 1.00 1.06 1.07 1.04 1.07 1.04 1.04 1.03

0.02 0.51 0.18 0.44 0.17 0.37 0.93 0.56 0.52 0.91 0.60 0.46

Relative value-added contributions of JMNs In the previous exercise, production linkages were described using flows of intermediate inputs. We now extend the analysis further and take into account inputs needed for JMNs production and the impact of JMN production on adding value for both China and Japan. To calculate the induced value that is added by an additional JMN unit of production, we need to multiply a diagonal matrix of vˆ value-added ratios with the induced-production coefficient vector. V = vˆ ∗ B ∗ f

(8.4)

where vˆ is a diagonal matrix consisting of the elements v = V / X (the ratio of valueadded V to total production X of JMNs), B is the Leontief coefficient matrix, and Bi j is a column vector of final good productions of JMNs. Moreover, the induced import from the ROW can also be calculated by multiplying a diagonal matrix of the

Evolving industrial interdependence and coordination 159 import ratios A R with the induced-production coefficient vector. MR = A R ∗ B ∗ f

(8.5)

Here, A R is a diagonal matrix consisting of the elements of a = A/ X (the ratio of A imports to total production X of JMNs). Table 8.9 shows the distribution effects of an additional increase in JMN final goods production for each sector, which falls into the value-added categories of the three parts (China, JMNs, and Japan), import from ROW, and the cost of freight and insurance. According to Table 8.9, JMNs in the transportation equipment sector contributed significantly to the value of the Chinese economy both in 1995 and 2000 (39.57 percent and 46.16 percent, respectively). There was also a remarkable increase in value-added JMN contributions to China in the electrical machinery and precision instruments sectors (from 21.76 percent in 1995 to 26.63 percent in 2000).

Table 8.9 Relative contributions in terms of value added CHINA Final Goods Production of JMNs 1995 Food 15.75 Textiles 5.93 Wood and pulp 31.90 Chemicals 14.33 Petroleum and coal 5.63 Non-ferrous metals 30.16 Iron and steel 12.62 General machinery 6.58 Electrical machinery 11.83 Transportation equipment 39.57 Precision instruments 6.45 Other manufacturing 19.68 2000 Food 41.86 Textiles 40.24 Wood and pulp 38.23 Chemicals 37.33 Petroleum and coal 56.38 Non-ferrous metals 31.74 Iron and steel 45.94 General machinery 37.07 Electrical machinery 21.75 Transportation equipment 46.16 Precision instruments 26.63 Other manufacturing 36.98

JMNs

JAPAN

ROW

TFI

TOTAL

55.22 58.12 4.87 44.37 0.37 20.98 17.81 51.22 43.85 52.17 52.97 64.60

7.42 7.49 1.83 1.83 5.12 3.27 1.45 11.27 8.29 2.36 3.65 4.75

19.89 25.24 57.82 38.60 78.02 44.47 66.98 29.99 34.52 4.38 36.23 8.39

1.72 3.23 3.58 0.87 10.85 1.13 1.14 0.94 1.51 1.52 0.70 2.59

100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00

16.65 17.81 2.30 3.23 1.05 3.35 6.10 11.63 13.99 11.04 25.05 8.59

27.59 27.19 31.18 26.54 18.68 34.50 32.78 36.33 32.20 33.86 39.12 41.18

12.29 11.76 24.00 29.91 20.02 28.72 13.49 12.76 28.13 4.69 5.92 10.23

1.60 3.00 4.29 2.99 3.87 1.69 1.70 2.21 3.93 4.25 3.28 3.03

100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00

Note: ROW represents the rest of the world, and TFI represents tariff, freight, and insurance.

160 J. Wang, N. Shrestha and H. Uemura JMNs with high value-added contributions across a number of industry sectors in China imply strong interdependent relationships between JMNs and local Chinese suppliers through purchase activities and subsequent rounds of indirect and induced spending. The contribution of JMNs to China for precision machinery, general machinery, and electrical machinery sectors increased significantly from 1995 through 2000. This surge indicates that the interdependent relationships between JMNs and local Chinese suppliers have been strengthening since 1995. Interpreting international production linkages from the institutional coordination viewpoint To understand structural changes with international production linkages in economic integration processes in East Asia, we investigate these changes from the industry-specific viewpoint of the “value chain” in the production process, in addition to the behaviors of JMNs. The interpretation of international production linkage changes among heterogeneous Japanese firms is given from an institutional analysis viewpoint in Table 8.10. The backward linkages of JMNs in the transportation equipment industry were much stronger than the electrical machinery and textile industries in 1995. Likewise, JMNs in the transportation equipment industry had stronger productioninducing effects on the Chinese economy. The production process is highly integrated in the transportation equipment industry; therefore, production has been supported by subcontractors and related firms that remain in Japan, yet transfer their plants to China. To develop organizational capability (Fujimoto 2007) in the transportation equipment sector, especially car manufacturing, the production process is not easily modularized, so JMNs have maintained a stable level of local procurements, which is supported by subcontractor activities transferring their plants to China. This is a sharp contrast to Chinese firms utilizing modularization in the car industry (see Chapter 7 of this book). Furthermore, JMN market strategies were “Chinese-market-oriented” in the transportation equipment industry. As a result, they developed strong ties with their subcontractors and local firms, supported by the expansion of the Chinese market and their high profitability. The electrical machinery industry had assembly lines transferred to China, but many of the components were procured from subcontractors or related firms in Japan in the mid 1990s. This was caused by specific characteristics of the electrical machinery industry, where production and transaction processes are coordinated in a “vertical value chain.” The design rules for electrical products, for example PC and VTR, have been “modularized,” and the coordinating mechanism of production and transaction processes depended on procurements that were more open since the mid 1990s (see Chapter 7 of this book).14 The local JMN procurements in the electrical machinery industry have rapidly increased in China, resulting in stronger production-promoting effects and have created more value in the Chinese manufacturing industry. As for the behavior of electrical machinery firms, their market strategies in the mid 1990s were “export-oriented,” but this has

Spinning and manufacturing processes depend on low-wage workers

Decreasing procurements from domestic plants in Japan

JAPAN

Industrial Specificities of Institutional Architectures

Purchasing materials from JMNs within the textile industry

Increasing local procurements, the purchase of materials from agricultural and commercial sectors

JMNs

Backward Linkages CHINA

Textile

Process industry with large centralized plants

Little import of manufactured goods from Japan

Purchasing materials from JMNs within the iron and steel industry

Low local procurements, and decreasing production-inducing effect

Iron and steel

Japanese multinationals (JMNs) in China

Increasing modularization of products, but some integrated production processes remain, Export market-oriented originally, but increasingly Chinese market-oriented

Import of components from related firms in Japan

Increasing open procurements and weakened production linkages between JMNs

Increasing local procurements and increasing production-inducing effects from the late 1990s

Electrical machinery

Table 8.10 Interpretation of international production linkages – from the institutional point of view

Integrated production process with subcontractor networks (just-in-time), Chinese market-oriented

Induced-export effect from Japanese subcontractors and steel producers

Transfer of subcontractors’ plants to China

Profitable operation with high local procurements and strong production-inducing effects

Transportation equipment

162 J. Wang, N. Shrestha and H. Uemura gradually shifted to “Chinese-market-oriented” after the late 1990s. The change in the market strategy has promoted the local procurements of electrical machinery firms in China.15 In Japan, the creation of value has been diminishing in the manufacturing and assembly processes for electrical machinery plants, with business shifting to the design and systems integration departments. This resulted in decreased importance for the manufacturing and assembly processes in the “value chain” and caused the restructuring of firm organizations and the reduction of manufacturing workers in electrical machinery firms.16 Therefore, de-industrialization was accelerated in terms of the absolute level of employment in Japan from the 1990s onwards (see Chapter 6 of this book). In this sense, there is asymmetry in the value created between electrical machinery firms operating in Japan and JMNs in China. Value creation has decreased in Japan’s manufacturing and assembly processes, while JMN manufacturing and assembly plants in China have increased value added creation in the Chinese manufacturing industry. However, in the aftermath of the 2008 global financial crisis, the decrease in final goods trade from China to the USA led to a sharp decline in intermediate goods trade between China and Japan. Although demand in China and other East Asian countries is recovering, JMNs must reorganize their international production linkages effectively. In this situation, they should establish adequate coordinating mechanisms of “cross-border production networks” (Guy 2009) and should promote the dynamism of “regional systems of innovation” (Cantwell and Iammarino 2003) in core industrial regions in Japan, China, Korea, and other Asian countries.

Conclusions In this chapter, we investigated the increasing interdependence among Asian capitalisms and the effects of JMNs on the Chinese and Japanese economies through international production linkages. The main results are summarized as follows. • First, FDI, international production linkages, and intermediate goods trade have made a modification in the “flying geese pattern” of economic development with increasing economic integration between China, Japan, and other East Asian countries. A key element has been international production sharing, which was promoted by JMN activities. Consequently, the interdependence has been heavily concentrated on limited industries, in particular, the electrical machinery and transport equipment industries. Although the intra-regional market and Chinese market have gained strength, they account for a relatively small share of final demand. The rapid deterioration of economic conditions following the 2008 global financial crisis highlights the high exposure and vulnerability of the East Asian economies to external demand. • Second, the global downturn reduced demand from East Asia’s trading partners and impaired international production linkages, which had disproportionate effects on intra-regional trade. Japan was hit exceptionally hard by the crisis, more than other East Asia countries. The decline in US demand had an

Evolving industrial interdependence and coordination 163 amplified effect on Japan because of the reduction in Japan’s net exports to the US and to neighboring Asian countries, especially China, where products for final export to the US would have been assembled. In this situation, JMNs must reorganize their international production networks and establish adequate coordinating mechanisms throughout East Asia. • Third, the analysis in this chapter contributes to the “economic integration debate” by using a recompilation method of AIO tables. The dependence of JMNs’ value-added on intra-regional demand in East Asia was analyzed thoroughly. In particular, the recompiled AIO tables were used to analyze JMN “backward” production linkages and their value-added contributions to China and Japan. During the mid 1990s, the backward linkages of JMNs in the transportation equipment industry were stronger than those in the electrical machinery industry in China. In the electrical machinery sector, although assembly lines were shifted to China, import procurements from subcontractors in Japan were still dominant in the mid 1990s, with vertically integrated production processes still predominating. However, with more modularized electrical products, the localization of JMN procurements in the electrical machinery industry has rapidly increased in China. In the transportation equipment sector, production processes have continued to be integrated, so the level of local procurements has remained stable. This has also been supported by the shift of Japanese subcontractors’ plants to China. International production linkages, promoted by JMNs, will become deeper and wider between China and Japan in the future. This will determine the evolution of JMN production and transaction processes and Chinese and Japanese industrial growth patterns in the dynamic process of economic integration in East Asia.

Notes 1 Coriat et al. (2006) explain, from the viewpoint of régulation theory, how globalization and economic integration are in process, affecting each other. They also emphasize that FDI flows, which promote regional integration processes, are expanding, but remain unstable in East Asia. 2 The intermediate goods trade is significantly important for both theoretical and empirical studies. As for the theoretical implication of the intermediate goods trade for the Ricardian trade theory, see Shiozawa (2008). 3 See METI (2007), p. 23. 4 Calculations are based on the IDE Asian International I–O Tables for years 1990, 1995, and 2000. The shaded portion on the figure has a low interdependence level of less than 1 percent. 5 See Hasebe and Shrestha (2006) and Shrestha (2008) for the details. 6 Because of data constraints, East Asia refers to Indonesia, Malaysia, the Philippines, Singapore, Thailand, China, Taiwan, and Korea. 7 Owing to the unavailability of Taiwanese data, this nation is excluded from the CaEast Asian region. 8 The trade intensity index is defined as (xi j / X i )/(xwj / X w ), where xi j and xwj are the values of country i’s exports and of world exports to country j , where X i and X w are country i’s total exports and total world total exports, respectively.

164 J. Wang, N. Shrestha and H. Uemura 9 IT products are defined as the aggregate of SITC 75 (office and data processing machines), SITC76 (telecommunications equipment), and SITC 77 (electrical equipment). 10 Figures for February 2009 indicate a 50 percent year-on-year contraction in Japanese export and a 43 percent decrease in imports. 11 Local procurement ratio is defined as the share of local intermediate inputs to total costs. 12 The response rates of METI’s survey are about 60 per cent, which is a limitation of the data. In fact, the response rate was 60.4 percent in 1995, and 62.9 percent in 2000. 13 For an explanation of induced export effect, see Yamada (2002). 14 For the “architecture” of manufacturing firms in China, see Fujimoto and Shintaku (2005). The original idea of design rules and modularization was presented by Baldwin and Clark (2000). 15 For the relationship between market strategy and local procurement, see Wang (2004, 2007), and Kiyota et al. (2005). In our international I–O analysis, conceivable changes in the backward linkages of electrical machinery firms after the collapse of the IT boom were not checked because of the limitation of the data. 16 Uemura (2004) analyzes the effects of changing value chains in electrical machinery firms on the employment system by using a questionnaire survey. The change also affects the boundary of firm in the electrical machinery industry. For the dynamic theory of the boundary of firm, see Langlois (1995).

9 Analysis of the linkage effect in Chinese export-led growth According to the subdivisions of Asian international input–output tables Chengnan Yan

Introduction The Chinese economy has achieved an annual growth of about 10 percent since its shift to the Socialist Market Economic System. In 2005, China’s GDP was 2,250 billion dollars (5.1 percent of the world’s total), which was six times its GDP in 1990. Further, its international trade reached 1,400 billion dollars (6.7 percent of the world’s total), which was 12 times that of its 1990 trade figure. Consequently, the influence of China’s economy on the world and neighboring East Asian economies has increased rapidly. The recent global depression because of the financial crisis has increased expectations that this Chinese economic growth will help the world economy to recover. China’s remarkable economic achievement was propelled mainly by exportbiased development in the southeast coastal area, which was based on low labor costs and a depreciated exchange rate. Moreover, it was largely dependent on foreign direct investment (FDI), which brought capital, technology, advanced management expertise, and other benefits. This kind of export-led growth was the result of Deng Xiaoping’s “Get Rich First” development strategy, which meant promoting economic development in the coastal area (where the economic foundation had been laid) in order to generate wealth before expanding incrementally the multiplied effect to the underdeveloped inner-areas. This kind of development strategy matched the idea explained by “Unbalanced Growth: Development as a Chain of Disequilibria,” which looked at the situation in undeveloped economies (Hirschman 1958). The conditions expounded upon in this article fit China’s economic conditions of the 1990s; namely, the labor force was abundant and capital and technology were scarce. In other words, the goal was to designate the southeast coastal area and labor-intensive export industries as the “Growth Poles” and spread the growth results to the underdeveloped areas (middle and western areas) and other industries (domestic consumption and investment goods production industry and capital- or technology-intensive industry) by increasing the linkage effect between areas and industries.

166 C. Yan The purpose of this chapter is to examine the changes in domestic and international linkage effect in the 1990s, and analyze the causes of change that are deeply related to the features of China’s export-led growth regime. In the analysis, we have selected 16 sectors in four industries1 from the subdivisions (78 sectors in 1990 and 95, and 76 sectors in 2000) of Asian International Input–output Tables (AIO). The rest of this chapter is organized as follows. In the second section, we summarize the features of the export-led growth in China after the 1990s. In the third section, we explain the increasing interrelations between the Chinese and the Asian economies based on the growth of the intermediate goods trade. In the fourth section, we analyze changes in the backward and forward linkage effect in 16 sectors with respect to 10 endogenous economies of the AIO. In the final section, we summarize the conclusions of this analysis.

Features of Chinese export-led growth after the 1990s It is well known that China’s economic growth after 1990 depended on export growth. Though there is no common definition for “export-led growth,” usually it means a case of rapid growth in export demand where the ratio of exports as a percentage of total GDP has been expanding and the productivity growth in the export sector is larger than that in the domestic goods production sector.2 Further, there has been no precise definition or detailed criteria of “Chinese export-led growth,” but many researchers have discussed China’s economic growth as exportled growth.3 In this chapter, we define export-led growth using the definition by Uni et al. (2003) and that of Chapter 8: “The growth type wherein the export sector’s growth is faster than that of the domestic sector, and the influence of export growth on the whole economy’s growth has become large due to increasing investment, production, and productivity.” Table 9.1 compares the demand and productivity growth rates of the domestic and export sectors in the 1990s. In the 1990s, the annual growth rate of export demand was over 20 percent, and it was two times that of domestic consumption goods (annual growth rate was 9.9 percent) and non-residential investment goods (11.8 percent). Consequently, the ratio of the three sectors in terms of total demand has changed: the ratio of consumption goods has decreased (annual 1.7 percent

Table 9.1 Sectoral dynamics in the 1990s (annual growth rate, unit: %) Consumer goods Non-residential Export goods investment goods Real final demand 9.9 Labor productivity 10

11.8 8.4

21.3 18.4

Source: As per China Input–Output Tables and China Statistical Yearbook, 1992, 2002.

Analysis of the linkage effect in Chinese export-led growth 167 decrease), and the ratio of non-residential investment goods has been sustained (annual 0.2 percent increase). Only the ratio of export goods has risen rapidly (annual 9.7 percent increase). After 2000, the increasing tendency to export continued, with the value of exports in 2005 reaching 762 billion dollars and its ratio as a percentage of total GDP expanding to 34 percent, compared to 20 percent at the end of the 1990s. Furthermore, the annual growth rate of labor productivity in the export goods production sector was 18 percent, that is, approximately two times that of the consumption goods and the non-residential investment goods production sectors. Indeed, the growth of exports has led to increases in investment, production, and productivity throughout China’s economy, as mentioned in Chapter 8. Added to that, when one considers the role and contribution of the rapid growth in the Chinese coastal area – where the export industry has been concentrated – in creating employment and propelling macroeconomic growth, China’s economic growth after the 1990s can be called export-led growth. China’s export-led growth can be regarded as the result of FDI combined with a low-income domestic labor force, and is heavily dependent on the production of labor-intensive export industries in the coastal area. As shown in Table 9.2 in the next section, China’s intermediate goods imports and final consumption goods exports increased rapidly in the 1990s, especially from and to the endogenous countries of the AIO. Therefore, the linkage of China’s economic growth with Japan, NIEs, ASEAN, and the USA, which were the main suppliers of FDI and the main partners in China’s processing trade, has continually expanded. We can summarize the features of China’s export-led growth as follows. • First, it largely depends on FDI. The annual growth rate of FDI in China was 14 percent after 1990 and reached 60 billion dollars in 2005. The FDI that flowed into China was generally in the areas of capital supplying, advanced technology and management expertise transfer, competitive market system construction, and social system changes. Added to that, the growth of the coastal area, where FDI has been concentrated, has contributed greatly to China’s macro economic growth. The labor productivity of the export goods sector was about two times that of the domestic goods sector due to the imported capital and intermediate goods that came with FDI, which included advanced technology.4 • Second, the ratio of labor-intensive goods and of the production process as a percentage of the value of total exports is high. Though the growing Chinese domestic consumption market is one of the important reasons to expand FDI, the abundant supply of low-income labor remains the primary factor behind FDI flows to China. Consequently, the increase in FDI has expanded the ratio of the processing trade as a percentage of total Chinese exports. In addition, FDI from Japan and NIEs was concentrated in the coastal area, where capital and intermediate goods imports and processed goods exports are most conveniently conducted. The ratio of the processing trade as a percentage of total Chinese trade increased rapidly after 1990, reaching 55 percent of total exports and 42 percent of total imports in 2005. In other words, the production process,

Agricultural machinery

Special industrial machinery

Ordinary industrial machinery

Boilers, engines, turbines

Other made-up textile products

Wearing apparel

Knitting

Weaving and dyeing

Spinning

Total supply

489,136 13% 17,221 6% 21,253 8% 3,994 11% 5,471 15% 1,221 9% 2,756 9% 10,838 10% 10,529 −7% 2,844 24%

Domestic supply 2,496 18% 14 21% 14 22% 10 17% 5 27% 1 21% 1 31% 10 27% 6 15% 2 45%

Total of ASEAN 5 1,557 25% 93 17% 85 22% 79 11% 158 10% 35 4% 2 34% 27 26% 12 19% 4 47%

Taiwan

Table 9.2 Changes of intermediate goods supply (annual rate, million dollars)

552 35% 39 25% 39 28% 53 16% 23 28% 5 23% 5 25% 13 31% 4 26% 2 51%

Korea 4,653 18% 102 18% 99 22% 58 14% 156 11% 35 6% 74 9% 222 10% 119 2% 31 33%

Japan 4,130 12% 213 −9% 223 −6% 4 18% 11 15% 3 10% 17 15% 112 6% 63 −2% 12 32%

USA 13,388 19% 460 14% 460 17% 205 14% 353 14% 79 8% 99 14% 384 14% 204 6% 51 37%

Total endogenous

Continued

36,642 16% 1,171 11% 1,067 13% 481 10% 2,500 −3% 558 −8% 286 10% 859 12% 559 1% 138 32%

Total import

7,726 −1% 11,964 19% 1,967 37% 7,217 18% 1,423 26% 1,150 15% 2,107 17%

Domestic supply 5 21% 22 53% 1 60% 7 26% 3 28% 3 21% 3 23%

Total of ASEAN 5 26 12% 111 37% 5 54% 8 36% 18 18% 2 32% 6 27%

Taiwan 6 25% 119 34% 0 76% 4 42% 4 30% 3 27% 6 26%

Korea 159 2% 668 17% 26 41% 306 15% 121 9% 43 12% 91 5%

Japan 25 10% 97 33% 3 54% 62 15% 34 15% 7 21% 147 −13%

USA

Source: Recalculation based on Uni (2008a). Original data is the Asian International Input–Output Tables, 1990, 1995, and 2000.

Other transport equipment

Shipbuilding

Motorcycle and bicycles

Motor vehicles

Household electronic Machinery

Telecommunication equipment

Heavy electrical machinery

Table 9.2 Continued

222 8% 1,017 29% 36 49% 388 18% 181 14% 58 17% 253 4%

Total endogenous

511 5% 3,114 23% 77 48% 959 15% 605 8% 109 17% 434 4%

Total import

170 C. Yan where the added value is lowest in the generally known “Smile Curve,” has been transferred to China, whereas R&D and technically intensive processes, where the added value is highest, were left in the home countries. • Third, with the FDI and export industries being concentrated in the southeast coastal area, regional disparity between the coastal provinces and inner-China provinces has increased. From 1990 to 2005, China accepted 605 billion dollars in FDI, but approximately 90 percent of that was invested in the southeast coastal area. These FDI have achieved the development of export industries and of economic growth in the coastal area, but they have also expanded the disparities between regions in macro economic growth and individual income gains.5 This outcome differs greatly from the objective sought by China’s development strategy; thus, the multiplied effect from the coastal area to under-developed areas has not materialized.6 China’s export-led growth after the 1990s depended not only on these three basic features, but also on the depreciated exchange rate and adjusted income growth implemented by the government.7 The depreciated Yuan rate increased the price competitiveness of China’s export goods on the world market and promoted export growth. However, the benefits of increased domestic labor productivity are somewhat lost to China. Further, the domestic and export industry structures, which depend on the low-income comparative advantage, restrict the increase of wages and national income gain. In this sense, the comparative advantages of Chinese export-led growth decrease the investment incentive to technically intensive industries and restrict domestic consumption demand growth. Furthermore, the international environment of China’s export-led growth imposes certain limitations. Since the rapid growth of exports of a large economy like that of China will result in its trading partners accumulating deficits, it causes “hollowing-out” in some cases. In reality, China’s export-led growth is receiving harsh criticism from the US, the EU, and Japan, and appreciation pressure on China’s currency has increased.8 Further, the large ratio of exports as a percentage of total GDP makes the Chinese economy more vulnerable to international economic fluctuations. Since 2008, with the rapid decrease of export demand after the financial crisis, China’s export industry has undergone significant damage and the necessity of transferring the growth regime from export-led to domestic consumption-led has been recognized.9

Extending interrelations between China and the Asian economies The features of China’s export-led growth, as mentioned above, have increased China’s interrelations with neighboring Asian economies. Since the export-led growth depends on the expansion of FDI and the labor-intensive processing trade, the interdependence on intermediate goods imports from the Asian economies (especially from Taiwan, Korea, and Japan) and on processed intermediate and final goods exports to the world (especially to the USA and Europe) has grown.

Analysis of the linkage effect in Chinese export-led growth 171 Table 9.2 shows the structural changes of China’s intermediate goods supply in the 1990s. It is based on the 16 sectors of four selected industries from the 76/78 sector division of AIO. In order to emphasize the changes that took place over 10 years, we have mentioned the amount of domestic supply and the imports of intermediate goods in 1990 and their annual change rate over 10 years. We can summarize the changes of China’s intermediate goods supply by countries as follows. • First, out of the total of intermediate goods supply, imports increased annually by 16 percent, whereas domestic supply increased annually by 13 percent over 10 years. The degree of overseas dependence has become higher. Further, imports from endogenous countries of the AIO grew by 19 percent, but imports from the US are only 12 percent. Therefore, it can be said that the ratio of imports from the USA as a percentage of total imports has decreased, while that of East Asian economies has increased. The large-scale imports from Japan as well as their high growth rate show that China’s intermediate goods supply depends heavily on Japan. The highest annual growth rate of imports, however, is that from Korea, at 35 percent. The ratio of Korea goods to those from Japan was only 12 percent in 1990, but grew to 71 percent in 2000 and represented 11 percent of China’s total intermediate goods imports in 2000. The growth in imports from Korea can be explained by the rapid growth of FDI, which increased very quickly in the 1990s.10 In other words, with the expansion of FDI from Korea, the intermediate goods imported from the home country have increased. • Second, in the textile industry – the spinning, weaving and dyeing, and knitting sectors – the dependence on overseas imports has increased; however, in the apparel and other made-up textile products sectors, the import dependence has decreased. In other words, the ratio of domestic supply has greatly expanded. As is typical of the labor intensive and downstream industrial sectors of the textile industry, the rapid growth in the apparel and other made-up textile products sectors was due to the development of domestic upstream sectors such as the spinning and the weaving and dyeing sectors. Further, overseas dependence in the upstream sectors of the textile industry rose in the 1990s. Thus, there have been some constraints with regard to the sustainable development of China’s textile industry. • Third, in the general machinery industry, the ratio of domestic supply in all sectors has decreased, but the rates of change in each sector are very different. Although the domestic supply in the agriculture machinery sector has risen, it has decreased in the special industrial machinery sector. This means that in the low-tech machinery sector, the domestic supply has expanded, but in the hightech machinery sector, the import dependence has risen. In addition, the growth of domestic supply in the agriculture machinery sector is based not only on the technical level of this sector, but also on the rapid domestic demand growth promoted by the state.

172 C. Yan By countries, Japan and the USA supplied nine-tenths of total general machinery imports from the endogenous economies in 1990, but the ratio of Korea and Taiwan increased rapidly over the next 10 years and exceeded that of the USA in 2000. However, imports from Korea and Taiwan are less than half the amount from Japan; hence, it may be said that China’s machinery industry is heavily dependent on Japan. • Fourth, the ratio of domestic supply greatly decreased in the electrical machinery industry, which has undergone the most rapid growth since the 1990s. The growth rate of the domestic supply in the heavy electrical machinery industry was especially negative, which differed greatly from that of the telecommunication equipment sector and the household electronic machinery sector, where growth rates of domestic supply were high. In the telecommunication equipment sector, the growth rate of domestic supply is 19 percent but the growth rate of imports is 23 percent, showing that the overseas dependence is rising. Moreover, the growth rate of imports from endogenous economies is higher than that of total imports with the annual growth rate having reached 29 percent, showing that China’s dependence on the Asian economies is increasing. In the household electronic machinery sector, the growth rate of which increased rapidly in the 1990s, the growth rate of domestic supply and imports is approximately twice that of the telecommunication equipment sector. However, the imports were only 4 percent of domestic supply in 1990 and the degree of overseas dependence was still low in 2000 (about 11 percent). Some analysts have concluded that the rapid growth of the electrical machinery industry in China promoted international linkages and the horizontal division in the Asian area.11 However, as shown in Table 9.2, the conditions are largely different by sector. Although in the telecommunication equipment sector the international dependence is high (about 30 percent), in the heavy electrical machinery and the household electronic equipment sectors, the ratio of imports as a percentage of total intermediate goods supply was still low (about 10 percent). Further, the changes by country show that there are remarkable differences in the degree of interdependence and in growth rate. • Finally, in the transport equipment industry, there is a decreasing tendency with regard to international dependence, except in the shipbuilding sector (it is the only export-biased sector in the transport equipment industry). However, the degree of overseas dependence is high, including in the motor vehicles sector. The degree of overseas dependence of China’s motor vehicles industry was onetenth of the domestic supply in 2000, but Japan’s share represented one-third of total imports, showing that China’s motor vehicles industry largely depends on Japan. If the rapid growth of Japanese motor vehicle makers’ local production after 2000 is taken into consideration, then the dependence on Japan is increasing. In the motorcycle and bicycle sector, the ratio of domestic supply increased over 10 years, from seven-tenths to nine-tenths, because many enterprises from Taiwan, Japan, and the US had entered China before 1990 and the domestic supply capacity for intermediate goods expanded. Regarding changes in

Analysis of the linkage effect in Chinese export-led growth 173 imports by country, the dependence on Japan remains very high in both the general machinery and the electrical machinery industries, and the dependence on the US also remains high. The supply from Korea and Taiwan has quickly increased, but remains small. As Chinese export-led growth largely depends on the labor-intensive processing trade, the growth rate of intermediate goods imports is higher than that of the domestic supply and the growth rate of goods imports from the Asian economies is larger than that of total imports, even though there are some irregular sectors in the textile and transport equipment industry. Consequently, the overseas linkage effect of China’s economy increased, especially with the East Asian countries. Due to space constraints, we abbreviated the explanations about China’s export of processed intermediate goods and final consumption goods, but we can verify the truth of the expanding interrelation between China’s economic development and neighboring Asian economies, as the data on intermediate goods imports have shown.12

Analysis of linkage effect on the East Asian economies We can imagine that there are increasing direct influences between China’s exportled growth and its partner economies because of the changes in trade, but we cannot capture the indirect multiplied effect that is caused by international and domestic industrial linkages (Okamoto et al. 2007). In this section, we will examine and analyze the changes in linkage effect based on the subdivisions of AIO in order to explain the direct and indirect influence of China’s economic development on the East Asian economies. It is well known that there are two kinds of linkage effect. One is the “backward linkage effect,” which is the pulling effect from downstream industry to upstream industry; the other is the “forward linkage effect,” which is the pushing effect from upstream industry to downstream industry, with increases in the demand and supply of intermediate goods (Hirschman 1958). Regarding Hirschman’s definition, the backward and forward linkage effects are the direct and indirect multiplied effects that exist between the domestic downstream and upstream industry. However, domestic linkage effects are small in China due to its export-led growth increasing the ratio of intermediate goods imports from neighboring Asian economies and of exports to the USA. In other words, the Chinese export-led growth after the 1990s has expanded the overseas linkage effect, and the result of China’s economic growth is pervasive. In this sense, the linkage effects analyzed here are the international linkage effects which are caused by capital flows and international trade, and by the international multiplied effect mentioned by Myrdal (Myrdal 1957). The data used here are based on the findings of Uni (2008a); these calculate the backward and forward linkage effects on all endogenous economies and in all industries of the AIO in the years 1990, 1995, and 2000, by using hypothetical extraction method.13 However, since this chapter focuses on the linkage effect

174 C. Yan of China’s industrial development on 10 endogenous economies of the AIO, we recalculated and analyzed the data on China extracted from the entire data.14 We aimed to analyze the detailed changes over 10 years starting from the 1990s, and for purposes of comparison we combined 78 sectors (in 1990 and 1995) and 76 sectors (in 2000) into 67 sectors.15 As with Table 9.2, we picked 16 sectors of the textile industry, the general machinery industry, the electrical machinery industry, and the transport equipment industry, and calculated the change in linkage effect in the 1990s. Table 9.3 shows the backward linkage effect in 16 sectors in 1990 and the changes over 10 years, and Table 9.4 shows the forward linkage effect. Where the value of the change is larger than 0.01, we used gray to distinguish it from the small value. The sectoral backward linkage effect changes can be summarized as follows. • First, in the textile industry, the value of the Japanese backward linkage effect is the largest in most sectors (except for the 1990 value of the US effect in the spinning and the weaving and dyeing sectors). That was true even after China’s imports of intermediate textile goods such as Japanese fiber decreased, and the development of China’s textile industry caused the hollowing-out of the Japanese textile industry. However, even in 2000, Japanese textile companies in China imported three-tenths of intermediate goods from their home country, and the backward linkage effect on Japan increased after 1990. • The backward linkage effect especially increased in upstream sectors like the spinning and the weaving and dyeing sectors, more than in the downstream sectors like the apparel and other made-up textile products sectors. It can be said that the backward linkage effect in relative industries such as the chemical or machinery industries has become larger than that of the upstream textile industry. The backward linkage effect on Korea was largely extended in all sectors, especially in downstream sectors like knitting, apparel, and other textile-related product sectors, and the value has rapidly approached that of Japan. • Second, in the general machinery industry the changes for Korea and Taiwan are large in all sectors, and in the special industrial machinery and the agricultural machinery sectors the change for Japan is large. However, with regard to the value of the backward linkage effect, Japan’s is still high and is larger than that of Korea and Taiwan, which shows the influence of China’s machinery industry on Japan to be large. In this sense, the development of China’s machinery industry largely depends on imports from Japan, whose technical level is higher than China’s. Further, in 1990 the value of the US change was the second largest after Japan, but the change over 10 years was small, being surpassed by that of Korea and Taiwan in 2000. In addition, the value and changes of the backward linkage effect on ASEAN countries are small. • Third, in the electrical machinery industry, the backward linkage effects on all the endogenous economies had increased. In Japan, the value is almost equal to the total Korean and Taiwanese value, showing that China’s electrical machinery industry depends heavily on Japan. Especially in the telecommunication

Wearing apparel Other made-up textile products Boilers, engines, trbines Ordinary industrial machinery Special industrial machinery

Weaving and dyeing Knitting

Spinning

1.261 −0.019 1.1937 −0.0143 1.5328 0.029 1.0268 0.5161 1.0319 0.5114 1.4401 −0.0267 1.4443 −0.0753 1.4725 0.0786

China

0.0006 0.004 0.0006 0.003 0.0011 0.0054 0.0009 0.0041 0.001 0.004 0.0016 0.001 0.0017 0.0012 0.0018 0.0017

Indonesia 0.0019 0.001 0.0016 0.0006 0.0037 −0.0003 0.0014 0.0017 0.0014 0.0017 0.0018 0.0013 0.0022 0.0017 0.0024 0.0017

Malaysia 0 0.000 0 0.0003 0 0.0004 0 0.0004 0 0.0004 0.0003 0.0002 0.0003 0.0003 0.0003 0.0005

Philippines 0.0007 0.002 0.0007 0.0014 0.0014 0.0016 0.0008 0.0019 0.0008 0.0019 0.0013 0.002 0.0017 0.0022 0.0017 0.0027

Singapore 0.0007 0.002 0.0005 0.0014 0.0017 0.0019 0.0004 0.0022 0.0004 0.0024 0.0004 0.0019 0.0006 0.0018 0.0005 0.0027

Thailand 0.0129 0.020 0.0105 0.0204 0.037 0.0131 0.0351 0.0089 0.0352 0.0094 0.0045 0.0192 0.0071 0.0186 0.0055 0.0276

Taiwan 0.005 0.030 0.004 0.0278 0.0206 0.0337 0.006 0.0401 0.006 0.0417 0.0041 0.023 0.0036 0.0249 0.0024 0.0305

Korea

0.0212 0.029 0.0177 0.0304 0.0421 0.0271 0.0401 0.026 0.0403 0.0269 0.0599 0.0087 0.0499 0.0098 0.035 0.0429

Japan

Table 9.3 Changes of backward linkage effect (data in the first line are the values for 1990; the second line is the change over 10 years)

Continued

0.0354 −0.019 0.0313 −0.0166 0.0354 −0.0142 0.018 0.0019 0.0181 0.0023 0.0187 0.0082 0.0243 −0.0028 0.0189 0.0093

USA

1.62 −0.0592 1.5902 −0.0383 1.1678 −0.1009 1.7578 −0.1766 1.2171 −0.1144 1.1728 0.1572 1.6321 −0.1151 1.5418 −0.0632

China

Source: Same as Table 9.2.

Other transport equipment

Motorcycle and bicycles Shipbuilding

Agricultural machinery Heavy electrical machinery Telecommunication euipment Household Electronic Motor vehicles

Table 9.3 Continued

0.0015 0.002 0.0023 0.001 0.0012 0.0038 0.0026 0.0025 0.0012 0.0005 0.0021 −1E-04 0.002 0.0008 0.002 0.0004

Indonesia 0.0036 0.0005 0.0037 0.0007 0.0032 0.0198 0.0042 0.0014 0.0025 −0.0005 0.0037 −0.0009 0.003 0.0008 0.0031 −0.0003

Malaysia 0.0004 0.0005 0.0004 0.0006 0.0003 0.0082 0.0005 0.0009 0.0001 0.0001 0.0004 −0.0001 0.0004 0.0002 0.0003 0.0002

Philippines 0.0013 0.003 0.0019 0.0025 0.0024 0.0187 0.0019 0.0038 0.0011 0.0009 0.0022 0.0009 0.0036 0.0006 0.0019 0.0009

Singapore 0.0021 0.0005 0.0005 0.0023 0.0005 0.0098 0.0005 0.0028 0.0018 −0.0003 0.0017 0.0002 0.0007 0.0016 0.0018 0.0002

Thailand 0.0059 0.0272 0.009 0.0206 0.0145 0.0493 0.0091 0.0242 0.0047 0.0108 0.0157 0.0035 0.0077 0.0201 0.0084 0.0133

Taiwan 0.0031 0.0309 0.0029 0.0293 0.0123 0.0451 0.0023 0.0336 0.0022 0.0166 0.0054 0.0152 0.0072 0.0237 0.0064 0.0179

Korea

0.0435 0.036 0.0519 0.0239 0.0905 0.0153 0.0442 0.0231 0.0826 −0.0136 0.111 −0.0591 0.0923 −0.015 0.0933 −0.0427

Japan

0.0187 0.009 0.0215 0.0078 0.0238 0.0394 0.0222 0.0122 0.0211 −0.0045 0.0379 −0.0158 0.0236 0.006 0.105 −0.0881

USA

Wearing apparel Other made-up textile products Boilers, engines, turbines Ordinary industrial machinery Special industrial machinery

Weaving and dyeing Knitting

Spinning

1.231 0.2071 1.2297 −0.0343 0.377 −0.2491 0.4441 −0.0872 0.4466 −0.2333 0.9078 0.1478 1.0868 0.6511 1.4101 −0.2882

China

0.0031 −0.0025 0.0008 −0.0003 0 0.0001 0.0001 −0.0001 0.0038 −0.0021 0 0.0029 0.0003 0.0011 0.0004 0.0006

Indonesia 0.001 0 0.0017 0.0001 0.0006 0.0005 0 0.0004 0.0025 0.0018 0.0001 0.0004 0.0005 0.0013 0.0005 0.003

Malaysia 0.0016 −0.0011 0.0024 −0.0018 0.0005 1E-04 0.0012 −0.0012 0.0084 −0.0082 0.0007 −0.0007 0.0026 −0.0024 0.0028 −0.0027

Philippines 0.0016 0.0002 0.0024 −0.0015 0.0005 −0.0005 0.0012 0.0007 0.0084 0.0041 0.0007 0.0012 0.0026 −0.0003 0.0028 −0.0002

Singapore 0.0053 −0.0016 0.0041 −0.0005 0.0012 0.0033 0.0004 −0.0004 0.001 0.0041 0.0006 0.0006 0.002 −0.0004 0.0022 −0.0008

Thailand 0 0.0023 0 0.0026 0 0.0001 0.0001 0.0003 0 0.0043 0 0.0017 0 0.0105 0 0.005

Taiwan 0.0001 0.0167 0 0.0173 0 0.0006 0.0001 0.0026 0.0001 0.0331 0 0.0043 0 0.0097 0.0002 0.0066

Korea

0.0379 −0.0136 0.0425 −0.0228 0.0068 −0.0022 0.0691 −0.0637 0.0677 0.0713 0.0119 0.003 0.0366 −0.0087 0.0276 −0.0022

Japan

Table 9.4 Changes of forward linkage effect (data in the first line are the values for 1990; the second line is the change over 10 years)

Continued

0.0121 0.0113 0.0256 −0.0025 0.0046 0.0221 0.0108 0.0026 0.0187 0.0891 0.0055 0.0128 0.0126 0.0449 0.0356 0.0289

USA

0.6556 0.1616 1.5727 −0.0103 0.4936 0.1598 1.6351 −0.5501 1.0473 0.1068 0.2578 0.0897 0.7223 −0.077 0.4965 0.3595

China

Source: Same as Table 9.2.

Other transport equipment

Motor cycles and bicycles Shipbuilding

Agricultural machinery Heavy electrical machinery Telecommunication equipment Household electronic Motor vehicles

Table 9.4 Continued

0.0006 0.0001 0.0005 0.002 0.0003 −0.0001 0.003 −0.0024 0.0001 0 0.0013 0.0023 0.0011 0.0002 0.0001 0.0006

Indonesia 0 0.0006 0.0003 0.0114 0.0001 0.0101 0.0008 0.0016 0.0001 0.0005 0.0001 −0.0001 0.0004 0.0001 0 0.0008

Malaysia 0.0003 −0.0003 0.0041 −0.0036 0.0017 −0.0006 0.0049 −0.0044 0.0013 −0.0013 0.0006 −0.0006 0.0012 −0.0012 0 0

Philippines 0.0003 0.0009 0.0041 0.0325 0.0017 0.0107 0.0049 −0.003 0.0013 −0.0004 0.0006 −0.0006 0.0012 −0.0009 0.0006 0.0001

Singapore 0.001 −0.0004 0.0021 0.0128 0.0004 0.0077 0.0084 −0.008 0.0011 −0.0005 0.0001 0 0.0006 −0.0006 0.0046 −0.0043

Thailand 0 0.0019 0.0001 0.0084 0.0001 0.0079 0.0001 0.0057 0 0.0019 0.0002 0 0 0.0016 0 0.0065

Taiwan 0 0.0047 0.0002 0.028 0.0001 0.0105 0.0001 0.0055 0 0.0044 0 0.0004 0 0.0027 0.0003 0.0035

Korea

0.0094 0.003 0.0443 0.0111 0.013 0.0088 0.043 −0.0238 0.0215 −0.0068 0.0075 −0.0071 0.0154 −0.006 0.0109 0.0043

Japan

0.0032 0.0101 0.0252 0.0485 0.0262 0.0464 0.0551 −0.0034 0.0088 0.0263 0.0041 0.008 0.0083 −0.001 0.0105 0.0056

USA

Analysis of the linkage effect in Chinese export-led growth 179 equipment sector, the backward linkage effect expanded by approximately 10 percent in 2000. Among the three sectors, the value of the telecommunication equipment sector is higher than that of the other two sectors, and it had almost doubled by 2000, showing the highest overseas linkage effect. Further, the total value for the ASEAN 5 matched Japan’s in 2000, showing the enlargement of the horizontal division in Asia. • Finally, in the transport equipment industry the country where the backward linkage effect is the largest is again Japan (although the linkage effect has largely decreased in the motor vehicle sector), but is larger than the total backward linkage effect of the endogenous economies. In the motorcycle and bicycle and the shipbuilding sectors, the value of Japan’s effect is larger than the Asian total, which excludes Japan. In 1990, the overseas backward linkage effect of China’s transport equipment industry was mainly concentrated on Japan and the USA, but in 2000 it had spread to Korea and Taiwan. Among the four sectors of the transport equipment industry, the shipbuilding sector (whose export ratio is high) and the motorcycle and bicycle sector (whose share in the world market is high) can be classified as export oriented. The backward linkage effects on Japan have decreased and those on Korea and Taiwan have increased in these two sectors. However, the decreasing rate in the shipbuilding sector, which is highly technically intensive, is smaller than that in the motorcycle and bicycle sector. We can verify the fact that, even though the total dependence on Japan has decreased, China’s transport equipment industry remains largely dependent on Japan in some technically intensive industries. When the analysis of the backward linkage effect depicted in Table 9.3 is performed, although there are some irregular sectors (mainly in the transport equipment industry) and countries (mainly the Philippines, Japan, and the USA), the backward linkage effects of most sectors on the endogenous economies expanded over the 10 years of the 1990s. The backward linkage effect on ASEAN countries quickly increased but the value is small and most of the backward linkages are concentrated on Japan, Korea, Taiwan, and the USA. The increasing rate of Taiwan and Korea is particularly remarkable. Though their value is not equal to Japan’s, it has reached the level of the US value. In 2000, the backward linkage effect on Japan was the largest across all industries, showing the large direct and indirect influence of Chinese industrial development on Japan. Next, the sectoral forward linkage effect changes can be summarized as follows with respect to four industries. • First, in the textile industry the growth rate of the forward linkage effect on the USA is remarkable. The values are especially large in the knitting, apparel and other made-up textile products sectors, showing the USA’s character as the last importing area for China’s textile production. In the upstream sectors of the textile industry, such as the spinning and the weaving and dyeing sectors, the effect on the USA, Korea, and Taiwan has increased rather than the effect on Japan decreasing. In ASEAN countries, the forward linkage effect on Thailand is large. Further, in

180 C. Yan 2000, the forward linkage effect on overseas economies of the other made-up textile products sector was larger than that on the domestic, showing that the expansion of textile production in China largely depends on exports. Further, the value of the forward linkage effect of the apparel sector is small, since it makes limited use of intermediate goods, but the extension of the forward linkage effect of Korea is large and the value of that of the USA is large. • Second, in the general machinery industry (except for the change in Taiwan in the general industrial machinery sector that exceeded 0.01) the changes in the other Asian countries were small, including that in Japan. On the other hand, change in the USA has greatly expanded in all sectors and has become the largest forward linkage effect on any country due to the development of China’s general machinery industry. • Third, in the electrical machinery industry the forward linkage effect decreased in some ASEAN countries, whereas the backward linkage effect in all endogenous countries increased. In all three sectors of this industry, the forward linkage effect on the USA is the largest. The features of China’s electrical machinery industry, consisting of imports of intermediate goods from neighboring Asian countries and exports of processed goods to the USA, become clear. In the heavy electrical machinery and telecommunication equipment sectors in Japan, which used intermediate goods more than final consumption goods, the forward linkage effect has increased. However, it has decreased in the household electronic machinery sector. Further, in Taiwan and Korea it has increased suddenly in three sectors. While it may be said that the concentration of the electrical machinery industry in China has grown, Korean and Taiwanese manufacturers have increased re-imports and exports to third countries simultaneously, whereas Japanese manufacturers have decreased re-imports. • Finally, in the transport equipment industry only the value of Japan’s effect in 1990 had been conspicuous; the others were very small. However, the value of the forward linkage effect on the USA, Korea, and Taiwan became larger in 2000; and in all sectors excluding shipbuilding, the value for the USA has become the largest. Especially in the motor vehicles sector, the extension of the forward linkage effect is large and the value is likewise big. Further, the changes in Malaysia, Taiwan, Korea, and the USA have grown, but in Japan, Thailand, and Singapore, they have decreased.16 Other than in the motor vehicles sector, the value or changes of forward linkage effects are small. In addition, the forward linkage effect on Korea and Taiwan has greatly increased, other than in the motorcycle and bicycle sector. When the analysis of the forward linkage effect changes shown in Table 9.4 is performed, in all industry sectors (excluding the telecommunication equipment sector) for all countries (excluding the USA) the forward linkage effect had decreased or the value was small (showing as 0). The forward linkage effect analyzed here is the influence from the intermediate products exports, which are produced separately from the final consumption goods such as thread, cloth, and the parts for machinery, electrical equipment, and automobiles.

Analysis of the linkage effect in Chinese export-led growth 181 Similar to the backward linkage effect, the forward linkage effect has expanded in ASEAN but the value is small and the changes in Korea are large. Unlike the backward linkage effect, Japan’s ratio in the total is small and has decreased considerably over 10 years. Conversely, the US has experienced greatly extended forward linkage effects in the sectors classified as final use goods production, like knitting, apparel, household electronic machinery, motorcycle and bicycle, motor vehicles, and telecommunication equipment. In these sectors, the value is larger than the total for the endogenous economies, excluding China and the US. It is evident that with the expansion of Chinese final use goods exports to US, some intermediate goods exports to US were extending too; this basically depended on the concentration of the processing trade in the southeast coastal area of China.

Concluding remarks In this chapter, we aimed to analyze the changes of backward and forward linkage effects on neighboring Asian economies (as well as the USA) resulting from Chinese export-led growth in the 1990s. The linkage effect analysis of this chapter differs on two points with respect to the existing linkage effect analysis related to China’s economic growth, found in the literature. First, we have emphasized that the linkage effect changes of China’s economic development in the Asian economies were based on China’s export-led growth regime and significant expansion of the labor-intensive processing trade, and not simply on economic growth and expansion of trade. Second, we have pointed out that the linkage effect structure differed greatly between sectors that were usually regarded as one industry (based on the large or middle divisions) in other existing linkage effect analyses, and we have made this clear by using subdivisions of the AIO. On the other hand, since the AIO was published only until 2000 we could not properly examine and analyze the changes of the linkage effect after 2000. However, if the changes in China’s international trade data and the extensions of China’s export-led growth in the 2000s are considered, we can presume there have been no big changes in the main tendency. The main conclusions in this linkage effect analysis can be summarized as follows. 1 Export-led growth in China after the 1990s has expanded international linkages by increasing intermediate goods imports (shown as the growth rate of imports being larger than that of domestic supply), which depended upon the main features of this growth regime. Further, the growth rate of imports from the East Asian economies has been faster than that of total imports. Consequently, the dependence of China’s economic growth on the endogenous economies of the AIO has increased. 2 With respect to changes by country, the Japanese intermediate goods supply was the largest and the growth rate of Korea and Taiwan greatly extended during the 1990s, and in some sectors was larger than Japan’s. Of the ASEAN five countries, although their ratio of total Chinese imports increased, it was small even in 2000. There have not been remarkable changes in the linkage,

182 C. Yan except in the sectors of the electrical machinery industry. In other words, the Chinese international linkage with the endogenous countries of the AIO was mainly strengthened in relation to Japan, the USA, Korea, and Taiwan. 3 The increase in FDI and the extension of intermediate goods imports and exports in China have changed the direct and indirect multiplied effects on domestic and international related industries. As a result of China’s export-led growth after the 1990s, the backward linkage effect on domestic-related industries decreased and that on the East Asian economies increased. Further, the forward linkage effect on domestic industries also decreased, whereas that on the USA and Korea showed an increasing tendency, with Japan being the country to have received the greatest linkage effect of China. Since the purpose of Japanese FDI changed during the 1990s from a focus on re-imports to one on local sales and exports to third countries, the forward linkage effect on Japan has decreased in some sectors. However, considering the distinguished size of the backward linkage effect, the multiplied effect of Chinese economic development on Japan is large. 4 Finally, on the basis of the detailed examination in four industries with subdivisions of the AIO, we have found that there are considerable differences by sectors that were summarized as one industry in other existing analyses. For example, there is a great difference between the linkage effect structure of the apparel and the other made-up textile products sectors, which are downstream sectors, and the spinning sector, which is an upstream sector, even though they all belong to the textile industry. Similarly, the linkage effect structures were very different between the special industrial machinery sector and the other sectors of the machinery industry, between the telecommunication equipment sector and the other sectors of the electrical machinery industries, and between the motorcycle and bicycle sector and the other sectors of the transport equipment industry. These differences depend on the domestic intermediate goods supply capacity from the upstream industry to the downstream industry. Though China has a fullset type of industrial structure, there exist major differences in the development level of each industry and the intermediate good supply capacity differs by sectors. Therefore, in some industries in which technical intensity is low, such as the apparel sector, the dependence on imported intermediate goods has decreased; but in some industries in which technical intensity is high, such as the telecommunication equipment sector, the dependence on imported high-tech intermediate goods has increased.

Notes 1 The four industries include the textile, general machinery, electrical machinery, and transport equipment industries, which were not only the typical export-led industries but also the most expanded industries in China after the 1990s.

Analysis of the linkage effect in Chinese export-led growth 183 2 In Uni et al. (2003), the export growth rate is more than 1.5 times that of the GDP, and the ratio of export as a percentage of GDP is more than 10 percent; these are regarded as the criteria for export-led growth. 3 See Lawrence (1996), Shinohara (2003), Kwan (2005), Tran (2007), Uni (2007), and Yan (2008). 4 For more detailed explanations about the direct and indirect role of FDI in Chinese economic development, see Ohashi (2003) and Wu (2005). 5 The disparity between GDP per person of the southeast coastal area and the western inner-China area has continually increased in the 15 years after 1990, from 1.8 times in 1990 to 2.5 times in 2005. 6 According to the estimation of Hioki (2004), the multiplied effect from developed coastal areas to middle and west areas was approximately 10 percent. Further, the effect on the western areas was 2–3 percent only. In other words, the multiplied effect is not significant. 7 The decision to adjust the Chinese yuan’s exchange rate rests not only with the central bank (the People’s Bank of China), but also requires the permission of the Cabinet of the Chinese government. In this sense, the adjustment of the exchange rate in China is a highly political decision. Further, the growth rate and minimum wage are also adjusted by government on the basis of the growth rate of the macro economy, productivity growth at the macro level, and the rate of inflation (Yan 2005). 8 In response to this type of international pressure, in July 2005 the Chinese government announced the move to a currency basket system from a de facto fixed exchange rate system, and to a declared floating rate of exchange within the scope of the government monetary supply. Toward the end of 2008, the yuan-dollar rates had risen by approximately 18 percent. 9 The Central Economic Work Conference of 2008 emphasized the need to transfer the growth regime from export-led growth to domestic consumption-led growth in order to prevent the serious consequences resulting from the decrease in export demand. A series of policies and measures was decided upon to achieve this. 10 In the latter half of the 1990s, the FDI from most Asian economies had fallen because of the Asian currency crisis of 1997–8; only the investment from Korea rose by about 50 percent in five years, and the amount in 2000 was 1,490 million dollars. After 2000, the increasing tendency was continued and the amount in 2005 was 5,168 million dollars, which was larger than the amount from the ASEAN five plus Taiwan, and it was approximately 80 percent of the amount from Japan. 11 Regarding the development of the horizontal division in East Asia, and especially in the electrical machinery industry, see Kimura et al. (2002), White Paper on International Economy and Trade 2006 and Kuroiwa (2006). 12 Regarding the analysis of processed intermediate goods and final goods exports to the East Asian economies, see Yan (2008). 13 Regarding the details of hypothetical extraction method, see Kuroiwa (2006). 14 The aggregation of data in 1990 and 1995 was 780 × 780, and in 2000 was 760 × 760. 15 Since the integration of the industrial sector, 67 industrial sectors form the 67 × 67 queue in determining backward and forward linkage effects on each economy. 16 China’s motor vehicles industry has extended very rapidly in the 2000s and the concentration of the international motor industry’s investment in China continues apace. But to capture the change of linkage effect with regard to this industry, we have to wait for the next AIO. Production of major Japanese motor manufactures in China also expanded after 2000. In this sense, the linkage effect on the motor vehicles industry between China and Japan may change considerably after 2000.

10 The Chinese growth regime and the world economy Robert Boyer

Introduction Since the collapse of the Breton Woods system and the demise of the Fordist growth regime in most OECD countries, the end of Soviet Union and the emergence of China, India, and Brazil, the international system has undergone drastic structural transformations, in search of a new world order that would be both geopolitically viable and economically more efficient than the present one. These epochal changes have stimulated the production of a vast literature in every social science, and each research program has provided quite specific answers to questions around these major contemporary issues. Broadly speaking, some researchers investigate the origins and durability of the Chinese ascent: this is mainly the task of macroeconomists, institutional change analysts, and economic policy specialists. By contrast, researchers in international relations question the viability of the current “non-system” inherited from the decomposition of the post-World War II regime. They address the issue of capital flows regulation, the protectionist threat to free trade, the design of a new exchange rate regime, and, of course, reform of international organizations such as the IMF, World Bank, World Trade Organization, or International Labor Organization. However, China has no specific role in these discussions. The purpose of the present chapter is to tentatively try to integrate these two lines of analysis. The core idea is simple enough: the very highly specific sociopolitical compromise observed in China simultaneously explains the success of its development strategy and its growing influence in the evolution of the world economy. One has to analyze one of the core institutional innovation of the post1978 reform, the local-state corporatism, and its progressive transformation into a society-wide compromise on the basis of the following quid pro quo: acceptance of the monopoly of the Communist party in the political domain against a permanent increase of living standards via rapid and steady growth (second section). Within the régulation theory paradigm, this implies the dominant role of the form of competition in the wage–labor nexus and a highly specific role for the State, as the conductor of the permanent reorganization of the public and private sectors (third section). Consequently, the related macroeconomic regime is quite specific to China. Its asymmetric insertion into the world economy is a mechanism compensating for domestic structural unbalances: the trade surplus that has been

The Chinese growth regime and the world economy 185 accumulating during the last decade has been quite instrumental in correcting a major disequilibrium in income distribution (fourth section). The shock associated with the 2008 crisis does confirm the specificity of the Chinese regulation mode and accumulation regime. Paradoxically, the emphasis upon the shift toward domestic-led growth might well be blocked by the strong legacy of an investmentled macroeconomic regime (fifth section). It is then possible to make explicit some of the channels according to which China is contributing to the redesign of world international relations. Nevertheless, it is far from a typically determinist process, contrary to the widely diffused belief that China is bound to replace the USA as the hegemonic superpower (sixth section).

A genuine co-evolution of institutions and organizations The trajectory out of a Soviet-type regime is closely related to a typically Chinese configuration that displays an original mix in which economic rationale and political are made first compatible and finally complementary (Nee 1992; Chavance 2000; Lin Justin 2004; Naughton 2007; Fairbank and Goldman 2010). The four stages in the transformation of the Chinese economy • After the Maoist revolution, the subsequent quarter of a century included a succession of fast booms and sudden, drastic declines associated with the leading role of investment decisions made by central authorities. In some cases, for instance, during the Great Leap Forward and more so the Cultural Revolution, the social and economic evolutions were so dramatic that the political authorities realized how inefficient Soviet-type institutions had become. • In a sense, the first wave of reforms was intended to create degrees of freedom at the microeconomic level in order to develop production to overcome insecurity and poverty. Initially, the large State sector was left intact, but new contracts were designed in order to incentivize producers, especially those from rural areas, to extend their supply. A minimal degree of competition was created by allowing the entry of new actors at the local level. This cautious, experimental, and pragmatic approach to decentralization inaugurated a continuous process that led to the progressive replacement of State expenditures and redistribution by the development of banks designed to channel higher savings toward credit to existing firms and new entrepreneurs. At odds with the transition of the Soviet economy after 1989 (Sapir 1998), the reforms launched a positive sum game, with no loser. • After 1993, the second wave aimed at strengthening market economy institutions via market unification across provinces and the provision of various ownership structures for companies. Given the dynamism of all the new firms, the State sector could be downsized and the process of privatization could begin. Simultaneously, in order to control possible discrepancies at the local level, the tax system was centralized again and macroeconomic control was developed. The workers of the former State enterprises and some peasants were clearly among the losers.

186 R. Boyer Table 10.1 The progressive emergence of the present competition-led accumulation regime 1949–76 1978–92 Reforms without loser

1993–2001 Reforms with loser

Succession of five cycles with major instabilities First wave of economic reforms – Introduction of markets and contracts on top of the existing institutions – Competition by entry and no privatization – Decentralization of authority and resources – Cautious and pragmatic approach – Declining government share in GDP – Creation of Export-Processing Zones – Higher household savings channeled into the banking system The second wave of economic reforms – Strengthening of market economy institutions – Market unification – Company law and diversification of ownership – State-sector downsizing; beginning of privatization – Focus on finance and regulation – China becomes net importer of oil (1993) – Creation of Export-Processing Zones – Recentralization of resources, macroeconomic control – Surge in FDI

2001–10 Cautious external liberalization

Accession to WTO – Creation of SASAC: monitoring State Ownership (2003) – Large openness to FDI, in order to diffuse frontier technologies and organizations – Trading market access for technology A common feature in all periods High saving and investment rates

• After 2001, with the adhesion of China to the World Trade Organization, the competition extended from the domestic domain to the international arena, whereas foreign direct investments were welcomed with the hope that they would diffuse frontier technologies and organizations. Furthermore, recurrently, the objectives and the instruments of the central State interventions were redesigned and adapted in order to correct emerging imbalances created by the previous stage of reforms (Table 10.1).

A complex hybrid form: the local State corporatism This success of reforms cannot be explained by pure chance, since the process has been observed for more than three decades. Similarly, it is not only a matter of good macroeconomic stabilization policy, since the issue at stake is the stability and resilience of a complex architecture linking institutions and organizations at

The Chinese growth regime and the world economy 187 Table 10.2 From a series of local corporatisms to Chinese macro dynamism Authors

Arguments

Consequences for the socioeconomic regime

Oi (1992)

• Tax responsibility for each administrative level allows local government entrepreneurship • Rural governments as local corporations

• An incentive for rural industrialization • A possible synergy between polity and economy

Krug and Hendrischke (2007)

• Constrained cooperation game • Business-government and between local governments micro-macro level networking and local businesses • Institutional competition • Complementarity and among local entities alignment of interests at the local level

Bergère (2007)

• A party/State promotes the transformation of bureaucrats into an emerging capitalist class • After 1990, urban entrepreneurs are more dynamic than rural ones

• Entrepreneurial success is linked to the proximity to public administration • Permanent exchange between economic and political spheres

Domenach (2008)

• Nestedness of public and private sectors • Mobility of the elite from political to economic and vice versa • A specificity of investment decisions in planned economies

• A basic compromise: “Promise of better standards of living against political monopoly of the Communist Party” • Growth as the core objective

• When the elite has both political power and economic resources in control, they may maximize investment growth rate

• A transposition to the local level of a theory of social planning

Grosfeld (1986)

Zou (1991)

the many levels of Chinese jurisdiction. A converging set of researches suggests that China has invented a way to align, at least partially, the interests of politicians and entrepreneurs (Table 10.2). The starting point is the tax reform that gives greater responsibility to each local public entity. The public status quo is maintained but there are strong incentives for local authorities to nurture the emergence of entrepreneurs who will create more value, hence a larger tax base, and finally more resources for public spending. The local State corporatism hypothesis gives a precise definition to this hybrid form (Oi 1992; Peng 2001). In a sense, this cooperation between politicians and

188 R. Boyer entrepreneurs is the logical outcome of the simultaneous compliance with their respective objectives: on one hand, recover the maximum tax revenue, on the other, optimize the competitive edge of each locality via the dynamism of investment, production, and employment (Krug and Hendrischke 2007). Nevertheless, the struggle of all localities, one against another, does not turn into chaos and permanent conflict: this is the contribution of intense networking between business and government and the micro and the macro levels, whether that of the Communist Party or of Guanxi (Xin and Pearce 1996). However, this would not be sufficient to arrive at a coherent pattern at the macroeconomic level: one institution more is required. The historians and political scientists who have investigated the role and functioning of the Communist Party confirm that so-called bureaucrats have been quite instrumental in creating a group of entrepreneurs that would sustain the process of reforms and economic growth. Therefore, at the national level, the intricacy of the State-party functioning allows a permanent exchange between economic and political spheres (Bergère 2007). The mobility of the elite from the political to the economic, and conversely, is observed at all levels of the Chinese society. What is the glue that makes such a complex architecture coherent? Many political scientists suggest that the Chinese growth regime is built upon an implicit compromise: “Better standards of livings against the political monopoly of the Communist Party.” It is itself open to the most dynamic groups of society, from organic intellectuals to the most successful entrepreneurs (Domenach 2008). If one accepts these premises, the Chinese economy is not a typical capitalism moved by the exclusive search for profit by private entrepreneurs; the elites have both the political power and the control of economic resources in order to monitor the society. Therefore, the efficiency criterion is not the maximization of welfare of consumers according to a consumerist variant of capitalism; it is not the maximization of value for shareholders; it is the mix of political and economic objectives. In this configuration, the relevant actors tend to maximize investment growth rate or production growth per se (Grosfeld 1986; Zou 1991). The politics/economics and local/national nexus The synergy between these domains and levels can now be made more explicit. In the absence of a full-fledged legal system and of a unique form of incorporation of firms, public authorities have the ability to define, at least locally and for a given period of time, the rights around the use of resources (land, raw materials, work force, talents, etc.) and those to legitimize some rules in the appropriation of income flows. Under this umbrella, entrepreneurs may make decisions about production, investment, and technology. When they are successful, they are creating value that can be allocated for reinvestment, social and infrastructure expenditure, and contribution to the tax base of the related entity. Conceptually, this exchange may propel a virtuous circle involving bureaucrats and entrepreneurs. However, in isolation, such a system could become more predatory and corrupt than efficient in value creation. There are two additional features of the local State corporatism. On the public side, each entity is partially accountable with respect to a higher

The Chinese growth regime and the world economy 189 Higher level authority revenue

Market competition at the economy-wide level

Local authorities

Local entrepreneurs

1. A form of security/control concerned with the rights over income flows

Investment, production growth

2. More taxes to comply with (a) Provision of services for and benefits to the community (b) Allocation of resources (land, competences, raw materials, etc.) and credit

Social/political legitimacy Positive spillover

(c) Required transfer to higher level entity

Figure 10.1 Local state corporatism hypothesis: a synoptic view.

rank entity that could correct the most detrimental forms of private appropriation. On the business side, if local entrepreneurs make wrong decisions they will be penalized in the competition with other businesses nurtured by many other localities. Thus, the local State corporatism has another relevant property: to articulate the various levels of Chinese society (Figure 10.1). Some empirical evidence may support this hypothesis. First, the pro-growth nature of the incentive system associated with the 1978 reforms is clear enough concerning, for instance, the evolution of the steel industry. Initially, all the allocations were decided by the Central government. Then, local government allocations began extending production, and after a while, the enterprise market sales were booming. A decade later, both Central and Local government production have declined, to the extent that, at the end of the period, the supply of steel was largely privatized (Naughton 2007: 93). The process has thus prevented the dramatic collapse that subsequently took place in the Soviet Union, when State firms were brutally privatized, resulting in a drastic contraction of production over quasi than one decade (Sapir 1998). This process contradicts the conventional idea of tremendous continuity over the Soviet period and the present one in China. In the early stages of the reform, State appropriation and spending represented one third of the GDP, but with the success of decentralization and the dynamism of production, this share has declined to 11 percent in 1994. Since then, the recuperation has been modest (Naughton 2008: 102). This means that in China, the State is neither typically Keynesian nor Beveridgian nor Bismarkian, since the provision by the State of education, health, and housing has nearly vanished. By contrast, the State has been

190 R. Boyer mainly the architect of a sophisticated web of incentive contracts linking economy to polity, and vice versa, localities to provinces, and provinces to local economies. In a sense, this is not a surprise and can be related to political science literature about the merit of federalism in limiting excessive taxation and promoting firms’ differentiated strategies. Given the continental size of China, it is logical that more than two thirds of the public expenditures are local (Lou and Wang 2007: 159). This shows again the importance of decentralization of public interventions and their permanent adjustment. For instance, the excesses associated with the rather complete decentralization of taxation are corrected in the mid 1990s by a recentralization of taxation, associated with a more active role of the Central government in the redistribution of revenue across provinces.

A definite institutional architecture: a régulationist analysis How are we to convert these micro and meso analyses of the interaction between a series of local state corporatisms into a characterization of the macro dynamics of the Chinese economy? The purpose of the French Régulation School (Boyer and Saillard 2000) is precisely to explicit the role of institutional forms, i.e., a meso level concept, in bridging the micro and the macro. Therefore, there is no single pattern and dynamic for modern economies but a multiplicity, in relation to different institutional architectures (Amable 2003). A few régulationist researches (Chavance et al. 1999; Song 2001; Uni 2004, 2007; Aglietta and Landry 2007) have already paved the way for an interpretation of the origins and limits of the Chinese development strategy (Table 10.3). In the light of their results and the present analytical framework, China is exploring a genuine and largely unprecedented brand of capitalism. The primacy of competition In essence, the two founding social relations of capitalism are market competition and the capital/labor relation. Their conjunction implies that accumulation is the dominant feature of this socioeconomic regime, far away from any steady state. In this respect, a structural analysis suggests that the related accumulation regime in China is highly competitive. In fact, numerous entities with different legal status and localization (village, district, province, and so on) permanently compete to capture the natural resources, the equipments, and, finally, the product markets. This logic applies to foreign multinationals; all of them want access to the booming Chinese market and low labor costs. Thus, they are ready to make concessions in terms of technology transfers. On the other hand, localities propose land tax exemption and free infrastructure in order to attract FDI. The size of the economy and the dynamism of each local State’s corporatism do compensate for the lack of legal enforcement of competition by public authorities. Actually large fixed costs and increasing returns to scale are so strong that they generate a permanent state of overinvestment. This unbalanced growth pattern is sustained by very large productivity increases: rural workers are transferred from very low

The Chinese growth regime and the world economy 191 Table 10.3 Some régulationist researches on China Authors

Period and method

Main results

Chavance et al. eds. (1999)

• Period 1978–90s • The categories of régulation • Comparative analysis of the theory can be used to post-socialist transformation understand the transition of in Eastern Europe, Russia, and former socialist economies China • Contrasted national trajectories due to different initial productive and social configurations and diverse transition strategies

Song (2001)

• Period 1978–98 • Institutional and statistical analysis of mainland China’s transformations

• After 1978, the government reforms household responsibility, and this brings more rural income, but after 1990, partial de-linking of rural income and productivity • Competition between regions under the rules set up by central government • Atomistic competition in most industrial sectors • An unintended virtuous circle that ends in a growth slowdown and deflation after 1995

Uni (2007)

• Period 1992–2006 • Discussion of various export led growth models: Hicks, Pasinetti, Balassa–Samuelson, according to wage formation and exchange rate regime

• Until 1997, wages are indexed on export sector productivity: a Balassa–Samuelson type growth regime • After 1998, wage growth slowed down, due to indexation with respect to non-tradable good sector productivity

Aglietta and Landry (2007)

• Period 1980–2006 • Macroeconomic analysis of production, demand, income, finance of China

• The obstacles to a mass consumption led regime: – A declining wage share from 1996 to 2004 – The absence of welfare – An inefficient financial system in the allocation of capital

productivity jobs to state of the art technologies embodied into the most modern equipments. Thus, this growth pattern is mixing extensive (more workers enrolled into capitalist production) and intensive (continuous productivity increases) accumulation. The related over-capacities imply cut-throat competition, declining

192 R. Boyer production costs, and thus declining market prices. The rising prices of raw materials, partially generated by Chinese growth itself, are the only countervailing forces to this deflationary bias. The second basic institutional form, i.e., the capital–labor relation, has also quite an atypical configuration. First, from a legal standpoint, there is no single status for the worker; it differs drastically for urban and rural workers, and this differentiation is monitored by the hukou. Thus, migrant workers going from the rural to the urban zones had, until recently, no formal rights. Second, since the workers’ organization is embedded in the Communist party itself, labor has no autonomy to defend its own interest and to coordinate its struggle across firms, status, and localities. Consequently, the wage–labor nexus is balkanized and serialized, and this is not strictly equivalent to a competitive wage–labor nexus, in which anonymous market forces would govern the entire working population (Zhao 2003; Knight and Li 2005). Of course, migrant workers play the role of the reserve army, but other workers employed in urban or rural firms with the relevant hukou benefit partially from profit sharing, in conformance with typical corporatism (Song 2001). However, since there are many such local corporatisms, labor segmentation and great inequalities define the normal pattern in the Chinese wage labor nexus (Table 10.4). The entry into the world economy: the consequence of a pro-growth Chinese (implicit) compromise This is a powerful original feature of the Chinese growth regime. The entry into the international relations does not come from outside but is essentially a domestic decision. Quantitatively, the opening of the Chinese economy is impressive, but qualitatively, public authorities have a remarkable amount of control over entries of capital, the management of norms, the interventions in the exchange market, and the constitution of large reserves in order to prevent the equivalent of the 1997 Asian crisis. The core argument of this chapter is that it is not the expression of an ideological or doctrinal preference but the projection of the domestic accumulation regime into the world economy (Figure 10.2). There is a clear hierarchy whereby the integration into international economy is the consequence of the domestic institutional forms. Nevertheless, Chinese officials are not free to follow a fully autonomous external policy. They have to cope with the highly specific dynamism of a competition-led accumulation regime in which cut-throat competition is the engine for an overinvestment tendency. Given the dependent nature of the wage–labor nexus, segmented, serialized, and for many workers competitive, the related overcapacities cannot be reduced through the dynamism of household consumption. De facto, the weak bargaining position of labor has been associated with a quasi-continuous decline of the wage share in national income. This might stabilize and halt the decline of the average profit rate, but it does not reduce the gap between production capacities and aggregate demand. Furthermore, the difficulty of access to credit by private firms is inducing cash-flow-driven investment (Reidel and Jin 2007), whereas the poor

The Chinese growth regime and the world economy 193 Table 10.4 The five institutional forms: the Chinese configuration Institutional forms

Main features

Impact upon Regulation mode

1. Forms of competition

2. Wage–labor nexus

3. Monetary/ credit regime

4. The State/ economy nexus

5. Insertion into the international economy

Acute competition among numerous and various entities (firms, provinces, localities) • Dual status (rural/urban) • Balkanized and serialized works • Absence of own collective organization Dialectic between large-scale decentralization and need for control at the macroeconomic level • A pragmatic and anticipatory central state • A multilevel/ complex governance A selective insertion – Constraints upon FDI – Control of external current account – Specific domestic norms

Accumulation regime

A tendency toward The driving force of constantly declining accumulation production costs and prices Strong influence of the Unbalanced income large pool of rural distribution: low and workers on declining wage share competitive wage formation

A fine-tuning in reaction to quickly evolving domestic/international economy

A tool to sustain and manage a high growth regime

High reactivity to emerging disequilibria

Periodic reconfiguration of institutional forms

The exchange rate is a The trade surplus is the key political consequence of variable, along with domestic imbalances domestic credit, in between smoothing external production/demand shocks

public welfare system (unemployment benefits, healthcare, and lodging) is an incentive for building strong household savings that are a response to the uncertainties of families and individuals over the life cycle. The permanence and the rise of the Chinese trade surplus over more than a decade are the expressions of this unbalanced domestic accumulation regime. In other words, contemporary China is a stellar example of the hierarchical domination of competition, at home and consequently at the world level. From a theoretical point of view, it is clear that almost all institutional forms do take into account the nature of competition. This is exactly one of the definitions of an institutional hierarchy (Isogai et al. 2000; Boyer and Saillard 2000; Boyer 2005a). From an empirical standpoint, in 2000, CEOs of listed companies reported that the most important constraining factor

194 R. Boyer

Protectionist backlash threat

Wage–Labor nexus

Forms of competition Cutthroat competition: over investment

segmented (rural/urban) and serialized workers Declining wage share

Unbalanced accumulation regime

Permanent trade surplus Asymmetric insertion into the world economy

Active monitoring by money and credit

Periodic reconfiguration of institutional forms

Figure 10.2 Competition: the hierarchical institutional form in China.

in management was the product market (79.1 percent) whereas the stock market (4.8 percent) or the labor market (4 percent) were minor constraints (Naughton 2007: 321).

The macroeconomic regime: trade surplus is compensating structural domestic unbalances The purpose of régulation theory is not only to make explicit the mechanisms that deliver coherent institutional architectures by chance, compatibility, complementarity, hierarchy, or co-evolution. It intends to convert a qualitative diagnosis into a quantitative appreciation of the emergence, maturation, and the crisis of various development modes, defined as the conjunction of mechanisms of short-run adjustment (they define a régulation mode) and the factors that govern long-term growth (they support an accumulation regime). The related exercise has now to be fulfilled for the Chinese development mode. A structurally unbalanced growth pattern One finds global statistical evidence of overaccumulation in the fact that however difficult might be the measure of a capital stock, the output–capital ratio has been permanently declining since the early 1990s. Nevertheless, the rate of profit is not declining accordingly because the profit share has been compensating for the deterioration of the so-called “productivity of capital” (Figure 10.3). Mechanically, the counterpart of the higher profit share is a lower wage share. Whereas the number of wage earners has drastically increased with the shift from rural to urban labor, the share of household consumption in total demand has declined (Figure 10.4). Such a trend makes highly improbable the wage-led regime that has been an implicit orientation of the Chinese government since early 2000 (Aglietta and Landry 2007). On the demand side, quite clear long-run trends can be observed. Of course, the rate of investment is fluctuating with the succession of acceleration and

The Chinese growth regime and the world economy 195 0.7 0.6 Q/K

0.5 0.4

Pro/Q

0.3 0.2

Pro/K

Output-Capital Ratio

2005

2000

1995

0

1990

0.1

Profit Rate

Profit Share

Figure 10.3 Declining output capital ratio and profit share. Source: Minqi (2007), p. 45.

Share of GDP. 1980-2005

0.55 0.5 0.45 0.4

Household Consumption

2005

2000

1995

1990

1985

0.3

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0.35

Labor Income

Figure 10.4 Long-term decline in wage share and household consumption. Source: Minqi (2007), p. 44.

deceleration periods along with a tendency to increase through the various phases of economic reforms. Simultaneously, the share of exports in total production has increased dramatically from 10 percent in 1980 to nearly 40 percent in 2006. However, the most impressive evolution concerns the quasi-permanent decline of the share of consumption. Within a model of optimal growth, one would expect that an initial big push of investment finally converges toward a steady state with a

196 R. Boyer Share of GDP, 1980-2006

0.7 0.6 0.5 0.4 0.3 0.2 0.1

Consumption

Investment

Net Exports

2005

2000

1995

1990

1985

1980

0 -0.1

Exports

Figure 10.5 Rising trend of investment share. Source: Minqi (2007), p. 43.

constant share of investment and consumption. On the contrary, in China, the deepening of capital is an ongoing process, the relative share of consumption declines, but the anticipated crisis of over accumulation has not happened between 1980 to 2006, which is quite a long period indeed. The spectacular rise of exports and the more modest increase in trade surplus have played a determinant role in stabilizing a quite unbalanced domestic growth regime (Figure 10.5). The challenging task of the Central State: controlling vibrant and numerous local State corporatisms The unfolding of this competition-led accumulation regime generates three major imbalances. First, the quasi-destruction of public welfare has triggered a widening of social inequalities, but poverty has declined along with the dynamism of growth. However, nearly all groups in Chinese society suffer from the difficulty of access to and the cost of such basic collective goods as education, health, and protection against unemployment. Therefore, the Central Government tries to alleviate this potential source of social and possibly political conflicts. Second, the financial system has been modernized, and centralized entities have been created in order to rationalize the credit and reduce the misallocation of capital. Nevertheless, at the decentralized level, the alliance between business and political authorities continues to generate non-performing loans. Their objective is not efficiency in the allocation of resources but support to the ongoing sociopolitical compromise. Third, and more importantly, the Central Government has to deal with the permanent overcapacities and the need to sustain a high rate of growth, just to absorb the flow of migrant workers from rural to urban zones. The exchange rate policy is part of the related policy. Therefore, the multiplicity of

The Chinese growth regime and the world economy 197 Central state Undervalued exchange rate Tentative restrictive monetary policy Public budget

Local mesocorporatism

Local mesocorporatism

Local mesocorporatism

1

2

3

Poor welfare

Laxist credit

Overcapacity

Competition-led growth

Figure 10.6 From the local to the national: the three major tools of the Central State.

levels and entities is simultaneously a chance for Chinese growth but also a source of recurring and potentially dangerous imbalances (Figure 10.6). The appearance of a mercantilist State Therefore, the present analysis challenges a common diagnosis about the specificity of China: it is a contemporary example of a mercantilist State that would accumulate excessive reserves for pure geopolitical reasons. However, the whole Chinese institutional architecture generates macroeconomic adjustments that assume that the external position is the key adjusting variable. Consequently, in the absence of a redesign of the whole domestic accumulation regime, it is probably naive to imagine that the exchange rate policy of China could be decided in conformity with the reduction of world imbalances.

China after the subprime crisis: A confirmation of a genuine régulation mode and accumulation regime Does the present framework keep its relevance after the international diffusion of the subprime crisis? Interestingly enough, this structural and systemic crisis has reverberated across quite all Nation-States and it has revealed the existence of contrasted development modes (Boyer 2011). Three conventional ideas have been drastically challenged. Beijing’s sustained capacity to monitor the Chinese economy Given the permanent flow of reforms in the direction of a typical market economy, many observers have been anticipating the loss of macroeconomic control by Chinese authorities. Numerous tensions have been viewed as potentially destabilizing the sophisticated and fragile institutional architecture. For instance, within the alliance of bureaucrats with capitalists, the dynamism of accumulation could

198 R. Boyer have given a progressive leadership to the latter to the detriment of the former, thus removing the autonomy of fiscal and monetary policy from the State. Similarly, the opportunistic behavior of lower-level entities could have overcome the regulatory ambitions of Beijing, especially in terms of credit and finance. Furthermore, some Chinese financiers in Shanghai could have allied with the international financial community to promote the full opening of the external capital account. These prognoses were not correct. • As soon as the severity of the American crisis was perceived by the Chinese government, directives were given in order to relax credit constraints, and the increase in the volume of the financing of infrastructures and investments is impressive. The impact on the economy was so large that, at the end of 2009, a more restrictive monetary policy was adopted in order to prevent a new speculative bubble, for instance, in the housing sector (Figure 10.7). • The progressive revaluation of the yuan with respect to the dollar has been halted in order to sustain the price competitiveness of low medium tech sectors and thus generate sufficient job creation. The future market for the yuan has validated this return to a peg with respect to the dollar (Figure 10.8). Chinesestyle economic policy still exists and seems to prosper. A possible exacerbation of the structural domestic imbalances This rapid economic recovery, in spite of the brutal decline in international trade, challenges the second idea, according to which China could be a simple extreme example of export-led growth strategy (Yan 2011, Chapter 9 of this book). By contrast, the macroeconomic evolutions from 2008 to 2010 strengthened the previous growth regime. The share of export in GDP declined in the early phase of the crisis but then recovered, and the investment share was experienced as a surge and

House price Credit

30

30

20

20

10

10

0

0 Sources : Datastream, EIU, NATIXIS

-10

-10 02

03

04

05

06

07

08

09

10

Figure 10.7 Strong anti-cyclical credit policy of China in reaction to the subprime crisis (annual growth rate). Source: Artus (2010b), p. 6.

The Chinese growth regime and the world economy 199 8.5

Spot rate

8.5

3 months ahead 6 months ahead

8.0

9 months ahead

8.0

1 year ahead

7.5

7.5

7.0

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6.5

6.0

S o u r ce s : D a ta s tr e am, N ATI X I S

02

03

04

05

6.0 06

07

08

09

10

Figure 10.8 Stopping the re-evaluation of the yuan in order to promote industrial recovery. Source: Artus (2010c), p. 8.

compensated for the collapse of exports. This confirms that within a competitiondominated institutional architecture, the dynamism of investment is crucial. An optimistic assessment may point out that infrastructure is the key target of the Chinese plan; it will reduce bottlenecks in transport, energy, and water supply and thus prepare the competitiveness of tomorrow (Lin 2010). Nevertheless, productive investment also experienced a decline with the re-emerging of the fear of major overcapacities, for example in the steel sector. Therefore, the Chinese government decided in mid 2010 to again place some upper limits on the borrowing of firms in sectors with major overcapacities. There was another confirmation of the resilience of the competition-led regime; with the anti-crisis plan, the share of consumption in GDP stopped declining and then stabilized, but no upward trend has been observed in 2010 (Figure 10.9). In turn, this evolution is closely related to the persisting decline of household consumption share and especially of labor income share. China and other emerging economies may grow and have a positive impact on the world economy in spite of the severe crisis in mature OECD countries. However, the other side of the coin is quite preoccupying: the sources of Chinese growth have remained the same during the last two decades, and the structural imbalances previously detected have been exacerbated. The impressive success in short-run management has not halted adverse trends that persist and challenge the long-run viability of the Chinese development mode. Overcoming income distribution and productive structure inertia Within régulation Theory, such inertia may be interpreted along two different lines. 1 The first one contrasts the aim of the government to move toward a domestic-led Chinese regime against the structural stability of the prevailing accumulation regime. Given the inability to act directly on private consumption, the

200 R. Boyer Household consumption Export Investment

50 45

50 45

40

40

35

35

30

30

25

Sources : Datastream, CEIC, NATIXIS

25 20

20 02

03

04

05

06

07

08

09

10

Figure 10.9 After 2008: still more investment and less consumption shares in GDP. Source: Artus (2010b), p. 5.

government is bound to use the old tools, i.e., credit control and exchange rate policies. A recurring finding is that investment, consumption, and net export trends exhibit only very slow changes. Given the present configuration of the Chinese economy, a simple model of demand formation suggests that the extremely low share of wages, the high elasticity of investment with respect to profit, and the high household saving rate make a profit-led regime quite likely (Boyer 2000). 2 A second interpretation recognizes that the Chinese government has decided ambitious reforms: the 2008 labor law has reinforced the contractual rights of workers, the large disparity between rural and urban hukou has been reduced and the 2008 crisis has triggered a more dynamic use of minimum wage policy (OECD 2010). But this last policy takes place at the prefecture level and it is mitigated by wage concessions in order to fight against job destruction. In such a context, it is far from evident that this will stop the widening of regional income disparities (Shankar and Shah 2008). All long-term historical analyses of capitalisms make explicit a significant result: at least a quarter of century, i.e., a generation, is necessary for a structural change in basic institutional forms to coalesce into a new institutional architecture and a coherent mode of development. This could well apply to the present Chinese strategy that aims at constructing a welfare system strong enough to reverse the underconsumption trends. The jury is still out, since one decade more is required to assess if the post-2008 policy implies a simple inflexion in the previous socioeconomic regime or a historical bifurcation.

The uncertain recomposition of the world economy China: a key player in the emerging new international regime The decade of the 2000s can be interpreted according to two stylized hypotheses: first, the American and Chinese capitalisms, even if seemingly in fierce

The Chinese growth regime and the world economy 201

Trade surplus

United States Consumer of last resort Center of financial intermediation

Financing of external/public deficit

Raw materials

The rest of the World

China As the engine of growth in Asia, saver of the world

Raw materials

Third world: boom of raw materials Emerging economies: de-industrialization Developed countries: financialization and de-industrialization

Figure 10.10 USA, China, and the rest of the world.

competition, are de facto quite complementary; second, their joint interactions basically set the pace of the rest of the world economy. It becomes clearer and clearer that the American excess of consumption is largely the mirror image of the excess of saving of Asia, and especially China and Japan. The American strategy of economy without manufacturing, specialized in financial services and property rights defense, assumes that the rest of the world can provide the American consumer with the required manufactured goods; China has been specializing in precisely the final stage of consumer goods manufacturing. The persistent American public deficits are financed by the Asians who agree to buy and keep a large amount of US Treasury bonds. Conversely, American multinationals invest massively in China to get access to a large and growing market. In structural terms, the USA and Asia form a duopoly that, until now, has been stabilizing the world economy. When both economies are booming, the rise in the price of natural resources promotes a rapid growth of rentier economies such as Saudi Arabia, Russia, and even Brazil and Argentina. However, economies that had previously shifted from import substitution to export-led growth, such as Mexico, then suffer from the delocalization of foreign capital to Asia. The majority of already industrialized countries in OECD have to adapt to the structural manufacturing competitiveness of China and the American pressure to adopt a form of shareholder capitalism. Thus, in the contemporary world, some countries are more equal than others: the USA and China enjoy a significant degree of freedom in their domestic policy, and then the rest of the world has to adapt to their decisions via the evolution of risk premium, interest rates, exchange rates . . . . (Figure 10.10) Trade, foreign investment, natural resources: the strong imprint of China This emerging international system has been labeled a new Breton Woods since China aims at controlling the yuan/dollar exchange rate,and the interactions between

202 R. Boyer 7 6

Foreign capital and joint venture firms Chinese public owned firms Chinese private firms

7 6

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0 -1

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96 97 98 99 00 01 02 03 04 05 06 07 08 09

0 -1

Figure 10.11 Rising world market share of China . . . at the initiative of multinationals. Source: Artus (2009).

the US and China are crucial. Some specialists in international relations see beneath the creation of the G7, G8, and then the G20, a de facto G2 between the USA and China. On some key international issues – world financial regulation and climate change, for instance – both governments basically agree on a “national interest first” strategy. Nevertheless, the present configuration is far from stable, since many conflicts recurrently emerge. • The declining world market share of mature OECD economies, the permanent rising share of Asia and China (Figure 10.11), and the recurring and large deficit on the American side and significant surplus for the China do induce in the USA many calls for one form or another of protectionism. • A second conflict relates to the appropriation of national resources. The AngloSaxon conception is to let spot and future markets set the relevant prices, whereas the Chinese prefer to negotiate medium-term contracts that exchange, for instance primary commodities against the supply of manufactured goods and the construction of infrastructures. Given the fact that China is now appropriating nearly a third of quite all natural resources annual production, the competition with the rest of OECD countries is acute. Furthermore, since after 2008, financial markets are desperately searching for new sources of speculation, oil, gold, and rare natural resources are experiencing a speculative bubble far ahead of any future real scarcity. The poorer countries do suffer a lot from such a hike in agricultural product prices that are thus also involved in this process of financialization. • A third source of conflicts concerns the ability of Chinese multinationals to buy foreign firms in some strategic sectors such as harbors, energy, or highlevel technology, for instance, in the biotech sector. It is quite remarkable that a middle-income country such as China is already promoting the transnationalization of its national champions: since 2007, the flow of FDI out of China has drastically increased, from $2.7 million in 2003 to $25.6 million

The Chinese growth regime and the world economy 203 in 2008 (Artus 2009a). The more severe frictions probably relate to the issue of intellectual property rights and appropriation of frontier technologies. It is striking that the export performance of China is more and more generated by foreign multinationals that organize the circulation of newly created knowledge between their various locations (Figure 10.11, supra). Since the domestic firms do not benefit as much as expected from the spillover of multinationals in China, they now go abroad and use the massive reserves to buy the jewels of the most advanced national systems of innovation. The recurring difficulties in the construction of an endogenous and indigenous Chinese innovation system (Gu and Lundvall 2006) make this new strategy quite tempting. After the failure of “Do it yourself,” and the uncertain benefits of the subsequent strategy “Bargain for it,” “Buy advanced knowledge” is at the top of the agenda of Chinese authorities (Naughton 2007: 356–60). This conflict is probably the more acute, since, outside China, mature economies have tried on a massive scale to adopt the strategy of innovation-led growth that consists in innovating faster than the Chinese process of catching up progresses. The complex and contradictory impact of China’s ascent Nevertheless, “the rest of the world” is far from being a homogeneous entity. Actually, each region (Latin America, Africa, Asia, and Europe) and every country within each region display articulations deeply contrasting with those of China (Artus 2010a). Some innovation-led economies (Germany, Japan, and South Korea, for instance) export to China high-tech equipment goods or intermediate components on a massive scale. In countries, the import of Chinese mass-produced consumer goods helps in sustaining living standards, and this mechanism partially compensates low wages or agricultural income. The large financial reserves of East Asian countries are used to buy Treasury bills of OECD economies that experience permanent and growing public deficits. Consequently, lower mediumlong-term interest rates contribute to the viability of Keynesian economic policies that stimulate household consumption, but at the possible cost of excessive longterm public and private debt. These three links are a priori and initially good for the recipient countries in terms of growth and welfare. Nevertheless, other transmission mechanisms are detrimental and seem to justify the existence of a “Chinese threat.” Almost all labor- and, more recently, capital-intensive sectors suffer from the structural advantage of their competitors – either Chinese firms or foreign multinationals – that the bulk of their production made in China. The destruction of low skill jobs in the USA and Europe pushes ahead the protectionist agenda, because the periodic retraining of workers has been neglected, except in Scandinavian social democratic economies such as Denmark, Sweden, and Finland. However, this competition is not restricted to maturing or sunset sectors. Chinese authorities unceasingly seek a modern and self-sufficient innovation system that could be built upon the natural advantages of continental economy, rich talents at home and abroad, a large number of potential users of new goods, and increasing returns to

204 R. Boyer scale typical of research and development expenditures. For the time being, the effort is more in terms of inputs than outputs, and quantity seems to prevail over quality (Simon and Cao 2009), and organizational problems inherited from the catching up process are still unsolved (Song 2010; Daniel and Benezech 2006; Laurens 2006). Nevertheless, during the 2010 decade, China may finally reach the scientific and technological frontier and convert this progress into mass production of entirely new goods. The backlash over weak national systems of innovation and declining industrial bases may be important and trigger a wave of technological nationalism all over the world. A final feedback of China on the world economy might be a durable rise in the terms of trade between natural resources and manufactured goods. This would be good news for primary exporters, especially for Latin America (Devlin et al. 2006) but would simultaneously imply a reduction in standards of living of the poorest populations, for instance in African countries with poor agricultural productivity and few resources. This cursive analysis suggests why the perceptions of globalization and China’s rise are so diverse and how difficult it will be to reconstruct new rules of the game at the international level (Boyer 2011).

Conclusion The main issue addressed in this chapter is simple: what are the emerging links between the inner dynamism of the Chinese economy and the redesign of the world system? It proposes the following provisional conclusions. 1 The high rate of Chinese growth results from a genuine form of mixed economy that organizes the synergy between polity and economy, the public and the private, the local and the global. 2 After 1978, a local State corporatism has emerged and promoted strong incentives to increase investment, production, and employment and redistribute the related economic and political benefits. At the provincial and the national level, this implies strong competition due to the permanent reproduction of overcapacities. Over time, an equivalent logic has been extended to the urban/coastal regions and finally at the national level. It is built upon an implicit but strong compromise that exchanges high growth and the hope of better living standards for the monopoly of political power held by the Communist Party. 3 Under this regime, serialized and segmented workers (rural/urban, according to the legal status of the firms and the different sectors . . .) absorb the cost of the related overaccumulation. The decline of the workers’ share in GDP leads to a structural imbalance in demand generation, and this generates a permanent surplus in international trade. This is the common root of both the rapid and relatively stable Chinese growth and the rising share of Chinese exports in world trade. 4 The decision to keep a controlled exchange rate regime, implying an undervalued yuan, is not necessarily evidence for a typical mercantilist strategy, since it might well be the consequence of the projection of the basic Chinese

The Chinese growth regime and the world economy 205 socioeconomic regime into the world economy. The control of the volume and direction of credit, as well as the ability to react quickly, to experiment constantly, and to try to anticipate emerging problems are other typical attributes of the Chinese State. 5 Therefore, China is acquiring a greater and greater influence over the evolution of the world economy. It is a market for export of sophisticated goods, it moderates inflation due to the lower price of Chinese manufactured products, and it helps in lowering long-term interest rates; however, China is simultaneously contributing to the destruction of low-skill jobs elsewhere, and recently even of some highly skilled employment in advanced sectors. The exact balance is specific for each country given its productive specialization, social stratification, and economic policy. 6 On the domestic side, one should not overestimate the long-term viability of this de facto complementarity between the declining North American hegemony and the emerging economic super power of China. Clearly, many frequently quoted factors do limit its growth: the regional imbalances between coastal provinces and inner ones, the widening of inequalities between urban and rural populations, the absence or the poor quality of the public healthcare system, and the tensions over a largely privatized education system. The rapid ageing of the population and the difficult task of building a pension system for a society that will become old before becoming rich are also factors to be taken into account. Finally, the environmental issues around pollution and water are quite a fundamental challenge to the present competition-led growth regime. Nevertheless, this chapter stresses a still more important issue: the quick and powerful expansionary plan decided in response to the 2008 crisis is – at least in the short-medium run – still reinforcing the ills of the present accumulation regime. It combines permanent overcapacity, a decline of consumption share in GDP, a recurring surge of non-performing loans, a highly speculative stock market, and real estate bubbles in response to the accumulation of international reserves and the related excess of liquidity. The political objective of a domestic needs-led regime has not yet propelled a reversal of the two-decade-old structural opposite trends. 7 On the international side, the Chinese ascent triggers many frictions and unbalances. Recurrently, American businesses and governments complained about the Chinese administered exchange rate regime. The dependence of the Chinese reserves with respect to the evolution of the dollar makes quite difficult the way out of the dilemma embedded into the present international financial unbalances Furthermore, international finance exerts a clear pressure in order to open the Chinese capital external account. The complexity of these interactions explains why the future of China and of international economy is so uncertain.

Korea: major transformations but uncertain régulation modes

11 The Korean economy between two economic crises Hybridization or convergence towards a market-led economy? Wooseok Ok and Junho Yang

Introduction The 1997 financial crisis exposed the weaknesses that were inherent in the traditional Korean development model. Although mainstream economists argued that the success of the Korean economy before the crisis must be attributed to its “market-friendly” development strategies (World Bank 1993), a more plausible explanation for this success would be provided by a combination of active investment policies, export-oriented industrial policies, moderately repressed financial institutions, and specific government–firm relationships (Ok 2004). However, lessons from history indicate that the success of a development model bears its own failure. The 1997 financial crisis revealed the weaknesses inherent in the traditional Korean development model when it had to tackle new challenges such as increasing globalization, the increasing dominance of financial capital in the world economy, an obligation to introduce changes in technological learning paradigms, etc. In response to the 1997 crisis, the Korean economy began pursuing a more market-oriented growth strategy. At the core of the post-crisis reforms were the corporate reforms, which aimed at enhancing management transparencies and improving the financial status of corporate enterprises, financial and capital market liberalizations and accompanied regulations such as the Bank for International Settlements (BIS) ratio regulation, as well as the flexibilization of the labor market. Although the average annual growth rate was significantly lower during the post-crisis period than during the pre-crisis period, the overall performance of the Korean economy during the post-crisis period could be considered to be positive. In this respect, an increasing number of observers have been speculating that the Korean economy is now geared towards a market-led economy. However, two important reservations are required to confirm this observation. Generally, the introduction of a few market-oriented reforms does not necessarily produce the expected results. The new reforms often interact with several elements of the historically formed existing model and the final economic outcome is the result of this interaction. In this respect, institutional search processes very often lead to a long and undetermined transitional period, and the final shape of the new growth regime depends on the stability and sustainability of its economic

210 W. Ok and J. Yang performance. Particularly for Korea, the market-oriented reforms, despite their apparent good performance, are combined with the highly concentrated existing market structure, in creating deep cleavages between exports and domestic production, large firms and SMEs, and among different worker groups. This tendency is creating enormous tension within the economic model, and may threaten its long-term sustainability. In the context of the theory of régulation, this chapter traces the institutional changes – with respect to the financial and the labor markets – in the Korean economy after the 1997 financial crisis. On this basis, we will tentatively evaluate whether the emerging institutional forms reveal an internal coherence in the framework of the new growth regime. The second section discusses the changes in the financial institutions and their relationships with the accumulation regime. The third section traces the increasing labor market duality in the postcrisis Korean economy, and provides certain institutional explanations regarding this phenomenon. The fourth section summarizes the discussions and presents tentative evaluations regarding the sustainability of the new growth regime.

Financial institutions and accumulation regimes Changes in the financial institutions Lending patterns of banking institutions One of the major changes in the Korean financial regime since the 1997 financial crisis can be found in the lending behavior of domestic banks. Before the financial crisis, domestic banks maintained certain levels of corporate or even counter-cyclical loans, regardless of business fluctuations; however, during the post-crises period, business fluctuations have become an important determinant of the domestic banks’ degree of flexibility for extending corporate loans. This change in the lending behavior of the domestic banks is indicated in Figure 11.1. Although the coefficient of simple regression of the growth of corporate loans on GDP growth during the pre-crisis period, which measures the domestic banks’ degree of flexibility for extending corporate loans according to business cycles, was approximately −0.63, that for the post-crisis period is approximately 1.68. This change is primarily owing to the policy orientation of the Korean financial regulatory authority after the crisis; although this regulatory authority is now increasingly emphasizing the importance of adherence to the principle of prudence by financial institutions, it attempted to ensure the provision of countercyclical loans to private firms (including small and medium enterprises (SMEs)) through government-owned banks such as the Industrial Bank of Korea during the pre-crisis period. The fact that loans for large companies accounted for only 20 percent of the total corporate loans extended by domestic banks during the pre-crisis period implies that domestic banks tended to exhibit a high degree of patience vis-à-vis SMEs, since the corporate performance of SMEs are generally strongly procyclical as compared to large firms. In other words, before the financial crisis, the domestic

The Korean economy between two economic crises 211

The growth rate of corporate loans(%)

(a)

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22

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7

8

9

GDP growth rate (%)

1999 1/4~2008 1/4

(b)

The growth rate of corporate loans(%)

40 30 20

y = 1.6838x +13.045

R 2 = 0.1357

10 0

-6

-4

-2

-10

0

2

4

6

GDP growth rate (%)

Figure 11.1 Responsiveness of the corporate loans extended by commercial banks to the GDP fluctuations before and after the 1997 financial crisis. Note: The observations are quarterly growth rates. Source: Bank of Korea.

banks maintained a particular level of corporate loans regardless of the business cycles, and this partially supported constant research and development (R&D) and equipment investments by both large firms and SMEs. In contrast, as the lending behavior of commercial banks has become procyclical after the crisis, the R&D and equipment investments by firms are becoming increasingly unstable. Moreover, since banking institutions respond sensitively to the external market situation, they have increasingly begun pursuing so-called profit fundamentalism, rather than playing their original role, that is, that of intermediaries. This is one of the results of the neoliberal financial market reforms, which was imposed by the “IMF-conditionality” immediately after the 1997 financial crisis.1 Although the time period included in the analysis is rather short, the procyclical behavior of the corporate loans extended by domestic banks with regard to business fluctuations appeared to have been weakened during the current global

212 W. Ok and J. Yang crisis. This may be reflected in the general shrinkage of the number of corporate loans extended by banking institutions despite partial economic recovery owing to the prolonged pessimistic anticipation regarding the future economic conditions by the economic agents. Bigger banks and their consequences In Korea, the proportion of corporate loans to total bank loans has been continuously declining since the early 1990s; however, this proportion suddenly plunged after the 1997 financial crisis (Figure 11.2). As the rapid increase in the total assets of commercial banks that is depicted in Figure 11.2 indicates, this acceleration is related to the fact that the sizes of the commercial banks are continuously increasing.2 Ironically, in response to the financial crisis, the original intent of the Korean government’s measures to increase the average sizes of the commercial banks was to ensure efficiency in extending corporate loans and rationalizing the general financial systems. However, in reality, those measures generated a rapid increase in the number of household/consumer loans, for example, property mortgages, at the cost of a reduction in the number of corporate loans. In other words, combined with the so-called BIS regulation, the Korean government’s measures incited commercial banks to give preference to extending household/consumer loans, which tend to generate a greater profit at a lower cost, over corporate loans, which are usually accompanied by high costs.3 One of the direct consequences was the deterioration of the stability of the corporate investments, which is crucial

90

12,000,000

80

10,000,000

70

8,000,000

60 50

6,000,000

40

4,000,000

30 20

2,000,000

10

-

Total assets of commercial banks(million KRW) The percentage of business loan in total loan(%)

Figure 11.2 Banking assets and proportion of corporate loans. Source: Bank of Korea; Financial Supervisory Service.

2008

2007

2006

2005

2004

2003

2002

2000

2001

1999

1998

1997

1996

1995

1994

1993

1992

0

The Korean economy between two economic crises 213

Proportion of SME loans in total loans(%)

1

y = -0.0805x + 1.4956

0.9

(***)

0.8

(***)

R2 = 0.3425

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

9

10

12 11 13 Natural logarithm of total of bank assets

14

15

Figure 11.3 Correlation between the size of the bank assets and SME loans: 1997–2007. Note: The observations are based on monthly data for traditional banks. The Bank assets are calculated as the sum of bank and trust accounts (100 million won). Source: Financial Supervisory Service.

for macroeconomic stability. In addition, the aggressive expansion in the number of household/consumer loans, which accompanied imprudent authorizations of credit card loans and property mortgages, resulted in the proliferation of poor credit ratings and sharp increases in real estate prices. The Korean government’s measures also curtailed the “local-friendly” banking practices, and put the close relationships that existed between local banks and local SMEs before the 1997 crisis in danger; the principal lenders involved in such “local-friendly” banking practices included relatively smaller local commercial banks. Figure 11.3 clearly indicates the negative correlation between the size of bank assets and SME loans in the Korean financial market.4 Increasing volatility of the exchange rate fluctuation The Korean exchange rate system during the 1980s may be characterized as a “multicurrency basket system,” which is a combination of the fixed exchange rate system and the floating exchange rate system. Moreover, a “market average exchange rate system” was introduced in 1990 and maintained until the 1997 financial crisis. As such, the exchange rate systems evolved slightly from the 1980s to the end of the 1990s; however, there was a basic common ground for these two systems in that they permitted active government interventions. In this respect, the Korean exchange rate system was far from a perfectly “marketdriven” co-ordination mechanism.5 The high growth of the Korean economy during this period was partially supported by the exchange rate stability, which in turn stabilized the investment behavior of private firms.

214 W. Ok and J. Yang

8

4

00 -2

-2

20

05

01 20

00 -2 97 19

00

0

6 99 93 19

99 -1 89 19

-1

2

8 98 -1 85

19

19

81

-1

98

4

200 180 160 140 120 100 80 60 40 20 0

Figure 11.4 Standard deviation of exchange rate fluctuation. Source: Bank of Korea.

A “market floating exchange rate system,” which is a market-driven exchange rate system, was introduced as an element of market-oriented economic and financial reforms after the 1997 crisis. This change has dramatically increased the volatility of the dollar exchange rate of the Korean won. This can also be confirmed by comparing the standard deviations of the exchange rates for the periods before and after the 1997 financial crisis (Figure 11.4). Changes in the accumulation regime Accumulation regime before the 1997 financial crisis: consumption/investment-led accumulation As discussed above, the financial institutions in Korea before the 1997 crisis can be characterized as a “coordinated financial system.” With active government interventions and controls, these financial institutions exhibited the following characteristics: First, bank loans were extended regardless of business cycles. Second, in order to encourage “relationship-based” banking, the average sizes and the scales of operations of the banks were kept relatively small. Third, the volatility of the exchange rates, which influences domestic investments, was moderated. This type of financial system was based on various financial regulations such as stringent controls over corporate lending by banks, regulations over the sizes of the bank, capital market controls, and exchange rate controls. The “coordinated financial system” supported the macroeconomic stability of the entire economy in this manner. The most important advantage of this system was that the overall investments were made from a longer term perspective, and are not influenced by the conjunctural business cycles (see Table 11.1). In particular, the stability of the bank loans for the SMEs was maintained, regardless of whether the business

The Korean economy between two economic crises 215 Table 11.1 Estimated investment functions before and after the 1997 financial crisis Before the 1997 financial crisis (January 1994– April 1997)

After the IMF financial crisis (January 1999– January 2008)

Dependant variable: 4-quarter growth rate of investments −0.041∗∗∗ Constant −0.304∗∗∗ (−3.665) (−1.872) Consumption 3.080 1.228 growth rate (5.270) (5.502) 0.226∗∗∗ Export growth −0.184∗∗ rate (−2.189) (3.535) Stock index −0.124∗ 0.048∗∗ growth rate (−1.675) (2.278) R2 0.843 0.691

During the current global financial crisis (February 2008– January 2010) −0.014∗ −(0.131) −0.930∗ (−0.413) 0.932∗∗∗ (3.945) −0.140∗∗ (−2.512) 0.976

Note: The values indicated in brackets indicate the t values. ∗∗∗ ∗∗ , , and ∗ denote values significant at the 1%, 5%, and 10% levels.

cycles favored making stable investments in them. In this sense, the “coordinated financial system” constituted one of the most important components of the consumption/investment-led accumulation regime during the pre-crisis period.6 Accumulation regime after the financial crisis: the rise of the finance-led accumulation regime The Korean financial institution system during the post-crisis period may be characterized as a “liberal financial system.” This system is characterized by the following features: first, business cycles are an important consideration for extending bank loans; second, the average size of the banks increased; therefore, “relationship-based” banking became unfeasible; third, the volatility of the exchange rate increased; therefore, the investments of private firms became more unstable. This system is based on market-oriented financial reforms and financial deregulations, such as the regulations on the BIS ratio, measures for a larger bank size, measures aiming at revitalizing the capital market, and the market floating exchange rate system. This change translated into a higher degree of macroeconomic instability and greater procyclicality in the investment behaviors of private firms. All these changes made the sustenance of the investment-led accumulation regime difficult. Consequently, the accumulation began to be led more by exports rather than by domestic consumption (including investments). Although the financial deregulations contributed to stimulating domestic consumption through unregulated credit card issues, these partial positive effects were, over the longer run, completely counterbalanced by their negative effects because the upsurge of household debts and the resultant proliferation of bad credit ratings repressed the recovery of the household consumptions. The procyclical

216 W. Ok and J. Yang lending behaviors and the disappearance of “relationship-based” banking practices made the SMEs’ access to financial resources more difficult. Since a major part of the success of the large firms can be attributed to the export markets, the accumulation increasingly began to be led by exports. Financial liberalization also increased the dependence of the firms on the capital market for their financial resources, and the stock prices became an important determinant of private firms’ investment behaviors. This implies that the Korean accumulation regime is primarily oriented towards a “finance-led” regime. The overall measures of financial liberalization, which were based on the conditionalities of the International Monetary Fund (IMF), repeatedly enlarged the gap between large firms and SMEs in terms of their access to financial resources as well as in strengthening the hierarchical nature of the Korean financial system.7 In summary, with the weaker influence of domestic consumption and stronger influence of exports and stock prices on investments, the Korean accumulation regime after the 1997 financial crisis can be characterized as a hybrid type of regime. This regime is putting an end to the old Korean accumulation regime which was principally led by domestic investments and consumptions, and is creating a great barrier against investment stability, which nurtured the stable growth of the pre-crisis period (Table 11.1). Accumulation regime emerging from the global crisis: moving towards an export-led accumulation regime? The result presented in Table 11.1 indicates that since the outbreak of the global financial crisis in 2008, although the influence of consumption on investments has weakened, the influence of exports on investments has dramatically increased. The influence of exports on investments is apparently becoming even stronger owing to the weak consumption capacity resulting from the global crisis. For overcoming financial turmoil, the Korean accumulation regime relied more heavily on the performance of a small number of large exporting firms, which derive benefits from the neoliberal business environments such as increased exchange rate variability and a more flexible labor market. On the other hand, the coefficient for the stock price index also became negative, which implies that the finance-led characteristics of the Korean accumulation regime, at least temporarily, became weaker. This is because after the global financial crisis, the overall policy is oriented towards ensuring a stronger regulation of the financial market.

Changes in the labor market Major evolutions in the Korean Labor market since 1997 Changing patterns in employment creation Although there are several discussions regarding “jobless growth,” the real change in the Korean labor market dynamics after the 1997 financial crisis may be related to the shifts in the patterns of employment creation. Traditionally, it was the large

The Korean economy between two economic crises 217 Table 11.2 Annual growth rate of employment, SMEs versus large firms

SMEs Large firms

1994–6

1996–8

1998–2001

2001–4

2004–7

4.57 5.88

−4.60 −12.95

5.97 −8.68

3.56 −1.75

2.93 −3.25

Source: Korea Federation of Small and Medium Businesses, Statistics of Small and Medium Enterprises, various years.

firms, particularly, the affiliates of Chaebol groups, that had played the role of the engine of employment creation. In 1996, the large firms were responsible for a quarter of the total employment in Korea. The role of large firms continues to be important; however, their relative importance appears to have reduced after the 1997 crisis. In 2007, the share of workers employed in the large firms was only approximately 12 percent. After the outbreak of the 1997 financial crisis, the restructuring process in the large firm sector was more comprehensive and enduring than in the SME sector. Furthermore, the average employment growth in the SME sector was higher than that for large firms (Table 11.2). Although the growth rate of employment for large firms continues to remain rather volatile, the employment creation by SMEs reflects greater stability, which implies that SMEs are a more stable source of job creation in Korea. After the 1997 crisis, the so-called micro-establishments with less than 10 employees have been proliferating rather rapidly in Korea. For example, in Korean manufacturing, the number of micro establishments increased from 42,192 in 1999 to 58,408 in 2006, and the number of employed persons in these establishments increased from 270,382 to 371,556 during the same period. Given that 402,914 jobs were created in the manufacturing sector during the same period, the jobs created by microestablishments account for one quarter of the total number of jobs created in the manufacturing sector, and over 90 percent of the jobs created by the SMEs (Korea Statistics Office). The shift in the role of employment creation does not appear only according to firm size. The contribution of service industries to total employment generation was approximately 60 percent in 1992 and has been continuously increasing with a temporary stagnation during the 1997 financial crisis, and accounted for approximately three-quarters of the total employment in 2008. More dramatic changes can be found at the absolute level of employment in the manufacturing industries. The manufacturing sector accounted for 4,980 thousand jobs in 1992, which reduced to 4,079 thousand in 2008. Although the service sector is now the only source of job creation, the manufacturing sector has lost its status of “engine of employment creation,” which it enjoyed during the rapid growth period. Proliferation of “non-standard” types of worker The overall labor market performance in the Korean economy since the 1997 crisis is also strongly associated with the rising proportion of the so-called non-regular workers (Table 11.3). The proportion of non-regular workers to the

218 W. Ok and J. Yang Table 11.3 Number of nonregular workers and the proportion of non-regular workers to total wage workers, 2002–2008 2002

2003a

2004a

2005a

2006a

2007a

2008a

Wage workers

14,030 14,149 14,584 14,968 15,351 15,882 16,104 (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) (100.0) Regular workers 10,190 9,542 9,190 9,486 9,894 10,180 10,658 (72.6) (67.4) (63.0) (63.4) (64.5) (64.1) (66.2) Non-regular workersb 3,839 4,606 5,394 5,483 5,457 5,703 5,445 (27.4) (32.6) (37.0) (36.6) (35.5) (35.9) (33.8) – Contingent workers 2,063 3,013 3,597 3,615 3,626 3,546 3,288 (14.7) (21.3) (24.7) (24.2) (23.6) (22.3) (20.4) – Part time workers 807 929 1,072 1,044 1,135 1,201 1,229 (5.8) (6.6) (7.4) (7.0) (7.4) (7.6) (7.6) – Atypical workers 1,742 1,678 1,948 1,907 1,933 2,208 2,137 (12.4) (11.9) (13.4) (12.7) (12.6) (13.9) (13.3) Notes: a Several changes have been introduced in the survey since 2003, thereby requiring caution in interpreting trends. The entire sample of households for the EAPS was replaced in January 2003, and the question structure in the supplementary survey was partially modified. b The sum of sub-categories exceeds the total number of non-regular workers because there is an overlapping amongst different categories of non-regular workers. Source: Korea National Statistics Office, Economically Active Population Survey (EAPS) Supplement, various years.

total wage workers increased continuously until 2004. After the implementation of the so-called non-regular employment law in 2007, there has been a slight reduction in the proportion of non-regular workers, although the data needs to be interpreted cautiously owing to the short time period that has lapsed since the implementation of the law. Among the non-regular workers, the proportion of the “contingent workers” category, which includes the workers with a fixed-term contract or those without a fixed-term contract but whose employment is not expected to continue owing to involuntary reasons, increased the most rapidly between 2002 and 2004. This category of worker also experienced the largest reduction after the introduction of the “non-regular employment law” in 2007. Increasing labor market duality First, the average level of wages for non-regular workers are significantly lower and decline more rapidly than the wage levels for regular workers. The average level of monthly wages of non-regular workers was only 61 percent of that for regular workers in 2007. In terms of hourly wage, the non-regular workers earn only 68 percent of the amount earned by regular workers. The wage gap between non-regular and regular workers is also widening over time; the average monthly wage of non-regular workers declined from 80.5 percent to 68.0 percent of that for regular workers during the 2002–7 period (Eun et al. 2008).

The Korean economy between two economic crises 219 The non-regular workers are also disfavored in terms of coverage under various social insurances, firm-provided benefits, training opportunities, and employment stability. For example, in case of the national pension system, although only 39 percent of the non-regular workers are subscribed to the national pension system, the corresponding number is 77 percent for regular workers. For the other two important social insurances, the figures are quite similar. Only 35.6 percent of non-regular workers benefit from retirement pay, whereas this figure is 74.5 percent for regular workers. Although 27.9 percent of non-regular workers receive bonuses, 71.5 percent of the regular workers benefit from bonuses in addition to their regular wage. The same pattern can be found in the cases of overtime pay and paid leave. In 2008, 30.4 percent of the regular workers reported to have participated at least once in training programs, whereas the corresponding figure for non-regular workers is only 19.8 percent. Finally, non-regular workers suffer from a higher degree of job instability; although 33.7 percent of the non-regular workers lost their jobs in 2005, the corresponding figure is only 13.3 percent for regular workers (Lee et al. 2009). The duality appears to be strengthening between large firm and SME workers as well. As compared to the large firm workers, the relative wage levels and working conditions for SME workers have deteriorated sharply over time. First, the level of average monthly wage is lower when the firm size is smaller, and grows more slowly than that of the large firm workers (Figure 11.5). For example, on an average, the workers in establishments with 100–299 employees receive only three-quarters of the monthly wages of large firm workers. The average monthly wages of the employees in establishments with five-to-nine-employees is approximately half of the monthly wages of large firm workers. Apart from the general trend of the widening wage gap between SMEs and large firms, Figure 11.5 reveals two noteworthy tendencies. On one hand, with the recovery from the 1997 financial crisis, the wage gap according to the firm size is 90 80 70 60 50

5-9

10-29

30-99

2007

2006

2005

2004

2003

2002

2000

2001

1999

1998

1996

1997

1995

1994

1993

40

100-299

Figure 11.5 Relative monthly wages per employee according to firm size, 1993–2007 (large establishments = 100). Source: Korea National Statistics Office, Monthly Labor Survey for various years.

220 W. Ok and J. Yang widening at an accelerated pace. As a matter of fact, the relative level of the average monthly wages of SME workers compared to the large firm workers remained rather stable between 1993 and 1997. The acceleration of the widening of the wage gap appears to reflect the general deterioration of the economic environment for SMEs after the financial crisis as well as the intensification of globalization and financial difficulties. On the other hand, the smaller the firm size, the more rapid the decrease in the relative wage level. The relative level of the average monthly wages of workers in firms with 5–9 employees and with 10–29 employees as compared to the large firms with over 300 employees fell from 60 percent to 52 percent and from 70 percent to 62 percent, respectively, during 1999–2007, which represents a fall of 8.1 percent and 7.5 percent points for firms with 5–9 employees and with 10–29 employees, respectively. In contrast, the corresponding figures for the workers in the firms with 30–99 employees and 100–299 employees are approximately 4.2 percent and 3.4 percent points, respectively. As can be easily anticipated, the jobs created in SMEs are less stable than those in large firms. On one hand, SMEs tend to be younger than large firms; therefore, the average job tenure of the SME workers is shorter than that of large firms. On the other hand, SMEs tend to rely more intensively on fixed-term contracts, which permits firms not only to have a higher degree of flexibility but also to save a certain amount of labor costs by reducing the benefits for workers. In Korea, the average job tenure for workers working in firms with 100–299 employees was only two-thirds of that for larger firms in 2007 (Figure 11.6). The workers in smaller firms have a shorter average job tenure; the average job tenure for workers in firms with less than five employees is only 20 percent of that for workers in large firms. Another concern is that as compared to large firm workers, the average job tenure of SME workers is shortening over time. Finally, the increasing dualities between regular and non-regular workers on one hand, and between large firms and SME workers on the other, are interrelated

80

72 62

61

60 42 40 20 0

19

41

26

20

2003 1-4

67

5-9

10-29

30-99

25

2007 100-299

Figure 11.6 Relative job tenure of the SME workers, 2003–7 (large establishment workers = 100). Source: 2008 Korea Labor Institute (KLI) Labor Statistics (calculated from EAPS).

The Korean economy between two economic crises 221 50 47 47 40 30

29 26

20

39 38 19 18

38 38

17

24

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29 8

15

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4 6

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2003-2007 2003-2007 2003-2007 2003-2007 2003-2007 less than 5

5-9

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100-299

20032007 300 or more

incidence of non-regular workers share in the total of non-regular workers

Figure 11.7 The incidence and proportion of nonregular workers according to firm size, 2003–7. Source: Eun et al. (2008).

evolutions. In reality, most of the non-regular workers are employed in the SME sector (Figure 11.7). In 2007, only 6 percent of the non-regular workers were employed by the firms with over 300 employees, and a proportionally larger share of non-regular workers were employed in the smaller firms. Similarly, the incidence of non-regular workers is higher in the smaller firms. In firms with less than five employees, although approximately half of the wage workers have non-regular labor contracts, the corresponding figure for firms with over 300 employees is only 20 percent. The labor market duality: A labor market response to the financial crisis The ongoing changes in the Korean labor market since the 1997 financial crisis are the product of the combination of underlying institutions, policy responses to the 1997 crisis, and changes in the manner of insertion into the international market either on the product or on the labor market (Figure 11.8). In the product market, there is a growing tendency of “profitability polarization” between large firms and SMEs. Although, on average, the profit rate for large firms during the 2000s was higher than that during the 1990s, the profit rate for SMEs has been continuously declining since the 1997 crisis. Evolution since 1997: The ongoing globalization process and its effects combined with the upsurge in the Chinese economy and weakened domestic demand has created a downward pressure on the profitability of SMEs. In particular, the linkage effects among different industries are recently weakening in Korea owing

222 W. Ok and J. Yang

Reforms after 1997: Financial Market Liberalization /Deregulation

Evolution after 1997: Tighter insertion into the world Economy 1) China effect: off-shorting 2) Stronger demand for skilled workers 3) IMF conditionalities

Underlying institutions: Oligopolistic product market

Weak SME Sector

Bad jobs

Labor shortage Dual Labor Market

Reforms after 1997: Partial labor market flexibility + Weak social safety net

Underlying institutions: Oligopolistic product market + firm-level unions

Figure 11.8 Interaction of the two dualities.

to the following two main reasons: first, the new leading sector, namely the ICT manufacturing and services, have lower-than-average backward-linkage effects; second, as long as tighter international competition arising from the progress of globalization induces an intensive global off-shoring, the import inducement coefficients from the input–output table continue to increase rather rapidly (Kim 2007). This tendency is particularly dominant in the export sector and ICT manufacturing and services. The sluggish growth of domestic demand aggravates the fragility of Korean SMEs in terms of their profitability, given that a major part of their products are sold in the domestic market. Reforms after 1997: As discussed above, the financial reforms that aimed at securing the financial stability of firms and financial institutions through, for example, regulations on the BIT ratio, resulted in strengthening the procyclicality in the lending behavior of financial institutions. Since SMEs encounter greater information asymmetry problems as compared to those encountered by large firms, the procyclical behavior of the financial institutions is apparent in their decision to extend loans to these first firms. As a result, SMEs tend to encounter disproportionately greater difficulties in identifying financial resources for investments (Cho 2006). Underlying institutions: With fiercer competition among SMEs, the asymmetric subcontract relationships between large firms and SMEs, which took shape during the earlier industrialization period, is creating a downward pressure on the prices of the products of SMEs who have entered into contracts with large firms, since large firms are tempted to impute the competition pressure encountered by them to SMEs.8 Moreover, the productivity growth in the SME sector, in terms of either labor productivity or total-factor productivity (TFP), is much slower than that in the large-firm sector (Kim 2005).

The Korean economy between two economic crises 223 With respect to the labor market, there is a growing tendency of “employment polarization.” There is a sharp contrast in terms of wage rates, working conditions, and job stability between regular/large-firm workers on one hand and non-regular/SME workers on the other, and this gap appears to be widening with time. Evolution since 1997: The rapid technical changes, which necessitate continuous skill upgrades, as well as the intensification of globalization, particularly the ever-growing trade expansion with China, are creating a significant amount of pressure on Korean firms to become more flexible. In the face of this pressure, large Korean firms are adopting a new strategy, which ensures higher numerical flexibility. This strategy, while retaining the regular workers for activities related to firms’ core competencies, relies more on outsourcing practices and non-regular workers for non-core, simple activities. Consequently, the contribution of large Korean firms to employment creation is weakening considerably, despite their relatively good performance. Reforms after 1997: At the outset of the period of recovery from the 1997 financial crisis, the policy imperative of the Korean government was to increase labor market flexibility through the provisions of easing the collective dismissals and employment of dispatched workers, which was intended to facilitate the restructuring process of the firms that were in trouble financially. However, the impact of the collective dismissal provisions on the de facto labor market flexibility in Korea appears to be mitigated, particularly for the large firms where the power of labor unions is generally strong. Faced with strong resistance from unions, large firms tended to prefer contract buyout measures (so-called honored retirements) to collective dismissals, and increasingly relied on outsourcing and non-standard types of employment such as dispatched workers.9 As a result, although the regular workers in large firms remain relatively well protected, the non-regular/SME workers are exposed to greater job instability. Underlying institutions: The industrial relation system in Korea can be characterized by a combination of moderately strong employment protection legislation (EPL) with rather fragmented, firm-based unions. With the democratization and subsequent activation of labor movements, which were largely suppressed under the authoritative regime, the large-firm unions began becoming stronger and more systematically organized since the end of the 1980s. Combined with the oligopolistic product market, this evolution created an asymmetric negotiating power of unions according to their firm size.10 The firm-based unions tend to be more oriented to pursue their own interests and are very often reluctant to organize non-regular workers as members or to represent their interest. As a result, the regular workers in large firms tend to be over-represented under the Korean collective bargaining system. Finally, it must be noted that the two polarization processes closely interact with each other throughout this process. During the high growth period, in order to fill “the institutional voids,” the large business groups ensured productivity with the necessary degree of flexibility through the internal labor market (Lee et al. 2008). This has contributed, over a longer term, to the establishment of labor market

224 W. Ok and J. Yang duality. With democratization and human capital development, the labor costs for the large firms rose rather rapidly and their cost advantage dissipated gradually; however, they managed to adapt themselves in this changing environment through aggressive technology upgrades and efficiency improvement. In contrast, SMEs, owing to their fragile technological competences and cost pressures under the subcontracting system, were not able to provide their workers with the same wage increases as the large business groups. As a result, SMEs increasingly began facing severe shortages of adequate workforce, which translated into a kind of lowskill/low-productivity trap for the SME sector. Under this condition, workers in large firms have to bear greater costs in case of dismissals; therefore, they attempt to organize themselves in a better manner in order to secure a higher degree of job stability, which renders the labor market duality even stronger. The dual labor market adjustments During the high growth period, the Korean firms did not feel the need to make fundamental changes in their strategies for enhancing quantitative flexibilities. On one hand, the level of employment protection was generally low either in terms of formal legislation or in practice. On the other hand, the large firms were vigorously pursuing size expansion and diversification; therefore, their concerns were not regarding negative adjustments in employment size. The 1997 financial crisis dramatically changed the Korean firms’ priorities. From the end of the 1980s, the employment protection legislation became stronger as a result of the upsurge of the labor movement, and the workers became increasingly organized, particularly in the large firms. Furthermore, the experience from the 1997 crisis placed the capability to respond to the requirements of employment reduction in case of negative shocks at the top of their strategic priorities. The proliferation of non-regular workers since the 1997 crisis reflects this move in the strategic priorities of large Korean firms towards maintaining the capability of more flexible employment adjustment, and simultaneously retaining their core competencies within their organizational boundaries. Thus, the Korean firms tend to rely increasingly on non-regular employment contracts for less skill-intensive and peripheral tasks and use regular job contracts for their core tasks. This is because those tasks require a minimum degree of stability for maintaining their non-price competitiveness and regular workers in large firms are more difficult to fire when the economic conditions become unfavorable. Thus, although the policies for greater labor market flexibility adopted after the 1997 financial crisis primarily targeted regular workers in large firms, the employment adjustments for this type of worker during the post-crisis period tend to be less governed by market mechanism and the non-regular workers in SMEs are more directly exposed to a market-driven employment adjustment process. Table 11.4, which reports the simple correlations between employment growth and GDP growth, demonstrates these changes rather effectively. In order to compare the growth rate of employment of the given quarter with the GDP growth rates for the same and lagged periods, the correlation coefficients are calculated on the

The Korean economy between two economic crises 225 basis of quarterly growth rates. For the entire period included in the analysis (from the first quarter of 1990 to the second quarter of 2010), the correlation coefficients for temporary workers are in a majority of the cases greater than those for permanent workers. Furthermore, although the correlation coefficients for temporary workers are the greatest with one- or two-quarter lagged GDP growth rates, the employment growth rate for permanent workers is most closely correlated with the three-quarter lagged GDP growth rate. This implies that, as expected, the employment growth rates of temporary workers respond more closely and more quickly to GDP fluctuations than that of permanent workers. When the correlations are indicated for two separated periods, that is, before and after the 1997 financial crisis, there is a drastic contrast. For the total number of employments, although the employment growth rate is the most closely correlated with the one-period lagged GDP growth rates during the post-crisis period, for the pre-crisis period, it was most closely correlated with two- and three-period lagged GDP growth rates. This implies that, during the post-period, the number of new jobs generated adjust itself more promptly to the GDP fluctuations. When the correlations are calculated separately for different types of workers, the differences continue to be important. During the pre-crisis period, the time lag in the employment adjustments seems to be similar for permanent and temporary workers. During the post-crisis period, although employment adjustments for Table 11.4 Simple correlation coefficients of employments with regard to the GDP fluctuations Total number of workers 1990 1/4–2010 2/4 GDP (t) GDP (t − 1) GDP (t − 2) GDP (t − 3) GDP (t − 4) 1990 1/4–1996 4/4 GDP (t) GDP (t − 1) GDP (t − 2) GDP (t − 3) GDP (t − 4) 2000 1/4–2010 2/4 GDP (t) GDP (t − 1) GDP (t − 2) GDP (t − 3) GDP (t − 4)

Non-wage workers

Permanent workers

0.358 0.548 0.627 0.567 0.360

0.160 0.238 0.301 0.335 0.350

0.093 0.189 0.270 0.313 0.293

0.351 0.518 0.525 0.375 0.086

0.237 0.297 0.468 0.494 0.308

−0.187 −0.186 −0.359 −0.256 0.003

0.124 0.123 0.291 0.204 0.112

0.201 0.277 0.368 0.426 0.181

0.261 0.380 0.353 0.293 0.097

0.114 0.171 0.243 0.247 0.188

−0.064 −0.047 0.003 0.176 0.154

0.266 0.402 0.256 0.078 −0.026

Data sources: Bank of Korea and Korea National Statistics Office. ∗ Nonpermanent workers include “temporary” and “daily” workers.

Non-permanent workers∗

226 W. Ok and J. Yang (a)

(b)

1997 crisis

110

110

105

105

100

100

95

95

90 85

2008 crisis

115

90 1997 4/4

1998 1998 1/4 2/4

1998 1998 3/4 4/4

1999 1999 1/4 2/4

1999 3/4

total permanent

85

2008 2008 3/4 4/4

2009 2009 2009 1/4 2/4 3/4

2009 2010 2010 4/4 1/4 2/4

non-wage non-permanent*

Figure 11.9 Employment adjustment during the two crises. Data Source: Korea National Statistics Office. ∗ Nonpermanent workers include “temporary” and “daily” workers.

permanent workers tend to appear only three or four quarters after the GDP fluctuation, these adjustments are made rather promptly for temporary workers. More striking is the fact that the current and quarterly lagged GDP growth rates indicate slightly negative correlations with the employment growth rate. It is also interesting to note that the roles of the non-wage workers, including self-employed and family workers, also changed. During the pre-crisis period, the number of the non-wage workers fluctuated in the opposite direction of GDP growth. This is because a majority of those workers belonged to the quasi-informal sector; therefore, they tended to be reinstated as formal wage workers during economic booms and forced out of the formal sector during downturns. In contrast, the changes in the number of non-wage workers correspond with the GDP fluctuations during the post-crisis period. This is because, under the dual labor market adjustment, the formal employment sector is no longer capable of absorbing these workers even during economic booms. This implies that the non-wage workers have now become one of the important components of the dual labor market adjustment. The employment adjustment process after the 2008 global financial crisis demonstrates how firmly the dual employment adjustments in Korea settled in as a response to the unanticipated negative economic shocks. The difference between the employment adjustment process during the 2008 crisis from that during the 1997 crisis is striking (Figure 11.9). During the 1997 crisis, when the top priority of the Korean business firms was corporate restructuring, the permanent workers were the principal targets of employment adjustment. As the dual employment adjustment settled in, as in the case of the 2008 crisis, the Korean firms no longer adjust their employment levels through permanent workers, but rely entirely on the temporary workers.

The Korean economy between two economic crises 227

Concluding remarks – a tentative evaluation of the new Korean growth regime Before the 1997 financial crisis, the financial and labor market institutions were favorable for the performance of both large firms as well as for SMEs. The relatively stable exchange rate and non-cyclical/relationship-based banking behavior favored investments by SMEs and their active participation in exporting activities. In addition, the performance of the large firms spilled over on the SMEs because in the absence of significant “China Effects,” the success of large firms in the exporting market created new demands for the SMEs, thereby increasing their profitability and stimulating their investments. As a result, the pre-crisis growth regime was able to provide a relatively high growth rate, stable investments, and a low level of income inequalities. On the contrary, the financial and labor market institutions did not appear to provide a plausible economic environment to the SMEs under the post-crisis growth regime. The overall financial liberalization, highly volatile exchange rates, and short-term profit-oriented banking practices significantly reduced the SMEs accessibility to financial resources and their incentive to export. The Korean economy’s increasing interdependence with the Chinese economy has also contributed to disrupting the close relationships between the performance of large firms and that of SMEs. Although large firms perform relatively well in the export markets, the advantages obtained by the large firms from this success do not fall upon the Korean SMEs any more owing to the widespread off-shoring to China. The increased labor market duality not only hampers the stimulation of domestic consumption, but also negatively impacts the SMEs’ capability building by reducing their opportunity to identify skilled workforces, since the large share of wage workers are facing an increasingly unstable employment situation. As a result, despite its moderately good performance in terms of growth, the new growth regime effected relatively weak and highly unstable investments and ever widening income inequalities. In the longer term, there are two possible factors that may influence the sustainability of a new growth regime. On one hand, after the 2008 global financial crisis, the policy makers tended to accentuate financial regulations. Furthermore, there is an increasing fear in Korea regarding the bubble burst, as the Japanese had experienced in the early 1990s; therefore, there is a good possibility that measures may be introduced to control the hyper-volatility of the financial market. On the other hand, the political pressures for addressing the labor market duality are rapidly increasing. The political parties can no longer obtain votes simply by relying on their performance in terms of economic growth and are required to reduce the income inequalities because under the increasing labor market duality, an important proportion of the voters do not perceive the overall growth as real.

Notes 1 A typical example is the additional clause in the regulations of the BIS capital adequacy ratio, which regulates the ratio of owner’s equity for bank (Article 2 of the Banking Act);

228 W. Ok and J. Yang

2

3 4 5 6

7 8

9

10

this clause was amended in February 1999. This regulation induced the commercial banks to focus increasingly on the market-oriented principles in their corporate lending. A view that was widely shared among the Korean policy makers was that the decline in profitability owing to the overcompetition in the banking sector was one of the important causes of the 1997 financial crisis. In this context, in June 2000, the Korean government amended the law on the mergers and acquisitions (M&As) of banking institutions, and based on this, vigorously encouraged M&As between local banks, which had their branches in various metropolitan cities and regions. When the size of a bank is bigger, the “relationship-based” loans become more costly, because the decision-making within the bank becomes more complicated and the use of qualitative data becomes rather limited. See Park (2005) for a more exhaustive empirical study on this topic. For example, the government’s regulations and interventions on the variation in the exchange rate were maintained until December 1997 under the “market average rate system.” The concept of “consumption/investment-led accumulation regime” in this study is different from the one that is usually adopted in the literature of the theory of régulation. We adopt this terminology, especially from an empirical perspective, in order to describe the specificity of the Korean accumulation regime before 1997. The strengthening of consumers’ purchasing power owing to the sharp wage increases since the late 1980s resulted in a strong feedback effect between private consumption and equipment investment. This aspect of the Korean accumulation regime before 1997 appears to be rather similar to those found in the usual Fordism; however, it must be distinguished from the aspects of the usual Fordism, because there existed strong causalities that ran not only from private consumption to equipment investment, but also in the opposite direction. The estimation result obtained from a VAR model, which has not been reported here owing to concerns regarding the length of this paper, confirms this observation. However, in Korea, stock price does not impact private consumption in the same manner as that under the US accumulation regime, which can be characterized as a typical financial-led regime. During the high-growth period, the negative impacts of this subcontract system on SMEs were partially compensated by positive spillover effects resulting from the effective performance of the Chaebol groups. The changes in the firm strategies towards a heavier reliance on outsourcing practices and weakening of the interindustry linkages, owing to the growing offshoring practices of large firms and the development of information technology (IT) industries, appear to make these benefits dissipate. For example, during the strike in Hyundai Motors, the management’s announcement on the collective dismissal of 2,678 workers resulted in a union strike for a period of one and a half months. The strike ended when the management decided to lay off only 277 workers. Finally, Hyundai Motors achieved employment adjustment through contract buyout (“honored retirement”). The probability of unionization increases with the employer’s ability to pay, and the latter is positively associated with the market power of the firm in question. Thus, the union density is 4.6 percent point higher in the concentrated industries. A recent study indicates that in the industries where the three-firm concentration ratio is 10 percent higher than others, although the non-unionized workers earn 1.4 percent more than the other industries on an average, the corresponding figure is 2.4 percent for unionized workers (Kim 2007). The Korean subcontracting system makes these asymmetries in negotiating power even stronger.

12 The great transformations in the Korean economy since 1962 Processes and consequences Hyungkee Kim

Introduction The Korean economy has seen drastic changes since 1962, which signified the first year of government-led industrialization and is considered as the starting point of the Korean industrial revolution. For a period of less than half a century after 1962, there have been significant turning points in the Korean economy. Moreover, there were profound structural transformations in terms of a development model. The 1997 financial crisis was the most significant turning point because the existing development model collapsed and thus facilitated structural transformation. This paper will identify and discuss five turning points and two great transformations in the Korea economy over the past 50 years. Turning points are defined as a partial change in institutions or economic structures. Great transformations are defined as an overall shift in the development model. In the process of the two great transformations, the Korean economy experienced profound structural changes. In the first great transformation after the 1987 workers’ struggles, there was a shift in the development model from an export-led regime to Fordism. In the second great transformation after the 1997 financial crisis, there was another shift in the development model from Fordism to hybrid regime. During the second great transformation, the Korean economy was confronted with low growth and polarization. These problems are not cyclical but a structural phenomenon in that they were brought about by the collapse of the existing Fordist development model and the introduction of neoliberal policies after the 1997 financial crisis. Some major consequences that arose from the second great transformation will be highlighted in this paper; the vulnerability and inequity of the Korean economy will be investigated.

The two great transformations in the Korean economy Viewed from the aspect of the development model, five turning points of the Korean Economy can be identified since 1962, the first year of the Five-Year Economic Development Plan. The first turning point occurred in 1972–3, when the developmental dictatorship regime and the age of heavy industry began. The second turning point occurred in 1975–6, when there were significant changes in both

230 H. Kim the labor market and production systems. This turning point is characterized by a shift from the stage of an unlimited supply of labor to that of a limited supply of labor1 and the introduction of mass production system by the Hyundai Motor Company. The third turning point occurred in 1985–6, when economic dependency began to decrease2 and trade liberalization proceeded. The fourth turning point occurred in 1987, when the developmental dictatorship regime collapsed due to the June civil protests and when democratization of industrial relations was spurred on by the July–August workers’ struggles. The fifth turning point occurred in 1997–8, when a financial crisis that caused the collapse of the developmental state model and introduced neo-liberal policies to Korea occurred. Korean economic history after 1962 is characterized by the rise and fall of the developmental dictatorship model or the developmental state model.3 There were substantial structural changes in the Korean economy in less than half a century. Among the five turning points, two great transformations that had the strongest impact on the structures of the Korean economy can be identified. The first great transformation: from export-led regime to Fordism The first great transformation was the process where multiple shifts occurred. By multiple shifts are meant a shift from a dictatorship regime to a democratic regime in political arena, a shift from a regulated market economy to a liberal market economy in the economic arena, and a shift from an export-led regime to Fordism in the development model. From 1962 to 1987, the Korean economy has been a regulated market economy in which an authoritarian government intervened intensively in the economy. Through the use of preferential loan and sanction, government intervention facilitated the formation and growth of the chaebols, the Korean-specific conglomerates, which became the key players in the export-led growth. Industrial relations were despotic in that they were militaristic, patriarchal, and paternalistic (Kim 2003). The labor movement was oppressed by the government, which prohibited labor rights such as the right to strike and the right to unionize. The development model before 1987 is defined as an export-led regime which involves an accumulation regime with a “mass production-mass export” nexus and “high productivity-low wages” nexus and a mode of regulation with developmental dictatorship and market despotism (Kim 1999). Thus, as shown in Figure 12.1, the macroeconomic circuit of the export-led regime is summarized as a nexus of “mass production–high productivity–low wages–mass export.” The mass production system in the export-led regime was maintained by three pillars: technological dependency (import of core capital goods, technology, and conception functions from abroad), financial dependency (dependency on foreign debts), and commercial dependency (high dependency on the international subcontracting network dominated by the multinational corporations). The labor process model was Taylorist in that work organizations were characterized by the separation of conception from execution, hierarchical control, and deskilled simple labor. A flexible labor market, creation of massive labor forces with simple

The great transformations in the Korean economy since 1962 231 Export-Led Regime Mass Production

Mass Export

High Productivity

Low Wages

Fordism Mass Production

Mass Consumption

High Productivity

High Wages

Figure 12.1 Macroeconomic circuit of export-led regime and Fordism.

skills, and despotic industrial relations were other important elements of the accumulation regime in the export-led regime. The mode of regulation corresponding to the export-led regime is characterized by developmental dictatorship and market despotism. Developmental dictatorship implies investment coordination and credit assignment by the government, and statist economic control with extensive administrative regulation on business activities (Lipietz 1987). Market despotism means the discipline effects of unemployment created from a low bargaining power of workers owing to an excess supply of labor, suppression of labor unions, low union density, and lack of a social security system. Both developmental dictatorship and market despotism became a mode of regulation that gave regularities to the export-led regime. This type of market economy in which developmental dictatorship and market despotism prevail can be defined as a “regulated market economy.”4 Thus, the development model that existed before 1987 can be defined as an export-led regime based on a dictatorship regime, a regulated market economy, and despotic industrial relations. The June civil protests and the July–August workers’ struggles in 1987 brought the export-led regime to a crisis and forced it to transform gradually into Fordism. The June civil protests broke up the dictatorship regime and brought about political democratization. The July/August workers’ struggles put an end to the despotic industrial relations and initiated the democratization of industrial relations. In short, these civil protests and workers’ struggles facilitated the shift from dictatorship to democratization. What were the prominent changes in the process of the shift? First, drastic wage increases after the 1987 workers struggles transformed the low-wage regime into a high-wage regime. On one hand, high wages brought

232 H. Kim about an impediment in the circuit of “mass production–mass export” by decreasing price competitiveness. On the other hand, high wages created a new circuit of “mass production–mass consumption” by shaping a consumption norm of mass consumption. High wages facilitated the shift of the macroeconomic circuit from “mass production–mass export” to “mass production–mass consumption.” Still, high productivity made high wages possible. Thus, the macroeconomic circuit of “mass production–high productivity–high wages–mass consumption” could be completed. This change suggests that, as shown in Figure 12.1, the export-led regime began to transform into Fordism after 1987. After 1987, there were substantial changes in the labor market structures. The rigidity of the labor market and labor market segmentation by firm size were the most prominent phenomena. The enhanced bargaining power of unions and the formation of an internal labor market after 1987 brought about wages and employment rigidity, that is, labor market rigidity. This was especially so in the large firms, where unions were strong and a structured internal labor market existed. As wage differentials and the welfare gap between monopolistic large firms and competitive small and medium-sized firms widened and as labor mobility from small and medium-sized firms to large firms was actually blocked, labor market segmentation by firm size appeared. As for the mode of regulation, political and industrial relations democratization disintegrated developmental dictatorship and market despotism. As the developmental dictatorship collapsed, investment coordination, credit assignment, and administrative regulation by the government loosened. Thus, there was a gradual change in the economic mechanism from a government-led economy to a corporate-led economy, and from a regulated market economy to a liberal market economy.5 Moreover, a collective bargaining system emerged as a major variable in the labor market as labor rights were secured. The social security system such as the Minimum Wage Legislation, the National Pension Act, and the Employment Insurance Act were introduced, even though they were at a rudimentary level. These factors weakened the coercive effect of market despotism or the discipline effect of unemployment. Wage determination and employment adjustment through collective bargaining appeared as a new mode of regulation. However, as the regulated market economy was transforming into a liberal market economy, the governing power of the chaebol firms began to increase; and as openness of the national economy increased after 1986, competition on a worldwide scale intensified. In short, the first great transformation is summarized as a series of multiple shifts from dictatorship to democratization, from export-led regime to Fordism, and from flexibility and homogenization to rigidity and segmentation in the labor market. This transformation proceeded until the 1997 financial crisis. The decade from 1987 to 1997 could be called “the golden age of Korean capitalism,” because the “high growth–high productivity–high wage–quasi-full employment” phenomenon emerged during this period, even though the welfare state was not as mature as it is today. As Table 12.1 shows, wage growth was higher than productivity growth between 1987 and 1996. This fact is remarkable because, both before

The great transformations in the Korean economy since 1962 233 Table 12.1 Growth rates of real wages and real labor productivity in manufacturing industries Year

Growth rate of real wages

Growth rate of real labor productivity

1980–1986 1987–1996 1997–2006

4.2 9.1 4.1

7.4 6.9 8.9

Sources: Korea Labor Institute, KLI Labor Statistics 2007.

14 12 G r o w t h

10

99 00

8 6 4

08

)

R a 0 t e –2

(

88

86

84

91

90

95 94

02 07

01

2

%

87

83

82

85 04

06 05

96

89

93

92 97

03

09

–4 –6 –8

0.675

98 0.680

0.685

0.690

0.695

0.700

0.705

0.710

0.715

0.720

0.725

1-Gini Coefficient

Figure 12.2 Relations between economic growth and income distribution (1982– 2009). Source: Ministry of Strategy and Finance, Bureau of Statistics.

1987 and after 1997, wage growth was much lower than productivity growth. Moreover, during this golden age, high growth paralleled improvement in income distribution, as seen in Figure 12.2. However, in November 1997, a catastrophic financial crisis followed the golden age. Financial crisis brought about numerous bankruptcies, massive unemployment, wage cuts, and negative growth. The golden age of a decade was gone. There are three alternative hypotheses on the causes of the 1997 financial crisis in Korea. One hypothesis contributes the crisis to weak economic structures. There is disagreement on the specific weakness that brought on the crisis: high costs or low efficiencies? If high costs were the problem, was it due to high wages or high land prices? If low efficiencies were the problem, was it government regulation or overinvestment or a Taylorist labor process? Another hypothesis blames imprudent financial liberalization and opening as the primary cause.6 The third

234 H. Kim hypothesis blames the attack of speculative international financial capital on the Korean chaebol firms as the major cause. The latter two hypotheses emphasize that the fundamentals of the Korean economy were strong at the time just before the crisis broke out. Although the crisis had complex origins, the immediate cause of the financial crisis was acute shortage of liquidity, that is, shortage of foreign exchange. A synthetic hypothesis on which most scholars agree is that while underling causes were the weakness of the economic structures from low efficiency, the immediate cause was imprudent financial liberalization and opening The second great transformation: from Fordism to hybrid regime The 1997 financial crisis decisively disseminated the existing development model and drastically changed the structure of the Korean economy. Therefore, the financial crisis provided the real momentum for the second great transformation of the Korean economy. This, which began just after the unprecedented economic crisis following the 1997 financial crisis, was the transition process from a developmental state to neoliberalism, from a mass production economy to a knowledge-based economy, and from Fordism to a hybrid regime. Elements of the Fordist accumulation regime, the finance-led accumulation regime, and the knowledge-led accumulation regime mixed to form a hybrid regime with neoliberal characteristics. The second great transformation was facilitated largely by the IMF restructuring program. High interest rates and an austerity policy, which formed the core of the IMF restructuring program, struck a severe blow to the Fordist accumulation regime. The Fordist accumulation regime originally based on mass production and mass consumption was sustainable by Keynesian expansion policy that boosted aggregate demand. However, the monetarist austerity policy recommended by the IMF undermined the very foundation of the Fordist accumulation regime. The high interest rate policy especially aggravated the financial and foreign debt crisis of Korean Fordism based on a high-debt model. It also had a destructive impact on the firms and households which were borrowing much from the banks. Numerous bankruptcies occurred because of the high interest policy of the IMF (Stigliz 2002). The economic consequences of the IMF restructuring program can be summarized as follows: marketization, liberalization, and monopolization of finance in the financial sector, liquidation of high debt and overinvestment and introduction of shareholder capitalism in the corporate sector, flexibilization and polarization of the labor market in the labor sector, and downsizing and privatization of public enterprises in the public sector (Kim and Kim 2005). After the 1997 financial crisis, substantial changes in the financial system, investment patterns, and business management became effective. The changes in the financial system were as follows: complete opening of the financial markets, rapid increase in stocks owned by foreign investors,7 securitization of the financial market, and the introduction of a market-oriented financial system. As for

The great transformations in the Korean economy since 1962 235 the investment pattern and business management, the major goal of management became to increase shareholder value. Thus, the tendency of risk-averting management seeking short-term profitability gained momentum. Table 12.2, which shows an estimation of equipment investment function before and after the 1997 financial crisis, proves that while the current profit rate (β6) had no significant effect on equipment investment before the financial crisis, it had a significant positive effect after the crisis. This means that the short-term profitability became a factor in the investment decision making of the firms after the 1997 crisis. Moreover, as seen in Table 12.2, the proportion of the information technology (IT) industry (β5) had a more significant and positive effect on the equipment investment after the crisis than before. This suggests that this element of the knowledge-based economy became stronger after the crisis. Other prominent changes after the crisis were the differential effects of wages and stock prices on the consumption. As Table 12.3 shows, while real wages (β1) had a positive effect on consumption before the crisis, it had a negative effect on Table 12.2 Estimation of equipment investment function: before and after the financial crisis

α (constant) β1 (real private consumption) β2 (real exports) β3 (real interest rates) β4 (real effective exchange rates) β5 (proportion of IT industry) β6 (rate of operating profits) β7 (real FDI) IMF dummy Adj-R 2

1987.1/4–1997.2/4

1997.3/4–2004.4/4

−5.62∗∗∗ 1.18∗∗∗ 0.24∗ 2.72∗∗∗ −0.15 0.40∗ −0.23 −0.05∗∗ − 0.99

−8.84∗∗ 2.14∗∗∗ −0.46∗∗ −0.65 −2.71 0.66∗∗ 0.30∗ 0.03 −0.11∗∗ 0.98

Sources: Samsung Economic Research Institute (2006).

Table 12.3 Estimation of consumption function: before and after the financial crisis 1987.1/4–1997.2/4 α (constant) β1 (real wages) β2 (stock price index) β3 (real interest rates) β4 (rate of inflation) β5 (unemployment rate) β6 (house price index) β7 (real household loan) Adj-R 2

∗∗∗

7.56 (24.43) 1.32∗∗∗ (8.13) −0.13∗∗∗ (−3.29) −0.03(−0.04) −1.29(−0.67) −5.75∗ (−1.92) −0.35∗ (−1.72) − 0.98

Sources: Samsung Economic Research Institute (2006).

1997.3/4–2005.4/4 10.39∗∗∗ (40.73) −0.01∗∗ (−2.17) 0.06∗∗∗ (3.70) −0.70∗∗∗ (−4.19) −1.52∗∗∗ (−4.34) −2.61∗∗∗ (−9.49) −0.24∗∗ (−3.22) 0.23∗∗ (6.19) 0.99

236 H. Kim consumption after the crisis. In contrast, while the stock price index (β2) had a negative effect on consumption before the crisis, it had a positive effect after the crisis. In Fordism, mass consumption based on high wages is the driving force of the macroeconomic circuit. It is acknowledged that in the finance-led accumulation regime, there is a positive relationship between stock prices and consumption (Boyer 2000). Thus, these facts suggest on one hand that Fordism prevailed before the crisis. On the other hand, they suggest that the elements of shareholder capitalism and the finance-led accumulation regime appeared after the 1997 financial crisis. As a result, corporate governance changed from the chaebol system to the chaebol system8 with shareholder capitalism. Changes in the labor market are noteworthy. Legitimization of collective dismissal just after the crisis through the consensus of labor, management, and government, opened the door to labor market flexibility.9 Labor market flexibility brought about massive unemployment just after the crisis and an increase in non-regular employment in subsequent years. The most outstanding changes in the labor market after the crisis may be the collapse of the internal labor market. As seen in Table 12.4, there has been a substantial increase in the share of hiring experienced workers in the job accession rate after the crisis, in contrast with a drastic decline in the share of hiring new graduates. This suggests that the internal labor market in major companies collapsed after the crisis. As the internal labor market collapsed, the labor market became flexible. Thus, lifetime employment was no longer conventional after the crisis. The collapse of the internal labor market and lifetime employment was really a great transformation of labor market after the crisis. The labor market flexibility in the 2000s was realized in an increase in non-regular employment rather than in unemployment. Thus, labor market was polarized not only between the monopoly and competitive sectors but also between the regular and non-regular workers. While the “rigidity and segmentation” of the labor market prevailed before the crisis, “flexibility and polarization” were the new characteristics of the labor market after the crisis. Table 12.4 Change in hiring pattern after 1997 financial crisis in major companies

Hiring of new graduates (A) Hiring of experienced workers (B) Within a company (C) Other (D) Job accession rate (E) (Total) (A/E) × 100 (B/E) × 100

1996

1997

1998

1999

2000

2001

2002

7.5 4.6 3.6 2.6 18.3 41.0 25.1

5.6 4.2 3.0 2.1 14.9 37.6 28.2

3.8 4.7 4.5 1.9 14.9 25.5 31.5

4.1 11.2 10.5 3.7 29.5 13.9 38.0

4.1 14.4 4.6 3.5 26.7 15.4 53.9

2.5 9.3 3.2 2.3 17.4 14.4 64.6

1.9 8.5 6.7 2.8 19.9 9.5 42.7

Notes: Raw data was from Employment Insurance Data Base. This data includes 13,081 establishments (1,724 establishments in the top 30 chaebol firms, 1,502 establishments in public sector, and 9,855 establishments in financial sector). Sources: Kim and Jeon (2004).

The great transformations in the Korean economy since 1962 237 In summary, there were epoch-making changes in the second great transformation. The elements of two different accumulation regimes, that is, finance-led and knowledge-led, emerged simultaneously. A shift from the developmental state under a dictatorship regime to neoliberalism under the democratic regime and a shift from Fordism to a neoliberalist hybrid regime were the core of the second great transformation.

Vulnerability and inequity of the Korean economy During the two great transformations, the Korean economy grew continuously and the size of the economy expanded tremendously. Presently, Korea maintains the 14th largest GDP in the world and is a member of the G20. However, the vulnerability and inequity of the economy have increased greatly, especially during the second great transformation. First, the potential economic growth rate fell steadily. It was 7.8 percent in 1981–90, but it decreased to 6.3 percent in 1991–2000 and 4.8 percent in 2000–6. As a consequence, the GDP growth rate decreased from 9.8 percent in 1981–1990 to 6.6 percent in 1991–2000 and 3.9 percent in 2001–2008. The growth rate of equipment investment decreased from 12.4 percent in 1981–90 and 8.7 percent in 1991–2000 to 2.9 percent in 2001–8. It was much lower than the economic growth rate in 2001–08. One of the causes of low investment might be the effect of shareholder capitalism introduced after the financial crisis. Short-termism of financial capital restrained long-term investment. Further, a high dividend in order to increase shareholder value hindered new investment. Next, industrial polarization between the sectors intensified. Linkage between exports and domestic demand weakened largely due to IT industry-biased export. In Korean IT industries, linkage between the exports and domestic demand is weak because dependency on import components and technology is relatively high in the IT industries. The share of IT industries in total exports was 42.8 percent in 2005. The correlation between the exports and equipment investment became negative after the 1997 crisis, as Table 12.1 shows. Meanwhile, there was a drastic decrease in the contribution of domestic demand to economic growth from 6.7 percent point in 1970–1986 and 8.9 percent point in 1987–96 to 1.5 percent point in 1997–2005. The fact that the contribution of domestic demand to growth was the greatest in 1987–96, although negligible in 1997–2005, gives a very important implication to the structural changes in the Korean economy after the financial crisis. On the one hand, this suggests that a genuine Fordism, in which economic growth was led by domestic demand based on high wages, was established in 1987–96, when the first great transformation occurred. On the other hand, it suggests that Fordism collapsed after the 1997 financial crisis, which then ignited the second great transformation. Weakening of industrial linkages between large firms and small- and medium-sized enterprises owing to global outsourcing by large firms was another phenomenon after the crisis. Third, income polarization between the groups also intensified. During 1987–96, the golden age of Korean capitalism, income inequality decreased as the

238 H. Kim

Know ledge Inv estment (% of GDP)

trend of the Gini coefficient as Figure 12.2 indicates. However, income inequality increased abruptly after the crisis. The Gini coefficient stayed at a high level even after the crisis was overcome. Income polarization, which intensified dramatically just after the crisis, has not mitigated substantially as yet. This sustained income polarization was brought about by multiple factors such as the financial crisis itself, a price increase of real estate, a finance-led accumulation regime, and a knowledge-based economy. Fourth, jobless growth emerged prominently after the crisis. The employment inducement coefficient10 decreased greatly. While the employment inducement coefficient of the final demand was 63.7 persons in 1980, it decreased to 9.7 persons in 2006. While the economic growth rate in 2006–8 was 4.2 percent, the employment growth rate was 1 percent. Thus, employment elasticity11 was 0.24 in 2006–8, while employment elasticity in 1971–5 was 0.53. This drastic decrease in employment elasticity suggests that jobless growth appeared in the Korean economy. Jobless growth was most prominent in the manufacturing industry. Employment elasticity in the manufacturing industry decreased from 0.26 in 1981–97 to −0.10 in 1998–2006. Moreover, the share of non-regular employment increased from 26.8 percent in 2001 to 33.3 percent in 2010. Although more jobs were created in service industries, those were largely low-wage jobs. These facts show that decent jobs decreased after the crisis. Fifth, social investment and social protection were poor, despite high income inequality and high flexibility of the labor market. As Figure 12.3 shows, while knowledge investment as a percentage of GDP belongs to the top level among OECD countries, social investment as a percentage of GDP is the lowest in the OECD countries. High knowledge investment and low social investment are characteristics of the development model of Korea. This suggests that while the shift

8 US

7

Sweden

Korea

Finland

6

Canada

5

Japan

4

Denmark Netherlands Germany

Australia

France Austria

UK

3 Spain

2

Italy

1 0 0

5

10 15 20 25 Socail Ex penditure (% of GDP)

30

35

Figure 12.3 Knowledge investment and social expenditure of OECD countries (2001). Source: OECD Factbook 2006.

Expenditure on Labor Market Program (% of GDP)

The great transformations in the Korean economy since 1962 239 6 Denmark

5 4

Netherlands Finland

Germany

3 France

Sweden

2

Spain

Austria Italy

1

Australia Japan

0 0

1

2

Canada UK Korea

3 4 5 6 Labor Market Flexibility Index (Hiring and firing Practices)

US

7

8

Figure 12.4 Labor-market flexibility and expenditure on labor-market policies (2001). Source: OECD Factbook 2006, Lawson and Bierhanzl (2004) p. 122, Table 1.

from the mass production economy to the knowledge-based economy is almost completed, the shift from the developmental state to the welfare state is retarded. Last, as Figure 12.4 shows, while the labor market flexibility index was rather high, expenditure on labor market programs as a percentage of GDP was very low. In circumstances of high labor market flexibility, high expenditure on active labor market policies such as vocational training is needed to enhance the labor market security. However, labor market insecurity is very high because of a high labor market flexibility and low expenditure on labor market policy. A flexible and insecure labor market was one of the features of Korea’s development model.

Concluding remarks Neoliberalism under the democratic regime (1998–2007) could not proceed at full speed because the democratic government was reluctant to introduce neoliberal policies. However, as the conservative party seized power in the 2007 presidential election, the elements of neoliberalism intensified. The policy orientation of the new conservative government was neoliberalist in that deregulation of the labor market and financial market, tax cuts, and privatization were the core policies of the government and the ruling party. Extensive real estate tax cutting was the most prominent neoliberal policy. Nonetheless, neoliberalism under the conservative regime has been confronted with a strong resistance from people who wanted to stop neoliberal policies such as the privatization of health insurance and introduction of market principles into education. The unprecedented “candlelight protests” in the summer of 2008 blocked the government’s attempts to implement neoliberal policies. Moreover, the 2008 financial crisis originating in the USA deterred the neoliberal policies,

240 H. Kim because the government was obliged to implement the expansionary policies to cope with the economic crisis. However, the government never gave up the basic orientation of the neoliberal policies. If the ongoing crisis is overcome, the government will not hesitate to implement neoliberal policies extensively. The 2008 economic crisis showed that the existing finance-led neoliberal accumulation regime is not sustainable because of its severe volatility and polarization. The neoliberalism toward which the Korean government is oriented may no longer be sustainable. With the 2008 economic crisis, the phase of the second great transformation in the Korean economy will come to an end. The third great transformation will probably begin in the midst of the present economic crisis. The green growth strategy of the present government, if it is pursued strongly and continuously, could be a driving force of the third great transformation. Transition from the high-carbon mass production economy to a low-carbon green economy would be a core factor driving the third great transformation of the Korean economy.

Notes 1 According to the study by Bai (1982), the turning point in the Korean labor market was around 1975, when real wages began to rise significantly, owing to a relative shortage of labor supply. 2 Net foreign debt that was an indicator of the financial dependency began to decrease from 1985. 3 While some scholars such as Lipietz (1987) defined the Korean model before the 1997 crisis as “developmental dictatorship,” others such as Amsden (1989) defined it as “developmental state.” The former stressed the dictatorship regime in which the state not only oppressed the working class but also led the economic development. The latter highlighted the active role of the state in nurturing the infant industries. 4 Hall and Soskice (2001) classified market economies into liberal market economies and coordinated market economies. They included only western advanced market economies when they analyzed the varieties of capitalism. If the Asian market economies are considered, such as the Korean economy before 1987 and the Chinese economy after 1978 in which the state intervened in the market strongly, we can classify market economies into three categories: liberal, coordinated and regulated market economies. 5 This transition to a private sector led economy and a liberal market economy after 1987 was only in the beginning stage and the transition was very gradual. That transition proceeded rapidly after the 1997 crisis. 6 As mentioned above, financial liberalization and opening proceeded after 1986. 7 In 1997, the share of stocks owned by foreign investors was 14.6 percent, but it increased to 36 percent in 2002. 8 In the chaebol system, the owner as CEO has unilateral decision-making rights. Thus, there was no room for shareholder capitalism in a genuine chaebol system. 9 This consensus was concluded in the Tripartite Commission newly implemented in 1998 at the height of the crisis. 10 Employment inducement coefficient is measured by employed per billion won. 11 Employment elasticity is measured by employment growth rate divided by economic growth rate.

Part III

Diversity of Asian capitalisms: from globalization to Asian integration? The impact of internationalization: distinctive national trajectories but a common domination of competition

13 Asian capitalisms Institutional configurations and firm heterogeneity1 Yuji Harada and Hironori Tohyama

Introduction Recently, the argument about economic integration within East Asia2 has flourished.3 However, the institutionalization of regional integration has never been easy to achieve because of historical complications in this region on the one hand, and conflicting positions among countries with regard to the protection of their own industries on the other. In contrast, the international division of labor in Asian countries such as China, Japan, and Korea, that is, a de facto economic integration, has rapidly developed along with increasing foreign direct investment (FDI) and international production linkages among these countries and with other Asian economies (see Chapter 9). In discussing the relevance and the feasibility of an argument and/or movement for economic integration, we would have to consider the form these economies take, respectively, the differences between them, and their interdependence or complementarity to each other. Therefore, we require an analysis of the diversity of Asian economies. So far, many analyses of Asian economies have taken the approach of juxtaposing historical descriptions concerning different economies (see Chowdhury and Islam 2007). More theoretically, we can imagine a traditional way to explain the diversity of Asian economies and their division of labor, which is the so-called flying geese pattern of economic development. It relies on change in the structure of the international division of labor derived from the economic development and accompanying evolution of dynamic comparative advantage in each economy. Such a simple manner of thinking, however, has to be modified because of the complicated dynamism of Asian economies due to increasing FDI and international production linkages among them as described above. Moreover, the process of economic development in each economy would be influenced by social institutions that correspond with each phase of the development.4 We can see another strand of research in which the significance of institutions is emphasized to explain the diversity of Asian societies. For example, some researches applied the comparative study of welfare states proposed by Esping-Andersen to East Asian societies (see Holliday 2000; Holliday and Wilding 2001). Investigation of the diversity of economic systems in the light of institutions has also been developed in the régulation approach as well as in the varieties of

244 Y. Harada and H. Tohyama capitalism approach (Amable 2003; Boyer 2004c; Hall and Soskice 2001). These two approaches make the point that an economic system is not entirely characterized by a particular domain of institution, but is composed of a bundle of different institutions. It has also been pointed out that institutions can be said to be complementary under certain conditions (Aoki 2001a; Hall and Soskice 2001). On the other hand, empirical analysis identifies the diversity of capitalism using statistical methods and quantified data (Amable 2003; Hall and Gingerich 2009; Hall and Soskice 2001; Pryor 2005). In addition to the diversity of institutional configurations, it should be noted that the heterogeneity of firms has become significant in the era of globalization. In this era, firms are likely to be faced with much severer competition than before. They would each try to find a way to survive under such conditions, so that the differentiation of strategy and/or performance between firms would inevitably increase. Nevertheless, such heterogeneity might be restricted by the institutional configuration of an economy. With these factors in mind, we first investigate the diversity of Asian economies using statistical analysis. Subsequently, we briefly check the correlation between institutional configuration and economic performance by looking at the response of some economies to the financial crisis in 2008. Then, we also show the heterogeneity of Asian firms in terms of whether or not they are engaged in the global market, and show that the diversity of Asian economies is relevant to the heterogeneity of firms. We assume that this analysis based on firm level data contributes to our argument concerning the diversity of Asian economies, which is largely based on macrolevel institutional data. To be sure, the approach employed in this chapter is largely statistical, but our analysis does not deny the descriptive analysis. As mentioned below, there is a lack of quantified institutional data, especially regarding developing countries such as Asian economies, so that it might be difficult to verify the diversity by just a statistical analysis. We will therefore develop our argument incorporating the results of descriptive and historical analyses.

Preceding researches In the literature of varieties of capitalism, we find different types of comparative analysis about economies. In many cases, however, the economies dealt with are advanced ones. Developing economies, especially Asian economies, are not often included. For example, Hall and Soskice (2001) identified two types of economy, liberal market economies (LMEs) and coordinated market economies (CMEs), from the analysis of 22 large OECD countries.5 Hall and Gingerich (2009) confirmed a similar result by more elaborate statistical analysis. While these studies have accomplished pioneering and detailed work, the extent of their analyses is limited to advanced countries. However, we find some studies that investigate the diversity of Asian economic systems. Amable (2003) developed his analysis of 21 OECD countries in which Asian countries, Japan and Korea, were included. He collected data from the

Asian capitalisms 245 late 1990s, prepared by international organizations such as the OECD, with regard to variables grouped as different institutional domains: product markets, the wage– labor nexus, financial systems, social protection, and education. He employed two statistical methods, principal component analysis (PCA) and cluster analysis, for them. One of the characteristics of his analysis is to show that the classification of capitalism is not limited to a binary one but expanded to five types. Japan and Korea are categorized into a group described as representing “Asian capitalism” in comparison with advanced capitalisms.6 Other models are as follows: marketbased, social-democratic, Mediterranean, and continental European model. While it is possible to understand a specificity of “Asian capitalism” compared with occidental advanced capitalisms, it would not be realistic to restrict the breadth of Asian economies to these two countries. On the other hand, Berthelier et al. (2003) compared 51 economies in the world, including developing ones. They collected data in terms of variables categorized into four domains – product market, capital market, labor market, and social relations – from responses to a questionnaire that they administered and from databases developed by different international organizations. They derived eight classes of economies by applying PCA, multiple factor analysis (for MFA see below), and cluster analysis. Here, we look at four groups that concern Asian economies to be dealt with in our analysis: authoritative type including China, Indonesia, and Thailand; emergent-fragile type consisting of Malaysia and the Philippines; two “city-states,” Hong Kong and Singapore, named key junctions of financial trade; and the class consisting of Japan, Korea, and Taiwan characterized by the pursuit of technological progress coupled with the strict security of employment contract. It is partly easy and partly difficult to give a plausible interpretation to the results of this statistical analysis.

Setting up the analysis of institutional diversity Purpose and method Each economy is characterized by their institutional configuration that consists of institutions found in different domains as shown below. From that point of view, we reveal the institutional diversity among Asian economies on the basis of the statistical analyses. More concretely, we investigate what factors determine the diversity and how many categories of Asian economy there are. In addition, we also examine the position of Asian economies in comparison with those of advanced countries. We apply two types of multivariate analysis: MFA and cluster analysis. The former is an extended version of PCA, although it is not that well known. MFA analyzes the variance of observations described by several sets of variable (Escofier and Pagès 1998; Abdi and Valentin 2007). Here, observation and variable correspond to economy and institutions (or economic performance), respectively. Institutions are grouped into some domains. First, we do the MFA. Next, we carry out the cluster analysis on the basis of the result of the MFA to classify the economies into groups.

246 Y. Harada and H. Tohyama Data We deal with 10 East Asian economies and twenty advanced capitalist countries.7 We look at 54 variables from the following six institutional domains to identify the configuration of each economy: financial market (FM), product market (PM), labor market (LM), international trade (International), education (Edu), social security (SS). In addition, we also include GDP per capita as an indicator of economic development (EcoDev). Data are captured from sources such as the World Bank, IMF, UNDP, and ILO. The detailed list of variables is available in Appendix A. We took data from the period 2004–7 because the data are available and the situation of economies was relatively stable for that period. In fact, we obtain the average of available data of each variable and use it in the analysis.

Typology of Asian economies regarding institutional configuration In this chapter, we draw attention to the diversity of Asian economies as a principal interest. To achieve this purpose, we begin with an analysis of the diversity of a broad range of economies, including Asian economies and advanced countries. Then, we restrict the range of the analysis to Asia. Groups revealed in each analysis indicate the relative position among the economies under consideration. The definitive groups will be determined by taking account of both of the results. Moreover, we will refer to preceding researches in order to make the analysis more robust. Analysis of Asian and advanced economies MFA The first two factors resulting from MFA explain 45.07 percent of the variance of economies (see Figure 13.1).8 The first factor suggests that the degree of economic development – which is correlated with a competitive product market, higher level of social security, and less strict international capital control9 – determines the 27.23 percent of the variance of targeted economies on the positive side. The axis is also affected by the difficulty of entry and exit and/or the difficulty of firing on the negative side. The horizontal axis as a whole may be termed the degree of liberalization of different markets. On the other hand, the second factor explains 17.84 percent of the variance. It can be interpreted that the vertical axis represents the contrast of trade dependence and domestic social protection. More concretely, the public expenditure on education and the dependence on external trade determine the second factor on the positive side. Moreover, the vertical axis is also defined by the rigidity of employment and the degree of replacement rate on the negative side. We can confirm how different institutional domains influence the determination of the first and second factors. Institutional domains represented as several sets of variable are scattered in the first-second factorial plane, Figure 13.2. That figure illustrates that the effects of different institutional domains on the factors are diverse. For example, the level of economic development primarily defines the

Asian capitalisms 247 Contrast of Trade Dependence and Domestic Social Protection Higher public expenditure on education More dependence on external trade

6

Cluster 3 SGP HKG

The second factor (17.84%)

4 Cluster 2 MYS

2

Cluster 5 Cluster 1

USA

TWN

IND

0

Regulated product and labor markets

Cluster 4

THA

PHL

GBR AUS

KOR CHN

JPN

SWZ DNK

Degree of Liberalization of Different Markets Higher degree of economic dev. Competitive product market Higher social security Less international capital control

BEL

FIN SWE NOR GERAUT NLD FRA

PRT

-2

NZL CAN IRL

SPN

ITA

Cluster 6

GRC

Cluster 7

-6

-4

0

-2

The first factor (27.23%)

2

More rigidity of employment Higher replacement rate

Figure 13.1 Relative positions of Asian and advanced economies in the mid 2000s.

first factor, whereas it hardly affects the second. Regulations on a product market affect the first factor rather than the second one, whereas the influence of labor market institutions affects the second factor more than the first. Cluster analysis Carrying out the Cluster analysis10 using the result of the MFA, we get the following seven clusters (Figure 13.1): (CLUSTER 1) INDONESIA AND THE PHILIPPINES

This cluster is characterized by a low level of GDP per capita, regulated product and labor markets, lower level of social security, and stricter international capital control. (CLUSTER 2) CHINA, MALAYSIA, AND THAILAND

These countries have common features of relatively low levels of GDP per capita, regulated product and labor markets, lower levels of social security, stricter international capital control, relatively high public expenditure on education and higher dependence on external trade, and less rigidity of employment and hours worked.

248 Y. Harada and H. Tohyama 1.0

The second factor (17.84%)

0.8

LM

ss

0.6

FM Int

Edu

0.4

PM

0.2

EcoDev

0.0 0.0

0.2

0.4

0.6

0.8

1.0

The first factor (27.23 %)

Figure 13.2 Effect of institutional domains on first two factors.

However, China takes its own values in terms of certain variables such as public expenditure on education and dependence on external trade so that it would have a different position from the other two countries within the cluster. (CLUSTER 3) HONG KONG AND SINGAPORE

We find that they have the following common characteristics: high level of GDP per capita, less regulated product and labor market, less strict international capital control, higher public expenditure on education, much higher dependence on external trade, no rigidity of employment and hours worked, and lower level of replacement rate. Such characteristics would seem to imply the typical configuration of “City capitalism.” (CLUSTER 4) JAPAN, KOREA, AND TAIWAN

Although they show similar characteristics with regard to high GDP per capita, levels of barriers to entry, and public expenditure on education, they exhibit their own features in terms of other variables. Therefore, there appears to be less cohesion within this cluster. In particular, Taiwan is situated differently in its position from the other two countries.

Asian capitalisms 249 (CLUSTER 5) AUSTRALIA, CANADA, UK, IRELAND, NEW ZEALAND, AND USA

This cluster has the characteristics of high GDP per capita, a certain level of social security, less regulated product market and international capital control, relatively high public expenditure on education, less rigidity of employment security, and lower level of replacement rate. We term this “Advanced liberal capitalism” after the LMEs presented by Hall and Soskice (2001). (CLUSTER 6) AUSTRIA, BELGIUM, SWITZERLAND, DENMARK, GERMANY, FINLAND, NETHERLANDS, NORWAY, AND SWEDEN

Common characteristics to this cluster are high GDP per capita, a certain level of international capital control and barriers to entry, higher dependence on external trade, secured employment, relatively high replacement rate. We may term this “welfare capitalism,” although the strategies of some countries regarding social security differ from the others. (CLUSTER 7) SPAIN, FRANCE, GREECE, ITALY, AND PORTUGAL

They share common features as follows: a certain level of regulation in product markets, full-fledged social security, a certain level of international capital control, a not so high dependence on external trade, high rigidity of employment security, and high replacement rate. This may be termed “European mixed capitalism.” It is interesting that the result corresponds with that of Hall and Soskice (2001), in which the cluster was exceptional but was called “Mediterranean.” Analysis of the diversity within Asian economies Subsequently, we analyze the institutional diversity within Asian economies. Let us sum up the result. MFA We can explain 54.56 percent of the inertia of Asian economies by the first two factors that result from the analysis (Figure 13.3).11 We will show the variables affecting the two factors below. The first factor mainly consists of the following variables: the degree of economic development, and lower level of regulation in product and labor markets and international trade. Furthermore, As in the previous analysis, we can confirm that the degree of economic development significantly correlates with other variables.12 It may be concluded that the first factor is termed by the degree of liberalization of different markets as in the Figure 13.1. The levels of social security and education principally influence the second factor, which explains 18.66 percent of the variance. The higher the level of public expenditure on social security and the higher the adult literacy rate in an economy, the higher the value of the second factor is situated on the vertical axis. On the other hand, the higher the profitability of the banking system and the public expenditure on education, the lower the position of the economy is on the vertical axis.

250 Y. Harada and H. Tohyama Higer public spending on social security Higher literacy rate

4

JPN

The second factor (18.68%)

3

Cluster 4’

2 KOR Cluster 2’

TWN

1 Cluster 5’

Higher Degree of Economic Development Less regulated product and labor markets Less regulated external trade

CHN

0

Cluster 1’

THA

PHL

Cluster 3’ HKG MYS

-1 IND

SGP

-2

Higher profitability of banks Higher public spending on education

-4

-2

0

2

4

The first factor (35.88%)

Figure 13.3 Diversity within Asian economies in the mid 2000s.

Now we will check the effect of institutional domains (Figure 13.4). The degree of economic development (EcoDev), the product market (PM), and the labor market (LM) have a deep impact on the first factor, but not as much on the second one. As already mentioned, it may be understood by considering the noteworthy correlation between EcoDev and the level of regulation in the PM and LM. Further, we can confirm that the institutional domains such as social security (SS) and education (Edu) mainly affect the determination of the second factor. From the above argument, it could be said that the identity of each economy is preserved in the domains of social security and education, even after the progress of liberalization in different markets along with economic development. On the other hand, the role of the financial market is complex. Considering that the financial market is generally regarded as a symbol of economic liberalization, we could infer that it would affect the first factor as product and labor markets do. However, it actually influences both factors. In the light of more detailed information, it is confirmed that some variables regarding direct finance such as stock market capitalization affect the determination of the first factor; others regarding indirect and/or public finance affect the second. Cluster analysis According to cluster analysis based on the result of the MFA shown above, we can find five clusters within the Asian economies (see Figure 13.3): Indonesia and the

Asian capitalisms 251

1.0 ss The second factor (18.68%)

0.8 FM

0.6 Edu 0.4

International 0.2

LM

PM

EcoDev 0.0 0.0

0.2

0.6 0.4 The first factor (35.88%)

0.8

1.0

Figure 13.4 Effect of institutional domains on first two factors.

Philippines (Cluster 1’); Malaysia, Thailand, and Taiwan (Cluster 2’); Hong Kong and Singapore (Cluster 3’); Japan and Korea (Cluster 4’); and China (Cluster 5’). Almost all the clusters have similar characteristics as the ones resulting from the analysis in the previous section. Cluster 2’ differs somewhat with the incorporation of Taiwan and the exclusion of China. Taiwan is less integrated into the cluster and has many similarities with countries belonging to Cluster 4’. Cluster 3’ shows a characteristic of higher profitability of the banking system in addition to the ones seen in Cluster 3. Cluster 4’ is the Taiwan-excluded version of Cluster 4. Less cohesion remains in the cluster because there is even a gap between Japan and Korea. Cluster 5’ is newly identified and consists only of China. As pointed out in the previous section, China has many similarities with Cluster 2, but has peculiar characteristics with regard to the share of private banks in the banking system, directors’ responsibility in protecting investors, and so on. Transition of economies and persistence of diversity We have so far examined the diversity of Asian economies in the mid 2000s from the perspective of institutional configuration. Now, we will carry out a preliminary investigation of the transition of the diversity. We use the dataset where the data in the mid 1990s are added to the preceding one. The MFA with that dataset demonstrates how the institutional configuration of each economy changes from

252 Y. Harada and H. Tohyama the 1990s to 2000s. However, it should be noted that data from the 1990s are likely to be insufficient because the quantification of institutional data by international organizations such as the World Bank and OECD started in the late 1990s,13 and hence, the analysis is restricted to a preliminary one. Figure 13.5 shows the result. The two axes of the figure are constituted from the first two factors resulted from the MFA. The compositions of variables affecting the factors are analogous to those in the section “Analysis of Asian and advanced economies.” Thus, it may be acceptable to adopt the same names of the axes as the ones in Figure 13.1. Figure 13.5 implies that the diversity presented in the previous sections seems to have existed in analogous form in the 1990s, and that the economies would not converge for ten years at least. The figure also indicates the following points in terms of individual economies: First, Indonesia and the Philippines show peculiar transitions that are very different from the other economies. Second, the position of China does not radically change, contrary to our expectation. This might imply that the institutional configuration of China is comparatively rigid in spite of the embracement of capitalist institutions. Third, by contrast, Japan and Korea are moving more to the right-hand side. This may be interpreted as indicating that both countries made progress in liberalizing their markets for that period. It is also interesting that Taiwan presents a contrasting Contrast of Trade Dependence and Domestic Social Protection OSGP mid-2000s

mid-90s

HKG

3

2 MYS

1

USA THA

GBR

0 IND

DNK

Degree of Liberalization of Different Markets

BEL

JPN

KOR

FIN GER AUTNOR

CHN

-1

IRL

SWZO AUS

TWN

CAN NZL

NLD

PRT

PHL

SWE

FRA SPN ITA

-2

GRC

-3

-2

-1

0

1

Figure 13.5 Transition of economies from the mid 1990s to mid 2000s.

Asian capitalisms 253 shift with the other two countries belonging to Cluster 3. Fourth, as for the advanced countries, we do not observe the approximation of welfare capitalism and European mixed capitalism toward advanced liberal capitalism, contrary to what some economists expect. Rather, the countries of European mixed capitalism seem to move downward in the figure. Definitive groups of Asian economies Considering the results from three earlier sections, the socioeconomic context of each economy, and the preceding research outcomes, we can definitively identify five groups of Asian economies. (Group 1) Indonesia and the Philippines This group is characterized by a lower degree of liberalization of different markets. Moreover, both countries had experienced severe crises in terms of their politicaleconomic regimes: for Indonesia, it was the Asian financial crisis in 1997; and for the Philippines, it was the external debt crisis in the early 1980s. They were subject to structural adjustment policies by the IMF for some time afterwards. Such experiences might have prevented the progress of market liberalization and industrialization, and the introduction of foreign investment, in contrast with Malaysia and Thailand, which are usually recognized as ASEAN countries having relatively similar kinds of economy. We could also confirm that Indonesia and the Philippines moved in the opposite direction to Malaysia and Thailand, as seen in Figure 13.5. Therefore, we could term it “insular semi-agrarian capitalism.” (Group 2) Malaysia and Thailand This group has similar characteristics to Group 1 in terms of the degree of liberalization of markets. Moreover, it indicates relatively higher public expenditure on education and dependence on external trade, and less rigidity of employment and hours worked. Compared with countries in Group 1, they have not been heavily damaged by economic crises. We term this “trade-led Industrializing capitalism” because liberalization and industrialization steadily advanced and the countries are articulated in the network of world trade.14 (Group 3) Hong Kong and Singapore The following characteristics are shared in this group: significant degree of liberalization of different markets, higher trade dependence, lower domestic social protection, and high profitability of the banking system. This may be termed “city capitalism” and is compatible with the category shown in Berthelier et al. (2003). (Group 4) Japan, Korea, and Taiwan Higher economic development and barriers to entry in their product markets are observed as common characteristics. This group is not highly integrated, since

254 Y. Harada and H. Tohyama each country has its own features with regard to other variables. In the analysis within Asia, Taiwan is, in fact, categorized into a different cluster from the one with Japan and Korea. We could confirm such less cohesion even in a time series in Figure 13.5. Moreover, it is observed that even the latter is not highly integrated. Nevertheless, these three countries are comprised in a cluster because from a statistical point of view, it is determined by its relative distance from other clusters on the one hand, and these countries’ historical success in export-oriented industrialization based on a number of innovations in the electrical goods industry on the other. This may be termed “innovation-led capitalism.” It should also be noted that the group corresponds with the result of Berthelier et al. (2003). (Group 5) China It shares characteristics with Malaysia and Thailand as shown in the analysis with advanced countries. This would imply that its institutional configuration becomes heavily capitalist. However, it is isolated from them in the analysis within Asian economies. Such characteristics might evoke China’s peculiar political-economic regime, “selective embrace of capitalism” (Chowdhury and Islam 2007: 15). Furthermore, as is shown below, data at firm level also suggest that China would have a distinctive feature concerning the role of the State. Therefore, we term it “Continental mixed capitalism.” Let us sum up the findings of the analyses so far. We found factors determining the variance of Asian economies. It is governed not only by the degree of liberalization of different markets, which positively correlates with the degree of economic development, but also by the contrast of trade dependence and domestic social protection, consisting of the level of public expenditure on education and social security, the dependence on external trade, the rigidity of employment, and the replacement rate. On the basis of the above factors, we found five groups in the Asian economies that were clearly distinguished from the advanced countries. Some groups correspond with the result of the preceding research.

The diversity of Asian economies, the typology of Asian firms and economic instability The financial crisis of 2008, triggered by the bursting of the USA housing bubble and the subsequent bankruptcy of investment banks, devastated Asian economies and firms. However, the degree to which they were influenced by the crisis seems to differ according to the diversity of Asian economies. We see from Figure 13.6 that there may be a positive relationship between the liberalization of markets and the variability of GDP. This suggests that the more Asian economies have liberalized their domestic markets, the larger the variability of GDP.15 It is likely that the institutional diversity of Asian economies leads to different macroeconomic stabilities. Above all, focusing on financial market poses a question of how financial instability affected GDP growth volatility. In order to answer this question, we selected

Asian capitalisms 255 Variance of GDP Growth Rate in 2004-2009

25 SGP

20

HKG 15 MYS

TWN

10

THA PHL IND

-4

- 3.5

-3

5

KOR

CHN - 2.5

-2

- 1.5

-1

JPN

- 0.5

0

0

0.5

1

Degree of Liberalization of Diifferent Markets

Figure 13.6 Correlation between liberalization and economic stability: the 2000s.

5 0 -5

-5

GDPvolatiity(%)

GDPvolatity(%) 0 5

10

Korea

10

China

-5

0 Financialstress index, USA

5

-5

0 Fnandalstresshdex, USA

5

Malaysia

5 0 -5

-5

0

5

GDPvolatity(%)

GDPvobtity(%)

10

10

Philippines

-5

0 Financialstress index USA

5

-5

0 Fnandalstrasshdex, USA

5

Figure 13.7 Volatilities of GDP growth in Asian economies and the financial stress index in the USA.

four economies according to our typology of Asian economies: China, Korea, Malaysia, and the Philippines. The correlation between GDP growth volatility in Asian economies and financial instability in the United States over the period 1999:Q1 to 2008:Q3 appears in Figure 13.7.16 As can be seen there, volatilities in Malaysia and Korea are correlated with financial instability in the United States, whereas in the Philippines and China, volatilities are less sensitive to it.17

256 Y. Harada and H. Tohyama Given our typology of Asian economies, the correlation in Figures 13.6 or 13.7 implicates that institutional configurations governed how Asian economies evolved in response to a financial crisis. As our typology showed, markets in the Philippines and China are less liberalized than in Malaysia and Korea. More liberalized markets are likely to serve as the channels that transmit shocks more easily, resulting in more fluctuating economies. To be sure, the institutional diversity of Asian economies is likely to be relevant to how they respond to exogenous shocks, but firms even in the same institutional configuration have their individual strategies. For example, some firms operate in a global market and others only in a domestic market. This raises another, but related question of whether or not we can find the diversity of Asian economies in the firm level data. In other words, is the diversity of Asian economies relevant to the typology of Asian firms? Do Asian firms react to exogenous shocks in a different manner that is consistent with the concept of the diversity of Asian economies? In the following subsections, we first categorize Asian firms on the basis of how they are integrated into the global market. Then, we investigate the relationship between the typology of firms and the diversity of Asian economies. Typology of Asian firms The financial crisis that originated in the USA was allegedly transmitted to Asian economies through financial and trade channels. Given these two channels, we categorize Asian firms using two criteria: whether or not they are export oriented, in order to grasp the degree to which they are engaged in the global market, and whether or not they are dependent on foreign-owned commercial banks when financing new investments, in order to understand how they are engaged in the global financial market. In categorizing Asian firms, we use the firm level data collected through the World Bank’s Enterprise Surveys over the period 2002–5. A total of 6,714 firms in China, Indonesia, Korea, Malaysia, the Philippines, and Thailand are used (see Appendix B). Yet not all the variables are for all years for all countries. In order to see whether or not firms are export oriented, we use the question from the Survey: “what percent of your establishment’s sales are: (a) sold domestically, (b) exported directly, (c) exported indirectly (through a distributor)?” On the basis of these questions and answers, we create a dummy variable that takes 1 if a percentage of an establishment’s sales sold domestically (answer (a)) is larger than that of their sales exported directly (answer (b)) and 0 otherwise. In the same fashion, we create a dummy variable that takes 1 if an establishment is dependent on foreign-owned commercial banks when financing new investments and 0 otherwise.18 This variable is expected to grasp how a firm is integrated into the global financial market. Thus, we can obtain the four types of firm based on two dummy variables (see Table 13.1). As can be seen in our sample firms, nearly 73 percent of firms are domestic market oriented while 27 percent are export oriented. Nearly one-half of firms are dependent on foreign-owned commercial banks when raising funds for new

Asian capitalisms 257 Table 13.1 Typology of Asian firms Contribution over the last year of sources of financing for your establishment’s new investment: Foreign owned commercial banks

Export-oriented

No Yes

No

Yes

(A) 2,572 (52.59%) (C) 856 (46.96%) 3,428 (51%)

(B) 2,319 (47.41%) (D) 967 (53.04%) 3,286 (48.94%)

Total

4,891 (100%) 1,823 (100%) 6,714 (100%)

Pearson chi-squared(df = 1) = 16.8500, Pr = 0.000.

investments. According to this typology, firms of the type D are the most global market-friendly, whereas firms of the type A are the least such. The diversity of Asian economies and the typology of Asian firms We now turn to the issue of how institutional configurations are related to these characteristics of firms. In Table 13.2, a cross table of four groups of Asian economies and four types of Asian firm is shown. To begin with, the result of a chi-square test implies that there is a highly significant association between the typology of firms and the groups of economies. This fact shows that the strategies of firms can be influenced by the institutional environment within which they operate. As can be seen in Table 13.2, institutional characteristics such as regulated product and labor markets and stricter international capital control, which are specific to Group 1, are likely to induce domestic market-oriented firms to evolve more than export-oriented ones.19 The distribution of firms in Group 1 could prevent such exogenous shocks as a financial crisis from immediately transmitting to their economies, and result in less fluctuating economies. In contrast, export-oriented firms stand out somewhat and account for 46.35 percent in Group 2 where there is greater liberalization of markets and more foreign investments compared with economies in Group 1. This might lead economies in Group 2 to fluctuate more when they are faced with a financial crisis. Although China shares similarities with Malaysia and Thailand in that they have regulated product and labor markets and strict international capital control, the share of domestic market-oriented firms in China is much larger than in those two economies. This may be due to the fact that the State as a conductor plays a significant role in reorganizing the public and private sectors in China (see Chapter 10). As a result, it may be much easier for the Chinese economy to contain

2,572 (38.31%)

Total

Pearson chi-squared(df = 1) = 1.5e + 03, Pr = 0.000.

325 (22.74%) 925 (40.45%) 148 (24.75%) 1,174 (48.92%) 2,319 (34.54%)

651 (45.56%) 302 (13.21%) 406 (67.89%) 960 (40%)

No export-oriented – Foreign owned commercial banks dependent

No export-oriented – No foreign owned commercial banks dependent

Group 1 (Indonesia, Philippines) Group 2 (Malaysia, Thailand) Group 4 (Korea) Group 5 (China)

B

A

Table 13.2 Diversity of Asian economies and the typology of Asian firms

856 (12.75%)

125 (8.75%) 548 (23.96%) 20 (3.34%) 163 (6.79%)

Export-oriented – No foreign owned commercial banks dependent

C

967 (14.4%)

328 (22.95%) 512 (22.39%) 24 (4.01%) 103 (4.29%)

Export-oriented – Foreign owned commercial banks dependent

D

6,714 (100%)

1,429 (100%) 2,287 (100%) 598 (100%) 2,400 (100%)

Total

Asian capitalisms 259 economic fluctuations caused by a financial crisis. Apparently, China should fall into a different group from Malaysia and Thailand, despite the fact that those three countries share similar institutional characteristics. Regarding Korea, we expected an institutional characteristic such as liberalized markets to induce the number of global market-friendly firms to increase. However, the share of export-oriented firms is unexpectedly much smaller, which accounts for only 7.35 percent. When we take the increasing labor market duality and the dominant share of small- and medium-sized enterprises into consideration, this result may be responsible for the duality in the Korean economy (see Chapter 11). Large firms operating in a global market are supposed to be rather sensitive to exogenous shocks, and they may be large enough to affect the Korean economy as a whole (see Figure 13.7). Moreover, it should be noted that the share of firms depending on foreign-owned commercial banks, the B-type of firm in particular, stands out in comparison with other economies. This bias in the distribution of firms may cause the Korean economy as a whole to be vulnerable to exogenous shocks. Thus, the Korean economy might be sensitive to financial turmoil in the USA. To sum up the above descriptive analysis based on firm-level data, the diversity of Asian economies is likely to be relevant to the typology of firms, and accordingly Asian firms may respond to exogenous shocks in a manner that is consistent with the concept of the diversity of Asian economies.

Concluding remarks In the preceding arguments, we have shown the diversity of Asian economies on the basis of institutional characteristics as well as firms’ strategies. The essential points of our argument are as follows. We found five groups among the Asian economies clearly distinguished from the advanced economies. This diversity seems to be persistent, and Asian economies did not converge to one single model, at least for the 10 years under investigation. It was also found through investigating firm-level data that the diversity of Asian economies is relevant to the typology of firms, which are categorized on the basis of how they engage in the global market. We also showed that the diversity of Asian economies could account for how Asian firms and economies respond to exogenous shocks. Given our empirical results indicating that Asian economies are likely to evolve in a manner that is consistent with the concept of the diversity of Asian economies, it should be argued that the so-called flying-geese paradigm is replaced by the diversity of Asian economies paradigm when trying to understand the dynamics of Asian economies. As noted above, we acknowledged that our statistical analysis is restricted so as to reach a robust conclusion because of limited availability of data, institutional data, and microlevel data, in particular. Therefore, we need to reinforce our arguments presented in this chapter by utilizing the results of descriptive and historical analyses.

260 Y. Harada and H. Tohyama

Appendix A: data source 1 List of Variables for the Analysis of Institutional Diversity Institutional Domains

Variables

Source

Financial Market

Stock Market Capitalization/GDP Private Bond Market Capitalization/GDP Public Bond Market Capitalization/GDP Bank Concentration Net Interest Margin Bank ROA Protecting Investors Extent of disclosure index Extent of director liability index Ease of shareholder suits index Getting credits Depth of credit information index Public registry coverage Private bureau coverage Ownership of banks Interest rate controls/negative real interest rates

World Bank A New Database on Financial Development and Structure

Employing workers Difficulty of hiring index Rigidity of hours index Difficulty of redundancy index Rigidity of employment index Redundancy costs Minimum wage Centralized collective bargaining

World Bank Doing Business

Starting business Procedures (number) Time (days) Cost (% of income per capita) Min. capital (% of income per capita) Closing business Recovery rate (cents on the dollar) Time (years) Cost (% of estate) Price controls Administrative requirements Bureaucracy costs

World Bank Doing Business

Labor Market

Product Market

World Bank Doing Business

Gartner and Lawson (2010) Economic Freedom of the World

Gartner and Lawson (2010) Economic Freedom of the World

Gartner and Lawson (2010) Economic Freedom of the World

Institutional Domains

Variables

Source

International Trade

Net Direct Investments (% of GDP) Net Portfolio Investments (% of GDP) Current Account (% of GDP) Ratio of Export to GDP Ratio of Import to GDP Mean tariff rate Standard deviation of tariff rates Non-tariff trade barriers Foreign ownership/investment restrictions Capital Controls

IMF Balance of Payments Statistics Online

Education

Social Security

Economic Development

Gartner and Lawson (2010) Economic Freedom of the World

Combined Gross Enrollment Ratio Adult literacy rate (% of population aged 15 years and over) Public expenditure on education as % of total government expenditure Public education expenditure as % of GDP Pupil-teacher ratio, primary Share of expenditure for tertiary education (% of total education expenditure)

UNDP Human Development Index

Public Social Protection and Health Expenditure as percentage of GDP Public Social Protection and Health Expenditure as percentage of General Government Expenditure Public expenditure on health (% of GDP) Private expenditure on health (% of GDP) Gross replacement rates (Individual earnings, % average) men, 100% Gross replacement rates (Individual earnings, % average) women 100%

ILO Social Security Expenditure Database

GDP per capita

IMF World Economic Outlook Database

World Bank, Education Statistics, Ministry of Education, Republic of China Educational Statistical Indicators Taiwan

OECD Society at a glance: Health care expenditure

OECD & World Bank (2007) Pensions at a Glance

262 Y. Harada and H. Tohyama

Appendix B: data source 2 World Bank, Enterprise Sirveys

China Indonesia Korea Malaysia Philippines Thailand Total

Year of survey

Number of enterprises

2003 2003 2005 2002 2003 2004

2,400 713 598 902 716 1,385 6,714

Note: http//www.enterprisesurveys.org/?cid=FPD_EnterSurveyAlert EN_EXT

Notes 1 The authors gratefully acknowledge the editors for valuable comments and constructive suggestions. Of course, the usual caveat applies 2 According to the World Bank (1993), “East Asia” includes not only northeast Asian countries such as China, Japan, and Korea, but also southeast Asian countries such as the members of ASEAN. For the sake of simplicity, we call East Asia by “Asia.” 3 For example, the East Asia Vision Group has compiled a report entitled “Towards an East Asian Community: Region of Peace, Prosperity and Progress” in 2001. Its vision “goes beyond economic cooperation and extends into political, security, environmental, social, cultural, and educational arenas” (Munakata 2006, 12). 4 Masahiko Aoki proposes a new version of the flying geese pattern of economic development that takes account of the influence of political institutions and social norms. See http://www.vcasi.org/sites/default/files/geese-basic-J.pdf. 5 The countries categorized into LMEs are Australia, Canada, the United Kingdom, Ireland, New Zealand, and the United States. CMEs consist of Austria, Belgium, Switzerland, Denmark, Germany, Finland, Iceland, Japan, Netherlands, Norway, and Sweden. 6 Kitschelt et al. (1999) have proposed the same group as group-based CMEs by expanding the conception of CMEs by Hall and Soskice (2001), although their analysis was descriptive. 7 Countries dealt with are as follows: China (CHN), Hong Kong (HKG), Indonesia (IND), Japan (JPN), Korea (KOR), Malaysia (MYS), the Philippines (PHL), Singapore (SGP), Taiwan (TWN), and Thailand (THA) as Asian economies; Australia (AUS), Austria (AUT), Belgium (BEL), Canada (CAN), Denmark (DNK), Finland (FIN), France (FRA), Germany (GER), Greece (GRC), Ireland (IRL), Italy (ITA), the Netherlands (NLD), New Zealand (NZL), Norway (NOR), Portugal (PRT), Spain (SPN), Sweden (SWE), Switzerland (SWZ), the United Kingdom (GBR), and the United States (USA). 8 We identified three factors whose eigenvalues are more than one; but we omitted the third one here because it explains jut 7.3 percent of the variance. More detailed information of the results of the analyses presented below is to be requested of the authors.

Asian capitalisms 263 9 The correlation between these variables and the level of GDP per capita is 0.78, 0.66, and 0.73, respectively. 10 We apply the Ward method. Calculating values of the aggregation index at each level of hierarchy, we decide the number of clusters, cutting off the cluster tree at a certain level that makes a particular number of classes, according to the distance between values of the aggregation index at each level. A longer distance from s classes to s-1 classes implies that the s classes are firmer (Lebart et al. 2002, 180). Moreover, it is also important that cutoff at a certain level has a convincing implication in reality. The analyses below are carried out in a similar manner. 11 The eigenvalue of the first two factors are 4.817 and 2.508, respectively. We have three more factors whose eigenvalues exceed one. Each of them explains below 10 percent of variance. Therefore, they were omitted here. 12 All are beyond 0.6. 13 Database of Economic Freedom of the World provided by the Fraser Institute employs various methods to trace the data back to the past, although some variables replace others that have equivalent functions (Gwartney et al. 2010). 14 According to data from the ILO, the employment share of industry in Malaysia and Thailand are 29.65 percent and 20.5 percent, respectively, on average for the period 2004–7, both of which are more than the values in Indonesia and the Philippines. 15 More interestingly, we can also find a positive correlation between the second factor of the analysis in the section “Transition of economies and persistence of diversity” and economic instability in 2000s, although it is not depicted here. It may imply that the more dependence on international trade and/or the less employment security Asian economies have, the more the vulnerability of GDP growth. 16 GDP growth volatility indicates cyclical series of GDP growth, which are defined as actual series minus trend series. We obtained trend series by using the Hodorick–Prescott filter. A financial stress index (Cardarelli et al. 2009) is used as a proxy for financial instability in the United States. 17 Countries in Group 3 are not shown in the figure because of limited availability of data. 18 Here, we use the question: “Please identify the contribution of each of the following sources of financing for your establishment: (a) Working capital, (b) New investment,” one option of which is “foreign owned commercial banks.” 19 Non-export-oriented firms account for 68.3 percent, while export-oriented ones, 31.7 percent.

14 The consequences of internationalization of trade and financial transactions on growth Combining an institutional hierarchy hypothesis with a Keynes–Minsky approach Hiroshi Nishi

Introduction: economic growth in the era of financialization and globalization A serious financial crisis that originally began in the US economy in 2008 did not remain limited to the American economy; its impact was felt across the world. Consequently, the performances of the economies that were dependent on foreign countries were seriously affected owing to a decrease in exports or a decline in asset value. In the era of globalization, evaluating the economic performances of national economies has become rather difficult. Moreover, it necessitates a re-examination of the impact of increasing international trade and financial transactions on economic growth. In fact, a number of world economies have experienced profound transformation over the past 30 years; not only domestic economic transactions but also international economic transactions among countries have substantially increased. Epstein (2005) referred to this changing economic landscape as the rise of neoliberalism, globalization, and financialization. Let us briefly reconsider the processes and consequences of financialization and globalization. Financialization began in the modern global economies in the early 1970s. In particular, the abandonment of the Bretton Woods systems, which established the pegged exchange system and capital controls, was one of the origins of international financial liberalization. With the shift to the floating exchange system and financial liberalization, or the so-called financial big bang, new phenomena such as high volatility of exchange rates, high capital mobility, chronic trade imbalances, and international financial crises emerged (Blecker 2005). Dramatic improvements in information communication technology also facilitated international financial transactions. Considering the abovementioned factors, we may employ the conventional meaning of globalization. In other words, based on financial innovation and information technology, economic globalization initially refers to enhancing the mobility of money, people, and commodities beyond national boundaries; this

Combining a hypothesis with a Keynes–Minsky approach 265 results in deepening the economic interdependence among countries. In this context, as indicated by Yamada (2008), it is also rather important that globalization considers the latest facts indicating that international and financial transactions influence domestic institutional forms. The expansion of financial transactions has resulted in the emergence of the so-called finance-led economy or asset capitalism (Boyer 2000; Aglietta 2006). The following four characteristics of this era were established by Yamada (2008): first, the securitization of financial assets; second, the emergence of institutional investors; third, the financialization of household income, and lastly, the global expansion of security investments. Moreover, Crotty (2005) indicated the following two primary characteristics of this new era: on the financial side, the proportion of the financial asset values or total financial income in the gross domestic product (GDP) has significantly increased in numerous countries and across the global economy. On the real side, as product market competition intensifies at a global level, non-financial firms are compelled to adopt short-term survival strategies such as stock price maximization, “downsize and distribute,” etc. “Downsize and distribute” is a concept that was introduced by Lazonick and O’Sullivan (2000). It implies that managers downsize the corporations they control, especially by reducing the size of the labor forces in order to increase the return on equity. In other words, the increase in finance influences the form of employment within the organization. Therefore, it may be observed that as the financial market develops globally, price competitions become more severe and the role of compromise between labor and capital for determining macroeconomic performance becomes less effective. Such transformation is not independent of change in the so-called institutional hierarchy, as will be discussed subsequently. Do such changes in institutional forms effect stable and high economic growth? This chapter employs the Keynes–Minsky framework for theoretically studying economic performance. We also attempt to apply the research result of institutional economics that essentially focuses on institutional hierarchy. It investigates the relationship between macroeconomic performance and institutional structure. In post-Keynesian economics, Hyman Minsky’s “financial fragility hypothesis” emphasized the financial side of the economy. In the preceding researches conducted by Minskians, the dynamic mechanism of financial fragility is examined primarily in terms of the firms’ financial positions, interest rates, and capital accumulation. They revealed that the Minskian finance regimes (hedge, speculative, and Ponzi) change according to the levels of external debt, interest rate, and accumulation rate (e.g., Foley 2003; Nasica and Raybaut 2005; Charles 2006; Lima and Meirelles 2007). Therefore, the Minskians focused on macroeconomic dynamics and external finance. Following Taylor and O’Connell (1985), this chapter introduces another aspect of the Minskian perspective. Taylor and O’Connell (1985) had indicated Minskian panic by means of a portfolio comprising a variety of financial assets. In the scenario developed by them, interest rates increase owing to a high substitutability among the assets in the rentiers’ portfolio, which reduces investments and decreases profit rates. Consequently, the macrodynamics of debt

266 H. Nishi deflation effects a cumulative decline in the valuation of firms’ capital assets and their net worth. We believe that Taylor and O’Connell’s (1985) model is useful for examining an economy where the financial system is highly developed. For example, in a financial system where a number of assets are defined, the frequency of financial transactions is higher, which enhances the impact of the financial side of economy on the real side. Our attempt to combine a Keynes–Minsky approach with an institutional hierarchy hypothesis enables us to understand why growth and business cycles reflect the institutional structure. In addition, such integration makes the following contributions to Keynesian research as well as to the research regarding institutional economics. Keynesians, especially post-Keynesians, have indicated both theoretically (e.g., Blecker 2002) and empirically (e.g., Bowles and Boyer 1995; Naastepad and Storm 2007) that it is difficult to achieve wage-led growth in the context of the global economy. In other words, wage increases do not necessarily result in high economic growth. This is primarily owing to the fact that profit stimulates export demand, or that an increase in wage is considered to be a cost for firms rather than a source of effective demand. On the basis of these investigations, Keynesians analyzed the mechanisms of growth by considering a change in income distribution as an explanatory variable. However, income distribution may not always be a source of growth or stagnation; it could be a consequence of growth. To the best of our knowledge, no attempt has been made to investigate the possibility of inverse causation between income distribution and economic growth from a Keynesian perspective.1 By employing the concept of institutional economics, we will demonstrate the reasons for the possibility of the occurrence of such transformation. The issue of economic performance and institutions has been examined in terms of institutional complementarity at the national level. Institutional complementarity is believed to be present when the existence of a particular form assumed by an institution in one area reinforces the existence, operation, or efficiency of another institution in another area. This concept has been employed in order to explain why and how capitalism differs (Boyer 2005a). However, discussions regarding institutional hierarchy continue to be descriptive or static. Therefore, the manner in which institutional hierarchy influences economic performance remains unclear. According to the institutional hierarchy hypothesis, institutional forms change in such a manner that price competition (Petit 2005), international regime (Boyer 2004c), and monetary regime (Boyer 2000; Aglietta 2006) become predominant; they believe that the role of the wage–labor nexus has been the most ineffective. Essentially, a thorough discussion is necessary for empirical identification of which institution is the most effective; however, owing to increasing price competition and financial transactions, a change in institutional hierarchy necessitates a comprehensive theoretical analysis of the global economy. Therefore, we use a dynamic model for attempting to indicate the manner in which the viability of economic growth is related to the hierarchical institutional form of a national economy. This chapter is organized in the following manner: the second section briefly reviews the importance of institutional hierarchy for economic growth. The third

Combining a hypothesis with a Keynes–Minsky approach 267 section focuses on the institutional forms. The fourth and fifth sections present our model and examine the dynamic property of macroeconomic performance. The final section also discusses a few results. The last section concludes this chapter.

Institutional hierarchy hypothesis and its role in macroeconomic performance Essentially, the concept of institutional hierarchy was introduced in recent studies by French régulationists. According to Boyer (2005b), institutional hierarchy describes a configuration wherein certain institutional forms impose their logic on the entire institutional architecture, lending its dominant style to the mode of régulation. Similar to Boyer’s (2005b) definition, Amable (2003) regards institutional hierarchy as the relative importance of one or a few institutions for determining the structure of complementarity and the dynamics of institutional architecture. These institutions comprise economic actors whose activities are guided by the institutions themselves. Therefore, institutional hierarchy implies that although institutions induce specific behaviors of economic actors and economic performance, a few behaviors are effective, and others are ineffective – institutions have asymmetric functions. Based on such understanding, institutional hierarchy emphasizes the analysis of economic performance and institutional structures for predominant institutions. For example, the wage–labor nexus was the most important determinant during the so-called Fordist period; this was the period when a compromise between capital and labor was established. Such a compromise resulted in macroeconomic dynamics with the synchronization of mass production and consumption stimulated by real wage increases. However, since the 1970s, a number of changes such as securitization, shareholder value revolution, and increase in international portfolio investment have occurred. As mentioned in the previous section, such transformation is termed “financialization.”2 Boyer (2000) and Aglietta (2006) indicated that changes in investment behavior and redistribution of income from labor to shareholders create a stock market boom, which in turn stimulates consumption expenditures. Therefore, a financial variable instead of wages is considered to be the determinant of economic growth. Accordingly, the growth regime is altered to make it a financeled regime. In this regime, international and financial transaction variables play an important role in economic performance, and compel the wage or employment adjustments to remain flexible. In other words, institutional forms that support financial transactions at both domestic and international levels predominantly impose their logic on wage and employment determination, and on macroeconomic performance. The institutional hierarchy indicates that the determinant of macroeconomic performance changes historically. It must also be noted that institutional hierarchy does not always lead to favorable economic performance because of the following reason. Let us reiterate that institutional hierarchy implies the existence of predominant institutions that influence the functioning of subordinate institutions. However, the hierarchy among these institutions may be defined according to the relative importance of these

268 H. Nishi institutions for social groups (e.g., manager and labor, managers and shareholders) (Amable and Palombarini 2009). In other words, each institution is not a priori designed to derive superior macroeconomic performance. Therefore, inconsistencies among the functioning of the institutions may result in low or unstable economic growth. Moreover, introducing a reform in an institutional area for improving economic performance does not necessarily produce the expected result or may produce a less favorable result. Considering these arguments, it is rather important to analyze the macrodynamics in order to examine the conditions for macroeconomic performance to be viable with a certain institutional hierarchy.

Establishing the institutional hierarchy hypothesis in an open economy This section explains the institutional forms focused on by this chapter. Using régulationists’ terminology, the four institutional areas and their economic activities may be summarized in the following manner: (a) form of competition: intensification of price competition among domestic and foreign firms, (b) international regime: international trade in real and financial terms under the floating exchange rate system, (c) monetary regime: the existence of various assets and international financial transactions, (d) wage–labor nexus: employment adjustment on the basis of employment security. These ostensible four institutional areas defined by the régulationists are useful for conducting an institutional analysis of the economy. However, the economic activities in an area are usually surrounded by those in other areas. An open economy and its institutional structure are depicted in Figure 14.1. Figure 14.1 indicates that the domestic firms, household workers, capitalist rentiers, and a foreign country are economic actors. The domestic firms produce a single commodity using two factors of production, i.e., labor and capital, and a fixed coefficient technology. Although this commodity is employed for both domestic and foreign use, it is in a substitutive relationship with foreign commodities. The domestic firms are assumed to adjust output in response to the changes in effective demand, and they invest on the basis of current profit rates. The net export demand is added to aggregate demand, which is determined by the domestic effective demand, exogenous export demand, and exchange rate. The effective demand determines the total income that is distributed to the households as well as to the capitalist rentiers. Both households and capitalist rentiers spend a fraction of their incomes on consumption. In addition, capitalist rentiers are assumed to possess assets. Finally, it is assumed that the supply of labor grows at an exogenous rate, and that the total employment is below the full employment level. The international price competition compels both the domestic and foreign firms to accept a given price, which impacts the profit margins and the unit labor cost of both domestic and foreign firms. Therefore, the form of competition, i.e., point (a) above, assumes that international competition invalidates the domestic oligopolistic system and that domestic firms cannot determine the prices of their products at their own discretion. In other words, this assumption considers the

Combining a hypothesis with a Keynes–Minsky approach 269 Change in interest rate (c) Monetary regime (Assets market)

(Goods market) Effective demand = Total output

---------------------------

Money Equity Domestic bonds Arbitrage Foreign bonds

(b) Floating exchange rate system International regime

Consumption Investment Government expenditure Net export

(a) Price competition Total income

(d) Wage–labor nexus

Wage bill Profit bill

(Labor market) -------------------

Labor demand Wage rate

Figure 14.1 Institutional structure in an open economy.

era wherein “a bulwark against the cutthroat international competition” (Yamada 2008) collapsed. The floating exchange rate system as indicated in point (b) above is defined as the primary institution with respect to international regime. However, as we will subsequently establish, this regime is not an independent institutional area; it is also related to economic activities under the monetary regime, forms of competition, and wage–labor nexus. The floating exchange rate system indicates that the domestic currency fluctuates according to the changes in the return on assets and the purchasing power parity. Under the floating system, international interest rate differences and exchange rate risks influence the value of currency, which in turn influences the firms’ sales. Consequently, these financial conditions may control the net export demand and the stability of economic growth. Recently, the term financialization is being used for referring to the growing dominance of the market-based financial system (Epstein 2005; Skott and Ryoo 2008). Therefore, adjustment in the monetary regime is considered to be one of the characteristics of a market-based financial system. Uni (2009) indicated that in a market-based system, price adjustments such as interest rates and equity prices play a relatively dominant role in the allocation of funds. In addition, as the global financial system develops, diverse financial assets will be available and must be selected prudently. In order to describe this situation, the following four assets

270 H. Nishi available in the international financial market are considered: domestic money, equity, bonds, and foreign bonds. The capitalist rentiers consider the rate of returns including the profit and the interest rates for allocating their financial assets. These financial assets allocations are adjusted according to the interest rates and equity prices. Point (c) mentioned above, considers the allocations of financial assets. Finally, point (d) introduces employment adjustment on the basis of employment security, which is measured as the elasticity of employment to output fluctuation. As mentioned above, in the institutional hierarchy of a financially led economy, variables concerning international and financial transactions play a dominant role, and compel the wage or employment adjustment to be flexible. In this context, the functioning of reforms aiming at employment flexibility is examined. Moreover, these reforms are assumed to be determined according to institutional hierarchy. In our model, institutional hierarchy is established in the following manner: international regime > monetary regime/form of competition > wage–labor nexus (the inequality indicates the hierarchical relationship). In order to embody this hypothesis, the concept of “closure” is employed. Closure introduces causality into our model, and indicates the determinants of the macroeconomy.3 The selection of closure is country specific and time dependent, and its attributes enable or constrain the behavior of economic actors in principal institutions. Therefore, the macroeconomic dynamics are not independent of institutional forms, which are embodied by closure. It must be reiterated that institutional hierarchy implies that adjustments in predominant institutional areas impose unilateral constraints on adjustments in the subordinate institutional areas. In this context, using closure, our model explains that variables concerning international and financial economic activities play a dominant role and since these variables influence the variables concerning wage and employment, the latter play a subordinate role.

Combining the institutional hierarchy hypothesis with a Keynes–Minsky dynamic approach The following are the major notations that are employed henceforth: X is the output (total income), X ∗ is the potential output, K is the capital stock, E is the effective employment level, σ is the wage share, 1 − σ is the profit share, X ∗ /K = ν is the potential output–capital ratio (constant and set to unity for simplicity), X/K = u is the output–capital ratio (effective demand),4 r = (1 − σ )u is the profit rate, C is the consumption demand, I is the investment demand, G is the government expenditure, g = I /K = K˙ /K is the actual rate of capital accumulation, W is the nominal wage, P is the price level, e is the nominal exchange rate, i is the nominal interest rate, and z is the relative price between domestic and foreign products. Price and income distribution under a competitive market structure Initially, the price levels and income distributions are examined. The competitive environment compels both domestic and foreign firms to accept a given price level.

Combining a hypothesis with a Keynes–Minsky approach 271 Given the price level, the wage and employment levels, and the profit margin are given by

WE P = X

(14.1)

and PF =  F

WF E F XF

(14.2)

respectively, where  > 1 is the gross profit margin and the subscript F indicates foreign variables. In the domestic economy, the total income PX is distributed among the household workers as wage income and among the capitalist rentiers as profit income. On the basis of the mark-up pricing, the domestic wage share is given by WE/PX = 1/, and the profit share is given by rPK/PX = 1 − 1/. The former is denoted by σ and the latter by 1 − σ . Since the price levels in each of the countries is given, the relative price, z = PF /P, in each of the countries is also given according to time t. The exoge∗ , where the hat symbol indicates nous growth rate of the price is denoted by P the growth rate (e.g., xˆ = (d x/dt)/x). This formalization implies that the international competitive environment compels the growth rates of the product prices for both the countries to also be given. This functions as the first “closure” in equation (14.3), which is indicated below. In addition, it is assumed that domestic firms endeavor to obtain a fixed proportion of the profit share in order to satisfy the demands of capitalist rentiers with a sufficient distribution of income, or they may survive the era of international competition by maintaining a high rate of profit. In this case, equation (14.1) may be expressed dynamically in the following manner: +E = P ∗ +  W X

(14.3)

We will subsequently derive the so-called Phillips curve on the basis of this equation. Effective demand and dynamics of output adjustment Household workers earn wage income and capitalist rentiers receive profit income. Although the household workers spend their entire income, the capitalist rentiers spend only a small proportion of their income. Therefore, the consumption demand at the macro level is given by: C = C W + C P = σ X + (1 − s P )(1 − σ )X

(14.4)

where C W and C P denote the amount spent on consumption from wage and profit incomes, respectively. s P ∈ (0, 1) denotes the capitalist rentiers’ propensity to save a portion of their profit income.

272 H. Nishi The following linear investment function, which is based on the profit principle, is employed: K˙ = I = (g0 + g1 (1 − σ )u − g2i )K

(14.5)

where g0 is a constant term and g1 represents the profit effect on investment. The negative effect of the nominal interest rate on the investment is given by −g2 i . 5 The government expenditure is also introduced in a countercyclical manner. For example, Stockhammer (2008) demonstrated that despite recent neoliberal stream, the government share in GDP continues to remain high in numerous countries, which contributes to the stability of the economy. The government expenditure is represented in the following manner: G = (α + βG (u G − u))K

(14.6)

where α is a positive as well as constant, which implies that government spending is proportionate to capital stock. u G represents a government’s target output– capital ratio, which is assumed to be exogenous. Under the assumption that βG is positive, the second term in the parenthesis implies that the government supports economic activity when the economy is in recession. In an open economy, the net export term is included to indicate additional demand. The net export, N X, is defined in the following manner: N X = (ε0 + ε1 ez − ε2 u)K

(14.7)

where ε0 is a positive constant term that represents the external demand conditions. The term ε1 ez implies that a depreciation of the domestic currency stimulates net exports, where the term ez is the product of the nominal exchange rate and the constant relative price. Coefficient ε1 is assumed to be positive since the so-called Marshall–Lerner condition is likely to be effective in the medium as well as the long run. Finally, the term −ε2 u implies that imports increase when the domestic economy is booming. The following equation defines the dynamics of output adjustment:

X C + I +G + NX u˙ = φ − (14.8) K K where φ denotes the positive speed of adjustment. This implies that the rate of capacity utilization changes according to the excess demand, which is measured by the unit of capital stock. Substituting equations (14.4)–(14.7) into equation (14.8) yields the dynamics of output–capital ratio under the floating exchange system, which is given by u˙ = φ[−u{(1 − σ )(s P − g1 ) + βG + ε2 } + α + ε0 − g2i + βG u G + ε1 ez] (14.9)

Combining a hypothesis with a Keynes–Minsky approach 273 Financial transactions under the floating exchange rate system Let us consider a case wherein the development of an international financial system enables a domestic economy to possess worldwide assets. It is assumed that the domestic economy possesses four assets including domestic money, bonds, equity, and foreign bonds. In this case, given a constant foreign growth rate and a risk premium on the other foreign financial assets, the foreign bonds are assumed to be a proxy for all foreign assets (Yoshikawa 2009). Following Taylor and O’Connell (1985) and Yoshikawa (2009), we derive the equilibrium condition in the asset markets. First, the equilibrium of the domestic asset markets is considered. There exists an outside primary asset, F, or fiscal debt that may take the form of money, M, or short-term bonds, B, that are held by the capitalist rentiers. The firms’ outstanding stock of equity is defined by Q and its market price is denoted by pq . The following equation expresses the total wealth of the capitalist rentiers, which is denoted by A: A = M + B + pq Q

(14.10)

The change in the capitalist rentiers’ wealth over a period of time is given by A˙ = M˙ + B˙ + p˙ q Q + pq Q˙ = p˙ q Q + s P (1 − σ )X

(14.11)

where it is assumed that firms do not offer fresh equity, and the wealth of capitalist rentiers increases from capital gains and savings. At every occasion, capitalist rentiers allocate their wealth across various assets as expressed by the following equations: μ(i, r )A − M = 0,

μi < 0,

μr < 0

(14.12)

ε(i, r )A − pq Q = 0,

εi < 0,

εr > 0

(14.13)

and ω(i, r )A − B = 0,

ωi > 0,

ωr < 0

(14.14)

where the demand share for each asset must satisfy μ + ε + ω = 1. The subscripts i and r indicate partial derivatives with respect to the interest rate, i , and the profit rate, r , whose signs and values determine the asset preferences. This implies that although an increase in the profit rate stimulates the demand for equity, it decreases the demand for money and domestic bonds. Further, although an increase in the interest rates on bonds (return on bonds) increases the demand for bonds, it decreases the demand for equity. The demand for money changes negatively with respect to an increase in both the interest and the profit rates. Only two equations of equations (14.12), (14.13), and (14.14) are independent. Following Taylor and O’Connell (1985), equations (14.12) and (14.13) are

274 H. Nishi .

employed for the money and equity markets, respectively and i and pq are the corresponding equilibrating variables for these two markets. The excess demand function for bonds (equation (14.14)) will be equal to zero if the other excess demand relationships satisfy the same condition. From equation (14.12), the money market excess demand function is given by μ(i, r ) − [1 − ε(i, r )]λ = 0

(14.15)

where λ = M/F ∈ (0, 1) is the proportion of the fiscal debt issued as money, which is set as constant. Equation (14.15) is analogous to the standard LM equation, and a change in r owing to u creates a variation in i . It must be noted that r = (1 − σ )u; therefore, differentiating equation (14.15) yields ηi di + ηr du = (1 − ε) dλ

(14.16)

where ηi = μi + εi λ < 0 (−)

(14.17)

(−)

and ηr = (μr + εr λ) (1 − σ ) (−)

(+)

(+)

(14.18)

Evidently, ηi is negative. This is because a higher bond interest rate reduces the demand for both money as well as equity. However, the sign of ηr is ambiguous, since it depends on the degree of substitution between money and equity. If these assets are low substitutes, then εr > |μr |. In such a case, ηr di =− >0 du ηi

(14.19)

and the so-called LM curve is upward sloping. On the contrary, if money and equity are close substitutes for capitalist rentiers, then the magnitudes of the two partial derivatives will be close to each other; therefore, εr ∼ = |μr |. In this case, if λ is sufficiently small, then ηr < 0. Therefore, in this case, we have the following equation: di ηr =− |μr |, then the steady state of the macroeconomy is locally stable. Proof: When the elements of the Jacobian matrix, J1 , which are included in equations (14.26) and (14.27), are evaluated at the steady state, they are defined in the following manner:

∂ u˙ di j11 = = −φ δ + βG + g2 ∂u du j12 =

∂ u˙ = φε1 z ∂e

(14.29) (14.30)

Combining a hypothesis with a Keynes–Minsky approach 277  di ∂ e˙ =− (14.31) j21 = ∂u θ du ∂ e˙ j22 = = − (14.32) ∂e It must be noted that in case of low substitutes of money and equity assets, the sign of di /du is positive; therefore, their signs are summarized in the following manner:   − + J1 = − − The necessary and sufficient conditions for the steady state of the dynamic system to be locally stable include trace J1 = j11 + j22 < 0 and det J1 = j11 j22 − j12 j21 > 0. It is trivial that the dynamic system satisfies these conditions.  Proposition 1 implies that if the degree of money and equity substitution is low, a shock in demand generates a new stable equilibrium. Figure 14.2 indicates the phase diagram. Let us consider the case of a decrease in demand. A decrease in demand lowers the output–capital ratio, which decreases the profit rate and demand for equity. In case of low substitutes, since the change in the demand for money is rather trivial, the interest rate decreases, thereby realizing equilibrium in the assets market. Owing to these financial dynamics, a lower interest rate directly increases the investment demand, and indirectly stimulates the net export demand by effecting a depreciation of currency. Consequently, the output–capital ratio increases, which generates a new equilibrium. Therefore, this negative feedback loop between the real and financial sides of the economy produces stable dynamics. On the contrary, let us consider a case wherein money and equity assets are close substitutes for capitalist rentiers. In this context, the following proposition may be substantiated.

u

e˙ = 0

u˙ = 0

e Figure 14.2 Stable dynamics in case of low substitutes.

278 H. Nishi P ROPOSITION 2 If money and equity assets are close substitutes, i.e., εr ∼ = |μi |, then the steady state of the macroeconomy may become unstable. Proof: Under the close substitutes assumption, the elements of the Jacobian matrix, J2 ,are comprised in equations (14.29)–(14.32) and the sign of di /du is negative. This yields the following equations: di trace J1 = j11 + j22 = −(φδ + φβG + ) − φg2     du (+) (−)

and

ε1 z di det J1 = j11 j22 − j12 j21 = φ δ + βG + g2 +    θ du    (+) (−)

According to these signs and a large absolute value of di /du, the following types of instability may be detected: 1 Given that the values βG , δ, and  are small, if the value of g2 is sufficiently large, then trace J2 takes a positive sign. 2 Given that the values of βG and δ are small, if the values of ε1 , z, and g2 are sufficiently large, or the value of θ is sufficiently small, then the value of det J2 takes a negative sign and the system descends into saddle-path dynamics. Let us consider an empirical fact that the exchange rate adjustment occurs much faster than the change in output. An extreme case is that the exchange rate adjustment is simultaneous, which may be represented by the infinite value of . Integrating equation (14.25) with respect to time, where t ∈ [0, s], yields 

s

e(s) exp(s) − e(0) =  · e M ·

exp(t) dt 0

e(s) = e M − [exp(−s)][e M − e(0)] Given the point s, if  → ∞, then e(s) = e M . However, the sign of det J2 depends on the signs of the terms in the bracket. 3 Therefore, regardless of the speed of exchange rate adjustment, the saddle-path unstable dynamics continue to exist owing to the chain among the changes in interest rates and exchange rates, and their impact on investment and net export. 

Combining a hypothesis with a Keynes–Minsky approach 279 u

e˙ = 0

u˙ = 0

e Figure 14.3 Unstable dynamics in case of close substitutes.

Taylor and O’Connell (1985) proposed that the close substitution effect between money and equity create unstable dynamics; this is a well-known fact among postKeynesians. The following indicates their interpretation of the Minsky crisis: a reduction in confidence increases the interest rates and reduces the profit rates, thereby generating additional money for rentiers and increasing their interest rates further. As a result, investments are depressed, expected profits fall even further, and this process becomes endless. Proposition 2 depends on the preferences of capitalist rentiers who consider money and equity assets as close substitutes while selecting assets. However, this result indicates that unstable dynamics occur because of the impact of the asset preferences of capital rentiers not only on investments, but also on net exports owing to the changes in the exchange rates. Figure 14.3 presents a possible phase diagram. A large ε1 z implies that changes in exchange rates excessively stimulate external demand, which represents the real-side dynamics of international economies. In contrast, a small θ implies that international differences in financial returns strongly impact the exchange rate. These destabilizing factors emerge from the financialside dynamics of an international economy. If the profit rate reduces owing to a negative demand shock, it results in an increase in the interest rate, thereby generating additional money for capitalist rentiers. In this process, the domestic currency appreciates, and net exports as well as investments are depressed. Therefore, both the expected profits and the stock price, pq ,7 fall even further. Overall, although a negative real shock in demand is one of the factors that causes internal stagnation, it is primarily accelerated by financial and external factors.8 Finally, if there is obvious instability, then it becomes necessary to implement certain economic policies. One possibility is to increase countercyclical expenditure by the government, i.e., a large βG . Minskians believe that such a policy ensures economic stability, which is termed “institutional dynamics.”9 In this regard, the result obtained here also supports the Minskians’ argument as well as the following result obtained by Stockhammer (2008), which has also been

280 H. Nishi discussed earlier in the paper; in a financialized economy, government intervention may be necessary and this increases the government’s share in GDP. Wage and employment adjustment under institutional hierarchy The impact of institutional hierarchy on wage and employment determination, which did not play any role in the abovementioned growth and cycle, is examined in this subsection. Since the output–capital ratio is constant (i.e., u ∗ = X/K ) at the steady state, the growth rate of effective output is equivalent to the growth rate of capital stock. The growth rate has been determined in equation (14.5), and the wage and employment growth path must satisfy equation (14.3). ˙ The growth rate of unemployment is measured as υ = n − E/E, where n denotes a given growth rate of the labor population. Subsequently, from equation (14.3) the “Phillips curve” may be expressed in the following manner:  =υ −n+ P ∗ + g ∗ W

(14.33)

Since equation (14.33) has one degree of freedom, an additional equation is necessary in order to complete the model. Therefore, the manner in which the fluidization of employment operates is examined. Let γ ∈ (0, 1) represent the elasticity of employment to output variation. A small value of γ implies that the employment adjustment is inflexible or sticky (high employment security), and a large value implies that it is flexible (low employment security). The adjustment may be formalized in the following manner: = γ g E

(14.34)

 is positive. Substituting equation (14.34) into equaand it is assumed that E tion (14.33), yields the steady state locus of the Phillips curve in unemployment and wage plane, which may be expressed in the following manner:



1−γ 1−γ  ∗ W =− υ+ n+P (14.35) γ γ ∗ represents the where −(1 − γ )/γ represents the slope, and (1 − γ )n /γ + P intercept of the curve. Here, let us consider a case where sufficient labor force is available in the economy, i.e., υ > 0. Using equation (14.35), we obtain the following proposition. P ROPOSITION 3 The fluidization of the labor market, wherein the labor demands change rapidly with respect to output fluctuation, does not stimulate economic growth, and only results in a flatter locus of the Phillips curve. Proof: By differentiating with respect to γ yields  1 dW 1 = 2υ − 2n dγ γ γ

Combining a hypothesis with a Keynes–Minsky approach 281

W

W0

PC0

W1

PC1 P*

υ1

υ0

υ

Figure 14.4 Phillips curve and flexibility of employment adjustment.

This exercise indicates that when γ is close to zero (sticky employment adjustment), the curve becomes vertical. On the other hand, as the labor market becomes more fluid, the steady state locus of the Phillips curve becomes flatter.  The growth rate is indicated in equation (14.5), which initially determined the 0 . Given the degree of employunemployment rate, υ0 , and wage growth rate, W ment security γ , the shape of the Phillips curve is determined. The initial situation is displayed by the broken line. If the labor market becomes fluid owing to reduced employment securitization (i.e., a rise in γ ), then the Phillips curve (PC) rotates from PC0 to PC1 , as depicted by the solid line in Figure 14.4. Given a particular growth rate, the unemployment rate is initially determined at a lower rate 0 to W 1 (e.g., υ1 ), and subsequently, the growth rate of wages also fall from W owing to a flatter Phillips curve (PC1 ). This proposition is rather important for an economy with institutional hierarchy. The proposition indicates that as long as sufficient labor force is available over a period time, flexible employment adjustment only makes the locus of the Phillips curve horizontal. Although fluidization of employment may reduce the unemployment rate, it also decreases the wage growth. Moreover, under the institutional hierarchy established thus far, employment flexibilization or increase in wages do not impact economic growth. This is because economic growth rate is already determined through the economic activities undertaken in institutional areas other than the wage-labor nexus. Therefore, the institutional adjustment of employment is not independent of other institutional forms.

Conclusion This chapter developed a Keynes–Minsky model by incorporating the increasing price competition at both the domestic and international levels, various financial assets, the floating exchange system, as well as employment adjustment. These variables were formalized in terms of the institutional hierarchy hypothesis and

282 H. Nishi Table 14.1 Macroeconomic performance indicates institutional hierarchy Dominant institutions

Functions assumed

Macroeconomic variables determined

International regime

Trade with competition and Interest rate difference, nominal financial transactions under exchange rate, and net export floating exchange system Monetary Transactions of varieties of Domestic interest rate and stock regime financial asset price Form of Force the firms to behave as Price and real exchange rates competition price-takers Output growth rate is determined by the economic variables resulting from dominant area Subordinated institution

Functions supposed

Macroeconomic variables determined

Wage–labor Employment security Wage and labor demand nexus Behaviors of wage and labor variables are determined as residual

the dynamic performance of macroeconomy was investigated. As mentioned in the introduction, historical change in institutional hierarchy is associated with globalization and financialization. Table 14.1 summarizes the hypothesized institutional structure and the results obtained in this chapter. In our model, the institutional structure is assumed to correspond to the following institutional hierarchy hypothesis: international regime > monetary regime/form of competition > wage-labor nexus. The asset transactions and international trade with severe price competition play an active role beyond the domestic economy, and these activities generate economic growth. In addition, wage and employment rates are determined as a result of growth with severe competition and financial transactions. Our results sharply contrast with the well-known propositions of régulationists (e.g., Boyer 1988) or post-Keynesians (e.g., Cassetti 2003). They explain that the change in wages may impact income distribution, effective demand, and growth rate. This depicts a situation where the so-called wage–labor nexus could still influence income distribution and economic growth and the era when workers had bargaining power and could participate in the wage determination to a certain extent (e.g., Fordist growth regime). In this context, wage and growth may have a direct or indirect relationship with employment rate. However, the transformation of institutional hierarchy may invalidate such macroeconomic dynamics. The evolution of wages may not be a source of growth, but may be the consequence of growth. Even if the domestic economy is booming, it is not necessary that wage and employment demonstrate a corresponding increase. The growth rate is determined by the economic activities undertaken in institutional areas other

Combining a hypothesis with a Keynes–Minsky approach 283 than the wage–labor nexus. This hypothesis offers the following important insight: institutional forms that support transactions in real and financial terms at both domestic and international levels predominantly impose their logic on wage and employment determination, as well as on macroeconomic performance. Therefore, the dynamics of economic performance must be understood by considering various types of institution, since an institution itself is related to other institutions in different ways, for example, by way of hierarchy. With respect to Asian capitalism, the model in this chapter may be close to the institutional configuration of the Chinese economy, if not to say that it corresponds completely. Let us refer to Chapter 10 by Boyer. According to his diagnosis, the form of competition dominates the structure of institutional hierarchy. In such an institutional structure, production costs constantly decline, and firms find it difficult to control the process of price determination of their own products. Under such severe competition, capital accumulation creates a tendency to overinvest and results in the creation of overcapacities. It is also important that the form of competition dominates the wage-labor nexus. A wage–labor nexus in this economy is characterized by serialized and segmented workers, and restrained wage share. Consequently, the overcapacity generated by investment under cut-throat competition cannot be absorbed by workers’ consumption, thereby creating a gap. In this sense, there is an imbalance in the generation of domestic demand in China. This is one of the reasons why the Chinese economy has to depend on external demand in order to reduce this gap. However, it must also be noted that monetary and international regimes implied in this model do not fit the actual regimes. The most important difference is the determination of the exchange rate; the Chinese exchange rate is basically administrated using a floating exchange rate system with a currency basket system. In this system, the proportion of exports in the GDP has drastically increased since the 1980s. In other words, although the opening of the Chinese economy is quantitatively considerable, authorities continue to strictly control the capital flow and the interventions in the exchange rate market. Our theoretical assessment indicates that such controls in monetary and international regimes that have been able to sustain a stable trajectory of the Chinese economy, which actually has a potential unbalanced domestic growth regime. On the contrary, if the international financial markets are more open and developed, and government interventions are less strict, then an exogenous shock by an autonomous decrease in exports, for example, may create endogenous instability owing to the stagnation of effective demand as well as to the transactions in international financial markets where numerous financial assets are available. If China experiences a dual change of deeper integration with the world economy and financialization both externally and internally, it may create unstable dynamics. Therefore, the theoretical analysis in this chapter is brings to light the potential macroeconomic dynamics of a financially developed economy with external demand dependence.

284 H. Nishi

Notes 1 As expected, naive neo-Keynesian models, à la Kaldor and Robinson, are not appropriate for discussing such issues. Their models assume a priori full capacity utilization case, and explain that high growth rates result in low wages. However, we will indicate that low wages do not necessarily accompany high growth rates even under the Keynesian low capacity utilization case. 2 Stockhammer (2008) also presented the financialization phenomenon. Our formalization attempts to introduce his observations regarding the proliferation of new financial instruments, the liberalization of international capital flows, and increasing instability in the exchange rate markets. In addition, he indicated that the impact of these factors on the economic growths of the USA and the European economies differed in some respects. Besides, Skott and Ryoo (2008) explored some financialization phenomena by extending the Kaleckian and Harrodian models. However, their model remains a closed one and does not consider institutional settings. 3 With regard to the relationship between closure and institutional forms, and such justification, see also Taylor (1991) and Pasinetti (2005). 4 In our model, the output–capital ratio is determined by effective demand. This ratio also plays the role of the capacity utilization rate, which is measured as the ratio of effective output to potential output(X/K ) · (K / X ∗ ). This is proportionate to u since the potential output-capital ratio, ν, is constant. Throughout this chapter, these terms will be employed interchangeably. 5 Since the inflation rate is constant in our model and is an exogenous variable, for simplicity, this negative impact in terms of the real interest rate is not considered. 6 Following Yoshikawa (2009), the arbitrage condition between the domestic and foreign bonds in terms of initial equilibrium has been formalized. Therefore, the explicit international capital flow function may be dispensed. 7 From equations (14.10) and (14.13), the stock price may be derived in the following manner:

F ε pq = 1−ε Q As is evident, for a given F/Q, pq increases as demand for equity ε increases. During a depression period, where interest rates increase and profit rates decrease, the capitalist rentiers substitute equity with money, and ε decreases. Therefore, using Taylor and O’Connell’s (1985) model, we can explain that stock prices decrease during depression. 8 In case of the existence of close substitutes, this system may have a zero trace value. However, it does not reflect the Hopf bifurcation. The proof is rather straightforward. Let g¯ 2 represent the value that ensures that trace J2 = 0. It is evident that g¯ 2 also satisfies the equilibrium condition of the system. Substituting this value in det J2 yields

 ε1 z di det J2 (g¯ 2 ) = φ − + φ θ du and this value is negative. Therefore, it does not satisfy the condition for the existence of Hopf bifurcation. 9 Minskians believe that institutions play a role in public interventions such as monetary policy and government expenditure, and indicate that sufficient countercyclical measures contribute to the stabilization of economy (Keen 1995; Nasica and Raybaut 2005).

Analysing conditions for monetary integrations: Asia and Europe

15 Comparative analysis of conditions for monetary integration Europe and Asia Hiroyuki Uni Introduction In this chapter, we aim to investigate the conditions for monetary integration in Asia and the EU and to measure productivity growth in export goods and non-tradable goods. One of the necessary conditions for long-term viability of monetary integration is that the relative prices of export goods between member countries do not change greatly. For instance, if Germany’s export prices were constant, the increase in Italy’s export prices would contribute to Italy’s cumulative trade deficit. Before monetary integration, this cumulative trade imbalance was prevented by the adjustment of exchange rates, such as the appreciation of the mark or the depreciation of the lira. After monetary integration, however, such adjustment became impossible. In the original EU member countries, the above necessary condition for monetary integration, that is, stability in the relative price of export goods, was accomplished by equalizing the inflation rate to a low level, as follows. Figure 15.1 shows the ratios of export prices to wholesale prices in the original EU member countries. All these ratios were constant at near one. This means that the prices of export goods and of non-tradable goods changed at a similar rate. Therefore, when the inflation rate declines to a low level under the Maastricht criteria of economic conversion, the price of export goods also becomes stable. Thus, if prices of export goods are stable in all the member countries, the above necessary condition for monetary integration is accomplished. For simplicity, we suppose that the wage rate is uniform within each country, the price of each good is the sum of its unit labour cost and the mark-up, and the markup rate is constant. Then, a proportional change in the prices of export goods and non-tradable goods means a proportional change in the productivity of these two goods. Furthermore, when this proportional growth rate of productivity is equal to the growth rate of wages, the prices of export goods and non-tradable goods remain constant. Therefore, the main way to accomplish the Maastricht criteria of economic conversion that aim to equalize the inflation rate to a low level is the depression of the growth rate of wages toward the growth rate of productivity. Previously, the former tended to exceed the latter. However, the reality after the currency unification in 1999 was different from the above-mentioned ideal. As shown in Table 15.1, the inflation rate in these

288 H. Uni 1.6 1.4

Germany France

1.2

Italy Belgium

1.0

Sweden Spain

0.8 0.6 1980

85

90

95

2000

Figure 15.1 Ratios of export prices to wholesale prices in EU; 1995 = 1. Source: IMF, International Financial Statistics.

Table 15.1 Changes in prices and trade deficits in Euro-area countries (unit: %) Country

Germany Greece Portugal Spain

Annual average growth rates (2001–8)

Current account/GDP

CPI

PPI

Export price

Relative price = Export price/PPI

2001

2008

1.8 3.4 3.0 3.3

2.8 4.9 2.9 3.4

0.2 2.8 1.4 2.2

−2.5 −2.0 −1.4 −1.2

0.0 −7.2 −9.5 −3.9

6.6 −14.6 −11.7 −9.6

Note: Export prices are exports of goods and services deflator in the National Accounts. Source: United Nations, Statistical Database of the Economic Commission for Europe.

countries was not zero. The reason is that the labour productivity of export goods grew faster than that of non-tradable goods from 2003 onwards. Under the above assumption, this disproportional productivity growth brought about a decrease in the relative price of export goods against non-tradable goods. Then, the price of non-tradable goods rose even when the price of export goods was kept approximately constant by wage rise at a similar rate as the productivity growth in export goods. This was the case in Germany. A more serious problem than inflation is the increase in export prices in Greece, Portugal, Spain, etc. The main reason for this is that wages rose faster than the labour productivity of export goods. The increase in export prices lowered the international price competitiveness of these countries. This was because the export price in Germany, which is the largest export country in Europe, was almost constant and because the adjustment of exchange rates was impossible after currency unification. As a result, the current account

Comparative analysis of conditions for monetary integration 289 of these countries worsened. The trade deficit increased cumulatively in Greece, Portugal, and Spain, whereas the trade surplus increased in Germany, as shown in Table 15.1. This trade deficit and fiscal deficit are the background of the European debt crisis and the subsequent euro crisis from the end of 2009 onwards. A counter-measure to the crisis is the austerity policy, such as wage cuts and government expenditure reduction in Greece, Portugal, Spain, etc. In these European countries, however, the differentials in productivity growth between the non-trade goods and export goods are smaller than those in Asian countries, as will be explained below; also, the difference between countries is smaller. Therefore, the trade deficit will cease to grow if the export price is kept constant by depressing the excessive wage rise in Greece, Portugal, Spain, etc. Summing up, we think that a basic necessary condition for monetary integration is maintained in the eurozone, although mild inflation accompanies this condition. The ratios of export prices to wholesale prices in Asian countries and in the USA are shown in Figure 15.2. This ratio declines in many Asian countries; that is, the prices of export goods decrease relative to those of non-tradable goods. In this case, even if the inflation rate became zero through the means mentioned above, stability in the relative prices of export goods between countries would not be realised. This is because the prices of export goods in each country would decrease at different rates. Therefore, the above necessary condition for monetary integration is not accomplished in this case. If the prices of export goods were kept constant, high inflation would occur. As will be explained below, the main reason for the relative decrease in the prices of export goods compared to those of non-tradable goods is the relative increase in the productivity of export goods compared to that of non-tradable goods. This ‘export-biased productivity increase’ (Hicks 1953) is a large obstacle 1.6

1.4 Japan Korea

1.2

China Singapore

1.0

Thailand United States

0.8

0.6 1980

85

90

95

2000

Figure 15.2 Ratios of export prices to wholesale prices in East Asia; 1995 = 1. Source: IMF, International Financial Statistics (except for China; Ratio of export deflator to GDP deflator extimated by World Bank).

290 H. Uni to monetary integration. In general, discussions on Asian monetary integration often focus on political obstacles such as insufficient consensus, especially between Japan, Korea, and China. Moreover, the theory of optimum currency areas dominates economic discussions, the focus of which is the symmetry between the short-term impacts of common exogenous shocks in these countries. In contrast to these discussions, we will discuss the economic conditions for monetary integration by focusing on the long-term problem: disproportional productivity growth in export goods and non-tradable goods. The differences between productivity growth in export goods and that in nontradable goods were often argued in the context of the Balassa–Samuelson effect. However, in most previous studies (Canzoneri et al. 1999; Égart 2002; Kovács 2004; Kawai et al. 2003), the manufacturing and service sectors are respectively considered as tradable and non-tradable goods sectors. It is evident that this dichotomy is not satisfactory. We measured productivity growth in export goods and non-tradable goods more precisely by calculating vertically integrated labour input coefficients from input–output (I–O) tables. There is a possibility that export-biased productivity growth might cause either inflation or a cumulative trade imbalance under a fixed exchange rate. Inflation is the result of the price increase of non-tradable goods by the Balassa–Samuelson effect. In fact, as shown in Figure 15.3, if the wages in all sectors and the productivity of export goods increase at the same rate, the price of non-tradable goods increases. We call the configuration shown in Figure 15.3 the ‘Balassa–Samuelson type’. Conversely, as shown in Figure 15.4, if the wages in all sectors and the productivity of non-tradable goods increase at the same rate, the price of export goods decreases. This is likely to cause the accumulation of trade surplus if the exchange rate is fixed. Both inflation and cumulative trade imbalance are unfavourable conditions for monetary integration that aims at the adoption of a common currency. Therefore,

Export goods productivity

=

– Export goods price

+

constant

Wage

Exchange rate fixed

Export goods price constant

>

+ Non-tradable goods price

– Non-tradable goods productivity

increase (inflation)

Country A

Non-tradable goods price constant

Country B

Figure 15.3 Export-biased productivity growth with inflation (Balassa–Samuelson type).

Comparative analysis of conditions for monetary integration 291

Export goods productivity

>

– Export goods price

+

Wage

decrease

=

+ Non-tradable goods price

– Non-tradable goods productivity

Country A

constant

Exchange rate If it is fixed, trade imbalance accumulates

Export goods price constant Non-tradable goods price constant

Country B

Figure 15.4 Export-biased productivity growth with cumulative trade imbalance.

we believe that the basic economic conditions for monetary integration are immature in Asia. However, this does not justify the contemporary exchange rate regime in Asia. The unilaterally managed floating system adopted by most Asian countries has the following defects. When the growth rate of the labour productivity of export goods exceeds that of non-tradable goods in several countries, their currencies need to appreciate against the currencies of other countries in order to avoid inflation and cumulative trade imbalance. However, such appreciation tends to be disliked or rejected under the unilaterally managed floating system. Furthermore, there is the risk of discretionary depreciation for unilateral interests. In order to ensure the necessary long-term adjustment of exchange rates, an institutional arrangement for the multi-lateral coordination of exchange rates is more effective than a unilaterally managed floating system, as shown in Figure 15.5. In the Conclusion, we explain the essential features of this ‘collectively managed floating system’, which can be put in place as a transitional exchange rate system until basic economic conditions for monetary integration mature. This chapter is organized as follows. In the second section, we explain how to measure the productivity growth of export goods and nontradable goods based on input–output tables. In the third section, which shows the results of measurements in Hungary, the Czech Republic, and Slovakia, we examine the implications and institutional background of these results. Specifically, we clarify that the ERMIIlike multi-lateral system for the coordination of exchange rates helps prevent the under-valuation or over-valuation of currencies. In the fourth section, we present the results of measurements of Asian countries from 1990 to 1995 and from 1995 to 2000. Institutional interpretation of these results clarifies the following facts. Most Asian currencies under the dollar-peg system were overvalued against the RMB due to the discretionary devaluation of the RMB against the dollar in 1994. This over-valuation was violently corrected in the Asian currency crisis in

292 H. Uni

Export goods productivity

>

– Export goods price

+

decrease

Wage

=

+ Non-tradable goods price

– Non-tradable goods productivity

Country A

constant

Exchange rate Collectively managed appreciation

Export goods price constant Non-tradable goods price constant

Country B

Figure 15.5 Export-biased productivity growth under collectively managed floating system.

1997. As a consequence of the Asian currency crisis, many Asian currencies were drastically devalued and most countries shifted to the managed floating system. However, the target setting of the managed exchange rate split into two kinds. In the Conclusion, we consider conditions for monetary integration in Asia. The present unilaterally managed floating system has limitations for the adjustment of exchange rates on a long-term basis. We propose an exchange rate regime based on multi-lateral coordination for Asia, whose growth is strongly characterized by export-biased productivity increase.

Measurement of the productivity growth of export goods and non-tradable goods The productivity growth of export goods and non-tradable goods was estimated in the following manner from the I–O tables (Uni 1995). • X is a column vector in which each entry shows the total amount of output of each commodity. • Y is a column vector in which each entry shows the total final demand for each commodity. It is the sum of the domestic final demand (denoted by D) and exports (denoted by F). • A is the input coefficient matrix in which entries in each column show the amount of domestic commodity used by the industry to obtain one unit of output.1 • a is a row vector in which each entry shows the amount of labour directly required to obtain one unit of output in each industry (unit: persons engaged in production).2 • L is a scalar to denote the total labour force (unit: persons engaged in production).

Comparative analysis of conditions for monetary integration 293 The following two equations show the quantity system in a country. (I − A)X = Y aX = L We obtain the following from these equations: (I − A)−1 Y = L We denote a(I − A)−1 = v, where v is a row vector in which each entry shows the amount of labour directly and indirectly required to produce one physical unit of each commodity, that is, ‘the vertically integrated labour input coefficient’ (Pasinetti 1993). vY = v(D + F) = L Column vector D is the product of the total domestic final demand (denoted as  D) and the share of each commodity in this total (denoted as column vector d). Therefore, D = d D Similarly, F = f F We obtain the following equation: v(d D + f  F) = vd D + v f  F = L vd and v f are scalars. These represent the quantity of labour directly and indirectly required to obtain one nominal unit3 of domestic final demand and export, respectively. Labour productivity is the reciprocal of the quantity of labour directly and indirectly required to obtain one physical unit of the product. Therefore, we multiply vd by the domestic demand4 deflators and v f by the export deflators derived from the National Accounts.5 These are ‘the vertically integrated labour input coefficients’. The rates of decrease of these coefficients can be regarded as the growth rates of the labour productivity of non-tradable goods and export goods.6 We pay attention to ‘the unit labour cost of export goods’, which is the product of ‘the vertically integrated labour input coefficients of export goods’ and ‘the wage rate in the manufacturing industry’. The price of an export good consists of this unit labour cost, the imported resources cost, and the capital cost (profit, etc.). In this chapter, we focus on the unit labour cost for the following reasons. First, the weight of the unit labour cost in the price of an export good is the largest. Second, our analysis is a long-term one. In general, the imported resources cost and the

294 H. Uni capital cost do not have significant long-term trends.7 Productivity and wages, both of which are components of the unit labour cost, have significant long-term trends. Therefore, the unit labour cost is suitable as the object of our long-term analysis. Third, the fluctuation of the imported resources cost cannot be controlled directly by exchange rates, even if the weight of the imported resources cost in the price of an export good is large in small Asian countries.8 In these countries, most foreign trade is done on a dollar basis. The export price in dollars consists of the unit labour cost and the capital cost (in dollars changed by exchange rate), and the imported resources cost. As the imported resources cost is originally on a dollar basis, it cannot be controlled directly by exchange rate. As the benchmark of exchange rates, we focus on ‘the unit labour cost parity (abbreviated as ULCP)’,9 which equates the unit labour costs of export goods between two countries. ULCP = (Country A’s unit labour cost of export goods)/(Country B’s unit labour cost of export goods) = {(Country A’s vertically integrated labour input coefficients of export goods) × (Country A’s wage rate)}/{(Country B’s vertically integrated labour input coefficients of export goods) × (Country B’s wage rate)}. Therefore, the growth rate of ULCP = {(Country A’s wage growth rate) – (Country A’s productivity growth rate of export goods)} – {(Country B’s wage growth rate) – (Country B’s productivity growth rate of export goods)}. For example, when the wage growth rate is equal to the productivity growth rate of the export goods in the USA (Country B), if the productivity growth rate of the export goods is higher than the wage growth rate in Japan (Country A), the value of Japan’s ULCP against the USA decreases. This means that Japan’s ULCP appreciates against the United States. We examine and compare the exchange rates of enlarged EU countries against the euro as well as their ULCPs against Germany. We examine and compare the exchange rates of Asian countries against the US dollar as well as their ULCPs against the USA. Further, we compare their exchange rates against the RMB and their ULCPs against China.

Results of measurements of Central European countries Using the standardized I–O tables10 prepared by Eurostat, we calculated labour productivity (the reciprocal of the vertically integrated labour input coefficient) in Hungary, the Czech Republic, Slovakia, and Germany in 1998 and 2003. As shown in Table 15.2, export-biased productivity increase is prominent in Hungary, the Czech Republic, and Slovakia. This is mainly because of the large inflow of FDI. From 1998 onwards, when their accession to the EU became decisive, the amount of FDI into these countries increased sharply. About 40 per cent of the FDI comprised investment in manufacturing industries. In particular, many automobile, electric, and electronic multi-national enterprises constructed factories for either final products or parts. As these factories are involved in the international division of labour and are equipped with the most advanced technology and equipment, the growth rate of labour productivity is high. Most of the products of these

Comparative analysis of conditions for monetary integration 295 Table 15.2 Productivity, wages, and exchange rates in Central European Countries (1998– 2003, unit: %) Country

Productivity growth

Nominal Inflation Exchange rate ULCP wage growth rate appreciation appreciation

Non-tradable Export goods goods Hungary Czech Slovakia Germany

3.2 3.3 2.9 0.8

11.1 9.1 8.3 1.9

11.9 5.8 8.0 1.9

7.5 2.5 8.0 1.3

0.1 2.9 1.9

−0.7 3.3 0.1

Notes: All growth rates are the annual average of logarithmic increments. The exchange rate appreciation is that against the euro. The ULCP appreciation is that against Germany. Sources: Productivity and ULCP were calculated from the Input–Output Tables (Eurostat), deflators: National Accounts (OECD), nominal wages in the manufacturing industry: Labour Statistics Database (ILO), other variables: IFS (IMF).

factories are exported. According to the 2003 I–O tables, the ratio of exports to the total products in the machinery manufacturing industries (Sector codes 29–35) was 89 per cent in Hungary, 77 per cent in the Czech Republic, and 88 per cent in Slovakia. In the twenty-first century, the annual growth rate of exports in these countries was about 10 per cent, which was twice that of the real GDP growth. Thus, in these countries, the growth rate of the productivity of the export goods exceeds that of non-tradable goods. In Hungary and Slovakia, the growth rate of wages was nearly equal to the growth rate of the productivity of export goods and was higher than that of non-tradable goods. The price of non-tradable goods is likely to increase in such a situation, which is similar to the Balassa– Samuelson model (Balassa 1964; Samuelson 1964). In many interpretations of the Balassa–Samuelson model, the following two assumptions are adopted. The first assumption is the law of one price regarding export goods. The second assumption is that wages and productivity in the export goods sector increase at the same rate.11 Under these two assumptions, when the labour productivity growth of the tradable goods sector exceeds that of the nontradable goods sector, the price of tradable goods will not change and the price of nontradable goods will increase. Consequently, an increase in general prices, that is, the weighted average of the prices of tradable and non-tradable goods, will result in the appreciation of the real exchange rate (Balassa–Samuelson effect). Hereafter, we refer to this case as the ‘Balassa–Samuelson type’, which is shown in Figure 15.3. In fact, as shown in Table 15.2, inflation rates in Hungary and Slovakia were high. On the other hand, the growth rate of wages in the Czech Republic was low and approximately equal to the labour productivity growth of nontradable goods. Therefore, the inflation rate in the Czech Republic was lower than that in Hungary and Slovakia from 1998 to 2003. In the Czech Republic, the growth rate of wages was 14 per cent and the inflation rate was 9 per cent from 1993 to 1997. The main reason for this slowdown in wage rise and inflation is that the unemployment rate

296 H. Uni in Czech doubled after the economic crisis in 1997, which was caused by the outflow of speculative foreign capital. Thus, in the Czech Republic, when the growth rate of the productivity of export goods is higher than that of wages, the unit labour cost tends to decrease. If wages and the productivity of export goods grow at the same rate in trading partner countries, the ULCP of the Czech Republic will appreciate. In fact, it appreciated against Germany at a 3.3 per cent annual rate. It is remarkable that the exchange rate of the Czech koruna against the euro also appreciated at a similar rate. In Hungary and Slovakia, which are Balassa–Samuelson type, the ULCP is constant if wages and the productivity of export goods grow at the same rate in trading partner countries. As shown in Table 15.2, the exchange rates of the Hungarian forint and the Slovakian koruna against the euro were also approximately constant. Thus, the disparity between the growth rate of the ULCP and that of the exchange rate was very small in all three countries. This is in striking contrast to the large disparity between Asian countries. The change of exchange rates along with the ULCP is guided by the exchange rate system in the new member countries of the EU. Most of the new member countries adopt ERMII or ERMII-compatible systems. ERMII is the modified version of the ERM, which was implemented in 1979 for the collective adjustment of the exchange rates of the EC member countries. According to Bofinger and Wollmershauser (2002), the most important elements of ERMII are as follows: the definition of central rates and fluctuation bands; the rules for marginal and intra-marginal interventions; the provision of short-term financing facilities for interventions; and an exit option, especially for the European Central Bank (ECB). For the sustainability of economic integration, the first element is decisively important. Under ERMII, decisions on central rates and fluctuation bands have to be made by the mutual agreement of eurozone member states. This eliminates one of the main risks of a unilaterally managed floating system, wherein individual countries are tempted to use the devaluation of their own currency in a beggar-thy-neighbour policy. One of the four criteria required for eurozone entry is ERMII membership for at least two years, without devaluation. Slovakia adopted the managed floating system from 1998 without large devaluation and joined ERMII in November 2005, aiming to introduce the euro in 2009. Despite not joining ERMII, Hungary has unilaterally shadowed it from 2001 onwards. In addition, the Czech Republic has not joined ERMII and has instead adopted the managed float with a direct inflation-targeting framework since 1998 (Rawdanowicz 2006).

Results of measurements of Asian countries Asian countries from 1990 to 1995 Using the Asian international I–O tables12 created by the Institute of Developing Economies, we calculated the growth rates of labour productivity (the decrease rates of the vertically integrated labour input coefficient) from 1990 to 1995 and

Comparative analysis of conditions for monetary integration 297 from 1995 to 2000 in Indonesia, Malaysia, the Philippines, Singapore, Thailand, China, Taiwan, Korea, Japan, and the USA. The results are shown in Tables 15.3 and 15.4.13 As shown in Table 15.3, export-biased productivity increase was prominent in China, Korea, Taiwan, Singapore, and the Philippines from 1990 to 1995. The reason for this increase in these East Asian countries is as follows. Following the success of NIEs in export-oriented industrialization, many East Asian countries made serious efforts to introduce foreign capital and technology and to implement an export promotion policy. As a result of these endeavours, the export-oriented factories that were equipped with this new technology succeeded in achieving high labour productivity growth through large-scale production. The export-biased productivity increase seems to continue until these countries reach the technological frontiers. We can find out the following from the gap between the wage growth rates and the productivity growth rates. Except for the Philippines, in the countries that experienced export-biased productivity from 1990 to 1995, wage growth rates were approximately equal to productivity growth rates of export goods. This means that growth in China, Korea, Taiwan, and Singapore was ‘Balassa– Samuelson type’. Consequently, the productivity growth rates of non-tradable goods were lower than the wage growth rates in these countries. This led to pressure to increase the price of non-tradable goods. In fact, the inflation rates in these countries were approximately equal to the differential between the wage growth rates and the productivity growth rates of non-tradable goods. As mentioned in the case of Hungary and Slovakia, a Balassa–Samuelson type country’s ULCP is constant if the productivity of export goods and wages grows at the same rate in trading partner countries. For most Asian countries, the largest trading partner is the USA and the largest competitor in exports is China. Therefore, we examine the currency values of Asian countries against the US dollar and the RMB. From 1990 to 1995, the productivity of export goods and wages grew at the same rate in the USA and China. Therefore, Korea, Taiwan, and Singapore’s ULCPs were approximately constant against the USA and China, as shown in Table 15.3. (Thailand and Malaysia’s ULCPs also were constant because the productivity of export goods, the productivity of non-tradable goods, and wages grew at the same rate.) As, in this period, most Asian currencies were pegged to the US dollar, their exchange rates were almost constant against the US dollar, as shown in Table 15.3. A prerequisite for the ‘dollar peg system’ is a Balassa-Samuelson type configuration, in which wages and the productivity of export goods grow at the same rate and the ULCP remains constant. In Indonesia and the Philippines, as the wage growth rates were much higher than the productivity growth rates of export goods, their ULCPs depreciated against the USA and China. On the other hand, although the Balassa–Samuelson type configuration existed in China, the Chinese government devalued the RMB by 33 per cent, from 5.76 yuan per dollar in 1993 to 8.62 yuan per dollar in 1994. Consequently, the exchange rate in Asian countries appreciated greatly against the RMB, as shown

12.0 4.6 4.2 11.4 7.7 10.4 5.0 −0.5 0.8 2.4

Non-tradable goods

Productivity growth

19.2 11.0 8.7 6.6 9.1 10.7 8.9 4.9 3.9 3.2

Export goods 18.3 12.9 7.8 14.9 7.9 8.4 8.7 9.6 2.0 3.9

Nominal wage growth

12.1 6.0 3.7 8.5 4.7 3.9 2.5 9.3 1.3 3.1

Inflation rate ULCP 1.7 −1.1 1.7 −7.5 1.9 3.1 0.9 −4.0 2.7

Exchange rate −11.1 −1.7 0.3 −0.4 0.5 1.5 4.9 −1.1 8.6

Appreciation against the US dollar

9.4 11.5 7.2 11.7 12.7 16.1 10.0 19.8 11.1

Exchange rate

−2.8 0.0 −9.2 0.2 1.4 −0.8 −5.7 1.0 −1.7

ULCP

Appreciation against the RMB

Sources: Productivity and ULCP were calculated from the Asian International Input–Output Tables, deflators: National Accounts (United Nations), nominal wages in the manufacturing industry: Monthly Labour Survey (Japan), NIPA (the U.S.), Stuivenwold and Timmer (2003) (Indonesia) and Labour Statistics Database (ILO), other variables: IFS (IMF).

Note: All growth rates are the annual average of logarithmic increments.

China Korea Taiwan Indonesia Thailand Malaysia Singapore Philippines Japan USA

Country

Table 15.3 Productivity, wages, and exchange rates in Asian countries (1990–5, unit: %)

Comparative analysis of conditions for monetary integration 299 in Table 15.3. Another prerequisite for the ‘dollar peg system’ in small countries is that the large competitors in exports maintain this system. This system was destroyed by the devaluation of the RMB. Asian countries were faced with two choices: a new exchange rate regime and a new level of exchange rate. The exchange rates of most Asian countries appreciated against the RMB and deviated upward from the constant ULCPs against China. The constant ULCPs meant that their relative unit labour costs compared with China did not change. In this situation, if their exchange rates against the RMB appreciated, their export competitiveness declined. Most Asian countries compete with China. Since the mid 1990s, China’s exports have tended to grow rapidly and other Asian countries’ exports have tended to grow slowly. According to the UN National Accounts, the index of real exports in 2005 (the value in 1995 = 100) is 1,074 in China, 701 in Korea, 342 in Taiwan, 245 in Indonesia, 360 in Thailand, 414 in Malaysia, 450 in Singapore, and 257 in the Philippines. Moreover, with regard to the share in Japan’s imports, China’s share dramatically increased to 5.1 per cent in 1990, 10.7 per cent in 1995, 14.4 per cent in 2000, and 21.0 per cent in 2005. The share of NIEs + ASEAN4 was stagnant at 21.4 per cent in 1990, 23.7 per cent in 1995, 25.1 per cent in 2000, and 21.2 per cent in 2005 (Institute for International Trade and Investment, Japan’s Trade Index by Commodity and Country, 2007, calculated from Ministry of Finance, The Trade Statistics of Japan). Asian countries from 1995 to 2000 As mentioned above, there was little relative change in unit labour costs from 1990 to 1995 in Asia. However, most Asian countries’ exchange rates against the RMB deviated from the ULCPs because of discretionary devaluation by the Chinese government. This led to imbalanced growth of exports: rapid growth in China and slow growth in other Asian countries. From 1990 to 1995, the movement to correct this deviation emerged. The correction of this deviation started in 1997 as a speculative attack on over-valued currencies; it was accomplished by a sharp erosion of the currency value. This rapid and violent adjustment of exchange rates had a destructive effect on real economies: outflow of short-term capital, sharp fall of asset prices, banking crises, decline in production, increase in unemployment, etc. As shown in Table 15.4, from 1995 to 2000, export-biased productivity growth continued in China, Korea, Taiwan, and Malaysia. In Indonesia and the Philippines, labour productivity decreased due to the economic crisis, which was accompanied by the currency crisis in 1997. In these countries, except Indonesia, the nominal wage rise slowed down compared with the previous period. This slowdown could be explained by the rise in unemployment. Inflation also slowed down compared with the previous period. Although export-biased productivity growth continued in Korea and Taiwan, they lost the ‘Balassa–Samuelson type’ characteristics because of the slowdown in the wage rise. Their productivity growth rates of export goods were higher than their wage growth rates, as in the case of the Czech Republic. In these cases, the unit labour cost tends to decrease. If the productivity of export goods and

5.8 4.1 4.5 −2.9 −0.6 −0.6 9.5 3.8 1.3 3.5

Non-tradable goods

Productivity growth

Note and Source: See Table 15.3.

China Korea Taiwan Indonesia Thailand Malaysia Singapore Philippines Japan USA

Country

7.4 10.1 6.5 −8.4 1.6 5.7 6.3 −5.9 0.8 5.8

Export goods 10.5 7.1 3.5 18.9 3.1 6.5 6.8 7.5 0.9 4.4

Nominal wage growth

1.8 3.9 1.4 16.4 4.1 3.1 0.9 6.2 0.3 2.4

Inflation rate

Table 15.4 Productivity, wages, and exchange rates in Asian countries (1995–2000, unit: %)

0.2 −7.7 −3.3 −26.4 −9.5 −8.3 −3.9 −10.8 −2.7

Exchange rate

−4.4 1.7 1.7 −28.6 −2.9 −2.1 −1.9 −14.7 −1.4

ULCP

Appreciation against the US dollar

−7.8 −3.5 −26.6 −9.7 −8.5 −4.1 −11.0 −2.9 −0.2

Exchange rate

6.1 6.1 −24.1 1.6 2.3 2.6 −10.3 3.1 4.4

ULCP

Appreciation against the RMB

Comparative analysis of conditions for monetary integration 301 wages grows at the same rate in trading partner countries, the ULCPs of these countries will appreciate. In fact, as shown in Table 15.4, the ULCPs against China in particular appreciated greatly in Korea and Taiwan. In contrast, the ULCPs of Indonesia and the Philippines depreciated greatly against China and the USA because their wages continued to rise as a result of the decline in the productivity of export goods. In countries other than China, the exchange rates depreciated sharply in the currency crisis in 1997. Furthermore, in these countries, except China and Malaysia,14 the exchange rate regime changed from the dollar peg system to the managed floating system.15 In the managed floating system, the monetary authority influences the exchange rate dynamics through active market intervention without specifying the exchange rate target. The depreciation in the currency crisis of 1997 reduced the deviation of exchange rates against the RMB from the ULCPs. There were two types of depreciation: depreciation targeting the ULCP against China and depreciation targeting the ULCP against the USA. The first type of exchange rate adjustment emerged in Korea, Taiwan, Thailand, and Malaysia. For example, Figure 15.6 shows the reciprocal numbers16 of Korea’s exchange rates against the US dollar and the RMB and their ULCPs against the USA and China (the value in 1990 = 100). As shown in this figure, from 1995 to 2000, these countries’ exchange rates against the RMB depreciated toward the same level as the ULCPs against China. Consequently, their exchange rates against the US dollar became lower than their ULCPs against the USA. The depreciation targeting the ULCP against China enabled them to recover export competitiveness with China. The under-valuation of their currencies against the US dollar was favourable for exports, but unfavourable for imports. The second type of exchange rate adjustment emerged in Indonesia, Singapore, and the Philippines. As shown in Figure 15.7, from 1995 to 2000, these countries’ exchange rates against the US dollar depreciated toward the same level as their ULCPs against the USA. Consequently, on the other hand, their exchange rates against the RMB remained higher than their ULCPs against China. Therefore, 200 150

Exchange rate against the RMB ULCP against China Exchange rate against the US dollar

100 50

ULCP against the USA

0 1990

1995

2000

2005

Figure 15.6 Korea’s exchange rate and ULCP. Note: As we plot reciprocal numbers of exchange rates and ULCPs (the value in 1990 = 100), an upward change in this figure shows appreciation and a downward change shows depreciation.

302 H. Uni 200 Exchange rate against the RMB

150

ULCP against China Exchange rate against the US dollar

100

ULCP against the USA

50 0 1990

1995

2000

2005

Figure 15.7 Philippines’ exchange rate and ULCP.

their export competitiveness with China did not recover sufficiently. The abovementioned index of real exports in 2005 (the value in 1995 = 100) is 245 in Indonesia and 257 in the Philippines, which is remarkably lower than 1,074 in China and rather lower than other Asian countries.17 The background of the target setting in Indonesia, Singapore, and the Philippines is as follows. First, as Indonesia’s and the Philippines’ levels of economic development were lower than that of China, the severity of export competition with China was lower than other Asian countries.18 Second, for Indonesia and the Philippines, which were suffering from high inflation, it was necessary to avoid the import inflation caused by the under-valuation of exchange rates against the US dollar. Third, as Singapore is a city-state and a trading nation, the share of the cost of imported resources in the production cost is high.19 Moreover, most foreign trade is done on a dollar basis. Therefore, it is important to keep its own currency value against the US dollar. As mentioned above, most Asian countries’ currency values fell sharply in the currency crisis in 1997. Since then, they have adopted the managed floating system and have tried to keep the depreciated exchange rate through market intervention. The target setting differed according to country. Korea, Taiwan, Thailand, and Malaysia, whose exports competed severely with China’s exports, targeted their ULCPs against China.20 On the other hand, Indonesia, Singapore, and the Philippines, whose exports competed less severely with China’s exports, targeted their ULCPs against the USA. Thus, the target setting of the managed exchange rate split into two kinds. The first cause of this divergence is the large departure of the RMB rate against the US dollar from China’s ULCP against the USA. The second cause is the unilaterally managed floating system in Asian countries. This divergence creates the following problem. As long as this large departure of the RMB continues, the currencies remain undervalued against the US dollar in countries targeting the ULCP against China. In contrast, the currencies remain overvalued against the RMB in countries targeting the ULCP against the USA. In general, this situation favourably affects the former countries’ exports and unfavourably affects the latter countries’

Comparative analysis of conditions for monetary integration 303 exports. Therefore, this is likely to create an economic growth gap in Asian countries. In fact, the economic growth rates after the currency crisis were considerably low in Indonesia and the Philippines, both of which belonged to the latter group.

Conclusions: proposal for a collectively managed floating system As mentioned in the fourth section, many Asian currencies were overvalued against the RMB by the discretionary devaluation of the RMB against the dollar in 1994. This deviation of Asian currencies from the trends of the ULCP was the trigger for the speculative attack on overvalued currencies in 1997. As a consequence of this attack, many Asian currencies were drastically and violently devalued and the economy suffered negative effects. After the currency crisis, under the unilaterally managed floating system, the target setting of the managed exchange rate split into two kinds. This was one of the causes of the economic growth gap in Asian countries. However, the under-valuation of currency is prevented in Central European countries under the institutional arrangement for multi-lateral coordination of exchange rates, such as ERMII. Taking this fact into account, it is evident that the unilaterally managed floating system in Asia is insufficient. The reason for the export-biased productivity increase in several Asian countries is their export promotion policy, which introduces foreign capital and technology. Therefore, export-biased productivity increase is likely to continue for several decades, until these countries reach the technological frontiers. On the other hand, both wage rise and inflation slowed down during the crisis. This trend continued after the crisis. Consequently, the growth rate of the labour productivity of export goods tends to exceed that of wages in several Asian countries. Their ULCPs against other countries will appreciate on a long-term basis. In this case, in order to avoid the under-valuation of currencies, the exchange rates of these currencies have to appreciate along with the ULCP on a long-term basis. Therefore, it is necessary to establish an exchange rate regime that enables this adjustment of exchange rates in Asia. As can be seen from the European experience, it is important that this adjustment be based on mutual agreement between the Asian countries. A unilaterally managed floating system is not appropriate because it involves the risk of discretionary control for unilateral interests. We propose a ‘collectively managed floating system’ that is similar to the ERM. The term ‘floating’ means the adjustment of exchange rates along with ULCP on a long-term basis. The term ‘collectively managed’ means that the management is guaranteed by the institutionalised cooperation of governments that share the necessity for and responsibility of this adjustment. The institutional foundations of the ‘collectively managed floating system’ will comprise the following four points.21 1 Define a calculation formula to calculate the ULCP based on objective data. This ULCP is used in the target rate setting.

304 H. Uni 2 Establish rules to adjust the target exchange rate when the actual exchange rate deviates from the target rate on a long-term basis by the gap in productivity growth or wage rise. 3 Establish rules on collective intervention to defend Asian countries’ currencies when these currencies face speculative attack. 4 Agree on the need for policy coordination to maintain the actual exchange rate’s short-term deviation from the target rate at an acceptable size. Under a similar institutional framework, the ERM contributed to the stability of exchange rates among EU countries from 1979 to 1999. During this period, with the help of the collective adjustment (réalignement) of target rates and collective intervention, the exchange rates between the currencies of this region were comparatively stable, although the mark rate against the US dollar fluctuated dramatically. In addition, these collective actions enabled the independence of the European currencies from the US dollar. These collective actions should be viewed as criticisms against the USA, which abandoned its responsibility of being the keycurrency country. Although the ERM faced speculative attack when the capital flow was deregulated in the 1990s, it succeeded in escaping the crisis by expanding fluctuation bands. Moreover, ERMII functions as a transitory system for new member countries after the currency unification in 1999. It took Europe several decades to establish the rules for collective adjustment and intervention, and Europe endured a long process of trial and error. Similarly, institutionalising cooperation in Asia is bound to be a time-consuming process. As a temporary measure, some researchers propose that the Asian countries peg their own currencies to a currency basket composed of their major trade/investment partners, rather than only the dollar. They emphasise that the managed floating rates should reflect the major players’ international competitiveness (French and Japanese Staff 2001; Asian Policy Forum 2000; Kawai 2002). In fact, some countries and the Asian Development Bank have made an effort to implement this proposal. However, considering the export-biased productivity growth in this region, these measures are insufficient. Institutionalising the multi-lateral mechanism of adjustment of exchange rates on a long-term basis is as necessary for Asia as it is for the EU. The purpose of our proposal is to multi-laterally institutionalise the stability of the Asian currencies, which is currently being individually pursued by the concerned Asian countries.22

Notes 1 As the Eurostat I–O tables are competitive import type, we use the Leontief inverse matrix modified for removing the effect of imports. 2 This vector is derived from sectoral data of the number of persons engaged in production (in the Employment Tables) appended to the I–O tables. Regarding Germany and Hungary, the employment table in 2003 is available but that in 1998 is not available. Regarding Asian countries, the employment table in 2000 is available but those in 1990 and 1995 are not available. The absent data are estimated using the proportionality

Comparative analysis of conditions for monetary integration 305

3 4 5

6

7 8

9

10

between the sectoral number of employees and the sectoral compensation for employees. For example, we show the case of Germany and Hungary. The provisional number of persons in the ith industry in 1998 = the number of persons in the ith industry in 2003 × {(compensation for employees in the ith industry in 1998)/(compensation for employees in the ith industry in 2003)}. The number of persons in the ith industry in 1998 = the provisional number of persons in the ith industry in 1998 × {(the total of the provisional number of persons in 1998)/(the total number of persons in 1998)}. As the unit of the Asian international I–O tables is the US dollar, we converted them to national currencies using exchange rates. For example, in the US’ National Accounts, domestic demand is the sum of Final consumption expenditure and Gross capital formation. EU countries: OECD, National Accounts, Asian countries and the USA: UN, National Accounts Main Aggregates Database (http://unstats.un.org/unsd/snaama/dnllist.asp) and Taiwan: Asian Development Bank, Statistical Database System (www.adb.org/Statistics/ sdbs.asp). Original data were published by each government, except for the Chinese export deflator, which was estimated by the World Bank. In the United Nations’ National Accounts, domestic demand is the sum of ‘Final consumption expenditure’ and ‘Gross capital formation’. Regarding the Czech Republic and Slovakia, sectoral data of the number of persons engaged in production in both years are not available. We calculated ‘the vertically integrated unit labour cost’ as follows. We obtained the growth rates of productivity by subtracting the growth rates of these unit labour costs from the growth rate of the nominal wage. If W denotes a row vector in which each entry shows unit labour costs in each industry calculated by dividing the above wage costs by the amount of output, W (I − A)−1 = w is a row vector in which each entry shows wage costs directly and indirectly required to produce one unit of each commodity, that is, ‘the vertically integrated unit labour cost’. We abstracted self-employed persons in this calculation. This does not affect the result to a great extent because the share of self-employed persons in the total number persons engaged in production is small (about 10 per cent) in the Czech Republic and Slovakia. In developing countries under industrialization, the importation of intermediate goods such as machinery parts tends to increase. The vertically integrated imported resources cost can be calculated by multiplying the matrix of imported resources input coefficient by the Leontief inverse matrix. The vertically integrated imported resources cost per dollar export goods is 0.52 in Singapore, 0.50 in Malaysia, 0.42 in the Philippines, 0.39 in Taiwan, 0.36 in Thailand, 0.34 in Korea, 0.19 in China, 0.17 in Indonesia, 0.12 in the USA, and 0.10 in Japan in 2000. Pasinetti (1993) calls the ULCP the ‘natural exchange rate’. The popular benchmark of currency value is purchasing power parity (PPP), which is calculated from the consumer price index, the production price index, or the export price index. The export price index is suitable for the base of PPP, and explains the change in exchange rates because the law of one price is realised internationally only regarding tradable goods. However, as we mentioned in the text, the export price consists of this unit labour cost, the imported resources cost, and the capital cost. The imported resources cost fluctuates largely due to the short-term change in exchange rates. Thus, the PPP calculated from the export price index is inadequate as the benchmark of the currency value because it is affected by the change in the currency value itself. In this chapter, as the benchmark of currency value, we use the parity calculated from the unit labour cost, due to the three aforementioned reasons. The number of sectors is 57 in Hungary, 58 in the Czech Republic, 57 in Slovakia, and 56 in Germany.

306 H. Uni 11 However, the regular interpretation of the Balassa–Samuelson effect is based on the technological disparity of productivity between sectors; it neglects the roles of the exchange rate system and wage institution. As mentioned above, the credibility of the two assumptions heavily depends on the characteristics of the exchange rate system and wage institution. In fact, the first assumption is not supported by some empirical research (Canzoneri et al. 1999; Égart 2002; Kovács 2004; Kawai et al. 2003) and the second assumption is not supported in many cases (see Tables 15.2, 15.3, and 15.4). 12 The number of sectors is 78 in 1990 and in 1995 and 76 in 2000 in all countries. 13 Uni (2007) measured the growth rates of productivity of export goods and nontradable goods using the official I–O tables in Japan, China, and Korea. Regarding Japan and Korea, the result is approximately the same as the results in this chapter. However, there are some differences in China’s results. The main reason for this seems to be in the fact that China’s export deflator is not published officially. In this chapter, we use the value estimated by the World Bank. Uni (2007) used the value estimated by the Chinese Custom House. 14 Malaysia also devalued the ringgit, maintaining the dollar peg system. 15 The IMF definition of ‘managed floating with no predetermined path for the exchange rate’ is as follows: ‘The monetary authority attempts to influence the exchange rate without having a specific exchange rate path or target. Indicators for managing the rate are broadly judgmental (e.g., balance of payments position, international reserves, parallel market developments), and adjustments may not be automatic. Intervention may be direct or indirect.’ The IMF definition of ‘independently floating’ is as follows: ‘The exchange rate is market-determined, with any official foreign exchange market intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it.’ According to the IMF classification in 1999, the exchange rate regimes in Korea, Indonesia, Thailand, and the Philippines were ‘independently floating’, similar to Japan’s case. However, as the monetary authorities in these countries frequently and discretionally intervened in the market, their exchange rate regimes were similar in practice to managed floating (Corden 2002). 16 An upward change in these figures shows appreciation and a downward change shows depreciation. 17 Moreover, after 2000, Indonesia’s and the Philippines’ exchange rates were unstable and tended to depreciate against both the US dollar and the RMB. On the other hand, other Asian countries’ exchange rates were stable and tended to appreciate. 18 The composition ratio of export by commodity in 2000 is calculated from the Asian International Input–Output Tables. The coefficient of correlation between China’s ratio and the Philippines’ ratio is 0.27, and that between China’s ratio and Indonesia’s ratio is 0.31. These coefficients of correlation are smaller than that between China’s ratio and any other country’s ratio. This means that Indonesia and the Philippines’ compositions of export are rather different from that of China. 19 As mentioned in endnote 8, in Singapore in 2000, the vertically integrated imported resources cost per dollar export goods was 0.52 and the cost per dollar non-tradable goods was 0.32. These are the highest among the 10 countries. 20 McKinnon (2001) regards Asian exchange rate regimes after the crisis as ‘de facto dollar peg’. From 1997 to 2005, since the RMB rate against the US dollar was fixed, the ‘de facto dollar peg’ was also the ‘de facto RMB peg’. However, taking into account the matching relation between exchange rates and ULCPs, ‘de facto RMB peg’ seems to be a more suitable name, although ULCPs after 2001 are unknown at present. 21 We referred to the key points outlined in Tanaka (1996) and Aglietta and Deusy-Fournier (1995). Our proposal is similar to ‘the reference rate system’ that Williamson proposed recently. One of the rules of the reference rate system is that ‘the structure of reference rates would be revised at periodic prespecified intervals through some defined

Comparative analysis of conditions for monetary integration 307 international procedure’ (Williamson 2007: 5). As the principles of determination of reference rates, Williamson recommended three approaches: large macro-economic models, an adjusted purchasing power parity approach, and Goldman Sachs’ dynamic equilibrium exchange rates (ibid.: 29). Our proposal belongs to the second approach. 22 As Williamson (2007) stated, ‘the present growth in global imbalances threatens to end up inducing a collapse of the dollar . . . that is why the merits of a reference rate system need to be discussed now even if one is not optimistic about the chances of its imminent adoption’ (ibid.: 55).

16 Given the heterogeneity of Asian countries, is a monetary integration or coordination possible? Se-Eun Jeong, Jacques Mazier and Sophie Saglio Introduction East Asian monetary integration has a long story. The Asian crisis of 1997 had shown the limits of a simple dollar-peg policy and of a market-driven regional integration without formal institutions. During the 2000s, much effort has been devoted to improve monetary and financial cooperation at the regional level, especially with the Chiang Mai initiative and the Asian Bond Market initiative. But results have been limited, mainly due to political issues with an underlying competition between China and Japan. The current financial crisis has given new interest to these questions of monetary cooperation at the regional level, as the decline of the US position and strengthening of China were observed at the world level. Due to the high heterogeneity of Asian countries, it appears necessary to preserve the possibility of exchange rate adjustments in a future monetary regime, at least for a long transition period. Various forms of monetary regime have been proposed from the Asian Currency Unit (ACU) to the common currency basket or the yen bloc, with improvement at the level of institutional forms, such as an Asian Monetary Fund and Asian bond markets. However, obstacles remain the same with a lack of political project and the will of China to preserve the autonomy of its monetary policy. A long transition period with adjustable exchange rates regime, based on a common currency basket or an ACU, might be the more likely, before the settlement of a yuan bloc. The paper is organized as follows. A second section analyses the long story of East Asian monetary cooperation since the 1990s. Using a macroeconomic model of East Asian interdependencies, a third section shows the utility of preserving an adjustable exchange rate regime in East Asia, at least for a long transition period. A fourth section compares the different forms of monetary regimes that can be considered for East Asia. A last section concludes.

East Asian monetary integration: a long story The 1990s and the crisis of 1997 To avoid exchange rate misalignments between increasingly integrated countries, a dollar-peg policy was implemented in most East Asian countries in the late

Is a monetary integration or coordination possible? 309 1980s. At the same time, financial liberalization was being developed during the 1990s, facilitating the finance of large current deficits. It also induced short-term indebtedness in dollars, especially of the banking sector, which appeared highly constraining when the crisis burst. The peg to the dollar of East Asian currencies led to large overvaluation in nominal terms, but less in real effective terms in the 1990s, in relation to important current deficits (Figure 16.1 and Table 16.11 ). On the eve of the Asian crisis, the overvaluation was more marked in Korea and Thailand, but cannot be regarded as the main factor of the crisis.

Exchange rate misalignments Exchange rate misalignments are evaluated by reference to the Fundamental Equilibrium Exchange Rate (FEER). The FEER is the exchange rate compatible, both with the external equilibrium (a sustainable current account) and the internal equilibrium (full employment without inflation pressures). The FEERs are estimated using a world model of foreign trade for the main currencies and simple national models of foreign trade for smaller countries. Misalignments are given in nominal exchange rate against the dollar (e = (E − E ∗ )/E ∗ ) and in real effective terms (r = (R − R ∗ )/R ∗ ) where E ∗ and R ∗ represent the equilibrium exchange rate. This allows determining undervaluation (e > 0 and r > 0) and overvaluation (e < 0 and r < 0) (see Jeong and Mazier 2003a; Jeong et al. 2010; Aflouk et al. 2010).

Overaccumulation, diffusion of the slowdown through high economic interdependency, contagion effects, and capital flights have played a major role to explain the generalization of the crisis. The stabilization plans imposed by the IMF have amplified the economic slowdown and given a new impulse to financial liberalization and deregulation. The lack of appropriate tools to solve the liquidity problems has been underlined while East Asia, as a whole, had sufficient reserves and net foreign assets to face the problems of countries in deficit. In this context Japan proposed in September 1997 the creation of an Asian Monetary Fund which could have helped East Asian countries to escape the constraints imposed by the IMF. However, this proposal was abandoned quickly in October 1997, facing opposition from both the USA and China. The USA did not want East Asian countries to become more autonomous. China was reluctant to give a leadership to Japan with this new institution. Note, also, that intra-East Asia imbalances were too generalized at that time and made the intra-zone finance more complex to organize. Japan was the only country largely in surplus and with important net foreign assets, but was confronted from the beginning of the 1990s by a durable economic stagnation (Table 16.2). The 2000s The recovery was rather quick after the crisis, thanks partly to large devaluations which boosted exports. After these huge devaluations, pragmatic exchange rate

Japan

Japan 300

180 160

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82 84 86 88 90 92 94 96 98 0

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Equilibrium real effective exchange rate

Equilibrium bilateral exchange rate against the dollar

China

120

China

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20 82 84 86 88 90 92 94 96 98 0

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Korea

Korea

140

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82 84 86 88 90 92 94 96 98 0

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82 84 86 88 90 92 94 96 98 00 02 04 06 08

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82 84 86 88 90 92 94 96 98 00 02 04 06 08

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Equilibrium real effective exchange rate

Equilibrium bilateral exchange rate against the dollar

Figure 16.1 Actual and equilibrium real effective and bilateral exchange rates of East Asian currencies (base 100 in 2000).

Thailand

Thailand 120

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82 84 86 88 90 92 94 96 98 00 02 04 06 08

82 84 86 88 90 92 94 96 98 00 02 04 06 08 Actual real effective exchange rate

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Equilibrium bilateral exchange rate against the dollar

Malaysia

Malaysia 120

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0 82 84 86 88 90 92 94 96 98 00 02 04 06 08

82 84 86 88 90 92 94 96 98 00 02 04 06 08 Actual real effective exchange rate

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Philippines

Philippines

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Figure 16.1 Continued

Indonesia

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0 82 84 86 88 90 92 94 96 98 00 02 04 06 08

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Figure 16.1 Continued Table 16.1 Current account of East Asian countries (in % of GDP)

Japan Korea China Rest of East Asia Indonesia Malaysia Thailand Philippines Hong Kong Singapore Chinese Taipei

1994–6

1997–2000

2001–4

2005–8

2.09 −2.26 0.77 −0.54 −2.71 −6.74 −7.25 −4.02 0.08 16.05 2.78

2.63 4.49 2.66 4.24 2.75 8.15 7.12 −2.40 1.93 16.67 2.26

2.99 2.19 2.53 6.73 3.09 10.20 3.28 −0.14 8.33 17.03 7.52

3.88 0.59 9.50 7.44 1.39 16.41 0.61 3.45 12.49 22.13 6.76

Source: CHELEM.

Table 16.2 Intra-East Asia trade balance (in % of GDP)

Japan Korea China Rest of East Asia Indonesia Malaysia Thailand Philippines Hong Kong Singapore Chinese Taipei Source: CHELEM.

1994–6

1997–2000

2001–4

2005–8

1.35 0.91 −1.68 −5.85 4.05 −3.12 −7.21 −9.63 −24.53 −19.55 1.94

1.03 2.88 −0.59 −5.02 9.75 1.89 −1.47 −7.76 −23.50 −15.15 −1.42

1.14 1.42 −1.49 −2.86 7.57 5.74 −1.54 0.59 −32.35 −4.77 1.92

1.74 1.89 −1.97 −2.27 5.30 6.52 −2.29 3.25 −48.92 2.14 6.77

Is a monetary integration or coordination possible? 313 policies were implemented with more diversity between countries than before, from a rather strict dollar-peg in Malaysia and China until 2005 to more floating regimes as in Korea. The result has been, on the whole, a general undervaluation against the dollar, even if it is less marked, in real effective terms (Figure 16.1 and Tables in Appendix). This was very different from the 1990s and has given to East Asian economies more room to maneuver, with large current account surpluses, but at the expense of the rest of the world (Table 16.1). Actually the relative positions of various countries were rather contrasted. The yuan was largely undervalued, in spite of a real effective appreciation. This apparent paradox is simply explained by the larger revaluation of the equilibrium exchange rate of the yuan owing to the remarkable improvement of the Chinese productive sector’s efficiency. The yen was also undervalued, but for a different reason and to a less extent, thanks to the real effective depreciation of the yen. This export-led growth strategy was used to help the Japanese economy to recover partly from the long stagnation of the 1990s. The Korean won was the least undervalued East Asian currency, following a rather sharp appreciation in nominal and real terms after 1999. The Korean exchange rate policy, with a won more freely floating, was more equilibrated from a global point of view, but put more constraints on the Korean economy. Thailand and Indonesia were able to preserve more undervalued currencies after the shock of the crisis. In the Indonesian case the amplitude of the depreciation had been impressive, but was in line with the devastating effects of the crisis on the productive sector. The Philippine peso has been continuously depreciated until the middle of the 2000s without large undervaluation in real effective terms, thus reflecting a declining structural competitiveness. On the whole, beyond a general, but unequal, undervaluation against the dollar, this relative divergence between East Asian currencies reflected that the pragmatic exchange rate policy did not prevent some distortions between the area’s countries. The main distortion was the undervaluation of the yuan against the other East Asian currencies, which was a factor of growing imbalances. But, as all the countries were in surplus, constraints were weaker than during the 1990s. East Asian countries drew the lesson from the crisis and tried to develop more formal institutions at the regional level in order to be able to mobilize local resources in case of countries facing problems of payments. Two main initiatives were undertaken, the Chiang Mai initiative and the Asian Bond Market initiative. The Chiang Mai initiative, signed in 2000 at the level of the ASEAN + 3, was an enlargement of the ASEAN Swap Arrangement, already existent, and an extension by bilateral swaps agreements. The IMF’s authorization was required for the operation to exceed a given level, which, in practice, limited the regional autonomy of the initiative. Long negotiations were necessary during the 2000s to increase the multilateral share of the swap agreement and to try to reduce the IMF’s control. Simultaneously, a rather weak process of Economic Review and Policy Dialogue was settled. In practice, the progress remained reduced and the level of credit which could be mobilized limited. This limited progress could be explained by the competition between China and Japan, which contributed to block initiatives, but also by the economic situation,

314 S.-E. Jeong, J. Mazier and S. Saglio which was less constraining in the 2000s with larger current surpluses than in the 1990s. The Asian Bond Market initiative was the second major step in 2002. Its aims were multiple: give a regional alternative to the finance of national economies; avoid the asymmetric in currencies (which implies borrowing in foreign currency for financing the economy in local currency) and the asymmetric of maturity (which refers to short-term borrowing for supplying long-term loans); help the ASEAN’s small countries whose size was too limited to develop bonds markets (Jetin 2010). Two Asian Bond Funds were successively launched in 2003 and 2004, the first, ABF1, issued in dollars, the second, ABF2, also issued in dollars but which invested in sovereign bonds in local currencies and led to an increasing capital mobility between the participating countries. Although limited in volume, these initiatives have been important as they facilitated the development of bond markets in East Asia during the 2000s, especially in Korea, Thailand, and Malaysia. Sovereign bonds remained dominant, but private ones have also increased. Asian banks have been able to issue more bonds on local markets. The share of debt in foreign currencies has decreased. As most East Asian countries became net creditors thanks to the accumulation of current surpluses, they were less exposed in the case of crisis. This development of bond markets and capital mobility in East Asia is in line with the “international risk sharing” approach, which considers that wellintegrated capital markets at the regional and international levels create powerful adjustment mechanisms facing asymmetric shocks. Although largely developed in the literature, this approach appears fragile and can be criticized, both from a theoretical and empirical point of view (Asdrubali and Kim 2004). The crisis of 2008 and the renewal of monetary regionalism At the difference of the Asian crisis of 1997, the origin of the crisis of 2008 has been outside East Asia, starting in 2007 with the subprime crisis in the USA and diffusing into the world economy. The impact on East Asia has been more limited, although significant in the short term and unequal according to the countries. First, some lessons will be drawn from an East Asian multinational model, before examining monetary and financial implications. Without trying to describe the impact

A multinational model of East Asia To analyze the impact of world imbalances on East Asia a model describing Japan, Korea, China and the other countries of East Asia in relation with the USA and the rest of the world is used (Mazier et al. 2006, 2008). The model is composed of two blocks, a multinational model of foreign trade describing the interdependencies between East Asian countries and, for each East Asian country, a macroeconomic model of the domestic demand. The foreign trade is analyzed in detail with export and import equations in volume and prices. The extra-Asian trade distinguishes relations between the USA and the rest of the world. The

Is a monetary integration or coordination possible? 315 modeling of interdependencies between the different areas allows a precise formalization of competitors’ prices and of the external demand of each area. For each East Asian country the domestic demand model is focused on households’ consumption, the rest of demand being treated as exogenous, and on income distribution with wage-prices equations and an analysis of the labor market flexibility. The heterogeneity of East Asian countries is described in detail, regarding both their foreign sector (degree of openness, market shares, and competitiveness parameters) and their domestic sector (Mazier et al. 2008).

of the crisis in its various components, focus will be put on the consequences of US imbalances, summarized in the model used by two elementary shocks, a sharp US slowdown (a reduction of 10 percent of the total US imports), and a depreciation of the dollar of 20 percent (Table 16.3). The slowdown of US demand has a negative effect on growth in all the Asian countries. Unemployment rises while wages and prices decrease. China, the most dependent on the US market, is the most affected. The Chinese trade balance also deteriorates vis-à-vis the US market (−1 percent of GDP), but improves

Table 16.3 Impact of US imbalances

GDP price (%) t =1 t =5 t = 15 GDP (%) t =1 t =5 t = 15 Trade balance in % of GDP US market t =1 t =5 t = 15 Extra-Asian market t =1 t =5 t = 15 Intra-Asian market t =1 t =5 t = 15 Source: Mazier et al. (2008).

Slowdown of US demand (−10% total US imports)

Devaluation of the dollar by 20%

Korea

Japan

China

Korea

Japan

China

−0.16 −1.56 −4.80

−0.02 −0.12 −0.84

−0.51 −0.86 −2.09

−5.36 −13.93 −25.56

−0.82 −2.53 −7.69

−1.86 −6.00 −12.36

−0.75 −1.10 −0.94

−0.30 −0.41 −0.58

−0.91 −1.25 −1.36

−3.83 −5.19 −3.02

−1.14 −2.03 −2.85

−1.78 −3.42 −2.99

−0.55 −0.52 −0.36

−0.25 −0.23 −0.22

−1.02 −0.95 −0.94

−0.91 −0.68 −0.15

−0.39 −0.58 −0.56

−1.12 −1.11 −1.10

0.06 0.18 0.53

0.02 0.01 0.01

0.10 0.13 0.17

−1.54 −1.66 −0.43

−0.21 −0.31 −0.30

−1.31 −1.20 −1.08

0.11 0.06 −0.04

0.00 −0.03 −0.04

0.20 0.19 0.26

−0.05 0.05 −0.37

−0.16 −0.20 −0.22

−0.12 −0.67 −0.31

316 S.-E. Jeong, J. Mazier and S. Saglio with regard to non-US markets, especially the intra-Asian market. The Japanese economy, not as dependent on the US market, is less affected. Korea occupies an intermediate position, but thanks to a sharp reduction of prices, the Korean slowdown is reduced in the medium term. The deterioration of the trade balance with the USA is reversed in the medium run while the Korean trade balance improves rather strongly in the extra-Asian market. A devaluation of the dollar by 20 percent against all the currencies has a strongly negative impact on Asian growth due to the loss of price competitiveness. Korea, more open and exposed to higher price elasticities, is the most affected, followed by China. As before, Korean prices decrease strongly with both the revaluation of the won and the deflationist effect of the slowdown. This contributes to improving the Korean trade balance after the initial deterioration at the expense of the other partners. China loses more market share in the US market and is hence persistently affected. Japan is less affected in both the short and medium terms. On the whole, US imbalances have rather contrasted effects on East Asian economies. Japan, less open and less dependent on the US market, is less touched. Korea, more open and with higher prices elasticities, is more affected in both the short and medium terms, but the sharp decrease of Korean prices could allow an improvement in the long run. China is in an intermediate position, when both effects (US slowdown and dollar depreciation) are taken into account, and is more durably affected. Intra-Asian competition is bound to intensify with a reinforcement of Chinese pressures on the intra-Asian market. The asymmetric effects of US imbalances on East Asian economies depend on the relative magnitude of the two components, the dollar depreciation and the slowdown of US demand. They induce intra-Asian imbalances which might be factors of tensions. This pleads in favour of institutions helping the management of these imbalances. The reality has not been the simple juxtaposition of these two elementary shocks. If the US slowdown did happen with the burst of the crisis at the end of 2007, the depreciation of the dollar has been anterior since the beginning of the 2000s (around 20 percent in real effective terms) but has stopped during the crisis, dollar assets being largely valued. Evolutions of bilateral parities of the dollar have been contrasted. The dollar depreciated strongly against the euro until 2009, before appreciating once again. It remained stable against the yen until 2007, thus allowing the Japanese economy to benefit of a marked real depreciation during the 2000s. Conversely, the appreciation of the yen against the dollar after 2008 has penalized Japanese growth. The yuan was stable against the dollar until 2005, has moderately appreciated until 2008, before being stabilized once again. Consequently, the undervaluation of the yuan has been accentuated. This exchange rate policy can be easily understood from the Chinese point of view, due to the strong negative effects of a yuan revaluation on Chinese growth, but it contributes to the persistency of global imbalances. Combined with the huge Chinese recovery plan of 2008, it has allowed China to preserve a high growth and to escape the crisis.

Is a monetary integration or coordination possible? 317 The evolution of the other East Asian currencies have also been differentiated. The Korean won and Thai baht appreciated against the dollar during the 2000s, but the baht succeeded more in preserving its undervaluation. Since 2008, the won has depreciated while the baht has stabilized against the dollar. Indeed, the Korean economy has been badly affected by the crisis and has suffered more than other East Asian countries. Before that date its external position was weaker and has been aggravated by the external shock. The regional institutions, especially inside the Chiang Mai initiative, were unable to contribute to solve the problems of the banking sector and a US loan from the FED was necessary at the end of 2008, followed by loans from the Japanese and Chinese central banks (Jetin 2010). The won depreciation, under markets’ pressure, helped the export sector, but at a financial cost for the banks. Beyond these various evolutions (Figure 16.1 and Table 16.6 in the Appendix), East Asian currencies remained undervalued against the dollar during the 2000s. This has lasted since the beginning of the crisis during which the answer has been an anchor on the dollar in most cases. The shock of the revaluation against the dollar, as it is analysed in the simulation of Table 16.3, did not actually materialize in East Asia, except for Japan, but it might still happen thanks to the current exchange rate misalignments, especially in the case of a weakening euro following the crisis of the euro area. This might have destabilizing effects on East Asian economies, due to asymmetric effects and to the unequal prevailing misalignments. Among the East Asian currencies, the yuan is the more undervalued, the won and the yen less so. This raises the question of a new exchange rate regime in East Asia and of new forms of monetary cooperation. This renewal of monetary regionalism is supported by two factors which appeared during the last decade, the relative decline of the economic power of the USA and the relative rise of China. The US economy has been at the epicenter of the crisis with the drift of the finance-led growth regime. In spite of large scale bailout policies, it still suffered from large imbalances and the economic recovery is not assured. The USA are no longer in a position to manage the global economy alone. Conversely, China has preserved its high growth, partly thanks to its exchange rate policy and to a large recovery plan. Even if China’s imbalances are also numerous, its relative position has changed radically at the global and regional levels. Simultaneously, debates have developed about the future of the International Monetary System, with, to summarize, two main options. The first one lies in the idea of replacing the dollar as key currency by a basket of the principal currencies (the SDR, the IMF’s Special Drawing Right). The second course considers a system of multiple key currencies (dollar, euro and, possibly, a future Asian common currency). These are long-term perspectives, but they underlie discussions about new forms of monetary cooperation in East Asia. The analysis will be conducted in two steps: first, the necessity of preserving an adjustable exchange rates regime in East Asia, at least for a long transition period, will be shown; second, the principal forms of monetary cooperation will be compared.

318 S.-E. Jeong, J. Mazier and S. Saglio

Plead in favor of adjustable exchange rates regime in East Asia From the perspective of the creation of an area where exchange rates would be stabilized, at least between the yen, the won, and some other East Asian currencies, the mode of adjustment prevailing in such a zone can be partly examined using the previous model where exchange rates are fixed. An analysis of the choice between fixed and more flexible exchange rate regimes requires consideration of factors which are not components of the model. Lower inflation expectations and reduced exchange-rate volatility are traditional arguments in favor of a fixed exchange rate system. These aspects of inflation expectations and exchange rate volatility are not incorporated in the model. However, to assess the role played by exchange rate adjustments, a partial enlightenment can be obtained by comparing the results of the model without or with exchange rate manipulations facing asymmetric shocks. The costs of fixed exchange rates clearly appear as adjustments through wages; employment and prices are painful, slow, and limited. Two kinds of asymmetric demand shock, affecting only a single country, will be considered first, one on domestic demand with a fall of consumption, another on external demand with a loss of external market shares. In order to assess the role played by exchange rate adjustments, the previous shocks in a fixed exchange rate regime will be compared with scenarios where the negative demand shock is combined with a devaluation of each relevant currency (yen, won, or yuan). Asymmetric domestic demand shock and devaluation We consider first a negative shock on internal demand equivalent to a −1 percent change in GDP, due to a fall of consumption or a reduction of public expenditures. The impact and adjustment mechanisms are the same in all countries, but the amplitude differs significantly. Production decreases in the short term, unemployment rises, wages and prices fall. This allows a progressive recovery, thanks to improved price competitiveness. China and, to a lesser extent, Korea are more reactive due to higher trade openness and rather high foreign trade price elasticities. However, it is only in the medium to long term that the initial shock is offset, which illustrates the limited efficiency of price–wage mechanisms to compensate for a negative demand shock (Table 16.4). Conversely, Japan appears more enduringly affected and less reactive than the other countries. Japanese production remains weaker while price deflation is reinforced. This can be explained by greater employment rigidity, but mainly by the smaller degree of trade openness and the weaker foreign trade price elasticities which make the wage-price adjustment mechanisms rather inefficient and very costly in terms of growth. This scenario can partly explain the stagnation and the deflation which the Japanese economy has endured since the early 1990s, in clear contrast to China and Korea. Diffusion effects in other East Asian countries are noticeable, but are not given in Table 16.4. A negative shock in China has a significant short-term impact on Korea (a −0.15 percent change in GDP), but less in Japan. The negative shock in Japan affects both China and Korea in the short term (−0.16 percent for GDP),

Is a monetary integration or coordination possible? 319 Table 16.4 Negative shock on internal demand (−1% of GDP in T1) Fixed exchange rate regime

GDP price (%) t =1 t =5 t = 15 GDP (%) t =1 t =5 t = 15 Trade balance in % of GDP US market t =1 t =5 t = 15 Extra-Asian market t =1 t =5 t = 15 Intra-Asian market t =1 t =5 t = 15

Flexible exchange rate regime (devaluation of 5% in T2)

Korea

Japan

China

Korea

Japan

China

−0.20 −1.47 −1.64

−0.07 −0.35 −1.63

−0.56 −0.40 −0.31

−0.20 1.71 6.08

−0.07 0.14 0.07

−0.56 1.06 3.25

−1.01 −0.69 0.14

−1.00 −0.96 −0.60

−1.01 −0.42 0.05

−1.01 0.66 0.99

−1.00 −0.49 0.04

−1.01 0.53 0.88

0.05 0.10 0.09

0.03 0.02 0.03

0.03 0.01 0.00

0.05 0.31 0.07

0.03 0.16 0.18

0.03 0.32 0.29

0.09 0.16 0.18

0.06 0.01 0.01

0.11 0.05 0.01

0.09 0.62 0.16

0.06 0.09 0.09

0.11 0.35 0.26

0.36 0.07 −0.03

0.06 0.01 0.01

0.30 0.05 0.03

0.36 0.02 0.05

0.12 0.08 0.07

0.30 0.31 0.13

Source: Mazier et al. (2008).

but China experiences more lasting effects. The deflationist effect on prices is also noticeable. We examine in a second step what occurs when exchange rate adjustments are feasible. For this we simulate the same asymmetric negative shock on domestic demand equivalent to −1 percent of GDP at time 1 (T1), followed by a 5 percent devaluation of each relevant currency at time 2 (T2). After the recessive effect induced by the negative demand shock, Korea and China manage to compensate for this negative impact in almost one year, thanks to the 5 percent depreciation of their currency. The simulation goes on to show a GDP increase of 1 percent in the medium term (Table 16.4). Their trade balances improve in all the markets. The improvement is stronger for Korea, particularly as regards its extra-Asian market. The amelioration of China’s trade balance is less evident, but its intensity is the same in all markets. The counterpart is, of course, the development of inflationist pressures which, in the long term, will put an end to the recovery movement.

320 S.-E. Jeong, J. Mazier and S. Saglio Concerning Japan, the scenario is slightly different. Indeed, after the negative shock, the depreciation of the yen allows a progressive return to initial conditions, but this recovery is much slower than for the two other countries, due to weaker trade openness and weaker price elasticities. Nevertheless, its trade balance improves in all the markets, particularly in the US market. Above all, even in Japan, the improvement of economic activity is clearly more significant than in the case of fixed exchange rates. The comparison of a fixed exchange rate regime with a more flexible regime, where exchange rates adjustments are possible, shows at first glance a rather clearcut conclusion. Facing asymmetric demand shocks, a return to the initial state is slower and more painful when a fixed exchange-rate regime prevails. Possible use of monetary adjustments strongly facilitates a return to the initial state. This statement neither incorporates the traditional advantages of fixed exchange rates in terms of price stability, low inflation expectations and reduced exchange rate volatility, nor the difficulty of introducing some flexibility in the management of exchange rates. However, these arguments do not change the main conclusions of our simulations for at least three reasons: 1 Past experiences of fixed exchange rate regimes, as the burst of the Argentine currency board in 2001, the failure of the dollar-peg policy in East Asia in 1997 or, more recently, the euro zone crisis in 2010, show that reduced volatility and financial stability cannot be regarded as their fundamental characteristics. 2 Price stability could be a more solid argument, as devaluations are often followed by inflation skid which, in the long term, reduces the initial advantage in terms of price competitiveness. Indeed, in many countries, fixed exchange rate regimes have been used to fight inflationist culture, in Latin America, East Asia as well as in Europe. But these inflation pressures could be compensated by appropriate measures, such as income policy or fiscal policy, without recurring to overvalued currency. This question is well documented in works that have used larger macroeconometric models than our own.2 3 The problem raised by the management of adjustable exchange rates regime must not be underestimated, especially in a world economy dominated by capital mobility, as capital flights and speculative attacks can be destabilizing factors. To preserve the stability of such a regime, some forms of capital control and taxation of financial transactions have to be reintroduced. This kind of measure is considered with less suspicion since the burst of the current financial crisis than before 2007, but concrete decisions remained very limited until now. Loss of competitiveness and devaluation As before, we now consider a negative shock in each market with a 10 percent loss of external market shares due to a loss of competitiveness. This disruption induces a decrease in GDP, a rise in unemployment and a fall in wages and prices. In the medium term the ensuing improvement of price competitiveness enables

Is a monetary integration or coordination possible? 321 Table 16.5 Loss of competitiveness (−10% on external market shares) Fixed exchange rate regime

GDP price (%) t =1 t =5 t = 15 GDP (%) t =1 t =5 t = 15 Trade balance in % of GDP US market t =1 t =5 t = 15 Extra-Asian market t =1 t =5 t = 15 Intra-Asian market t =1 t =5 t = 15

Flexible exchange rate regime (devaluation of 20% in T2)

Korea

Japan

China

Korea

Japan

China

−0.56 −6.05 −13.41

−0.06 −0.36 −2.51

−1.33 −2.33 −5.13

−0.56 5.41 7.04

−0.06 1.46 3.79

−1.33 2.88 7.05

−2.80 −4.48 −3.85

−0.86 −1.30 −1.77

−2.36 −3.51 −3.64

−2.80 0.09 −0.86

−0.86 0.37 0.52

−2.36 −0.28 −0.81

−0.45 −0.18 0.43

−0.23 −0.22 −0.18

−0.98 −0.89 −0.87

−0.45 0.65 0.59

−0.23 0.34 0.37

−0.98 0.17 0.12

−0.76 −0.59 0.64

−0.18 −0.29 −0.27

−0.69 −0.72 −0.63

−0.76 1.12 0.99

−0.18 −0.02 −0.03

−0.69 0.38 0.30

−0.23 −0.54 −0.80

−0.23 −0.31 −0.29

−0.19 −0.18 0.06

−0.23 −0.81 −0.62

−0.23 −0.11 −0.13

−0.19 0.76 0.53

Source: Mazier et al. (2008).

stabilization or a partial recovery, but the adjustment mechanism through wages and prices is once again very slow and inefficient (Table 16.5). The slowdown is more pronounced and long-lasting than in the case of a negative internal demand shock. Once again there are important differences between countries. Japan is less influenced in the medium term, thanks to its smaller trade openness, but the decline continues for longer, as the pressure on prices is more limited and less efficient. Korea and China are more affected with a substantial fall in prices in Korea which enables only a partial recovery through price competitiveness gains. We introduce in a second step the possibility of exchange rates adjustments. The 10 percent loss in external market shares in each market in T1 is followed by a 20 percent devaluation of the currency of the considered country in T2 (Table 16.5). After the strong loss of external market shares in the short term, especially in Korea and China, the devaluation enables a quick recovery which begins one or two years after the initial negative impact. Trade balances are improved,

322 S.-E. Jeong, J. Mazier and S. Saglio particularly in extra-Asian markets. The counterpart is, of course, the development of inflation pressures with the devaluation which limits medium-term recovery. Japan is more able to contain medium-term inflation and appears to benefit the most. Inflationist drift is more marked in Korea and China. However, a comparison with the same external demand shock with fixed exchange rates shows that a return to an initial state is facilitated by devaluation, compared to the painful and inefficient process of wage and price compression which is the only way to adjust under the scenario of a fixed exchange-rate regime. As previously, this first statement must be mitigated, as traditional advantages of fixed exchange rates in terms of stability and low inflation are not taken into account. On the whole, these simulations illustrate the costs of foregoing any kind of monetary adjustment. In the face of asymmetric demand shocks (external or internal), a return to an initial state is slower and more painful when a fixed exchange rate regime prevails among East Asian countries. In contrast, the possible use of monetary adjustments (here, devaluation) facilitates a return to the initial state. This pleads for a more flexible regime with stabilized exchange rates, but without ruling out limited monetary adjustments. Monetary adjustments could occur in case of negative asymmetric shocks or in case of variations of the equilibrium exchange rates due to structural changes (oil shocks, loss or gains of productivity). The FEERs, as they have been presented in the previous section, can be used as a reference in the management of such an exchange rate regime, with the definition of fluctuations’ bands beyond which monetary adjustments could occur. This proposition recalls older ones made by Williamson (1985) more than 20 years ago and which still seem useful. However, such an exchange-rate regime is more difficult to manage due to problems of higher instability. It might be completed by some measures of capital control in order to reduce short-term volatility. These measures are regarded with less suspicion since the last financial crisis. However, due to their structural differences, the East Asian economies have an unequal interest in a flexible, but managed and stabilized, exchange-rate regime. The capacity of adjustment of each country facing shocks depends in our analysis of two kinds of parameter, related to the foreign trade and the labor market.3 Foreign-trade parameters are representative of the mode of international insertion of each economy. Japan, less open, more price maker, with weaker export and import price elasticities, is less sensitive to exchange rate variations. Korea, more opened, more price taker, with higher price elasticities, is in the opposite position. China is an intermediate case, being as open as Korea for extra-East Asian trade, more price taker than Korea and with intermediate price elasticities. Representative parameters of the labor market, although simplified, correspond to the different wage labor nexus. The Japanese labor market appears less flexible with stronger nominal and real rigidities, especially a weak sensitivity of real wages to unemployment, and a weaker external flexibility with high employment adjustment duration and high flexibility of the rate of activity. China and Korea are more flexible, particularly with a short employment adjustment duration, and more intermediate value for the other parameters.

Is a monetary integration or coordination possible? 323 The characteristics of each mode of international insertion and wage–labor nexus can help to define the best exchange rate regime for each country. Actually, the combination of the two institutional forms is rather complex, as they partially compensate each other. Due to its foreign trade parameters, Japan is less sensible to exchange rate variations and would be less penalized by a fixed exchange-rate regime. On the opposite, its less flexible labor market limits its adjustment capacity and pleads for a more flexible exchange rate regime. By contrast, thanks to its foreign trade parameters, Korea would benefit more from a flexible exchange-rate regime, but its more flexible labor market allows the Korean economy to face more easily fixed exchange rates. China is in an intermediate case with its foreign trade characteristics which make its economy rather sensible to exchange rate variations and its flexible labor market. On the whole, this contrasted situation could help the East Asian countries to find a compromise around a flexible, but managed and stabilized, exchange-rate regime. Lessons from a comparison of European and East-Asian integration processes A brief comparison with the case of the euro area gives another insight. Using a multinational macroeconomic model of the EU, it has been possible to appreciate the efficiency of the adjustment mechanisms inside the Monetary Union (Mazier and Saglio 2008). The inefficiency and the cost in terms of growth of relativeprice adjustments have been underlined in cases of asymmetric evolution which are frequent, due to structural differences between euro area’s members. The lack of federal transfers inside the European Union reinforces the insufficiency of the adjustment mechanisms. The current crisis of the euro area illustrates the problems raised by a monetary union where there is no mechanism or institution capable of solving intra-area imbalances and where, by construction, exchange rates are fixed. In spite of a global euro with limited misalignment at the world level, the undervaluation of the euro-mark has contrasted with the overvaluation of the southern European euros during the 2000s (Jeong et al. 2010). This explains, in large part, the current crisis of southern Europe. However, the main difference between European and East Asian integrations has been at the political level. The European integration has been driven, since the beginning, by a political will, based on a French–German compromise, between two countries of an equivalent size, even if the economic power of Germany was stronger since the start. In the Roma Treatise in 1956, Germany imposed competition as the main rule of European construction, but France introduced structural policies, mainly with the Common Agricultural Policy and the structural funds at the regional level. In the early 1980s, France did not succeed in promoting industrial and research policies at the European level in order to complete and balance the EMS, which was also a French–German compromise. Facing huge blocking, the launching of the Single Market project in 1985 has been a turning point. The market forces’ liberalization and the reinforcement of competition policy were regarded as the only way to engender a new dynamics into the EU. Actually, the very optimistic targets were not reached at all and European growth remained

324 S.-E. Jeong, J. Mazier and S. Saglio weak. In a context of financial liberalization, the adoption of the Monetary Union in 1992 and the launching of the euro in 1999 were the ultimate step. They also resulted mainly from a French–German compromise on a political basis after German reunification. Between 1992 and 1999 the nature of the project has evolved from a small monetary union, close to a mark zone, which was favoured by Germany, to an enlarged union including the southern European countries. As such, the project was uncompleted and unbalanced. The current crisis of the euro area cannot be regarded as a surprise, but there is no more political will to go further. Conversely, since the beginning, the East Asian integration has been market driven with weak institutions. Actually, economic integration remained rather limited inside the ASEAN. It was only on a wider basis including China, Korea, and Japan that the level of integration increased, largely stimulated by the FDIs in China and the related intrazone trade. The heterogeneity of the zone was larger than in the case of Europe, both by the size of the participant countries and their level of economic development. Until the 1990s, Japan was the dominant country, but faced difficulties exerting its political leadership. The ASEAN + 3, better suited to tackle economic and financial problems, appeared only after the Asian crisis. Its institutional form remained rather loose, however. The rivalry between China and Japan appeared as a main obstacle and contributed to block initiatives, as was shown in Part I. China was the rising power and Japan, even if it was still the most developed and the largest economy, faced important economic problems from the 1990s. The building of a political compromise was far more complex than in the European case. China has overtaken Japan in 2010 and the gap between the two countries will increase rapidly in the near future, probably making the compromise even more difficult to get than in the past due to conflicting interests.

Which forms of monetary cooperation in East Asia? Since 2008, with the rise of China, the decline of the USA, and discussions about a new IMS, a new interest exists for monetary and financial cooperation at the regional level with the perspective of creating a third pole in East Asia. Two main proposals exist, the Asian Common Currency and the Common currency basket. (Few words will be said about others.) Asian currency The Asian common currency project goes back to c.2000 after the Asian crisis and the success of the launching of the euro (Kim and Ryou 2001). But discussions about the ACU were premature and almost died in the middle of the 2000s. They have been recently reopened in the context of the financial crisis (Shimizutani 2009). In contrast to the euro, which was motivated mainly by political reasons, the introduction of an Asian common currency would be encouraged primarily by economic reasons. It is presented as a long-term project. A first step would be the strengthening of financial surveillance and support systems in East Asia, especially with rebuilding the Chiang Mai initiatives. The second step would be

Is a monetary integration or coordination possible? 325 the creation of an ACU, composed of the yen, the yuan, the won, and other Asian currencies. Policy coordination, establishment of financial systems with accounts in ACU, liberalization of capital movements would be developed before introducing an Asian Common Currency as a last step. Although ambiguous, it would be an Asian single currency. An Asian common currency would present traditional advantages of a monetary union for Asian countries (stabilization of exchange rate, increase of regional trade, development of an Asian bond market reducing the asymmetric in currencies and the asymmetric of maturity, incitation for a larger coordination). At the world level, it would also help to stabilize the global economy with a three-polar system. Excess Asian saving would be reinvested more in the region, which would reduce global imbalances. However, the final step with the introduction of the Asian common (single) currency would raise considerable obstacles which are minimized. The proposed roadmap suggests that, after a transition period mainly dedicated to stabilization and strengthening regional cooperation, the introduction of the ACU would not intervene before the 2020s with promotion of its private and public use. The transition to the Asian Common Currency (in practice, a single currency) would be for the 2030s. If an ACU can be considered as an intermediate step with useful arrangements, the ultimate step, the single currency with an Asian Common Currency, seems less realistic. Even in the 2030s asymmetric will remain important in East Asia and adjustment mechanisms will appear insufficient within an East Asian monetary union. The difference of size between countries, with the dominant position occupied by China at that horizon, will be another main difficulty. The Asian Common Currency would imply a political compromise between China and Japan, which seems unlikely. However, the ACU project could be used inside an Asian monetary regime with fixed but adjustable exchange rates, each currency being defined relatively to the ACU within fluctuation bands, as was the case in the EMS. The size of these fluctuation bands is subject to discussion. Narrow bands, as in the primitive EMS, might be difficult to sustain with a high degree of capital mobility. Larger bands, as in the EMS after 1993, could be more manageable, but with more instability. Actually, the answer depends of two factors, the degree of capital control that the countries accept to introduce in order to have more arms to defend the parities’ structure, the realism of this exchange rates’ structure which must be close to equilibrium one to be defendable. The FEER approach, as it has been exposed previously, can give some indications in that perspective. But, even if the evaluation and the diagnosis were broadly accepted, it does not eliminate the political problem. Countries with undervalued currencies will be reluctant to revaluate at the advantage of their partners.

Common currency basket The Common currency basket has been proposed by Williamson (1998) in line with his earliest proposals. This basket, composed of the main commercial

326 S.-E. Jeong, J. Mazier and S. Saglio partners’ currencies (principally, the dollar, euro, and yen), would be used as an external anchor by the East Asian countries participating in the agreement. As this basket would be in common, it would help to eliminate the effect of fluctuations of the dollar, yen, and euro on intra-Asian trade. Each participating country would be committed to defending its currency inside a fluctuation band. The amplitude of the fluctuation band and the frequency of the exchange rate adjustments are open to discussion. In practice, various kinds of exchange rate policy can be implemented within this framework. This proposal leaves Japan outside the agreement for two reasons. The yen’s fluctuation against the dollar and euro are considered too large. Unless the yen was stabilized and included in the agreement, the common basket would be composed only of the dollar and the euro, which could place East Asian countries in an imbalanced position at a world level. Conversely, it seems difficult to keep Japan outside the monetary arrangement for a long period. Last, the transition from the current situation, where East Asian exchange rate policies are rather contrasted, to a common currency basket peg is not simple to define. For all these reasons, an imperfect common currency basket is more likely, each country keeping its own currency structure for its peg, but with a trend towards unification. In case of necessity, monetary adjustments would be possible, which would avoid too-large imbalances. Other proposals Other proposals have been made or have previously existed. The dollar peg is the oldest one. It has the advantage of simplicity and of using the key currency. It also offers a kind of informal coverture against exchange rate variations, as domestic bond markets are insufficiently developed in many East Asian countries to offer enough diversified assets. It has been used largely since the 1990s. But, in spite of an apparent stability, it did not avoid the development of large imbalances. During the 2000s, the dollar peg became more flexible with an increasing role played by the yen and, to a less extent, the euro. If the share of the dollar is durably reduced at the benefit of the other two main currencies, it could be interpreted as a transition regime towards a common currency basket where the different baskets are not unified. The yen bloc is another proposal which has gathered some more support after the Asian crisis in spite of the stagnation of the Japanese economy (Kwan 2001). The mechanism is based on currency basket for each country, with an increasing share of the yen according to the level of development of the country. The peg to the yen would be variable, the yen would be floating and play a role of anchor for the countries of the area. This monetary arrangement raises different problems. It gives a central role to Japan that does not reflect its actual position in the East Asian area. The yen is insufficiently internationalized. Last, such an arrangement could hardly be accepted by China because of the question of leadership. The yuan bloc has been more recently proposed with the rising power of China and its central position in East Asia. It has been noticed that movement of the yuan

Is a monetary integration or coordination possible? 327 has an increasing influence on the fluctuations of East Asian currencies (Shu et al. 2007). However, a yuan bloc is largely premature for many reasons. Capital markets have not been liberalized in China and the yuan is far from being convertible. The Chinese banks have still to be restructured, recapitalized, and modernized. The Chinese government has always been cautious in these matters and the current financial crisis reinforces this position. For these reasons, a yuan bloc can only be a long-term possibility, but might be the most likely. New institutional forms The financial crisis has given a new impulse to the regional dimension, not least because East Asia appears to be the most dynamic pole at the world level. But concrete results have been more limited. Some efforts have been made to progress at the level of the Chang Mai Initiative with the creation in 2010 of an ASEAN Macroeconomic Research Office which could be the beginning of a larger organism of monitoring and control. The project of an Asian Monetary Fund is also in discussion to face short-term adjustments at the regional level, independently from the IMF. The Asian surpluses make the situation more comfortable than at the end of the 1990s, but the pressure to find solutions is also more limited. The main problem is that China and Japan are both reluctant to develop a regional institution which would be too powerful and too autonomous and which could escape to their control or limit their own autonomy. This has been illustrated by the multiplication of bilateral swap agreements between China or Japan and other Asian countries, independently of the Chiang Mai Initiative (Jetin 2010).

Conclusion During the 2000s, much effort has been devoted to improving monetary and financial cooperation at the regional level, especially with the Chiang Mai Initiative and the Asian Bond Market Initiative, but results have been limited, especially regarding monetary cooperation. However, more pragmatic exchange rate policies have preserved undervalued currencies and large current surpluses, largely at the expense of the rest of the world. The main obstacle remains the lack of political purpose, at the difference of the European experience, and the underlying conflict between China and Japan. The impact of the current financial crisis has been important in the short term, particularly in Korea, but better managed than in the rest of the world. For the future, the heterogeneity between countries and asymmetric evolutions which prevailed pleads for pragmatism and the preservation of exchange-rate adjustments. It will be conditioned by the Chinese growth strategy, the amplitude of its rebalancing towards domestic demand, and the magnitude of the yuan appreciation. The autonomy of the Chinese monetary policy will be preserved. The chock of the dollar depreciation did not happen, but might happen. Its impact will depend of the reaction of the rest of the world, especially of the euro area which

328 S.-E. Jeong, J. Mazier and S. Saglio faces huge imbalances. It will have to be managed appropriately in the East Asian region to avoid tensions. However, intra-Asian imbalances are less developed than in the European case and less marked than in the 1990s, giving more room for maneuver. An imperfect common currency basket could be used as a short-term transition to define a regional exchange rate policy. But an ACU project would in the medium term be a more appropriate approach. In both cases the reference to equilibrium exchange rates could be a useful tool, although subject to debate. Long term, with the rising strength of the Chinese economy in East Asia, the yuan will play a dominant role and the monetary regime will become close to a yuan bloc. These long-term prospects about a new monetary regime in East Asia will not be independent of discussion on the future IMS with two main courses, a multipolar world with regionalism and a system of multiple key currencies (dollar, euro, yuan) or a global system based on the Special Drawing Right (SDR) as a key currency.

Appendix Table 16.6 Undervaluation (e > 0 and r > 0) or overvaluation (e < 0 and r < 0) in bilateral (e) or real effective terms (r ) of the euro, yen, yuan and dollar (in %)

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

e euro

e yen

e yuan

r dollar

r euro

r yen

r yuan

−5.5 −6.6 −5.6 −3.4 −6.7 −3.8 3.6 11.8 15.2 15.1 22.9 22.6 22.1 10.8 11.0 3.9

−2.5 −10.6 −14.7 −10.2 −10.7 −14.3 −2.1 2.3 9.7 15.9 23.9 32.3 35.6 27.7 21.6 4.4

17.3 −7.4 −9.9 7.1 7.4 1.8 8.8 5.2 16.4 23.0 25.5 41.7 47.4 39.7 35.3 29.3

7.1 8.5 3.7 0.0 −1.5 −4.3 −13.0 −11.0 −16.3 −17.7 −24.1 −30.6 −31.9 −23.3 −22.8 −7.7

−3.4 1.2 4.2 3.5 0.6 2.0 0.1 6.8 6.6 2.2 6.0 −0.4 −1.7 −4.1 −4.9 −1.5

−0.8 −3.4 −4.7 −2.7 −2.8 −8.9 −5.0 −1.4 2.4 4.0 7.4 8.7 10.3 11.3 4.8 −1.5

18.6 0.8 0.7 14.5 16.0 8.5 6.1 1.0 7.1 8.4 6.9 15.7 19.6 21.9 17.1 24.1

Source: Jeong et al. (2010).

Is a monetary integration or coordination possible? 329 Table 16.7 Undervaluation (e > 0 and r > 0) or overvaluation (e < 0 and r < 0) in bilateral (e) or real effective terms (r ) of East Asian currencies (in %) e won

e thaï

e mal

e phi

e indo r won

r thaï

r mal r phi r indo

1994 −6.3 −14.6 −7.4 −9.9 −2.0 −8.2 −12.9 −4.6 1995 −14.4 −25.8 −16.3 −10.5 −15.2 −4.5 −11.0 −1.6 1996 −23.6 −25.9 −6.3 −14.6 −7.1 −14.1 −14.1 −0.3 1997 −14.6 −3.5 −7.2 −13.8 12.2 −5.4 2.1 −0.3 1998 13.5 20.6 1.0 0.6 26.1 17.0 19.1 2.4 1999 4.8 15.7 6.8 −10.3 −3.2 5.6 12.4 2.6 2000 0.3 12.7 7.4 −0.5 11.0 −3.4 4.6 −0.6 1.0 −1.9 2001 −0.2 6.1 1.0 −2.3 18.5 −2.9 2002 4.9 10.4 6.5 4.2 17.3 −2.3 1.0 −1.8 2003 10.5 17.0 14.6 9.6 19.8 0.2 3.8 0.3 2004 18.2 16.5 17.7 14.9 10.6 1.8 −0.5 −1.9 2005 16.3 7.8 24.7 18.2 14.9 −3.3 −8.2 −0.9 2006 12.8 20.6 26.6 23.8 28.4 −5.9 −1.2 0.0 2007 11.3 29.5 25.2 25.3 28.5 −3.2 7.2 2.1 2008 10.1 19.3 32.0 21.6 21.9 −1.4 4.3 9.1 2009 10.3 19.3 14.3 16.6 22.6 3.8 9.1 4.7

−9.9 −1.4 −5.6 −3.5 4.3 −4.5 −3.3 −3.6 −2.6 −0.8 −1.6 −2.2 1.3 6.0 6.8 8.5

−4.7 −5.3 −1.9 15.1 25.9 −0.3 5.4 11.9 8.1 9.3 −2.8 −4.3 7.0 11.1 8.8 16.1

Source: Jeong et al. (2010).

Notes 1 More data on exchange rate misalignments are given in the appendix. 2 See, for example, in the case of the EMS, the OFCE-CEPII (1994) publications. 3 See Mazier et al. (2008) for a presentation of the main representative parameters for China, Korea, and Japan.

Conclusion The evolving diversity of Asian capitalisms, from the Asian crisis to the subprime crisis Robert Boyer, Hiroyasu Uemura and Akinori Isogai

The purpose of this book was threefold. It intended first to show why and how political economists should go beyond conventional static analyses of market economy and study contemporary issues from the viewpoint provided by the notion of capitalism. It is an invitation to study this specific socioeconomic system, which is constantly evolving under its inner dynamism. The first two sections of this conclusion summarize the main findings concerning this theoretical and rather general issue. However, this book’s second and substantive purpose was to capture and interpret the structural transformations observed since the 1990s in East Asia, which has served as more than a social laboratory. It is time to provide a synthesis of the findings of the historical analysis of the Japanese, Chinese, and Korean trajectories from an institutionalist standpoint, but the systematic comparative statistical analyses provided by many chapters herein must also be taken into account. A third novelty of this work is that it tightly interconnects domestic transformations and the changing pattern of international relations rather than simply juxtaposing and contrasting national régulation modes. The originality of Asian economic integration provides a strong incentive to extend régulation theory to a new domain, namely, that of international relations and the dynamics of the world economy. The following are the main findings concerning these three themes.

Asian capitalisms are distinct from the European and American configurations, and quite diverse among themselves Usually, the liberal market economy of the USA is the benchmark by which all other economies are ranked; the antithetical economy (i.e., that of Germany) is assumed to define a coherent and single alternative called the coordinated market economy. The present approach allows for an exploration of the nature and number of varieties of economy that have coexisted during a given historical period. Previous empirical analyses have already shown the existence of at least five brands of capitalism among OECD developed economies (Amable 2003). The novelty of

Conclusion 331 the present book is that it extends the same methodology to a large sample of East Asian countries to show that they exhibit more genuine configurations. Through the use of the régulation approach and available data, five groups of Asian capitalisms were identified in Chapter 13: City Capitalism (Singapore and Hong Kong), Insular Semi-agrarian Capitalism (Indonesia and the Philippines), Innovation-led Capitalism (Japan, Korea, and Taiwan), Trade-led Industrializing Capitalism (Malaysia and Thailand), and Continental Mixed Capitalism (China). These different Asian capitalisms have shown different patterns of macroeconomic dynamics, as well as different reactions to the Asian financial crisis and the subprime crisis (Figure C1). The detailed historical analysis of some national trajectories confirms the diversity of institutional architectures and the modes of régulation among these economies: after 1978, rapid transformations among Chinese institutional forms have been quite specific, compared to those observed in Japan and Korea. These findings have another important consequence: they refute a current, but of course, naive vision about the homogeneity of Asia as a generic and specific brand of capitalism. Quite the contrary, neither geographical proximity nor similar cultural patterns can sufficiently generate a single sociopolitical compromise that would define an “Asian capitalism.” An equivalent diversity has been found among 20

JAN KOR CHN TWN

15 10 % 5 0 –5 –10 80

85

90

95

00

05

15

HKG THA PHL MYS SGP IDN

10 5 0 –5 –10 –15 80

85

90

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00

05

Figure C1 GDP growth rates in Asian capitalisms. Note: JAN; Japan, KOR: Korea, CHN: China, TWN: Taiwan, HKG: Hong Kong, THA: Thailand, PHL: The Philippines, MYS: Malaysia, SGP: Singpore, IDN: Indonesia. Source: ADB Database and IDE Database.

332 R. Boyer, H. Uemura and A. Isogai Latin American economies, which display genuine configurations in reference to other regions around the world (Revue de la Régulation 2012). This book is thus part of an emerging research agenda that looks to elaborate a general theory visà-vis the evolution of capitalism.

Globalization and regional integration have generated more interdependence, but there is not any convergence towards a typically Asian generic capitalism The emphasis on institutional configurations provides a third major hint regarding international economic relations theory. The field was effectively coined by David Ricardo, whose theory of comparative advantage is based upon natural endowments of each national territory; this framework is still the reference in modern international trade theory. In contemporary economies, however, the ability to nurture innovation and promote technical change has a very prominent role in the relative wealth of nations; the theory stresses the impact of endogenous technical change, not only on domestic growth, but also on specialization and international trade patterns. Ultimately, however, the performance of any social system of innovation depends upon the coherence of the institutional forms that define or shape the system of incentives that individuals encounter. This theory of institutionally constructed competitive advantages is thus useful in capturing some key features of present-day international relations. Actually, both the strengthening of competition and the enhanced mobility of FDI and capital have, indeed, induced firms to exploit the diversity of natural and institutional endowments within different territories. Conversely, those firms’ strategies affect the evolution of national institutions: either they reinforce them when they are strong and rather coherent, or they erode and even destroy them when they are weak and unbalanced. This process is under way in Europe, under the umbrella of a common competition policy and monetary integration. Asia is no exception to this cause-and-effect chain: not all economies in that region have tended to converge towards a common “Asian model.” Since the mid 1990s, city capitalisms have accentuated their specificities and specializations in the financial and high-tech sectors; similarly, insular semi-agrarian capitalisms have also diverged from the rest of the Asian zone, whereas the institutional configurations of continental mixed capitalism, typical of China, have only marginally changed. The group of innovation-led capitalisms has experienced still another evolution that has driven Japan, for example, to more closely resemble welfare capitalisms in Europe. The early twenty-first century has thus experienced a renewed diversity in capitalisms; Asia does contribute to this general trend, which is at odds with popular rhetoric that associates globalization with convergence (Figure C2).

The old flying geese pattern is no longer the integrating mechanism for Asia These transformations modify the traditional principle of the international division of labor in East Asia, that is, the flying-geese pattern of economic development

Conclusion 333 SGP

Contrast of Trade Dependence and Domestic Social Protection

mid 90s

mid 2000s

HKG

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CAN NZL IRL

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Figure C2 Evolution of various capitalisms from the mid 1990s to mid 2000s. Source: Yuji Harada and Hironori Tohyama (2011), “Asian capitalisms: Institutional configurations and firm heterogeneity,” in Boyer, Uemura, Isogai (eds), Chapt. 13.

(Akamatsu 1962). The main driving forces behind changes in the flying-geese pattern are FDI and increasing international production linkages among the Asian economies, especially between Japan and China. It is not only that China is rapidly catching up with Japan; China has also become another economic power and is strongly involved in international production networks, along with Japan and other East Asian countries. Japanese capitalism is strongly influenced by both international competition and international production linkages with other East Asian economies (Chapters 1–6). Japanese firms have been very actively making FDI in East Asian countries in order to develop international production networks (Chapter 8). Consequently, the companyist compromise in large firms is no longer consistent with other parts of the Japanese socioeconomic system. These stronger pressures have led to wage compressions and to greater instability within employment relations. At the macroeconomic level, the companyist compromise has eroded progressively during the prolonged recession of the 1990s and the slow and insufficient recovery in the first half of the 2000s.

334 R. Boyer, H. Uemura and A. Isogai Thus, under competitive pressures, de-industrialization has accelerated, thus making innovation-led growth necessary if Japanese firms are to continue to lead the international division of labor in East Asia. For two decades, Chinese capitalism has had an increasingly larger impact on the world economy; conversely, its evolution has been influenced by the recent transformation of the world economy (Chapters 7–10). China’s rapid economic development in the manufacturing industry has partially depended on the increased modularization of electrical products, attracting many foreign multinational companies and utilizing international production networks (Chapters 7 and 8). China imports intermediate sophisticated goods from Japan, Korea, and other Asian countries, and exports final products to the USA and the EU. Though China’s manufacturing development has come to be supported by domestic demand stimulated by a high investment rate, it is still strongly influenced by its international insertion and production linkages. China’s very rapid economic development, which thus features strong international production linkages, has modified the traditional flying-geese pattern. China has become the largest manufacturing center in East Asia to export final products to the USA and Europe. Taiwan has developed the manufacturing industry, with innovative, mediumsized firms that produce modularized products, especially electrical equipment; it has become an innovation-led capitalism that is built upon a structural dependence on international trade with other East Asian countries and the USA. For these reasons, Taiwan’s gross domestic product (GDP) was influenced very much by the information technology recession in 2001 and the subprime crisis in 2008, as shown in Figure C1. Korean capitalism is deeply involved in the new East Asian division of labor (Chapters 11 and 12). The Korean manufacturing industry developed rapidly by importing capital goods and producing consumer durable products, such as cars and electrical machines; it also came to produce high-quality capital goods. The Korean economy has thus become an innovation-led capitalism, producing sophisticated high-tech products and exporting them to the world market. Korean companies are also using FDI to organize international production networks in the East Asian region. Other Asian capitalisms, namely, city capitalism, trade-led industrializing capitalism, and insular semi-agrarian capitalism, are influenced very strongly by international competition and foreign trade in the East Asian region, each in its own ways. City capitalisms were traditionally open trade centers, and they have recently developed the financial sector (Hong Kong) and the high-tech sector (Singapore), thus welcoming foreign multinational firms. Trade-led industrializing capitalisms have welcomed a considerable volume of FDI from developed countries, and they have also been involved in international production networks dominated by foreign multinational firms. Insular semi-agrarian capitalisms have accepted many foreign multinational firms in agrarian plantations, and the multinationals in turn export the products to the world market. Thus, what has changed in the typical flying-geese model of development? Basically, standardization and modularization, allied with unprecedented FDI mobility,

Conclusion 335 have created large production networks. Those networks have, in quite a few industries, disconnected the previous specialization of each national economy – industries that had previously been vertically integrated to produce a specific good. The multinationals are generally leading and organizing this process; governments do this via their industrial and trade policies. The genuine flying-geese model had Japan at its center, organizing the delocalization of production; in the 2000s, however, Korean, Taiwanese, and Chinese firms are themselves delocalizing their production capacities, according to interconnected global networks, inside East Asia but also with the rest of the world. Last but not least, in what is a major theme of this book, national institutions with their own hierarchies have mattered immensely, since the unequal ability to capture the benefits of this new international division of labor depends upon the quality and coherence of key domestic institutional compromises. As has been pointed out, this is a key factor in any explanation of the diversity and implicit hierarchy/complementarity among East Asian capitalisms.

Liberalization has been detrimental to the viability of national régulation modes and has propagated macroeconomic instability East Asia is a very good “social laboratory” for testing hypotheses vis-à-vis the origins and consequences of the two most recent world financial crises. In retrospect, most analysts agree that the globalization of finance has triggered a new form of crisis for all countries that had fully opened their external capital accounts. International Monetary Fund (IMF) adjustment plans were built upon the hypothesis of a repetition in Asia of the Latin American imbalances in public spending. Hence, quite costly and inadequate therapies convinced East Asian governments either to limit the access of international portfolio investment to domestic financial system, or to build large reserves, in order to prevent the repetition of such currency crises, or both. In a sense, the subprime crisis also points to the danger of a permanent capital inflow that generates an excess of liquidity in search of speculative gains, to the detriment of investments contributing to the structural competitiveness of the American productive sector. Financial deregulation, as promoted by the USA, has struck back at its originator and put an end to the finance-led growth regime. Given the severity of the subsequent turmoil in the world economy, it is no surprise that all East Asian economies have been affected (see supra Figure C1), but they learned from the 1997 crisis to design more adequate anticrisis economic policies. Nevertheless, reactions to crises differ significantly from one country to the next, as dictated by each country’s legacy of basic compromises, institutional capability, and government’s strategic choices. Japanese capitalism came to be influenced by international finance, after the Japanese “Big Bang” in 1998. Many foreign investors came into the Japanese stock market, and they started to own large numbers of shares of Japanese firms. This came to have a strong influence on Japanese firms’ corporate governance (Chapters 2 and 3). Furthermore, many foreign banks expanded their dealings in the Japanese interbank market. When the Japanese economy was hit by the

336 R. Boyer, H. Uemura and A. Isogai subprime crisis, those foreign investors sold their Japanese shares, and the foreign banks sharply limited themselves in those dealings. Besides its strong dependency on world trade, the Japanese economy has become very vulnerable to financial contagions, a condition typical of contemporary globalization. Chinese capitalism, as a continental mixed capitalism, was not greatly influenced by the Asian financial crisis in 1997. Even after it was hit by the subprime crisis in 2008, it was able to recover relatively quickly from the recession. The domestic financial system has been modernized in its transition to a capitalist economy, but it has not been liberalized; the limits imposed on foreign portfolio investments allow the Chinese government to control the exchange rate in accordance with domestic growth and employment objectives. For these reasons, the Chinese financial system is still less internationalized and exposed to the world financial market’s vagaries than are other systems (Chapter 10). Korean capitalism was hit hard by the Asian financial crisis, and it was constrained to accept a multiplicity of market-oriented changes in financial institutions, but also with respect to labor regulations. The increasing levels of employment segmentation that resulted have generated a widening of social inequalities. The banks have thus directed their credit more toward household consumption than investment in small- and medium-sized enterprises (SMEs). The previous growth regime, built upon a balance between investment and consumption, has been replaced by an export-led, finance-sustained, and rather fragile accumulation regime. There is no exaggeration in pointing out that Korea’s financial liberalization has implied a transition towards another régulation mode, one more fragile and featuring even more inequity than its predecessor. Could a re-regulation of finance restore a more balanced socioeconomic regime? This is precisely the issue that policy-makers face (Chapter 11). Other Asian capitalisms, namely, city capitalism, trade-led industrializing capitalism, and insular semi-agrarian capitalism, were greatly affected by the Asian financial crisis, and they transformed as a result; the growth rates of those economies also dropped very sharply during the subprime crisis as seen in Figure 1. However, trade-led industrializing capitalisms did not incur as much damage as a result of the subprime crisis, and soon started to export products again. This comparison suggests that the more accepting East Asian governments have become of liberalizing their domestic economy and especially their financial system – and as a result, to opening their capital accounts following the 1997 crisis – the more variable their GDP figures have become (Figure C3). One may assume that in the 1980s and 1990s, the origin of macroeconomic fluctuations was essentially domestic and exacerbated by deregulation; later, they resulted from world trade and international financial inflows and outflows.

The Japanese crisis and stagnation: erosion of the companyist mode of régulation, but no alternative Until the subprime crisis, the Japanese “Lost Decade” had been sometimes interpreted as an exceptional evolution, typically linked to mismanagement by policy

Variance of GDP growth rate in 2004–2009

Conclusion 337

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1st Factor (Xaxis) in Fig. 13.5

Figure C3 Correlation between liberalization and stability: the 2000s. Source: Yuji Harada and Hironori Tohyama (2011).

makers and the lack of a more vigorous deregulation of product and labor markets. Since then, many observers of the American economy have imagined that the long and painful process of reducing private debt could trigger an “American lost decade.” It would imply the “piling up” of public debt in the context of slow and uncertain growth. Most explanations for the long Japanese stagnation focus on financial matters; they capture an important feature of contemporary evolutions, but these interpretations underestimate the structural limits of the related growth regime. More precisely, the various chapters that analyzed transformations among Japanese institutional forms and firms’ organizations deliver a complementary interpretation: the past coherence between a managerial organization of large firms and coordinating mechanisms at the macroeconomic level has eroded, and the strengthening of market competition and the weakening of social consensus has obstructed the generation of any alternative régulation mode. This means that a quite-lax monetary policy of quantitative easing taken by the Bank of Japan – the first experience of its kind in Japan – may be unable to compensate for an incoherent set of institutional forms. Furthermore, in such a context, public spending serves as a poor substitute for a search for realignment of key institutions and organizations. Let us recall the process that led to the present stalemate. In the latter half of the 1970s, companyism was created at the firm level, and it was based on in-house skills-formation, innovation, and compatibility between job security for regular workers and the ability to flexibly adjust employment for non-regular workers. It was converted at the macroeconomic level into a companyist mode of régulation, and it featured the co-coordinating mechanisms of the hierarchical market–firm nexus: the complex and institutional coordinating mechanisms of employment and wages, including shunto; subcontracting networks; the role of the main bank within a financial system, based on patient capital; and, finally, explicit or implicit

338 R. Boyer, H. Uemura and A. Isogai coordination provided by the government. This was one of the major messages in our former research (Boyer and Yamada (eds.) 2000), but the situation has significantly changed since then. In the 2000s, there still exists in some large firms a companyist compromise between core regular workers and managers; however, given their increasing heterogeneity, it is no longer a norm among all Japanese firms. Moreover, even among firms that retain the essence of a companyist compromise, the number of regular workers benefiting from this compromise has decreased drastically in the last 10 years, since the compromise is restricted to the core workers who have contributed most to the long-term competitiveness of the firm. Some tasks have been subcontracted, and the number of non-regular workers has increased. On the whole, some firms that kept a companyist compromise are still very efficient, whereas other firms have experienced a relative decline in productivity. Within the companies that scrapped their companyist compromise, a large dispersion in productivity and performance has been observed. At the macroeconomic level, the companyist compromise has lost its major role as the matrix of the régulation mode because its original coordinating functions at the meso- and macro-levels of the hierarchical market–firm nexus have progressively eroded over the last 15 years. The increasing heterogeneity of firms, the increasing dualism of regular versus non-regular workers, the rapid increase in the number of non-regular workers, the collapse of shunto, the decomposition and delocalization of subcontracting networks, and finally the decline of the main bank and the surge of direct finance have implied a decline in most of the previous coordinating mechanisms that converted past local compromises into macroeconomic regularities. Consequently, these factors have eroded the companyist mode of régulation, making export-led growth regimes very unstable. At this stage, it is still very difficult to envision a new and coherent mode of régulation and corresponding growth regime in Japan. Clearly, this is an invitation to proceed to a similar analysis for the American and European economies after 2008; few of them, after all, have retained the effectiveness of their régulation modes in the face of liberalization and financialinnovation pressures. Again, East Asian capitalisms seem to have anticipated the state of most, if not all, of post-Lehman Brothers world.

The unexpected surge of East Asia and China: a turning point in the history and theories of capitalisms The rise of new industrializing economies, especially in Asia, has challenged the conventional wisdom of two generations of scholars who studied the history of capitalism in order to build a relevant theory. In the 1960s, many economists had taken into account the failure of development outside the already industrialized countries. Growth theory of that time assumed an asymmetric power-balance in the formation of the relative prices of manufactured and natural resources, barriers to entry and the related increasing returns, and finally the concentration of innovation among the core capitalist economies. The logical consequence was to

Conclusion 339 consider that the select club of developed countries was definitively closed. The emergence of Japan as an economic power was the first anomaly to counter that hegemony, and it de facto refuted conventional theory; the four “Asian Dragons” (i.e., Korea, Taiwan, Hong Kong, and Singapore) followed Japan soon thereafter. The response by theoreticians was quite partial indeed, via ad hoc hypotheses; many addressed the role of Asian cultural values or the transitory nature of the success of the Asian Dragons. The collapse of the Soviet regime introduced a second time-period to conceptions of capitalism. Its victory against the only alternative socioeconomic regime of the time was interpreted as evidence of the superiority and resilience of market economies. Similarly, the demise of communist parties was meant to imply the progressive but irreversible proliferation of western-style democracy: free and competitive elections, representative governments, and the alternation of different parties in the government. The implicit benchmark was American/English societies. In this context, China is an oddity: it featured a communist government with an exclusivity of political power – held with nearly three decades of high economic growth – that would not hesitate to monitor and control crucial domains of economic activity. The response of this collective research is rather simple, although, we think, edifying: each country has its own path in a trial-and-error process that progressively leads to a genuine form of capitalism. China’s highly specific sociopolitical compromise explains the success of its development strategy and its growing influence in the evolution of the world economy (Chapter 10). Its local-state corporatism has been progressively transformed into a society-wide compromise, in continental mixed capitalism: the acceptance of the monopoly of the Communist party in the political domain, in exchange for a permanent increase in living standards via rapid and steady growth. A cut-throat competition is shaping the evolution of the wage–labor nexus and the state has permanently to reorganize the public and private sectors. The macroeconomic regime is specific to China and has an asymmetric insertion into the world economy that compensates for domestic structural imbalances. Its trade surplus has been quite instrumental in correcting a major disequilibrium in domestic income distribution and in stabilizing the growth regime. What may look ex post like export-led growth is the result of an original socioeconomic compromise that was internally generated and not necessarily a projection of China as a hegemonic power. As seen previously, such success might generate a dangerous illusion, that is, convert a quite specific model into a benchmark and label it as a “miracle,” only to discover its intrinsic limits afterwards, and only when a major and unexpected crisis shows that the underlying logic of that atypical institutional configuration was drastically misunderstood. Let us remember other economic “miracles,” including the mythical representation of the “Japanese model” back in the 1980s! The last episode in this long series of “miracles” is the collapse of finance-dominated capitalism. This could be another source of overestimation with regard to the merits of Chinese capitalism: since it seemingly resisted so well the freefall of world trade, should not all developing economies follow the so-called “Beijing Consensus”?

340 R. Boyer, H. Uemura and A. Isogai Building upon nearly three decades of research on the transformation of various capitalisms and their structural crises, régulation theory puts forward two major results. First, any successful accumulation regime generates countervailing trends that finally cumulate and end in a drastic reversal and a major crisis, both of which mark the obsolescence of the prevailing régulation mode. Chinese capitalism is probably not an exception; clearly, many adverse factors may trigger a brutal reversal of fortune at any time: massive overaccumulation, rising social and regional imbalances, environmental problems, welfare for the aging and poor and, finally, emerging international frictions are all candidates for a starting point of a structural crisis. Second, the enthusiasm of developing economies’ governments for the “Chinese way” should be mitigated by a second finding: in the past, no replication of any brand of capitalism has ever succeeded!

What régulation and development modes “work” in a world of increasing heterogeneity and widening inequality? The unequal regional development and larger social disparities between rural and urban populations is still another challenge to be addressed by Chinese policy makers: how do we conceive and implement a resilient and effective régulation mode? To date, strict controls in the allocation of credit, public transfers of funds to the poorest regions, and a fine-tuning of exchange-rate and monetary policies have been the core mechanisms China has used to deliver a high and steady rate of growth. However, most other economies have been unable to cope with the increasing heterogeneity of firms and individuals. This novelty with respect to the post-World War II “Golden Age” opens a new agenda for régulation theory, and various chapters of this book have explored this issue (Chapters 1–3). A short recounting of history might be useful. This theory was elaborated in order to understand why high degrees of institutionalization with regard to the wage–labor nexus, highly regulated financial systems, and large public and welfare systems have worked together to promote a high and rather steady rate of growth and a general rise in the standards of living among most western capitalisms. The answer is rather simple: explicit and stable coordinating mechanisms have diffused the productivity increases generated by mass-production techniques. Inequalities were drastically reduced, and this created a rather homogeneous society where a large percentage of the population considered itself as belonging to a single middle class. This factor not only made the related régulation mode quite effective; its success also legitimatized it. As such, social justice and dynamic efficiency were made not only compatible, but also complementary. Consequently, it became relatively easy for researchers to capture the essence of this regime, and politicians to monitor such a permanently increasing positive sum-game (Figure C4). However, the maturation of this socioeconomic regime has generated adverse trends that have eroded its efficacy and resilience. At the end of the 1960s, productivity increases were slowed, inflation accelerated, and a slow erosion of the post-World War II configuration began. Firms have been internationalizing – via

Conclusion 341

Basic institutional compromise Ex.: Japanese Companyism American Fordism

A series of institutionalized coordinating mechanisms

Wage formation Ex.: shunto, Collective conventions

Oligopolistic competition

Redistribution via taxation, public spending, welfare

Emergence of macroeconomic regularities

Possible coherent régulation modes and growth regime

Figure C4 Golden age: the synergy between reduced inequality and coherent modes of régulation.

exports in the 1980s and FDI since then. International competition has shaken virtually all domestic labor market institutions and brought about segmentation and balkanization. Ultimately, the cumulative heterogeneity generated within the productive sector has been exacerbated by the rise of finance. All East Asian capitalisms have been affected by these powerful trends, but to varying degrees. During the last two decades, Japanese capitalism has experienced an increasing heterogeneity in terms of firm organization, as well as a rise in societal inequality. In particular, we see a divergence in labor contracts (Chapter 1), heterogeneous changes in the Japanese corporate system (Chapter 2), differential productivity trends among firms (Chapter 3), rising income inequalities following the 1990s (Chapter 5), and diverging profit and accumulation rates among different industries and different-sized firms (Chapter 6). The entry to the international capital market and fiercer international competition with Asian countries have brought about in Japan greater heterogeneity in terms of firm organization, as well as larger social-equality gaps. Such occurrences have also been caused by the erosion of previously strong coordinating mechanisms (e.g., shunto, the convoy system, the main bank, cross-shareholdings, and keiretsu). The coordination mechanisms of

342 R. Boyer, H. Uemura and A. Isogai the hierarchical market–firm nexus have been very much weakened by widening heterogeneities and the inequalities inherent in economic structures. An adequate mode of régulation has yet to be established, and adequate social policies that resolve inequality problems in Japanese society have yet to be implemented. Chinese capitalism has pursued pro-market reforms that enhance efficiency; however, they also exacerbate regional and social inequalities between rural and urban workers (Chapter 10). The heterogeneity of firms in China is produced by the existence of different ownership structures – for example, state-owned companies, partnership companies, joint stock companies – and by their unequal access to credit. Income inequalities between coastal and inland regions have also increased. The inequality in personal income distribution is one of the major obstacles to domestic consumer demand becoming a viable substitute for exports. The reorientation of China’s growth regime, which the Chinese government has sought to implement in response to the present crisis, calls for a progressive reduction in the disparities that the previous development pattern has generated. Korean capitalism experienced the first wave of diverging performance among firms and a segmentation of labor contracts, following the 1997 crisis; this new pattern has definitively eroded the previous accumulation regime, which sought to balance investment and consumption growth. Its financialization has added a second and strong factor of differentiation: among firms, according to their size, and among households according to their access to credit, in order to compensate for slower real-income increases. Consequently, the present configuration is a complex and probably incoherent hybrid model that features an increasing inequality that oscillates between finance-led and innovation-led development (Chapters 11 and 12). This ambiguity is exacerbating the potential macroeconomic instability of the Korean economy. Other Asian capitalisms exhibit different sources of inequality: trade-led industrializing capitalisms (Thailand and Malaysia) have experienced increasing income inequalities among urban individuals involved in informal networks. Insular semi-agrarian capitalism (Indonesia and the Philippines) have specific inequality problems and unbalanced productive structures, largely because some foreign multinationals dominate local-level production and transaction processes in the plantation sector. With the possible exception of these southeast Asian configurations, the factors and mechanisms that make the emergence of new régulation modes problematic appear to be rather common. The conjunction of relentless international competition and financial domination implies a weakening of any collective action that could otherwise restore or invent coordinating mechanisms that are sufficiently powerful to counteract inherent tendencies towards inequality and macroeconomic imbalances. This self-reinforcing vicious circle between heterogeneity and incoherent configurations (Figure C5) is at odds with a virtuous one where moderate and stable inequality and socially organized coordination could be used to enhance economic efficiency. In this context, effective social policies are necessary in each Asian country, and effective aid from Japan and China to southeast Asian countries may also be helpful in reducing inequality in those countries.

Conclusion 343

Unrestricted opening to foreign competition

Reveals the heterogeneity among firms (size, sector,…) and households (competences)

Collective action becomes more difficult

Liberalization of finance

Erosion of institutionalized coordinating mechanisms

Deepening of heterogeneity and inequalities

…The primacy of competition “The winner takes all”

Competition or Finance

Led configurations

Intrinsically unequal and unstable growth regimes and incoherent régulation modes

Figure C5 The 1990s and 2000s: the vicious circle between increasing heterogeneity and incoherent and unstable configurations.

How likely is an Asian Monetary Union? An economic opportunity confronted to basic political obstacles Given that the international production network has become wider and deeper, international trade has become strongly determined and steered by intermediategoods transactions in East Asia. In this situation, exchange-rate stability is needed for multinational firms to develop their businesses. However, there are two large obstacles to this development: large productivity growth differentials among Asian economies, and a lack of policy coordination among Asian governments. There are large productivity growth differentials in the export-goods and nontradable-goods sectors of each East Asian country (Chapter 15). One of the necessary conditions for the long-term viability of monetary integration is that the relative prices of export goods among the member-countries of a monetary union are unlikely to change greatly. In the East Asian region, however, relative prices continue to change over time, due to the existence of large productivity growth differentials. Therefore, the stability of Asian currencies – something that is currently being individually pursued by Asian countries – would be better fulfilled by the adoption of common rules that are institutionalized multilaterally. Considerable

344 R. Boyer, H. Uemura and A. Isogai Negotiation of a Single Market

From negative to positive integration

Common regulations

Removal of trade barriers

Recognition of the adverse impact of Asian 1997 crisis and 2008 subprime crisis

Chiang Mai agreement (swap among central banks)

Regular meetings developing trust

Call for political initiative

Need for an international entity: Asian Monetary Institute…

?

Incentives to further integration Better management of currencies Economic benefit for members countries

Deeper financial integration among Asian countries

Figure C6 Regional monetary stability as a shield against the world financial crisis.

effort has been devoted in the 2000s to improving monetary and financial cooperation in the East Asian region (Figure C6); however, results thereof have been limited, mainly due to political issues and the underlying rivalry between China and Japan. This state of affairs is unfortunate, since the current financial crisis has increased an interest that had peaked after 1997 in regional-level monetary cooperation (Chapter 16). Nevertheless, the motive of economic stability is not sufficient per se to overcome the many obstacles found on the road to East Asian monetary integration. National interests might drastically differ and governments oppose alternative conceptions of the objectives of monetary policy: exclusively financial stability, for example, or also growth? What other economic policy tools may compensate for a loss of national autonomy – a rather crucial issue that arose after the crisis of the euro – that began in 2010? How to convince international financiers that such a heterogeneous region may sustain the credibility and long-term viability of a common or even coordinated monetary policy (Table C1)? More importantly, the lack of political will among the most powerful governments to abandon a monetary autonomy that is highly valuable and required by their growth strategy (China), as well as the declining bargaining power of others (Japan), makes any breakthrough problematic in this direction in the current decade.

A key challenge: what new compromises and institutions are needed to reduce East Asian regional imbalances? Virtually all these economies suffer from the adverse consequences of exportled growth regimes. A strong dependence on the evolution of the world

Conclusion 345 Table C1 Merits and difficulties of Asian monetary integration Merits

Obstacles

• Less domestic vested interests than those governing trade liberalization • Proximity of visions and interests of central bankers • A direct response to the repetition of banking and exchange rate crises of the 90 and 2000 • Positive spill over financial integration • A trump for economic integration via trade

• Possible divergence of national interests and conceptions of monetary policy • Distance with respect to citizens’ aspirations • In the era of capital mobility, loss of autonomy of national monetary policies • Possible lack of credibility with respect to the international financial community • The social reluctance to full trade liberalization remains

economy – that was an asset in the previous phase of development – might well become a liability, given both the uncertainty surrounding future North American and European growth and the volatility of exchange rates of the currencies involved. More importantly, a form of wage repression has been a tool frequently used to cope with acute price competition, a vibrant example of which is China, where the labor share in total income has declined during the last decade. Last but not least, a significant part of the financial intermediation of excessive East Asian saving takes place on Wall Street or in urban areas, and this has been a noteworthy source of financial instability and recurring crises. At the level of each nation state, a basic compromise should thus concern the wage–labor nexus, for the sake of both social justice and dynamic efficiency. An indexation of real wage on productivity would thus assist in the formation of a consumption-led domestic market; it would discipline a “race to the bottom” in terms of low wages, making the domestic market as attractive as exports and facilitating the coordination of exchange policies. All institutional forms should be reformed accordingly, including the nature of competition, the monetary and credit regime, insertion into the world economy, and relationships between the state and its economy. Of special importance would be the strengthening and progressive unification of the status and welfare of workers within each East Asian country, especially in China. Similarly, active social policies should be implemented to resolve various poverty problems in both developing and developed countries in East Asia (Table C2 infra). In a sense, these domestic reforms would alleviate external imbalances at both the East Asian and world levels. To organize the international division of labor and international production networks, effective rules governing trade and FDI should be established at the East Asian level. Similarly, effective coordination and, ultimately, the creation of a regional financial center would be important steps toward a more effective allocation of capital in terms of welfare and growth among East Asian economies. Common infrastructure programs, technical norms, and alternative conceptions of development could also be contemplated therein.

Table C2 Asian integration and emerging modes of ‘régulation’/growth regimes Present configuration I NSTITUTIONAL FORMS • Financial • Close bank/ regime industry relations • Insertion into the world economy

• Form of competition

• Wage labor nexus

• State ◦ Monetary policy ◦ Tax, public spending

• Large openness to foreign capital, productive and financial • Trade related specialization (mainly towards the US and the EU) • Different exchange rate regimes

Transformations implied by Asian integration

Possible long run outcome

• Learning to monitor banks and finance • Cautious management of short term capital movements

• Resilient banking/financial systems • Less dependence; a say of Asia about the “new world order”

• Deepening of intra-Asian trade • Need to stabilize East Asian currencies

• Highly integrated production systems within Asia • Target exchange rates and stabilization fund. . . . and creation of a common currency • Asian single market

• Rather oligopolistic competition on each domestic market • Generally reactive to economic evolution and shocks (Korea after 1997) • Embryonic public welfare: firm/family solidarity

• More integrated approach of competition

• Governed by the financial credibility of each country • Minimalist spending, but significant public interventions

• Taking into account interdependency across countries • More public spending (infrastructure, research)

• Fight against inequality, heterogeneity of labor contracts • Need to build some forms of welfare, more collectively organized

• Institutionalize indexing of wages on productivity • Prevent low wage dumping by international accord • A form of East Asian welfare.

• Coordinated and ultimately common monetary policy (ACB) • Complementarity of public infrastructures and harmonization of some taxes

Conclusion 347

East Asia: what role in the next world system? Thus, given its size, dynamism, specialization, and financial power, the East Asian region should and will bear a crucial role in reducing current financial imbalances worldwide. In the early 2010s, the debate touched upon the issue of the yuan/dollar exchange rate and, more generally, the impact on both sides of the Pacific Ocean of exchange-rate manipulation. This concern has some legitimacy, but its implicit theoretical premise is that pure market mechanisms are sufficient to bring about a return to trade-balance equilibrium. Many econometric analyses show that price elasticities are not sufficient to warrant this result, and that income elasticity and the structural factors of the competitiveness are the key explanatory factors of the imbalance observed between the USA and China. This assertion supports the postKeynesian view that global imbalances are due to discrepancies between the USA and China in terms of investments and savings. Actually, major global imbalances bore a role in the genesis of the 2008 global financial crisis (IMF, World Economic Outlook, April 2009). If those imbalances are not reduced, another financial crisis may occur. In the 1990s, the USA’s current deficit was financed by Japan and Germany; in the 2000s, it came to be financed by China and other emerging economies too. In 2008, China’s current surplus accounted for 31% of the world’s total trade surplus; on the other hand, the USA’s current deficit reached unprecedented levels just prior to the collapse of Lehman Brothers. The current surplus was common to both China and other Asian countries, but the Chinese configuration was different. The ASEAN4 economies were hit by the Asian financial crisis of 1997; thereafter, in 1998, investment fell very sharply in a severe recession and remained at a very low level. Financial globalization played some role in diverting profit from productive investment. On the other hand, the saving rate did not greatly change before and after the Asian financial crisis; therefore, the related underinvestment caused a trade surplus in these countries following the Asian financial crisis. The stagnation in private investment was caused by the cautious attitude of financial institutions with regard to financing investment, and they bore a strong risk aversion to these Asian countries. In China, investment rose very sharply in the first half of the 1990s, but decelerated in the second half of the 1990s. It started to increase again in the early 2000s. The savings rate was relatively stable in the 1990s and was higher than the investment rate, generating a huge current surplus. The main cause of the increase in the investment rate was the specific coordinating mechanism between the central and local governments (analyzed in Chapter 10), as well as excess liquidity due to the exchange-rate policy of the Chinese government that it had instituted in an attempt to prevent the Yuan from appreciating. Both the USA and Asian countries bear responsibility in this situation. The USA will need to take policy action, if it is to reduce its current external deficit. If its strategy remains unchanged, one may expect quite dramatic episodes – including, but not limited to, a brutal rejection of the dollar as the central international currency, following its startling depreciation, and the possibility of a “hard landing”

348 R. Boyer, H. Uemura and A. Isogai for the US economy. At the same time, it will also be necessary for Asian countries to reform their national economies in the forms of effectively coordinating their financial systems, establishing effective social welfare systems, and implementing institutional reform policies that promote the growth of domestic demand. In this respect, both the USA and Asian countries bear special responsibilities.

China and Japan: from political conflicts to the perception of a common future The international division of labor has developed rapidly in East Asia, and both Japan and China are heavily involved in activities therein. As we have already seen, the traditional flying-geese pattern of Asian economic development has been modified completely by FDI and expanding international production linkages among Asian economies. In the de facto East Asian integration process, the Japanese and Chinese economies have become the two leading economic powers; in this situation, can the Chinese and the Japanese firms and governments negotiate and organize a complementary relationship that would be mutually beneficial? One of the important factors to promote their complementarity is an increase in intermediate-goods trade and international production linkages between the Japanese and Chinese economies. Furthermore, Japan’s research and development activities – not to mention its sophisticated designs in the high-tech industry – will complement China’s manufacturing activities, plentiful worker supply, and expanding domestic market (Figure C7). In spite of this possible structural complementarity, there will be an increasing asymmetry between the Chinese and the Japanese economies in the long term. The Chinese economy will enjoy a fast rate of growth in manufacturing, while the Japanese economy will experience slow growth and de-industrialization. In the interim, innovation will need to be sufficiently dynamic to sustain not only the manufacturing industry but also the Japanese economy as a whole. One form or another of coordination in innovation and industrial structural change – such as industrial policy coordination between both countries – should be welcome as a necessary complement to the international division of labor that results, de facto, from the active strategies of Asian and other multinational companies. One could even imagine that a more inward-looking and coordinated strategy involving Japan, China, Korea, and other East Asian countries would reduce the competitive pressure exerted upon the USA and Europe, thus facilitating those western countries’ own structural adjustments. At the same time, the threat of a creeping and possibly open protectionism would be reduced; simultaneously, the existence of fewer financial global imbalances would make the occurrence of a new major world crisis less likely (Figure C7 supra). Quite a happy end, indeed! Nevertheless, there may still exist potential threats to the future of East Asia, including financial instability, an increasing gap between the rich and the poor, regional military conflicts, and environmental disasters. The unfolding of history will bring about many unexpected events that the present book is unable to anticipate, in spite of the joint and persistent efforts and dedication of

Conclusion 349 Less trade frictions

China Asia Integration Korea and others

US Sells innovative products Less transfer to US of Asian savings

Reduced tensions on the global financial system

De-industrialization

Japan

Possible complementarity if political cooperation

Figure C7 Optimistic scenario: Asian integration alleviates world unbalances.

its contributors. This possible lack of perspicacity was not at any time considered a sufficient reason not to write this book. The authors hope that, in any case, it provides the reader with some interesting and relevant insights with regards to a quite complex configuration and open future.

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Index

Abdi, H. and Valentin, D. 245 accumulation: rate 110–14, 128, 265, 367; regime 3, 185–6, 190–9, 205, 210, 214–16, 228, 230–1, 237, 336, 340, 342 ACU see Asian Currency Unit adjustable exchange rate 10, 308 adjustable exchange rate regime 308 adult literacy rate 249, 261 advanced: capitalist countries 246; countries 73, 137–9, 244–6, 253–4; liberal capitalism 249, 253 age of modularization 8, 131–2, 137, 141 aging of the population 80 Amable, B. 4, 32, 66, 69, 80, 87, 134, 190, 244, 267, 268, 330 amendment: to the Antimonopoly Act 45; to the Commercial Code 45 American: and Chinese capitalisms 200; crisis 198; multinationals 201 annual salary system 98, 99, 105 Aoki, M. 32, 48, 57–9, 61, 65, 69, 70, 128, 134, 244, 262 architecture-based analysis of competitiveness 134, 136 arm’s length: financial system index 81, 84 ASEAN 5, 15, 126, 148, 167, 174, 179–81, 183, 253, 262, 324 ASEAN + 3 313, 324 ASEAN Swap Arrangement 313 Asian: Bond Market initiative 308, 313–14, 327; capitalism 3, 245, 283, 331; Common Currency 317, 324, 325; Currency Unit 11, 308; Development Bank 304, 305; economies 6, 23, 28–9, 30, 49, 107, 116, 119, 122, 127, 146–7, 165–6, 170, 172, 173, 181, 183, 243–6, 249–51, 253–9, 262, 263, 333, 348; financial crisis in 1997 253,

336; international input-output tables 6, 8, 9, 128, 144, 156, 165–6, 169, 306; Monetary Fund 308–9, 327 asymmetric: demand shocks 320, 322; domestic demand shock 318 Australia 88, 238, 239, 249, 262 Austria 88, 238, 239, 249, 262 backward: linkage effect 157, 173–5, 179–2, 222; linkages of production 156 Balassa-Samuelson: effect 290, 295, 306; model 295 Bank for International Settlements (BIS) ratio 209 banking institutions 210–12, 228 barriers to entry 248–9, 253, 338 Belgium 88, 249, 262, 288 between: -education effects 93–5, 104–5; -firm size effects 100–1 board: with committees 45; with statutory auditors 45–6 Boyer, R. 3, 5, 29, 42, 56, 60, 65, 67, 70, 108, 110, 126, 132, 135, 142, 190, 193, 197, 200, 204, 236, 244, 265–7, 282–3, 338 Bretton Woods systems 264 bubble boom 107–8, 112–13 bureaucrats 187–8, 197 Canada 88, 238, 239, 249, 262 capability: building 8, 131–2, 136, 138, 141–2, 227 capital: accumulation 71, 109–10, 113–14, 265, 270, 283; labor relation 190, 192 capital market-based direct finance 43 Central State 186, 193, 196–7 Chiang Mai initiative 308, 313, 317, 327

Index 373 China 1–5, 9, 15, 24, 28, 62, 115, 117, 122, 126, 128, 131–3, 138, 141–64, 166–7, 170, 172–4, 180–7, 189–94, 196–205, 223, 243, 245, 247–8, 251–2, 254–9, 261–2, 283, 289–90, 294, 297–302, 305–6, 308–9, 312–19, 321–7, 329, 331–4, 338–340, 342, 344–345, 347–349 China Effects 227 China-Japan I-O table 155, 156 Chinese: economy 8–9, 131, 133, 141–2, 144, 146, 156–7, 159–60, 165, 170, 185, 188, 190, 192, 197, 200, 204, 221, 227, 240, 257, 283, 328, 348 growth regime 184, 188, 192; multinationals 202; State 205; -style modularization trap 140 City capitalism 10, 248, 253, 331, 334, 336 closed integral architecture 136 cluster analysis 59, 73, 245, 247, 250 co-evolution 185, 194 collapse of the internal labor market 236 collective bargaining system 223, 232 collectively managed floating system 291, 292, 303 common currency basket 11, 308, 324–6, 328 Communist Party 9, 184, 187–8, 192, 204, 339 community development financial institutions 26, 28 company-bank compromise 6, 16 companyism 6–7, 15–16, 28–30, 56, 66, 67, 69, 337, 341; post- 69 companyist: mode of régulation 7, 8, 109, 122, 125, 128, 336–8; régulation 6, 16–19, 22, 24–25, 29, 30, 32, 109 compatibility 114, 194, 337 competition: -led accumulation regime 186, 192, 196; -led growth regime 205 complementarity 7, 19, 29, 32, 54, 65, 70, 136, 137, 142, 187, 194, 205, 243, 267, 335, 346, 348–9 consumer goods manufacturing 201 consumption 5, 73, 77, 88, 110, 115–16, 120, 124, 192, 194–6, 199–200, 203, 205, 215, 216, 227, 228, 235–6, 267–71, 283, 315, 318, 336, 342 consumption/investment-led accumulation regime 214, 215, 228 Continental mixed capitalism 254, 331–2, 336, 339 contingent governance 34

conversion 35, 38, 51, 52, 53 convoy system 17, 19, 341 coordinated financial system 214, 215 Coordinated Market Economies (CMEs) 240, 244 coordinating mechanism 71, 160, 347 corporate governance reforms 45, 46, 48 corporate grouping 33, 34 credit: control 200 crisis: of 2008 16, 50, 109, 124, 254, 314 cross-border production networks 162 cross-shareholdings 17, 41, 43, 341 currency: basket system 183, 283; crisis 183, 291–2, 299, 301–3; unification 287–8, 304 de facto regional integration 131, 132 decentralization 67, 185–6, 189, 190, 193 Deeg, R. 51, 61, 68 deficits 170, 201, 203, 288, 309 deindustrialization 81–2, 84, 121, 127 demand: formation 25, 108–9, 115–16, 126–7, 200; growth 110, 170–1 Deng Xiaoping 165 Denmark 88, 203, 238, 239, 249, 262 deregulation 7, 33, 37, 42, 57, 61, 67, 71, 72, 90–1, 97, 99, 102, 108, 239, 309, 336–7 devaluation of the dollar 315, 316 developing countries 90, 137–8, 141, 244, 305 development modes 194, 197, 340 developmental dictatorship 229–32, 240 direct financing 37, 42 discontinuation of wage increases 20 disparity between rural and urban 200 dispersion of labor productivity 58 displacement 51, 52 diversity: of Asian economies 243–4, 246, 251, 254, 256–9 dollar peg: policy 308, 320; system 291, 297, 299, 301, 306 domestic: consumption goods 133, 166; consumption-led growth 132–3, 183; -demand-led growth 26, 28; market oriented 256, 257 downstream industry 173, 182 dual labor market adjustments 224 dualism 59, 68, 70, 71, 85, 338 dynamic complementarity 136 East Asian: economies 1, 4–5, 8–9, 127–8, 143–4, 146–8, 162, 165, 173, 181,

374 Index 182, 183, 246, 313, 316–17, 322, 333, 335, 345; monetary integration 308, 344 economic: development 62, 144, 162, 165, 173, 181, 183, 240, 243, 246, 250, 253, 261, 262, 332, 334, 348; growth 10, 15, 22, 23, 28, 30, 92, 108, 110, 119, 127, 132, 143, 165–7, 170, 173, 181, 188, 227, 233, 237–8, 264–6, 269, 280–2, 303, 339; integration 16, 107, 122, 143–4, 146, 151, 155, 160, 162–3, 243, 296, 324, 330, 345; performance 7, 10, 244–5, 265–8, 283; risks 7, 72–3, 75, 78–82, 84, 87, 89 education 5, 16, 24, 62, 64, 94, 126, 127, 189, 196, 239, 245–50, 253–4, 261 employment: creation 216–17, 223; polarization 223; protection legislation (EPL) 7, 73, 80–1, 84, 88, 223–4; security 6, 16, 17, 19, 21–2, 28, 65, 118, 126, 249, 263, 268, 270, 280–2 endurance of limited employment security 19, 21–2 entry and exit 246 environmental issues 205 equilibrium-functionalist approach 51 ERMII 296, 303, 304 Escofier, B. and Pagès, J. 245 euro area 288, 317, 323–4, 327 European mixed capitalism 249, 253 excessive investment 2, 35–8 exchange rate: misalignments 308–9, 317, 329; policy 196, 197, 313, 316–17, 326, 347; regime 308, 317–18, 322–3 exchange rates adjustments 320, 321 executive officer system 46 exogenous shock 283 export: -biased productivity growth 290–1, 292, 299, 304; -demand 126, 166, 170, 183, 266, 268–9, 277; -led accumulation regime 216; -led growth regime 9, 16, 18, 23–4, 28, 123, 166, 181; -led industrialization 15; -oriented 160, 179, 209, 254, 256–7; -oriented firms 257, 259; -oriented industrialization 254, 297 external: capital account 198; debt crisis 253; trade 152, 246–9, 253–4 federalism 190 final goods 149, 157, 159, 162, 170, 183

finance-led accumulation regime 215, 234, 236, 238 financial: assets 26–7, 73, 77, 84, 88, 124, 265, 269–70, 273, 281, 283; crisis in 2008 216, 244; deregulation 17, 37, 42, 64, 69, 335; inatability 2, 254–5, 263, 345, 348; institutions 9, 18, 19, 26, 28, 41, 124, 210, 214, 222, 336, 347; market 73, 77, 78, 79, 80, 83, 84, 85, 87, 124, 127, 213, 216, 227, 239, 246, 250, 254, 260, 265; services 201; turmoil 83, 124, 153, 216, 259 financialization 15–16, 28, 33, 50, 201–2, 264–5, 267, 269, 282–4, 342 financiers 198, 344 Finland 88, 203, 238–9, 249, 262 first great transformation 229, 230, 232, 237 five turning points of the Korean Economy 229 fixed effects vector decomposition (FEVD) 80 fixed exchange rate system 183, 213, 318 flexibilization 209, 234, 281 floating exchange rate system 213–15, 268–9, 273, 283 fluctuation bands 296, 304, 325 flying geese pattern 144, 162, 243, 262, 332–4, 348 Fordism 9, 16, 228, 229–32, 234, 236–7, 341 Fordist growth regime 184, 282 foreign direct investments (FDI) 144, 186 foreign owned commercial banks 256, 257, 259, 263 forms of monetary cooperation 317, 324 forward linkage effect 166, 173–4, 179–82 France 30, 88, 238, 239, 249, 262, 288, 323 French-German compromise 323, 324 Fundamental Equilibrium Exchange Rate (FEER) 309 GDP: growth volatility 254, 255, 263; per capita 246–9, 261, 263 Germany 30, 60, 74, 84, 88, 132, 203, 238, 239, 249, 262, 288–9, 294–6, 304–5, 323–4, 330, 347 Get Rich First 165 globalization 3, 5, 7, 9, 11, 15, 16, 17, 19, 28, 33, 42, 76, 78, 82, 87, 143, 163, 204, 209, 220–3, 244, 264–5, 282, 332, 335–6 golden age of Korean capitalism 232, 237

Index 375 gradual transformation 51–2 gradualism hypothesis 132 Greece 249, 262, 288–9 growth: maximizing hypothesis 36; pattern 8, 10, 101–2, 107, 109, 115, 122–5, 191; regime 6, 16, 22–5, 66, 69, 107, 122–3, 125–8, 170, 183, 184, 192, 196, 209–10, 227, 267, 336, 338, 341 Growth Poles 165 Guanxi 188 Hall, P.A. and Gingerich, D.W. 244 Hall, P.A. and Soskice, D. 54, 65, 240, 244, 249, 262 health 189, 196, 261 healthcare 193, 205 Heckscher-Ohlin-Samuelson model 90, 92 heterogeneity: of Asian firms 244; of East Asian countries 315; of firms 42, 56–8, 61–2, 64–9, 70, 71, 122, 126, 244, 338, 340, 342; of organizational change 60 Hicks, J. 191, 289 hierarchical: domination 193; market-firm nexus 31, 33, 128, 337–8, 342 hierarchy 192, 194, 263, 267, 283, 335 Hirschman, A.O. 165, 173 historical-political approach 51 holding company 45 Holliday, I. 243 Holliday, I. and Wilding, P. 243 hollowing-out 170, 174 Hong Kong 4, 10, 118, 145, 148–51, 245, 248, 251, 253, 262, 312, 331, 334, 339 honored retirements 223 horizontal division 172, 179, 183 human capital asset 73, 75, 76 hybrid firm 7, 46 hybridization 46, 52, 54, 59, 209 hypothetical extraction method 173, 183 IMF: -conditionality 211; restructuring program 234 implicit compromise 188, 192 incentive contracts 190 income: distribution 9, 109, 128, 185, 193, 199, 233, 266, 270, 282, 315, 342; inequality 8, 9, 62, 90–3, 96, 102–3, 104, 237–8; polarization 237–8 increasing fluidity of the subcontracting transaction structure 40 indigenous innovation 131–2

Indonesia 4, 10, 145, 148–50, 163, 175–8, 245, 247, 250, 252–3, 256, 258, 262, 297–300, 302–3, 312–13, 331, 342 induced-export effect 157, 161 induced-production coefficient vector 158–9 industrial: interdependence 143; polarization 237 industrialization 15, 187, 222, 253, 305 inflation-targeting 296 innovation: and regional integration-led growth 126; -led capitalism 254, 331, 334; -led economies 203; -led growth 203, 334; strategy 131; system 65, 108, 203 input-output tables 291, 295 Institute of Developing Economics 155 institutional: architecture 10, 190, 197, 200, 267; change 7, 51, 52–4, 56, 57, 60–7, 68, 71, 72; complementarity 17, 32, 47, 54, 70, 128, 131, 135, 266; configuration 244–6, 251–2, 254, 256, 283, 339; coordinating mechanisms 8, 107, 337; diversity 52, 245, 249, 254, 256, 260; domains 52, 245–6, 248, 250–1; economics 131, 134, 265, 266; forms 3, 9, 32, 54, 65–6, 190, 193, 200, 265, 267–8, 270, 281, 283, 284, 308, 323, 327, 331–2, 337, 345–6; hierarchy 10, 193 264–8, 270, 280–3; layering 49, 52–3, 61; wage coordination 119 institutions 3, 6, 7, 8, 24, 26, 29, 31–3, 51–2, 54, 61, 66, 72, 74, 78, 80, 83, 86, 109, 185, 186, 221–3, 229, 243–5, 266–8, 282, 316, 324, 337, 344 Insular Semi-agrarian Capitalism 10, 253, 331, 334, 336 integrality trap 136 intellectual property rights 203 interdependence levels 144 inter-firm wage standarization 99 intermediate goods trade 117, 122–4, 126, 144, 146, 149, 162–3, 166, 348 international: capital control 247–9, 257; division of labor 107, 126–7, 243, 332, 334–5, 348; linkage 9, 166, 173, 182; production linkage 155; production sharing 143, 149, 151–2, 162; production sharing networks 152; regime 11, 136–8, 141, 200, 266, 268–70, 282; reserves 205, 306; system 184, 201; trade 6, 8, 107, 117,

376 Index 124, 126, 165, 173, 181, 198, 204, 246, 249, 261, 264, 268, 282, 332, 334, 343 intra-regional trade share 147–8 Ireland 249, 262 IT 90–3, 96, 97, 102, 104, 113, 133, 142, 150–1, 153, 164, 228, 235, 237 Italy 88, 238–9, 249, 262, 288 Jackson, G. 44, 48, 60, 71 Japan Federation of Employers’ Associations 99, 105 Japanese affiliate activities 153 Japanese: capitalism 5, 7, 56, 57, 61–9, 335, 341; corporate system 7, 31–6, 38, 41–2, 46–7, 49–50, 54, 122, 124, 341; FDI 8, 144, 147, 151, 182; financial big bang 124; firm as a system 31–2; multinationals 67, 143, 147, 155, 160 job: insecurity 57; security 63, 69, 113, 122, 337 jobless growth 216, 238 Kaldor’s growth theory 132 Kaldor’s law 134, 139 Keynesian approach 108 Korea 4–5, 10, 126, 133–4, 144, 147, 162, 170, 174, 179–82, 203, 210, 214, 223, 230, 237, 244–5, 248, 251, 253, 256, 259, 289, 290, 297, 301, 309, 313–14, 318, 321, 331, 334, 339, 348 labor market: duality 210, 218, 221, 224, 227, 259; institutions 72, 73, 78, 80, 83, 85, 87, 227, 247, 341 labor: -intensive 165, 167, 170, 173, 181; -management compromise 6, 16; productivity 8, 20, 58, 61, 70, 107, 110, 111–13, 118–19, 133–4, 139, 167, 222, 233 labor law 200 laid-off temporary workers (haken-giri) 50–1 large firms 18, 23, 28, 30, 32, 34, 37, 40, 43, 56, 66, 111, 115, 119, 127, 210, 216–17, 220, 222, 227, 232, 237, 259, 333, 338 Latin America 4, 203–4, 320 layering 51–3 Leontief coefficient matrix 157–8 liberal financial system 215 Liberal Market Economies (LMEs) 240, 244

liberalization of markets 253 lifetime employment system 31, 96 linkage effect 163, 165, 173–4, 179, 181, 183 local-friendly banking practices 213 local State corporatism 9, 184, 186, 188–9, 204, 339; hopothesis 189 local/national nexus 188 long-term employment practices 7, 44, 48, 53, 59 Lost Decade 4, 6–7, 11, 30, 56, 63, 66–70, 336–7 low-income labor 167 Maastricht criteria 287 macroeconomic analysis 8, 11, 107, 122, 191 main bank: -based indirect finance 43; system 17, 19, 21–2, 31, 34, 38, 41–2, 45, 47 Malaysia 4, 10, 145, 148–50, 163, 175–8, 180, 245, 247, 251, 253–7, 262–3, 297–9, 302, 305–6, 312–14, 331 managed floating system 292, 296, 301 management security 6, 16–17, 19, 21–2, 28, 69, 71 market: average exchange rate system 213; competition 61, 189, 190, 337; economy institutions 185–6; -led economy 209; -oriented growth strategy 209 mercantilist: State 197; strategy 204 merit: -based grade system 97–8, 105; -based wage system 97 micro and macro complementarities 134–5 misallocation of capital 196 mixed economy 204 Miyajima, H. 34, 43, 48 Miyamoto, M. 44, 48 mode of régulation 6, 7, 15–16, 22, 24–5, 28–9, 56–7, 66, 69, 71, 108, 123, 125, 127, 230–2, 267, 342 modularization 8, 136, 138–41, 144, 160–1, 164, 334 modularization trap 8, 136, 140–1 monetary: adjustment 322; cooperation 10, 308, 317, 324, 344; integration 10, 287, 289–92, 308, 332, 343, 345; policy 197, 198, 284, 308, 337, 344–6; regime 266, 268–70, 282, 308, 325, 328 multinational: firms 8, 137, 143, 334; model of East Asia 314

Index 377 multinationals 8, 141, 190, 202–3, 334–5, 342 Multiple Factor Analysis (MFA) 245 multiplied effect 165, 170, 173, 182–3 multivariate analysis 245 Myrdal, G. 173 national systems of innovation 203–4 natural resources 190, 201–2, 204, 338 negative de-industrialization 121 Neo-classical approach neoliberalism 69, 234, 237, 239–40, 264 neoliberalist hybrid regime 237 Netherlands 88, 238–9, 249, 262 new: growth regime 9, 24, 25, 69, 125, 128, 209, 210, 227; hybrid organizational forms 7, 31, 49, 54; J-type firms 31, 48–52, 54 New Zealand 249, 262 NIEs 15, 167, 297, 299 non-performing loans 196, 205 non-regular: employment 44, 236, 238; employment law 218; workers 19–22, 29, 44–5, 53, 58, 62, 85, 103, 106, 120, 124–7, 217–21, 223, 236, 337 non-regularization: of employment 47; view 91 non-residential investment goods 166–7 non-standard types of workers 217 Norway 88, 249, 262 numerical flexibility 51, 223 OECD 6, 62, 80, 87, 184, 199–203, 238–9, 244–5, 252, 295, 305 open modular architecture 136 organizational: architecture 136, 137, 142; changes 57, 60, 66, 69, 71, 136 output-capital ratio 109–10, 112–13, 194, 270, 272, 276–7, 280, 284 outsourcing hypothesis 91, 102 over: accumulation 111–12, 196; capacities 191; investment 194 pay-for-performance system 45, 48 peg to the dollar 309 People’s Bank of China 183 performance-based wage system 8, 20, 64, 71, 97–103, 105

Philippines 4, 10, 145, 148–50, 163, 175–9, 245, 247, 251–3, 255–6, 263, 297–303, 305–6, 312, 331, 342 political will 24–6, 29, 323–4, 344 population ageing view 91, 102 Portugal 249, 262, 288–9 positive de-industrialization 120 post-Keynesian 132, 265, 347 potential output-capital ratio 110–13, 270, 284 poverty 185, 196, 345 price revolution 23–4 Principal Component Analysis (PCA) 245 privatization 64, 128, 185–6, 234, 239 product: architecture 8, 136–7, 139, 141–2; cycle hypothesis 139; market 78, 194, 245–7, 250, 260 production: capacity 8, 134, 137, 138, 139, 141; -inducing effects 161 productivity differentials: between different-sized firms 119; between the industrial sectors 118 productivity: dispersion 58, 60–3, 68; growth 10, 49, 108–10, 113, 115, 118, 122–3, 127, 166, 183, 222–33, 288, 290–2, 295, 298, 300, 304, 343 profit: fundamentalism 211; rate 107, 109–13, 128, 192, 221, 235, 270, 273, 277, 279 profitability: of banking system 253; polarization 221 protectionism 202, 348 protectionist agenda 203 Pryor, F. L. 244 public expenditure: on education 246, 247, 248, 249, 253, 254, 261; on health 261; on social security 249 punctuated equilibrium view 51 quasi internal labor market 45 recompilation of the China-Japan tables 155 reform without losers period (1978–1995) 132 regional: integration 8, 23, 123, 131, 141, 143, 163, 243, 332; interdependence 143–4, 146–7; systems of innovation 162 regular workers 19–21, 72, 94–5, 100–1, 103–4, 124–5, 218–19, 223–4, 337–8 regulated market economy 20, 230–2 régulation: approach 65, 108, 243, 331; mode 3, 66, 185, 193–4, 336–8, 340;

378 Index theory 3–5, 16, 60, 65, 107, 110, 128, 163, 184, 191, 194, 199, 330, 340 régulationist school 51, 54 relationship-based banking 214–16, 227 relative value-added contributions 156, 158, 160 rentier economies 201 replacement rate 246, 248–9, 254 rigidity: of employment 246–7, 249, 253–4, 260; of employment and hours worked 253 scientific and technological frontier 204 second great transformation 10, 229, 234, 237, 240 segmentation 9, 59, 67, 139, 192, 232, 236, 336, 341–2 seniority-based wage system 43 shareholder: capitalism 201, 234, 236–7, 240; -oriented corporate governance 33, 43, 46 Shunto 45–7, 52–3, 66–7, 120, 122, 127, 337–8, 341 Singapore 4, 10, 144, 148–50, 163, 174–7, 180, 245, 248, 251, 253, 262, 289, 297–302, 305, 312, 331, 334, 339 skill-biased technological change (SBTC) hypothesis 8, 90–1 SMEs 54, 55, 70, 210–11, 214, 216–17, 219–22, 224, 227–8, 336 Smile Curve 170 social: democratic economies 203; inequalities 196, 336, 342; protection 7, 72–5, 83, 86–8, 238, 245–6, 253–4, 261 security 231–2, 246–7, 249–50, 261 Socialist Market Economic System 165 socioeconomic compromise 339 sociopolitical compromise 9, 184, 196, 331, 339 Soviet: economy 185; -type regime 185 Spain 238–9, 249, 262, 288–9 speculation 2, 202 spring labor offensive system 8, 64; see also Schunto stable shareholding 33–4, 41, 47 State 3, 9, 66, 171, 184–90, 193, 196–8, 204–5, 240, 254, 257, 339, 345–6 statistical analysis 8, 10, 191, 244–5, 259 stock: cross-holdings 19; market capitalization 250, 260 strong: complementarity view 54; convergence view 54

structural: adjustment 131, 139, 253; compatibility 30, 71, 108–9, 114, 119, 123, 125, 127–8; crisis 4, 8, 11, 108–9, 123–7, 340 structuralist macroeconomic framework 109 subcontract relationships 222 subprime crisis 2, 4–5, 7–8, 107, 123–5, 131, 143, 197–8, 314, 330–1, 334–6, 344 surplus spillover 127 sustainable development 132, 171 Swap Arrangement 313 Sweden 74, 84, 88, 203, 238–9, 249, 262, 288 Switzerland 249, 262 Taiwan 4, 10, 70, 145, 148–50, 152, 163, 168–70, 172–8, 179–80, 182, 245, 248, 251–4, 261–2, 297–302, 331, 334, 339 tax reform 90, 187 technical: changes 223; foundation of competitiveness 134 technological: capacity 142; change 8, 90, 93, 131, 136–7 technology: -intensive 165; -organization complementarity hypothiseis 134, 135, 137; transfers 190 Thailand 4, 10, 145, 148, 149, 150, 163, 175–80, 245, 247, 251, 253–9, 262, 263, 289, 297–302, 305–6, 309, 312–14, 331, 342 Thelen, K. 49, 51–2 total factor productivity (TFP) 70, 108, 222 trade: effect view 102; intensity 147; intensity index 148, 163 transition of the diversity 251 typology of Asian firms 254, 256–8 unbalanced growth 165, 190, 194 underconsumption trends 200 undervaluation of the yuan 313, 316 unequal recovery of profitability 115 unions 64, 90, 99, 103, 105, 120, 122, 223, 231–2 unit labor cost 268 unit labor cost parity (ULCP) 294 United Kingdom 262 United Nations Standard International Trade Classification (SITC) 150 United States 2, 5, 11, 94, 104, 201, 255, 262, 263, 289, 294

Index 379 upstream industry 173, 182 US imbalances 315, 316 varieties of capitalism 240, 244 vertical value chain 160 vertically integrated labor input coefficient 293–4, 296, 305 wage: differential 62, 91–3, 100, 102; inequality 8, 62, 90–1, 93–8, 100–6; institution view 8, 91, 94–5, 101–3; -labor nexus 9, 10, 17, 19–22, 30, 65, 110, 116, 184, 192–4, 245, 266–70, 281–3, 323; -led regime 194; share 43–4, 108–13, 115, 120, 128, 191–5, 270–1, 283; system 8, 22, 64, 91, 96, 97, 102, 105

welfare: capitalism 64, 249, 253; system 126, 193, 200 within: -education effects 93, 94, 95, 104; -firm size effects 100–1; -occupation effects 94–5 Worker Dispatch Law 52 world: economic crisis 1, 107, 109, 112–16, 123–5; economy 1, 3, 4, 9, 10, 15, 23, 49, 166, 184, 192, 194, 199–201, 204–5, 209, 283, 314, 320, 330, 334–5, 339, 345–6; system 204, 347 World Bank 88, 184, 209, 246, 252, 260–2, 289, 306 World Trade Organization (WTO) 184, 186 yen bloc 11, 308, 326 yuan bloc 308, 326–8

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