THE HISTORY OF JAPANESE ECONOMIC

DEVELOPMENT

This is an easy-to-read book that explains how and why Japan industrialized rapidly. It traces
historical development from the feudal Edo period to high income and technology in the cur-
rent period. Catch-up industrialization is analyzed from a broad perspective including social,
economic and political aspects. Historical data, research and contesting arguments are amply
supplied. Japan’s unique experience is contrasted with the practices of today’s developing
countries. Negative aspects such as social ills, policy failures, military movements and war
years are also covered.
Nineteenth-century Japan already had a happy combination of strong entrepreneurship
and relatively wise government, which was the result of Japan’s long evolutionary history.
Measured contacts with high civilizations of China, India and the West allowed cumulative
growth without being destroyed by them. Imported ideas and technology were absorbed with
adjustments to fit the local context.
The book grew out of a graduate course for government officials from developing coun-
tries. It offers a comprehensive look and new insights at Japan’s industrial path that are often
missing in standard historical chronicles. Written in an accessible and lively form, the book
engages scholars as well as novices with no prior knowledge of Japan.

Kenichi Ohno is Professor at the National Graduate Institute for Policy Studies, Tokyo. He
was born in Kobe, Japan and holds a PhD in Economics from Stanford University, California.
He worked at the International Monetary Fund and taught at the University of Tsukuba and
Saitama University before assuming his current position.
THE HISTORY OF JAPANESE
ECONOMIC DEVELOPMENT
Origins of Private Dynamism and
Policy Competence

Kenichi Ohno
First published 2018
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
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Routledge is an imprint of the Taylor & Francis Group, an informa business
 2018 Kenichi Ohno
The right of Kenichi Ohno to be identified as author of this work has been
asserted by him in accordance with sections 77 and 78 of the Copyright,
Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or reproduced or
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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
Names: Ono, Ken’ichi, 1957- author.
Title: The history of Japanese economic development : origins of private
dynamism and policy competence / by Kenichi Ohno.
Description: First Edition. | New York : Routledge, [2017] | Includes
bibliographical references and index.
Identifiers: LCCN 2017018249| ISBN 9781138215399 (hardback) |
ISBN 9781138215429 (pbk.) | ISBN 9781315444048 (ebook)
Subjects: LCSH: Economic development—Japan—History. | Japan—
Economic policy. | Banks and banking—Japan—History.
Classification: LCC HC462.95 .O626 2017 | DDC 338.952—dc23
LC record available at [Link]

ISBN: 978-1-138-21539-9 (hbk)

ISBN: 978-1-138-21542-9 (pbk)
ISBN: 978-1-315-44404-8 (ebk)

Typeset in Times New Roman

by Swales & Willis, Exeter, Devon, UK
Visit the companion website: [Link]/cw/ohno
C ON T E NTS

List of figures vi
List of tables viii
List of boxes ix

Introduction 1

1 An overview: evolutionary history and translative adaptation 4

2 The Edo society: preparing conditions for industrialization 21

3 Transition from Edo to Meiji 35

4 Importing and absorbing technology 46

5 Development of key industries 61

6 Budget, finance and the macroeconomy of Meiji 73

7 World War I and the 1920s 82

8 The banking crisis of 1927 95

9 The 1930s and the war economy 104

10 Postwar recovery 1945–49 118

11 The high growth era 131

12 Economic maturity and slowdown 150

13 The asset bubble and prolonged recession 162

Questions and answers 179

Bibliography 195
Index 202

v
FIGU R ES

1.1 Japan’s multi-layered identity 5

1.2 Integration viewed from outside 7
1.3 Integration viewed from inside 7
1.4 Umesao’s view of the world 9
1.5 Four periods of Japanese history 12
2.1 Population and rice production 25
2.2 General price level 27
2.3 Inter-regional economic linkage in the late Edo period 29
3.1 Survival of millionaires in the late Edo and Meiji period 41
4.1 Production, export and import of cotton yarn 49
4.2 Trade structure 50
4.3 Structure of export and import 51
4.4 Foreign advisors employed by the Meiji government 52
4.5 Technology and factory size 57
4.6 Manufacturing output in prewar Japan 57
4.7 Employment structure in prewar Japan 58
5.1 Profits of Osaka Spinning in the early years 64
5.2 Average duration of male employment in manufacturing 67
6.1 Central and local government expenditure 75
6.2 Yen–dollar exchange rate 76
7.1 Price movement and the composition of gross national expenditure 83
7.2 Estimated tariff protection 86
7.3 Gross capital formation 87
7.4 Timelines of Japanese automobile producers 89
8.1 The balance sheet of the Bank of Taiwan 99
8.2 Share of big five banks 101
9.1 Wholesale price level 106
9.2 Average income of farm households (including non-farm income) 106
9.3 Production of military goods 112
9.4 Supply of consumer goods per head 113
9.5 Maritime transport during the Pacific War 114
10.1 Industrial production index 119

vi
 F igures

10.2 Retail price inflation in Tokyo 122

10.3 Priority production system in theory (production index) 128
10.4 Priority Production System in practice (production index) 128
11.1 Real GDP growth 131
11.2 Japanese industrial prices relative to US prices 133
11.3 Central government revenue and expenditure 137
11.4 International reserves 138
12.1 The ratio of households owning consumer durables 151
12.2 Money supply and inflation 152
12.3 US bilateral trade balances with Japan and China 158
13.1 GDP growth 163
13.2 Real income per head relative to the United States 163
13.3 Nikkei 225 stock index average 164
13.4 Urban land price 164
13.5 Monetary base, money and bank lending 169
13.6 International reserves 169
13.7 Government debt as percent of GDP 170
A.1 Rice price in semi-log scale 190
A.2 Tokyo’s industrial areas in the Taisho period 190

vii
TABLES

1.1 Outline of Japanese history 15

2.1 Some basic terms of the Edo period 22
2.2 Examples of private professional schools (late Edo period) 32
4.1 Selected foreign investment projects during Meiji and Taisho 53
5.1 Largest enterprises by employment size (1907) 66
6.1 Estimated savings–investment balance by sector 78
9.1 Two major political parties in prewar Japan 108
11.1 Four major pollution lawsuits of postwar Japan 146

viii
B OX E S

1.1 The gap between economic and social achievements 18

2.1 Proto-industrialization and population dynamics 33
3.1 The lecture of Natsume Soseki 44
4.1 Meiroku Zasshi 58
5.1 Shibusawa, Yamanobe and others 70
6.1 Japan becomes a new threat to East Asia and the world 80
7.1 Taisho Democracy 92
8.1 Hamaguchi Osachi and Koizumi Junichiro 102
9.1 The origin of the Japanese system 115
10.1 Arisawa Hiromi and Okita Saburo discuss postwar recovery 127
11.1 Honda Soichiro: a postwar business hero 147
12.1 Prof. Komiya and the Japan–US trade friction 159
13.1 The future of manufacturing SMEs 176

ix
IN T R O DUCTION

This book offers a historical tour of Japan’s socio-economic changes over the last few
centuries paying particular attention to industrialization. It is not intended to be a mono­
tonous chronology or a collection of specialized academic research. Rather, it explains
why Japan developed so fast among all latecomers by presenting a broad and coherent
picture of its steps from a comparative perspective. While the writing style of this book
may seem plain and not overly technical, it nonetheless introduces the reader to a large
amount of facts and data as well as advanced—and sometimes highly controversial—
research on the modern history of Japan. As such, the book is suitable for those who have
little prior knowledge of Japanese society or economy but want to take a quick look at
how Japan industrialized. But those who already know much about Japan will also benefit
greatly from the rich information and arguments concisely presented in this volume. In
this sense, the book is introductory and professional at the same time.
Materials contained in this book were originally made available to master-level students
who took my course, Economic Development of Japan, from 1999 at the National Graduate
Institute for Policy Studies (GRIPS), Tokyo. The majority of my students were young govern-
ment officials from developing countries. In 2006, course materials were printed in textbook
form and began to be distributed free of charge to enrolled students. Soon, it became clear
that the book was very much wanted beyond the classroom by policy makers and advisors in
different countries who were eager to learn about Japanese development experience. I was
approached variously by my former students, a Chinese publisher, the Japan Foundation and
researchers abroad specializing in Japan, for permission to translate my English textbook
into several other languages. As a result, Japanese, Vietnamese, Chinese, Arabic, Russian
and Persian editions are now available. I have also frequently been asked to give a condensed
lecture on the subject to various audiences in Japan, Vietnam and Ethiopia. Meanwhile, my
course kept evolving and expanding as I discovered new studies and as my students raised
stimulating questions and comments.
The popularity of this textbook convinced me that the time was ripe for significant
revision and commercial publication—the original printing was financed by a research
fund that required noncommercial circulation—to incorporate new findings as well as to
reach larger readership. All chapters, sections and boxes have been revised considerably
or entirely rewritten, new information and diagrams have been added, and the final chapter
was extended with recent developments. The present publication should thus be regarded as
a new production rather than a slightly updated second edition.
I am not an economic historian but a practitioner of economic development. My main
research interest is why some economies industrialize rapidly while others stagnate at low to

1
 I ntroduction

middle income and never attain great prosperity. My hypothesis is that divergent growth per-
formance can be explained mainly by the amount of initial private dynamism and the quality
of industrial policy. In close cooperation with the Japanese government, I regularly con-
duct industrial policy dialogue with the leaders and policy makers of Vietnam and Ethiopia.
I advise them and train young people from these countries as well as other countries in
Asia and Africa. I also teach Policy Design and Implementation in Developing Countries at
GRIPS with other instructors. Through these activities, I am acutely aware of practical diffi-
culties these countries face in executing development policies. The central topic of this book,
how and why Japan industrialized rapidly from the mid-nineteenth century onward, may
seem a little worn-out to Japanese scholars who have already spilled a huge amount of ink on
the issue. But I still take it up, in the hope that we may see the road traveled by past Japan in
a new light shed by the standards and common sense of today’s developing countries.
This book contains no original research or new primary data. It is just a careful rear-
rangement of facts and analyses extracted from a large amount of existing literature mostly
written in Japanese. But this can be the strength of the book. It portrays Japanese history
not as random details specialists like to investigate, but as a comprehensive and continuing
story that compares Japan with other latecomers. Japanese experience is told not as a past
tale to be reminisced about but as a contemporary message to foreign elites who are at this
very moment struggling to develop their national economies. We recognize ourselves by the
existence of others. International comparison is essential to understand the characteristics
of any society in both its uniqueness and commonality. My lectures at GRIPS are meant to
be a mirror in which foreign students discover their own societies and their strengths and
missing elements. At the same time, they can also serve as a mirror for Japanese people to
re-discover themselves. I myself encountered numerous surprises in preparing and deliver-
ing these lectures. Domestic research closed to the rest of the world cannot uncover Japan’s
true position in world history.
History proceeds as endless interaction between domestic factors and foreign influences,
with the relative strength of each changing over time. In this process, domestic society is the
solid foundation into which foreign elements are selectively introduced—or so it should be
if foreign impact is to energize the existing society rather than destroy it. Japanese history is
unique in that the alternation of domestic and foreign forces went on for over two millennia
without serious disruption or eradication of any previous major achievements. This imparted
evolutionary and cumulative quality to Japanese history, unlike societies where foreign
influences often came in the form of violent invaders who wiped out existing political struc-
ture and rewrote state and ethnic boundaries, which made social continuity hardly possible.
In contrast, Japan’s evolutionary history generated resilience, flexibility and long memory
in both the rulers and the ruled. Japanese society developed organically from centralized
monarchy to its gradual disintegration, which brought a rise of local powers, and private
commerce and industry under feudalism. By the end of the Edo period (1603–1867), from
which this book starts its journey, Japanese society was mature enough to be able to quickly
absorb and internalize new systems and technology imported from the West.
After the general framework is presented in Chapter 1, the rest of the book sequentially
explains concrete cases of interaction between domestic and foreign forces, as well as between
public and private sectors, from the Edo period to present. Japanese industrialization, which
progressed very fast in the Meiji period and the post-WW2 period, is depicted as social trans-
formation driven by strong private dynamism supported by appropriate policies from the
sideline. The main engine of growth was active private players while the government, on

2
 I ntroduction

average, also played a useful role as a coach and promoter. The strength of both sectors, in
turn, was the result of Japan’s evolutionary history mentioned above. The reader should be
duly amazed at such dual strength, which is rarely seen in today’s developing and emerg-
ing economies. Few latecomer societies combine globally competitive entrepreneurship with
wise government, with the possible exceptions of Singapore, Taiwan and Korea. My students
from developing country governments are often impressed with how effectively Meiji leaders
and Showa businessmen worked, competed and cooperated. This also leads to the conclusion
that Japanese experience cannot be transplanted to a different soil without prior adjustment
and serious additional learning.
Another feature of this book is ample discussion of the socio-political elements behind
economic growth. Economics cannot be separated from politics and social change as they
arise mutually to shape national development. Negative events such as wars, social unrest,
environmental damage and political uncertainty are also taken up so far as they defined
and influenced the path of industrialization. The question of why Japan became an aggres-
sive invader and colonizer of neighboring Asia, ultimately leading to the Pacific War,
which is often skipped in the teaching of Japanese history, is squarely addressed to the
extent that this can be regarded as another main theme of this book apart from the reasons
for rapid industrialization.
I would like to thank my students at GRIPS over the last eighteen years for giving me an
opportunity and reason to write and continuously revise this book, and Ms. Yuka Akiyama
for her proficient support in preparing the current edition. The result looks quite different
from the original textbook, not just because the text and diagrams have been greatly modified
and added, and the front cover has been redesigned, but also because photographs generously
used in the previous edition were all eliminated for reasons of space and cost. Additional
lecture slides and data available to my students cannot be included for the same reasons.
Nevertheless, the book is sufficiently rich to serve as the first textbook for newcomers
in Japanese history as well as a compact guidebook on ongoing issues and debates for
specialists. Missing photos of political and business leaders, major historical events and
early factories and structures can be viewed easily in the internet age. I hope the readers will
enjoy the book.

Kenichi Ohno

3
1
A N O VERVIEW
Evolutionary history and translative adaptation

Domestic society and external forces

In any country, history proceeds as an interaction between domestic and foreign forces.
In the discussion of Japanese development that follows, this aspect of systemic interac-
tion will be highlighted. Japan’s modernization began with its encounter with the powerful
West in the nineteenth century. The path of Japanese industrialization thereafter can be
interpreted as the process of various domestic actors, including the government, businesses,
communities and individuals, responding to shocks and influences coming from abroad.
This perspective is very useful even today, since developing countries are now required to
develop in the strong presence of globalizing pressure. The development process of such
countries can also be understood as two systems, local and foreign, in dynamic interaction.
Today, new ideas and systems often come with such names as the market mechanism,
democracy, conditionality, international best practice, MDGs and SDGs, bilateral and
regional free trade agreements, and so on.
Domestic society is the base into which new foreign systems are introduced. Each
society has unique characteristics reflecting its geography, ecology and history. Existing
institutions in any society are mutually dependent and form a coherent whole (this is
called “institutional complementarity”). Domestic societies have their own logic and
mechanisms of internal evolution and, for certain periods, can evolve mainly through
internal forces. This evolution is usually slow and continuous. But when exposed to
strong foreign impacts, social equilibrium is suddenly disturbed and the country is dis-
lodged from its previous course. If the domestic response to foreign elements is resilient
and appropriate, the society will begin a new dynamic path of evolution. But if the
response is weak or inconsistent, the society may be destabilized or even destroyed under
foreign dominance.
In the twentieth century, isolation and self-sufficiency were pursued under socialist plan-
ning in some countries, but the effort failed miserably to produce economic dynamism. Since
the disappearance of the Soviet Union, refusal to integrate into the global economy has been
totally discredited as a national development strategy. While the policies of the World Trade
Organization (WTO), the International Monetary Fund (IMF) and the World Bank contain
many shortcomings, latecomer countries have no option but to join these international organ-
izations and receive their policy advice. Now the question is not whether to integrate but how

4
 A n overview

to integrate better. International integration is the necessary condition for development, but it
is not sufficient (UNCTAD, 2004).
The term development does not necessarily imply the existence of external influence.
Theoretically, development can be either internally motivated or externally driven. In
our age, however, it has become almost impossible to achieve sound and sustainable
development without effectively coping with and integrating into the global system.
Development now carries almost the same meaning as “catching up with industrial
countries” or “modernization through trade, FDI, and industrialization.” From a long
historical viewpoint, this is a very special type of development. But we can hardly think
of any other way. Whether desirable or not, this is the reality we face today.1
Throughout its history, Japan also experienced periods of relatively tranquil internal
evolution and periods of dynamic change under strong external influence. These periods
alternated to create Japanese society in a multi-layered fashion (Figure 1.1). Major external
impacts on Japan included the following:

•• Rice cultivation—introduced from the Eurasian Continent around the third century bc
(recent evidence shows that arrival of rice cultivation may have been earlier).
•• Buddhism—brought from China via Korean Peninsula in the sixth century ad.
•• Chinese culture and political system—imported vigorously from the seventh to the early
tenth century ad.

Pre-historic Japan

Rice cultivation

Buddhism & China

Heian & Samurai

Culture

Guns & Christianity

Edo Culture

Western influence

Figure 1.1 Japan’s multi-layered identity

Note: shaded areas indicate external impacts.

5
 A n overview

•• First direct contact with Europeans (Spaniards and Portuguese)—guns and Christianity
arrived in the sixteenth century ad.
•• Modernization—second contact with the industrialized West in the nineteenth century.
•• Post-WW2 reforms—under US occupation, defeated Japan was transformed into a
non-warring capitalist nation.

The Mongolians also tried to invade Japan twice in the thirteenth century, but their mili-
tary attempts failed. On each occasion, Japanese resistance, combined with a huge storm,
destroyed their fleet off the coast of Kyushu Island. Had the Mongolian invasion been
successful, Japan would have received another big foreign impact.
Compared with the history of other countries in the non-Western world, it can be said that
Japan absorbed successive external shocks rather well, and used them positively for change
and new growth. Japan also retained its national identity throughout this process, although
Japan today and Japan in the past look entirely different in their appearance. Japanese society
exhibits a multi-layered, onion-like structure as shown above, where old and new elements
coexist flexibly and different characteristics can surface depending on the circumstance.
Meanwhile, one Chinese social scientist has remarked that China is like a hard stone ball that
cannot change unless it is exploded and replaced by another hard ball (called “revolution”),
maybe of a different color.
The Japanese people happily absorb a large number of potentially conflicting elements
and use them interchangeably as occasions require. This is a unique feature of the Japanese
people not often seen in other societies. To put it positively, the Japanese are flexible, gener-
ous and pragmatic. But to put it critically, they are without principle, fidelity or consistency.
In his book Japanese Thought (1961), Maruyama Masao lamented that the Japanese had
no tradition of thinking logically though they were full of emotion and experience. This
criticism may be legitimate from the viewpoint of Western rationalism. But from another
aspect, the seemingly principle-less way of the Japanese may have value if we are to coexist
peacefully among different ethnicities, religions and ideologies in an integrated world. At
any rate, the point to be stressed here is that Japanese attitude is quite different from Western
attitude, without asserting which is superior.
This book focuses on Japan’s last great transformations driven by external shocks, namely
the process of Westernization and industrialization under the strong pressure of the West
during the nineteenth and twentieth centuries.

Translative adaptation
The idea of translative adaptation is proposed by Maegawa Keiji (1998), an economic
anthropologist at Tsukuba University.
When a country in the periphery joins the world system, it may look as if the country
(say, Ethiopia) is being absorbed in the dominant international order (say, the global trade
system). It looks as if the country is forced to abandon its traditional culture, systems, social
structure and so on, which are considered “backward,” in order to embrace the “international
best practice.” Viewed from inside the country in the process of “being absorbed,” however,
the situation is not always passive. In a proper integration process, Maegawa argues that the
country should take initiative in deciding the scope and speed of integration, making sure
that it can retain ownership (national autonomy), social continuity and national identity.

6
 A n o v e rv i e w

Existing World System

Democracy, market economy, industry,
technology, life style …

Dynamism for change (+)

Latecomer country
Integration risks (−)

Figure 1.2 Integration viewed from outside

Imported from outside

by:
“Translative adaptation”
(Maegawa Keiji) Invasion, colonization
Migration
Foreign Trade & FDI
Systems Aid
WB, IMF, WTO

Conflicts and
adjustments
Government
must manage
Base Society
Internal systemic evolution

Figure 1.3 Integration viewed from inside

The country surely changes, but the change is managed by its government and people and
not by foreign firms or international organizations. Foreign ideas and systems are intro-
duced not in the original form but with modifications to fit local needs and context. If this is
achieved, the transformed country is not really so weak or passive. It is taking advantage of
external stimuli to change and grow. This is called “translative adaptation.” Maegawa says
that Japan since the Meiji period did just that.

When a non-Western society encounters a powerful representative of Western civi-

lization, it is hardly possible to escape from its influences. Some ethnic groups have
been eradicated in short periods after contact with the West. At the same time, many
nations and societies have adopted Western institutions and objects from without in
order to survive (or by their own choice). However, it is important to recognize that

7
 A n overview

they did not accept Western inventions in their original forms. Any item in one cul-
ture will change its meaning when transplanted to another culture, as seen widely
in ethnography around the world. Not only cosmology, religious doctrine, rituals,
but also the family system, the institution of exchange, and even socio-economic
organizations like the firm exhibit the property of adapting to external institutions
and principles with the existing cultural system maintaining its form of structure.
The essence of what has been called “modernization” is the adaptive acceptance of
Western civilization under the persistent form of the existing culture. That is, actors
in the existing system have adapted to the new system by reinterpreting each ele-
ment of Western culture (i.e. “civilization”) in their own value structure, modifying
yet maintaining the existing institutions. I shall call this “translative adaptation.”
(Maegawa, 1998, pp. 174–175)

However, international integration is a risky process and not all countries can perform
translative adaptation successfully. A developing country exposed to strong external
pressure faces a great challenge. This is a critical moment in the history of that country.
Compared with the more predictable days of internal evolution, the fate of the society and
its people now hinges critically on how they react to this challenge. Domestic capability is
still weak, while the demands of globalization are high. Suddenly, the country is required
to make a great leap forward or fall into an abyss. It is as if an average student is told by his
teacher to participate in an international math competition. With enormous effort, he may
improve his skill and win. But it is more likely that he will fail miserably. The problem is
that the challenge is too big for his current ability. If the goal is unreachable, the effort is
not fruitful.
While there is no doubt that the effort of domestic businesses and communities is impor-
tant, the most crucial response to globalization must come from the policies of the central
government. If the government loses control of the integration process, dire consequences
may occur, such as macroeconomic instability, social disintegration, political crises, ethnic
conflict, foreign dominance, and so on.
When caught in a dilemma between weak capability and the great challenges of glo-
balization, some governments refuse to deal with the external world and revert to isolation,
economic control and the rejection of Western ideas. Other governments rush to embrace the
imported principles of free trade and Western democracy uncritically, without considering
the effects this brings to the domestic society. Both reaction patterns are shallow, extreme
and unadvisable. Translative adaptation requires much deeper knowledge of the top policy
makers. It is indeed a very difficult task.
Japan too faced great challenges when it opened up to the Western world in the middle of
the nineteenth century. It also experienced similar hardship after the war defeat of 1945. In both
cases, Japan eventually emerged as a brilliantly successful latecomer, at least economically.

Why Japan could succeed

Traditionally, we consider Japan in the nineteenth century as a weak, agricultural and back-
ward country with low technology suddenly exposed to influences from the powerful West.
Japan struggled to industrialize and somehow succeeded. But why did only Japan succeed
so early, among all non-Western countries? This is the biggest question for whoever studies

8
 A n o v e rv i e w

Japan’s modern history. However, Umesao Tadao, a distinguished scholar in comparative

civilization, says that there is no mystery here. According to him, Japan emerged as a
non-Western industrial country very naturally.
Until 1993, Umesao was the director general of the National Museum of Ethnology in
Osaka, which he founded in 1974. In his earlier days, he traveled extensively in Mongolia,
Afghanistan, Southeast Asia, Africa and Europe undertaking anthropological fieldwork. In
1957, he proposed a new theory of Japanese history and national identity.
Umesao (1986, 2003) says that the traditional view of Japan as a backward country
is wrong. He argues that Japan and Western Europe are two very unique societies in the
world. Both enjoy temperate climate. More importantly, both are located on the periphery
of the huge Eurasian continent. Thus, they are relatively insulated from violent invasions
by nomadic peoples residing in the central dry areas of the continent. He argues that this
locational advantage is crucial for the spontaneous and continuous development of society.
Japan and the United Kingdom are particularly similar in that they are island nations just off
the Eurasian Continent.
Japan and Western Europe were situated at an appropriate distance (not too far, not too
close) from the great civilizations of Eurasia—namely, China, India and the Middle East
(Islam). Both could absorb the cultural achievements of these civilizations easily by send-
ing official envoys or commercial traders while the chance of being invaded and destroyed
is much smaller than that of societies located in the middle of the continent. According to
what Umesao calls an ecological view of history, this geographical advantage permitted both
societies to evolve cumulatively and organically. They mixed domestic culture and foreign
impact properly, without being wiped out every few centuries and having to start over again
from scratch. The right distance from superior civilizations had the double advantage of
managing cultural inflow and defending against invaders.
Under these similar historical conditions, Japan and Western Europe developed inde-
pendently and in parallel—from centralized imperialism to power decentralization,
feudalism, absolutism, emergence of strong local private sectors, and finally capitalism. It is
no accident that the Industrial Revolution originated in the United Kingdom, and that Japan

Eurasian Continent

Russia

The
Western Meditterra- Dry Area China Japan
Europe nean and
(UK) Islamic
States

India

Figure 1.4 Umesao’s view of the world

Source: compiled by the author from Umesao, 1986, 2003 with comments and approval by Umesao.

9
 A n overview

was the only non-Western country to industrialize as thoroughly as the West by the twentieth
century. In no other areas did history evolve so sequentially. According to Umesao, Japan
got behind the United Kingdom because it adopted the bizarre policy of external isolation
from 1639 to 1854 (Chapter 2). Had this deviation not occurred, Umesao asserts, the two
nations would have achieved the Industrial Revolution at about the same time.2
What do repeated impacts from the outside world, without eradicating the core of the
receiving society, produce? Umesao seems to suggest that frequent merger of domestic
and foreign elements makes the society resilient to external shocks and at the same time
flexible enough to change, producing dynamism under continuity. This is plausible, but
exactly how this is done is still in the black box. One possible explanation is that the mind-
sets of both the ruler (policy maker) and the ruled (farmers, workers and entrepreneurs) are
transformed by institutional memory that leads to the formation of dominant social ethos
that preserves the society against shocks. That is to say, the history of turbulent times and
forced change is told and re-told through books, poems, songs and theatrical arts in which
the hero or heroine laments the cruel fate but chooses or accepts the action that best serves
the interests of the society and not of self. Such stories are never forgotten. Spiritual values
such as hard work, high aspiration, honesty, patience, sacrifice and broad vision become
esteemed and reinforced.
Chinese, Indian and Islamic civilizations produced great cultural achievements, but
their social structures were fundamentally static; only empire and dictatorship (and later,
colonialism) ruled. From one dynasty to another, there was no clear progress from the
viewpoint of social and political evolution. For thousands of years, emperors and kings
were basically the same though some were wiser than others and policies differed from one
dynasty to another. According to Umesao, only Western Europe and Japan satisfied the
historical conditions necessary to industrialize. Japan did not imitate the West as the two
areas developed spontaneously and independently (North America can be regarded as an
offshoot of Western Europe). He is pessimistic about the possibility of industrialization in
the rest of the world, including all the developing countries today.
This chapter has introduced Umesao’s view not because the author agrees with him
completely, but because it contains something that is interesting and stimulating. His inter-
pretation of Japanese history is unique and in the minority. In fact, his view is not very
well known even among Japanese, as he himself admits. Many would feel uneasy with the
assertion that industrialization takes place only under certain strict historical conditions and
nowhere else, which seems too simplistic and deterministic. If the path to industrialization
cannot be crafted but only inherited, Official Development Assistance (ODA), Foreign
Direct Investment (FDI), development assistance by bilateral and multilateral donors, and
all studies in economic development (including this one) are in vain. Can we really say that
China or India will never become a fully industrialized country? Does Africa have no hope?
Industrialization is more dynamic and flexible today. Umesao’s explanation may be valid
up to the recent past. However, we are now living in the age of internet, air travel and global
exchange of information. Physical distance from the center country should no longer matter
very much. Even though history is ingrained deeply in the characteristics of each people,
ethnic traits are also dynamic and changeable. There should be more than one path to devel-
opment in response to different initial conditions and shifting historical circumstances. With
great leadership and ideas, a new way of development suitable for each country should be
found. Additionally, Umesao does not discuss the role of technology, entrepreneurship and
investment very much. Being a specialist in comparative civilization, he emphasizes the

10
 A n overview

evolution of social structure rather than the technical absorptive capacity of each nation. But
the latter is also crucial in determining the success or failure of development.
Having said this, however, Umesao may be quite right in certain points. In particular, his
theory can explain why Japan had a unique social structure suitable for industrialization that
is not observable in other countries, even before its encounter with the industrialized West.
This was forged by the uninterrupted organic evolution of the Japanese society over the two
millennia. This permitted Japan to absorb new foreign influences flexibly in the translative
adaptation of Western thought and technology. Japan’s industrialization was driven by pri-
vate dynamism, which was the primary force, supplemented by mostly appropriate policy
support, which was secondary. Both of these conditions were generated through Japan’s long
evolutionary history. This, at least partly, should be an answer to the question of why Japan
was able to achieve success so early.
In a series of historical essays entitled The Shape of This Nation (1986–1996), writer
Shiba Ryotaro asked “What shaped Japanese people”. The two key elements extracted by
him as shapers of Japanese characters are an island nation and the samurai spirit. The former
made Japanese curious about foreign ideas and technology, and willing to import them after
adjusting them to local tastes and mindset (i.e., translative adaptation). For the latter, the
highest value of samurai is honor, not personal gain or family prosperity. This sentiment has
permeated Japanese life. Japanese people want to live and die honorably, avoiding shame
even without the commandment of God or government.

A brief history of Japan

While this book focuses on modern Japan, it is useful to take a brief look at the entire
Japanese history at the outset. The summary given below is not meant to be an academically
respectable discourse but a very rough sketch for those who know little about Japanese
history. For beginners, Japanese history can be divided into four major periods: (i) the
period in which emperors held real power, (ii) the period of samurai (warrior) leaders,
(iii) the period of modernization and military invasion, and (iv) the period of post-WW2
growth and slowdown. Figure 1.5 shows this graphically while a concise table of Japanese
history is provided in Table 1.1 at the end of this chapter.
Ethnically, the Japanese are a mixture of various people who came from the South and
the North and inhabited the archipelago first, and the people who later came via the Korean
Peninsula. The precise origins of these people are still debated. In the pre-historic period,
the Japanese people were hunter-gatherers with limited agricultural activity. They lived
separately in small villages with family as the basic unit but there was also trade through
long-distance maritime traffic. They lived relatively peacefully.
When rice cultivation was introduced from the continent (third century bc or earlier), life
changed significantly and history started. Rice cultivation on Japanese soil required collec-
tive effort by all villagers under effective leadership. Village size grew and social order was
established. Religious and military leaders emerged to form mini states. Wars among mini
states became common, and after a few centuries of fighting (details of which is not known
due to the shortage of written evidence), Japan was politically unified for the first time,
around the fourth century ad. But many powerful clans existed to influence the ruler and
policies, including the acceptance or rejection of imported Buddhism.
After a few more centuries, the imperial family grasped real power by slaying the most
powerful clan leaders and subordinating others (Reform of Taika, 645 ad). Under a series

11
 A n overview

I. Emperor’s Rule II. Samurai’s Rule III. Modernization IV. Postwar

Early 16th C
X
1867
NARA Rapid
recovery
and
Centralization MEIJI growth,
Westernization, slowdown
EDO industrialization,
militarilization
Tokugawa
Jinshin War × 671 HEIAN KAMAKURA Shogunate WAR
MUROMACHI 1937-45
Nobles,
Taika Reform × 645 SENGOKU Peace,
Decentra
lization Internal isolation,
Clan wars, conserva
fights dynamic & tive class
Hunting & fluid society
gathering society

xxxx xxxx xxx

Rice Buddhism Chinese culture & West: guns & Industrialized US occupation
political system Christianity West 1945-52

Figure 1.5 Four periods of Japanese history

Note: the bar at the bottom illustrates vigorous importation of foreign ideas and objects while xxx indicates interruption
or reduction of such imports. Major occasions of foreign imports are also shown.

of strong emperors, a centralized government modeled after Chinese bureaucracy and

tax system was created. Many capital cities were built and abandoned one after another
(consider how much resource was wasted in doing this!), but finally, in 794, the nation’s
capital was settled permanently in Kyoto.3 Military conquests of minority peoples were
conducted. Buddhism was used for the political purpose of demonstrating the emperor’s
power and ruling the country. This was the only period in Japanese history in which the
emperor had real political and military power.

The age of samurai

But power concentration did not last very long. Soon, local leaders, landlords and temples
became more independent from the central government and stopped paying taxes or obey-
ing official orders. They established shoen (manors) and employed people to cultivate it.
To protect their land from invaders, the warrior class (samurai) emerged. For samurai, land
was the most precious asset to be defended with their lives. Meanwhile, the political power
of the imperial family and surrounding nobles gradually declined. They composed poems,
performed countless rituals and ceremonies, and played kemari (garden football) in Kyoto.
To suppress uprisings or solve conflicts, they had to rely on the military might of the com-
peting samurai groups.

12
 A n overview

From the end of the twelfth century onward, samurai leaders began to form government
with the permission of the emperor.4 The age of samurai went through two distinct periods.
The first period saw constant fighting for land and power among samurai leaders while the
second, after national reunification was attained in the early seventeenth century, featured a
peaceful but highly conservative and bureaucratic rule by the Tokugawa family.
The first samurai government was established in Kamakura, 350km east of Kyoto, in
1192 (Kyoto was still the capital—where the emperor resided—but real power rested with
samurai in Kamakura). The top samurai was called shogun. The Kamakura government
guaranteed follower samurai their right to possess land and also distributed new land to
those with distinguished service in war. However, Japan was greatly shaken by two inva-
sion attempts by the Mongolians in 1274 and 1281. Each time, the great Mongolian fleet
attacked the coast of Kyushu but was repelled by a combination of Japanese resistance and
a huge storm. While unsuccessful, the Mongolian attacks led to the eventual collapse of the
Kamakura government in 1333. It ran out of land to distribute to samurai who bravely fought
Mongolians.
After this, long fights among daimyo (regional samurai leaders) ensued for nearly three
hundred years. It was a dynamic but very dangerous age. The Kamakura government was
replaced by another military government, based in Kyoto, of the Ashikaga family, but the
latter failed to restore order. The imperial family split into two lines (later merged), and sam-
urai fighting for family leadership or local land sided with the one or the other to justify their
private cause. Daimyos were initially appointed by the central government, but later became
autonomous from it. Private fights, some lasting for decades, became common, devastating
Kyoto and other cities, burning temples and weakening the central authority. Internal wars
culminated in the seventeenth century, called the Sengoku (Warring) Period, where daimyos
mobilized any means, military or otherwise, to eradicate others in a competition to emerge
as the ultimate ruler to reunify Japan and end all wars.
Oda Nobunaga, the merciless fighter, and Toyotomi Hideyoshi, the witty manager, came
close. But they did not finish the job. Finally, Tokugawa Ieyasu, the old and patient, emerged
as the winner and established the Edo government in 1603 (in what is now called Tokyo). He
burned the Osaka Castle and eliminated the Toyotomi family. The Warring period came to
an end and the Tokugawa family ruled Japan for two-and-half centuries, with fifteen shoguns
in all.
The Edo samurai government was politically conservative. It imposed rigid social order
and severely limited and monopolized foreign contact and trade, with a few exceptions.5
Under the feudal system, the central government allocated land to rule (called Han) to
daimyos. Peace was restored under a strict bureaucratic rule. Nevertheless, in recent histori-
cal research, the Edo period is viewed as a dynamically evolving period rather than a stagnant
dark age. Under international isolation that lasted more than two centuries (1639–1854), land
cultivation expanded, agricultural productivity rose, and commercial crops, trade, industry
and finance grew. Rich merchant families emerged and Japan’s unique culture developed.
Conditions for industrialization were ripe.

Meiji and modernization

Several Western powers wanted to open up Japan from its self-imposed isolation. First, the
Russians came. Then the British, the Americans, and the French knocked on the door. But
the Edo government refused to deal with them. Finally, in 1853, the American troops led

13
 A n overview

by Commodore Perry came with four “Black Ships” loaded with powerful guns to open
Japanese ports. The Edo government—and the entire nation—was thrown into confusion. In
the following year, the government yielded to the American pressure and signed the Japan–
US Friendship Treaty. Other Western powers followed the American move. The Americans
further demanded a full commercial treaty with Japan. A strong anti-foreigner movement
emerged all over Japan while others argued for actively trading with the West and importing
modern military technology. In 1858, in the midst of a heated national debate, the Edo gov-
ernment suppressed the opposition and concluded commercial treaties with the West without
the consent of the emperor. These commercial treaties were later found out to be defective,
with Japan having no right to judge foreign criminals or set its own import tariffs (Chapter 3).
Criticism against the Edo government rose sharply and internal political fights over foreign
trade as well as the legitimacy of the Tokugawa rule ensued for about a decade, finally top-
pling the Edo government militarily in 1867–1868.
The new Meiji government restored the emperor (who for a long time had no real power)
as the nation’s supreme ruler and adopted a policy of rapid Westernization, modernization
and militarization. In the political area, the first constitution modeled after German consti-
tutional monarchy was promulgated in 1889 and parliamentary election and sessions began
in the following year. In the economic area, the adoption of Western technology and the
creation of modern industries became the top national goal. The textile industry gradually
emerged as an internationally competitive industry. In the military area, Japan won a war
against China (Qing Dynasty) in 1894–95 and began to invade Korea (it was later colonized
in 1910). Japan also fought a victorious war against the Russian Empire in 1904–5. In the
early twentieth century, about a half century after opening ports under American military
threat, Japan was admitted as a member of Big Five, the group of powerful nations, along
with the US, the UK, France and Italy.
The Japanese economy experienced an enormous export-led boom during WW1. But a
period of mediocre growth ensued after the export boom ended. During the 1920s, heavy
industrialization proceeded despite frequent recessions, the Great Kanto Earthquake of
1923, and banking crises. The 1920s also witnessed the party cabinet system featuring
competition between the two major political parties, and foreign diplomacy couched on
the spirit of international cooperation (especially with the US). However, Japan turned
decisively to militarism in the 1930s. In the 1931 Manchurian Incident, Northeast China
was occupied by Japanese army stationed in China that acted independently from the
Tokyo government. Effort to fight militarism by politicians, academic and press even-
tually failed to stop army aggression. Political terrorism was rampant. A full-scale war
with China was initiated in 1937 and the Pacific War began in 1941. Wartime economic
planning was adopted. People were mobilized for war effort, and production of food and
clothing was curtailed for military production.

Postwar growth and slowdown

Japan was defeated in 1945 and the country’s economic base was lost by American bomb-
ing and sinking of ships. Under the US military occupation of 1945–1951, a production
recovery strategy based on material planning was successfully conducted in 1947–1948 and
postwar inflation was terminated in 1949. From the mid-1950s through the early 1970s,
Japan enjoyed very rapid growth and industrialization. The manufacturing sector expanded

14
 Table 1.1 Outline of Japanese history

Period Domestic events External events

Jomon (–3c. bc) Hunting and gathering, limited agriculture

Yayoi / Kofun Internal wars → Unification of Japan ←Rice production introduced

(3c. bc–5c. ad) →Diplomacy with China (tributary)
→Intervention in Korea (failed)
Asuka / Hakuho Clan politics ←Buddhism introduced (via Korea)
(5–7c. ad) Tenno (emperor) family consolidates power

Rise and Fall of Emperor

Nara (710–794) Ritsuryo System―emperor’s direct rule based on laws and ←Chinese political system and culture
Capital: Nara centralized government; Buddhism promoted as state religion imported

Heian (794–1192) Court politics and rituals by nobles

Capital: Kyoto Manorial system (power decentralization) × Diplomacy with China terminated
Rise of samurai (warrior) class

Kamakura First samurai government ←Two Mongolian invasions (failed)

(1192–1333) New Buddhist sects for people emerge
Cap: Kamakura

Samurai
→Trade with China resumes

The Age of
Muromachi Samurai government →Japanese pirates attack Chinese coast
(1338–1573) Two emperor lines compete (north and south) →Active trade with Southeast Asia
Capital: Kyoto Internal wars and rebellions

(continued)
 Table 1.1 (continued)

Period Domestic events External events

Sengoku (–1603) Fierce wars among daimyo (regional leaders) ←First contact with Europeans – guns and
Oda and Toyotomi gain power Christianity introduced
→Reunification by Tokugawa Ieyasu →Invasion of Korea by Toyotomi army

Samurai
Edo (1603–1867) Tokugawa Shogun Government (samurai rule, agricultural tax,

The Age of
Cap: Edo (Tokyo) class system)
•• Stability under strong government × Closed door policy―diplomacy and trade
•• Hans’ promotion of local industries severely restricted (except China, Holland,
•• Agriculture and handicrafts develop Korea, Ryukyu); bakufu monopoly of
•• Transport, finance, commerce, education develop, unified controlled trade; Christianity banned
national market emerges
•• Rich merchant families emerge
•• Unique popular culture develops
Fight over “open door” vs. “anti-foreigner campaign” ←America opens Japan by military threat
Han samurai topple Shogun Government (1853–54); commercial treaties
Danger of colonization by West
Meiji (1868–1912) Strong government under emperor adopts open door policy and National desire to catch up with West
(Capital: Tokyo to rapid Westernization
present)
Fukoku kyohei (strong economy and army) →War with China (Qing Dynasty, 1894)
Industrialization (private dynamism supported by government →War with Russia (1904)

Modernization
policy) →Annexation of Korea (1910)
 Taisho (1912–26) Democracy movement (short-lived) →Pursuit of Chinese economic interest; conflicts
•• Recessions and economic crises (1920s–30s) with US and Europe mount

Early Showa Fight among political parties, right-wing and military; political →Invasion of Manchuria (Northeast China,

Modernization
(1926–45) terrorism; coup attempts 1931)
Military takes over government →Full-scale war with China (1937)
Mobilization of people and resources for war →Pacific War (1941); invasion of Southeast Asia

Late Showa Democratization and demilitarization Economic recovery from War defeat (1945)
(1945–88) postwar crisis ←US occupation (1945–51)
Priority production system

Postwar
Rapid industrialization (1950s–60s) →Multilateral open door policy
•• Strong private initiative →Membership of IMF, World Bank, OECD
•• MITI’s industrial policy World’s No. 2 economy (around 1970)
Economic slowdown (1970s–80s)

Heisei bubble economy

Bursting of the bubble causes economic stagnation (1990s–)
Heisei (1988–) Fiscal and monetary stimuli fail to activate economy; Abenomics Top ODA donor (1990–99)
Rise of China and other emerging economies

Conflicts with China, Korea accelerate

 A n overview

strongly and Japan became the second largest economy in the world after the US by the end
of the 1960s. National security under the US military umbrella, global trade expansion and a
stable exchange rate contributed to the miracle growth.
As the Japanese economy matured, growth slowed down. In the 1970s, oil shocks and
floating exchange rates reduced Japan’s growth to about 4 percent per annum. An asset bubble
in land and stocks occurred in the late 1980s which burst in 1990–1991. Since the early 1990s
and even to this day, the Japanese economy has virtually stopped growing. Fiscal and mone-
tary stimuli have been tried repeatedly in increasing doses, but growth did not pick up. Under
Abenomics, even more aggressive monetary policy was started in 2013, improving the short-
term prospects and popular psychology. But growth strategy remained as ineffective as ever.
The rest of the book will chronologically discuss circumstances and conditions surround-
ing each age, as well as concrete cases of strong private dynamism and proper official support
which are the hallmark of Japanese industrialization. Alongside achievements, failures will
also be reported in economics, politics and diplomacy. The next chapter will focus on the
Edo period (1603–1867), which preceded the amazing Meiji period and prepared precondi-
tions for rapid catching up with the West in the late nineteenth to the early twentieth century.

Box 1.1 The gap between economic and social achievements

In the book entitled Japan’s Modernization and Social Change, sociologist Tominaga
Kenichi proposes a general framework to understand the various aspects of Japan’s
modernization and industrialization. Traditionally, there have been two opposing
interpretations of Japan’s modern history. The first view positively considers Japan’s
economic performance, especially its brilliant success as a latecomer. The second view
castigates past Japan as the oppressor of its own people and a military invader of the
neighboring countries. Is Japan a model for all developing countries, or a negative case
to be avoided at all cost? Tominaga cautions that a debate over such simplistic dualism
yields little result. According to him, modernization is a complex phenomenon that
must be analyzed with scientific concepts and models.
Tominaga first emphasizes that the modernization process of a non-Western country
does not trace the same path experienced by the West.

To be successful, the modernization of a non-Western country must be a cre-

ative process in which comparison between indigenous and foreign culture is
made, the superior aspects of the latter are selectively introduced, imported
and indigenous elements are combined to breed something new, and conflict
between the two is mitigated. Japan’s modernization was precisely such a
process. Modernization currently proceeding in the societies of Asia’s newly
industrializing economies also conforms to this description.
(Tominaga, 1990, pp. 38–39)

As the reader will surely notice, Tominaga’s assertion is essentially the same as
Maegawa’s translative adaptation explained in the main text. From this perspective,
Tominaga’s method divides society into the following four subsystems and describes
the evolution of each in detail:

18
 A n overview

(i) economic modernization (growth through industrialization);

(ii) political modernization (democratization);
(iii) social modernization in the narrow sense (transition from gemeinschaft [land-
and lineage-based groups] to gesellschaft [functional groups] as well as a shift
from closed rural communities to open urban communities);
(iv) cultural modernization in the narrow sense (transition from superstition and
irrational customs to scientific and rational thinking).

Tominaga’s main argument can be summarized as follows. The modernization of

Europe started with the internal development of political and social subsystems
followed by the Industrial Revolution. But latecomer countries cannot follow this
sequence. For them, economic modernization is “easier” than political moderniza-
tion. Social and cultural modernization is even harder. This is because much more
time and energy are required to transform a structure that dominates and permeates
every detail of people’s lives than to copy new technology and industries. This nat-
urally leads to a gap between fast economic growth and slow progress in all other
aspects. However, since the economic subsystem and the non-economic subsystems
are interdependent, this gap generates tension and conflict that distorts the modern-
ization process of that country. Prewar Japan, which boasted high technology and
modern industries on the one hand while imposing the concept of the holy nation
ruled by the emperor family lasting for millennia and the feudal family system on
the other, is a typical example. While expressed in sociological terms, Tominaga’s
assertion belongs to one of the very popular views on the merits and demerits of
Japan’s modernization process.
Tominaga also argues thus:

•• Before the Edo period, Japan did not generate any ideas or systems that could support
modernization. For this reason, modernization beginning from the subsequent Meiji
period called for a total negation of traditional systems and a switch to foreign systems.
•• Modernization cannot succeed in a society where gemeinschaft, closed rural
communities and irrational thinking remain. If modernization is pursued in the
presence of these elements, dilemma and friction become inevitable.
•• The serious modernization gap in prewar Japan was largely removed as a result
of bold postwar reforms, but some traditional elements still remain even today.
Japan’s modernization will not be complete unless these cultural remnants are
finally eliminated.

It is clear that Tominaga views Japan’s indigenous elements very negatively. He

regards them as nothing but obstacles to modernization rather than a basis on which
imported elements are to be grafted. This is in sharp contrast to Umesao’s high eval-
uation of the continuity of Japanese history which prompted him to say that Japan,
as Britain, evolved naturally and autonomously as a modern nation. It is also at
odds with Maegawa’s concept of translative adaptation and his assertion that Japan
successfully mixed domestic systems with foreign ones with the former serving as
the more fundamental base. Which interpretation is more reasonable? It is up to the
reader to decide.

19
 A n overview

Notes
1 Among development strategies, the promoters of endogenous development argue for restricting
external integration and letting local systems within each society become the growth engine. This
includes, for example, agricultural production for local consumption rather than commercial sales,
and communal development based on traditional religion, values and customs. This approach may
activate communities and provide a risk sharing mechanism in certain stages of development. But its
validity as a long-term universal development strategy is not confirmed.
2 In the historical discourse of Umesao Tadao, perhaps the most shocking passage is his view on
Japan’s invasion of neighboring Asian countries from the late nineteenth century to 1945. He argues
that, without the strange isolationism adopted in the seventeenth century, Japan would have reached
Southeast Asia much sooner and fought the British and French forces there. In his words, “Japan’s
role in international power politics was similar to that of Britain, France and the Netherlands.
Japan’s later behavior as a regional power was not solely the result of a surge of militarism after the
Meiji Restoration (1868). It grew from the gap between Japan and Southeast Asia in terms of their
situation in the history of civilization, and from the similarity of circumstances between Japan and
Western Europe” (Umesao, 2003, p. 110).
3 Kyoto literally means capital city. If the capital is defined to be the location of the emperor’s official
residence, Kyoto remained the capital of Japan until 1868.
4 Even after the emperor lost real power, samurai leaders still sought imperial approval to set up a
new government and legitimize their power. All subsequent governments (even today) have used the
symbolic authority of the emperor instead of terminating the imperial family and themselves estab-
lishing a new kingdom or dynasty. The benefit of receiving a formal imperial sanction to rule must
have been greater than the cost of keeping the emperor who rarely intervened in politics (there were
a few exceptions, however). Once this practice was established, deviation from it became politically
too costly as it would surely invite a severe accusation of demeaning the divine family.
5 The central government monopolized trade with China and Holland at Dejima, a tiny artificial island
in Nagasaki. All other Western nationals were expelled from Japan. Meanwhile, diplomatic and com-
mercial exchange with Korea was conducted via Tsushima Han, the Ryukyu (Okinawa) was under
the control of Satsuma Han, and Matsumae Han traded with the Ainu people in Ezo (Hokkaido).

20
2
T H E E DO SOCIETY
Preparing conditions for industrialization

The Edo period: 1603–1867

Japan was ruled by the governments of samurai (military leaders) from the end of the twelfth
century to the middle of the nineteenth century. Nominally, the emperor was the supreme
ruler who granted the authority to govern to the samurai leader, but the real power rested
with the latter. There were a few emperors who tried to restrain samurai power but they did
not succeed very much.
The first half of the samurai period (Kamakura 1192–1333, Muromachi 1338–1573
and Sengoku 1573–1603) was dynamic, dangerous and open to foreign trade, where sam-
urai were fierce fighters vying for land and power. The second half of the samurai period
(Edo 1603–1867) saw the nation reunified by the Tokugawa family restoring peace and
order under a conservative, bureaucratic and class-based government. Samurai continued
to practice sword but there was no more fighting.
Transition from the first to the second period of samurai, which occurred at the end of
the sixteenth century and the beginning of the seventeenth century, was a turbulent one.
Oda Nobunaga (1534–1582) and Toyotomi Hideyoshi (1537–1598) almost emerged as final
winners but their control slipped. The real winner was Tokugawa Ieyasu who won the deci-
sive Battle of Sekigahara (located between Nagoya and Kyoto, and visible today from the
Shinkansen) in 1600 and attacked Osaka Castle in 1614–1615 where the rival Toyotomi
family perished. The remaining daimyo (warlords) were reorganized as subordinates with
different ranks based on the degree of allegiance to the Tokugawa family. Ieyasu created a
new capital city in Edo and became the first shogun of the Edo Bakufu in 1603. Edo, a sleepy
little fishing village until then, was transformed into a huge political city by aggressive
public works including land reclamation, artificial canals and water supply networks. The
Tokugawa family ruled Japan for the next 264 years (fifteen shoguns in all). After the death
of Ieyasu, he was deified as the founder of the Tokugawa shogunate and is still worshiped
at Nikko Toshogu Shrine.
A particularly important development during the transition (the Sengoku period and the
early Edo period) was the removal of various middle-layer organizations such as Buddhist
temples and sects, manorial owners and regional landlords that had existed from the ancient
times. Power decentralization and indirect rule were now replaced by direct and unified rule
by the newly emerged daimyo (warlord) in each region. This was achieved by a number
of policies and brutal actions taken by Sengoku daimyos, especially Oda Nobunaga and
Toyotomi Hideyoshi mentioned above, who were the two most powerful military leaders

21
 T he E do S ociety

Table 2.1 Some basic terms of the Edo period

Bakufu Residence of a military ruler. Later it meant the central government established by
a military leader.
Shogun Originally, the supreme commander of a dispatched army. But it usually means the
top ruler of a central military government.
Han A local government unit (such as province or regional state); domain given to
daimyo to rule under the feudal system.
Daimyo Regional samurai ruler. In the Edo period, daimyo meant the head samurai of a
local government (han).
Edo The old name for Tokyo. Edo literally means the mouth of a bay. Incidentally,
Tokyo means the eastern capital (the western, or the traditional, capital is Kyoto).
Gosho Rich merchant families (Mitsui, Sumitomo, Konoike, Tennojiya, etc.)
Terakoya Private elementary school.
Shi-No- Samurai–Farmers–Craftsmen–Merchants; the four classes of Edo period from high
Ko-Sho to low.
Sat-Cho- Satsuma, Choshu, Tosa and Hizen; four powerful hans toward the end of the Edo
Do-Hi period that eventually ended the Bakufu and established the Meiji government;
now called Kagoshima, Yamaguchi, Kochi, Saga.

before Ieyasu finally took power. Their policies included military annihilation of opponents,
liberalization of commercial activities in newly occupied land, abolition of inter-regional
custom duties, official land survey and farmer registration (kenchi), confiscation of all
arms from non-samurai population (katanagari), construction of only one castle town in
every region, residential requirement of all samurai in castle towns, relocation of markets
and craftsmen to castle towns, and so on. Daimyos began to directly rule land, farmers and
samurai retainers. From this time onward, samurai and farmers were strictly separated in
profession and residence. Samurai who no longer protected their land became urban officials
receiving rice salary. This movement which started in the Sengoku period was continued and
completed by the Edo government.
If we define feudalism as the leader–follower relationship based on the granting of the
right to govern assigned land, the Edo society was a feudal system (there are academic
debates as to what exactly is feudalism but we will not go into that). The Bakufu had the
absolute authority to increase, reduce, relocate or even eliminate han, the land provided
to each daimyo for governing, depending on the degree of allegiance and the behavior of
each daimyo. Any violation of central order or regulation was severely dealt with, but as
long as this condition is cleared, each daimyo was free to conduct his policies within his
domain as explained below. At the end of the Edo period there were about 300 hans in
all sizes. The Bakufu itself occupied about 20 percent of the total nation, as if it were the
largest han. The Bakufu’s domain included major cities such as Edo, Osaka and Kyoto,
strategic ports, and gold, silver and copper mines.
We start the story of Japan’s economic development from the Edo period because the
preconditions for later industrialization and modernization were created internally during
this period. Let us list these pre-conditions at the outset:

1 political unity and stability;

2 agricultural development in terms of both cultivated area and land productivity;
3 the development of transportation and the emergence of nationally unified markets;
4 the rise of commerce, finance and the wealthy merchant class;

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5 the rise of pre-modern manufacturing;

6 industrial promotion by local governments (sometimes successful but not always);
7 high level of education.

These are the features of the Edo period that are commonly cited by many researchers. It
is interesting to note that these conditions are not met by some developing countries even
today. We may even say that developing countries of the twenty-first century are rarely
equipped with all of these conditions, and those that satisfy some of these conditions are also
not many. In this sense, Japan in the Edo period was on the verge of industrialization waiting
for external stimuli to start new growth. Though it did not yet have steam power or modern
machinery, political, economic and social conditions were ripe. How this situation was cre-
ated historically was explained, at least partially, in the previous chapter. This chapter will
selectively examine these conditions in detail.

Features of the bakufu-han system

Features of the Edo society can be described as follows.

1 It was a class society. The ruling class was the samurai (military men who were per-
mitted to carry a sword). The ruled included farmers (ranked no. 2), craftsmen (no. 3),
and merchants (no. 4). These four classes were called Shi-Nou-Kou-Shou (from top to
bottom).1 There was a big gap between the samurai class and other classes. Farmers
were officially placed no. 2 because they paid the rice tax, but they were not particularly
respected. Below all of these classes, there were also outcasts, eta and hinin, who were
institutionalized and used by the Edo government (see QAs at the end of the book).
2 Politically, it was a centralized system. The Bakufu had absolute political power over the fate
of hans and could even remove or abolish them at will. The shogun gave daimyos the land to
rule. In return, daimyos pledged loyalty to shogun.2 Any sign of disobedience was met with
the sternest punishment including seppuku (ritual suicide) and the termination of the family.
3 Economically, it was more decentralized. The Bakufu was not very capable of (or
interested in) conducting consistent economic policies. Its policies were unstable and
often myopic. On the other hand, each han could decide its internal policies including
administration, taxation, education, industrial promotion, issuing paper money and other
economic regulations as long as it was not explicitly prohibited by the Bakufu.
4 The Bakufu imposed the following expenses on hans:
(i) Sankin kotai (alternative attendance) which means bi-annual commuting of the han
lord between home and Edo. Every daimyo was required to reside in Edo every other
year and stay in his han the rest of the time. This cost a huge sum of money in travel
and residence since a large number of retainers also had to move with the daimyo,
and proper style in travel and residence must be prepared to match each daimyo’s
prestige.
(ii) Random and irregular assignment of public works such as building and repairing
castles, moats, roads, reservoirs, canals, river banks, etc. Because of this system, the
Bakufu could dispense with the public investment budget as any construction work
was simply ordered to hans.
(iii) Other ad hoc and arbitrary taxes and charges, for example, for celebrating the birth of
a son in the shogun family.

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 T he E do S ociety

Imposition of these arbitrary expenses on hans had the effect of weakening the financial
capability of hans so they were left with no resources to rebel. Many hans sank deeply into
debt and eventually defaulted on their obligations—except those which succeeded in reform-
ing their financial structure, promoting local trade and industry, and producing sufficient
revenues. Tokugawa Ieyasu and his posterity were clever enough to devise these stifling
methods. Absolute power over the fate and size of hans, along with huge and unpredictable
expenses imposed on them, kept each daimyo at bay. This must have been considered neces-
sary to end the warring period, which had lasted for a few centuries, once and for all.

Agriculture
The Edo society was agrarian, particularly at the beginning, with about 90 percent of the
population being peasants although this ratio subsequently declined a little. The basic unit
of production was the small family. Previously, one farming household often contained
dozens of people including many families and their servants. But a series of official land
surveys and peasant registration (kenchi) conducted before and after the beginning of the
Edo period dismantled the big family system into small farming units, with each family
guaranteed (and obliged to cultivate) its portion of the farmland.
According to the law, peasants had no right to move and were tied to the land as a labor
force and a tax base. But in reality, some farmers moved to new land, sometimes to avoid
a high tax burden or unreasonable policies and sometimes to simply improve their life.
Later, as rural income rose, many well-to-do farmers enjoyed village festivals and theaters
as well as trips to Ise Shrine, climbing Mount Fuji and travelling to other religious sites—
officially for worship, but actually for fun. Traditionally, peasants in the Edo period were
often described as hungry, repressed and vexed by high taxes, corrupt and greedy offi-
cials, and famines and other natural disasters. However, recent studies find them relatively
wealthy by the standard of agriculture in latecomer countries. This was particularly true in
Western Japan and toward the end of the Edo period.
Tanaka Keiichi (2000), an Edo historian, argues that farmers were very dynamic and
independent, and they often rejected Bakufu or han officials who tried to introduce inconsist-
ent or unreasonable policies. According to Tanaka, the Bakufu generally had no long-term
policy vision; most of their laws and regulations were ad hoc responses to ongoing historical
changes that could not be stopped. The Regulation of Keian, first promulgated in 1649 and
reissued throughout the Edo period, is the case in point. The Regulation was a collection of
prohibitions on farmers—don’t smoke tobacco, don’t buy sake or tea, divorce a wife who
likes to travel for fun and so on. This document should not be viewed as evidence on how
strictly the government constrained peasant life but as a hollow depiction of ideal farmers
that no longer existed and the Bakufu had no power to restore.
The agricultural sector grew in two phases: quantitative expansion first, then qualitative
intensification (Figure 2.1). From the mid-fifteenth century to the late seventeenth century,
which includes the previous Sengoku period and the early Edo period, there was an enor-
mous expansion of cultivated land (especially rice paddies). Earlier, rice was produced in
narrow valleys where mountains ended and plains began, because this was the only place
where constant water supply was available. But during this period, large-scale water manage-
ment projects were carried out all over Japan by daimyos and influential farmers to control
floods and use rivers for irrigation. As a result, land under cultivation expanded dramatically.

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 T he E do S ociety

Figure 2.1 Population and rice production (1600 = 100)

Source: Hayami and Miyamoto, eds, 1988, p. 44.

The plains, which had hitherto been uninhabitable marshlands, were turned into productive
paddy fields. The population increased rapidly in a way rarely seen in a pre-modern society.
Oishi Shinzaburo (1977) calls this “The Great Age of Opening Fields.”
By the late seventeenth century, land expansion came to a halt. The rapid growth of
farmland in the previous period also brought some negative effects including labor short-
age, deforestation, and frequent occurrence of floods. From this period onward up to today,
Japanese agriculture has emphasized intensive cultivation with large inputs of labor, fertilizer
and technology rather than the quantitative expansion of arable land.
From the eighteenth century onward, the area of cultivation and population remained rela-
tively stable, but rice output continued to grow thanks to increased productivity. Contributing
factors included double cropping, new species of rice, organic fertilizer (dried fish was
especially popular), and the introduction of new farming tools. Many guidebooks were pub-
lished to teach farmers how to produce crops more effectively. Miyazaki Yasusada’s Nogyo
Zensho (Encyclopedia of Agriculture) in eleven volumes, published in 1697 and reprinted
many times subsequently, was one of them. Okura Nagatsune and Sato Nobuhiro are the
other two agriculturalists who published 79 volumes and over 300 volumes, respectively, of
farming guidebooks.
At the beginning of the Edo period, peasants cultivated mainly for family consumption.
They ate what they produced and their living standards were at a subsistence level. From
the middle Edo period, because land productivity rose and agricultural surplus was created,
peasants began to sell their rice and other crops to the market which was often nationally
integrated (see below). Cash crop production increased and commercial farming began. Some
farmers, especially near Osaka, specialized in cash crops and purchased rice for consumption.
In many developing countries today, transformation from subsistence to commercial farming
is a common policy target. Japan in the late Edo period had already achieved it.
Villages were well organized and permitted autonomy as long as they paid rice taxes as
stipulated by the central or local government.3 The rice tax was levied on villages, not on

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individual farmers. Village leaders, who were often themselves farmers, allocated the rice
tax burden among villagers. In this sense, village leaders played the role of the lowest-level
tax administration. Thanks to them, the Bakufu and hans could raise tax revenues with little
administrative cost.
However, everything was not rosy. Farmers’ uprisings frequently occurred during the Edo
period, especially at the time of famine and toward the end of the Edo period. Rebellious
farmers were unhappy with taxes, inflation, famine, corrupt officials or government policies.
Uprisings were not impulsive or random. Strategies were discussed within the village or
among participating villages, objectives were set, leaders were appointed and proper proce-
dure and discipline were followed. Physical assets were targeted for destruction but no harm
was done to humans. Farmers’ uprisings in the Edo period were not uncontrolled phenomena;
they were highly organized.
Officially, all farmers belonged to (were tied to) assigned land as recorded in the kenchi
registration book. By the nineteenth century, however, the income gap between rich and
poor farmers emerged, the number of landless farmers increased, and large landowners
began to hire tenant farmers to cultivate their land. Small-holder family farming, which was
the production and tax base of the Edo economy, started to disintegrate.

Budget and money

The Bakufu’s revenues included the following:

•• rice tax from the land directly owned by the Bakufu (areas not distributed to other
daimyos);
•• monopoly on mining, foreign trade and minting money;
•• direct control on major cities (Edo, Kyoto, Osaka, Nagasaki, Sakai, etc.);
•• financial contributions from merchants in exchange for monopoly and cartel rights.

In addition, as noted above, the Bakufu freely ordered hans to various public works, elim-
inating the need to have their own public investment budget. On the other hand, the hans’
revenue consisted of the rice tax from their territory and the revenues from promoting local
industries (if this is successful).
The entire fiscal system was based on the rice tax. The fiscal unit of account was the
“koku” (volume unit, about 180 liters of rice). The han’s economic size (and its prestige)
was measured in koku and samurai salaries were also paid in rice—but of course rice salary
had to be cashed before buying things. Rice tax was collected by each village and physi-
cally transported to major rice markets, then redistributed to the rest of the country. The
Bakufu and han rice revenues were also cashed in those markets. Osaka was by far the most
important national rice market.
This rice-based economic system had the following consequences and developments:

1 Since rice had to be physically shipped across regions, this tax system required a nation-
ally unified transportation and distribution mechanism. Private merchants provided the
required services but the Bakufu and han governments often regulated and supported them.
As land transportation (by horse) was very costly and inefficient, water transportation on
the sea, river and lake was mainly used.

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 T he E do S ociety

2 The center of economic activity gradually shifted from subsistence farming to commercial
agriculture, then to handicraft industries. But the government’s tax base basically remained
on rice. There were occasional attempts to levy on commerce but this did not become a
reliable tax base. Non-rice production expanded while rice became an increasingly small
part of the national economy. As time went by, the Bakufu and han governments faced
fiscal crises while farmers and merchants enjoyed increasing income and wealth.
3 Faced with chronic fiscal deficits, the Bakufu repeatedly resorted to the following
measures: (i) monetary debasement (similar to printing money, which led to inflation),
(ii) spending cuts, (iii) tax increases and ad hoc levies, (iv) price controls and admin-
istrative reforms. Some commercial policies were tried such as forcing designated
merchants to form cartels with exclusive marketing rights in exchange for additional
financial contribution. However, such monopoly creation was often reversed and the
Bakufu soon reverted to free entry policy. These measures cannot be considered a set
of consistent policies backed by a long-term vision.

Money consisted of both gold and silver (see Figure 2.2). Gold was popular in Edo (Eastern
Japan) and silver was mainly used in Osaka (Western Japan). Copper coins were also used
for small transactions. Hans were allowed to issue paper money which could be circulated
in the han’s domain. But when local paper money was issued excessively, or when the han’s
finance was broke, there was no taker for such paper money. Inflation rose at the time of
famine and accelerated towards the end of the Edo period, especially after international trade
was resumed in 1859.

400

300

200
180
160
Price level measured in gold
140
120
100
90
80
70 Price level measured in silver
60

1720 30 40 50 60 70 80 90 1800 10 20 30 40 50 60

Figure 2.2 General price level (1840–1844 = 100)

Source: Shimbo and Saito, eds, 1989, p. 71.
Note: The general price index in Kyoto and Osaka, five-year moving average, semi-log scale.

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 T he E do S ociety

Transportation and commerce

The Bakufu designated five official highways and opened major sea lanes. They covered
the entire nation from North to South and East to West, but no international routes were
permitted. The private sector provided necessary travel services such as inns, restaurants, tea
houses, shippers, baggage carriers, etc. As part of non-tax obligation, farming villages near
official highways were required to provide horses at the time of heavy travel needs. Sankin
kotai (daimyos’ alternative residence between Edo and their hans) increased travel spending
and further stimulated the development of the road system. At the same time, out of mili-
tary concern, the Bakufu did not permit the free movement of people and merchandise. At
strategic points, sekisho (passport controls) were created. Some rivers were intentionally left
without bridges, to block the march of a potential enemy to Edo. Hans were not allowed to
build large military ships or maintain navies.
As noted above, from the very beginning, the Edo tax system presupposed a nationally
unified rice market. The development of cash crops and handicrafts further accelerated
nationwide commerce. Osaka was the commercial center with a large number of wealthy
merchants and money changers and lenders, while Edo was the political center as well as a
large consumption city. Naturally, the sea lane between the two cities was well developed.
In Osaka, even the futures market in rice was established in 1730. This is said to be the first
futures market in the world.
Active commerce produced gosho, or rich merchant families, such as Yodoya, Konoike,
Onogumi, Tennojiya, Hiranoya, Shimadagumi and Kajimaya. Some even survived the polit-
ical change from Edo to Meiji to become Japan’s leading business groups. The two merchant
families of the Edo period that survived and lead the Japanese economy even today are the
Mitsui group, initially engaged in kimono trade and money changing, and the Sumitomo
group, which specialized in copper mining and smeltering.
The fact that indigenous business groups emerged in the Edo period to later form zaibatsu,
playing key roles in absorbing Western technology, import substitution and competition
with foreign enterprises, was remarkable. In the history of latecomer industrialization, not
so many countries could withstand the powerful presence of foreign competitors and build
their national industries. Another important fact was that business entries and exits were very
frequent in the late Edo to the early Meiji period under the impacts of international trade,
shifting demand and relative prices, new technology and institutions, political change and
issuance of many new policies. No business groups could overcome these difficulties with-
out effective internal reform and creation of solid linkage with newly emerging commercial
activities. Using a series of unofficial ranking of wealthy merchants, Miyamoto (1999) finds
that the survival ratio of the top 231 merchants from 1849 to 1864 was 44 percent. The ratio
falls further to 15 percent by 1888 and a mere 9 percent by 1902. From this perspective,
Mitsui and Sumitomo are the exceptions rather than the rule. Most gosho declined or disap-
peared within decades. In a rapidly changing economy with fierce competition, it is hard to
stay profitable for a long time.
As with agriculture, the Bakufu’s policy towards commerce and industry was ineffective
and incoherent. Its physiocratic ideology and insistence on the rice economy prevented it
from turning to new tax bases in emerging agro-processing, commerce, finance and man-
ufacturing. In response to fiscal crisis, the Bakufu resorted to austerity, squeezing farmers,
imposing arbitrary contributions on daimyos and rich merchants, monetary debasement and
price control. Occasionally the idea of vitalizing the private sector through deregulation or

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industrial promotion surfaced, but it was always crushed by so-called reforms that tightened
economic austerity and regulation even more.
At times the Bakufu controlled and taxed private businesses, while at other times free mar-
ket was encouraged. Cartels were sometimes imposed and other times prohibited. Economic
historians still debate whether the Edo economy was more dynamic under the free market
policy than under the pro-cartel policy. According to Miyamoto and others (1995), the sound
development of the market economy depends on a number of institutions and customs to
facilitate transactions such as the bill of exchange and provision of credit. From this perspec-
tive, the authors defend the cartels in the Edo period as a private mechanism to generate such
services. From the viewpoint of historical institutional analysis, Okazaki Tetsuji (1999) also
tries to show that estimated GDP grew faster during the time when cartels were permitted
than when they were banned. He argues that trade cartels were a positive factor for the devel-
opment of the Edo economy rather than an impediment. However, the available data and his
regressions may be too crude to draw a strong conclusion.
Based on Miyamoto and Uemura (1988), Figure 2.3 illustrates national transaction pat-
terns of the late Edo period. In the early Edo period, which is not shown, Osaka was the

Local Local Local

Han Han
market market market

Greater Osaka Greater Edo

Handicraft and Economic Area
Manufacturing
Area

Osaka Edo
Han (Central (Central Han
market) market)

Local Local Local

Han Han
market market market

Flow of agricultural Flow of handicraft and

Flow of Bakufu money
products including rice manufactured goods

Figure 2.3 Inter-regional economic linkage in the late Edo period

Source: Miyamoto and Uemura, 1988, p. 285.

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 T he E do S ociety

center of production and commercial activities. Edo, the large consumption market, and all
hans traded bilaterally with Osaka while transactions among hans were limited. In the late
Edo period, the production capacity of the area surrounding Edo, regional cities and han
economies grew. As a result, local markets and direct trade among hans emerged without
the intervention of Osaka merchants. In addition to rice, a large number of agricultural and
manufactured products were traded in nationally and regionally integrated markets. The
center of economic activity gradually shifted eastward, from Kansai (Osaka and Kyoto) to
Edo and Eastern Japan. The relative weight of Osaka in the national economy decreased.

Industrial promotion
As agriculture and commerce grew, pre-modern manufacturing such as handicrafts and food
processing also began to develop. Each region created specialized products that were mar-
keted all over Japan. For example, tea, tobacco, wax, indigo, salt, knives, sword, pottery,
lacquer ware, silk, cotton, soy sauce, sake, paper, cut stone, medicine and chemicals were
traded widely. Emergence of these regional specialties was mainly the result of private effort,
but in some cases the support of local governments also made a difference.
In order to enrich the local population and increase the tax revenue, many hans pro-
moted local industries, and some even succeeded (Nishikawa and Amano, 1989). Here are
some examples:

•• Yonezawa Han (adding value to local inputs)—When Uesugi Yozan (1751–1822)

became the daimyo of Yonezawa Han in Northeast Japan, the han finance was bankrupt
and samurai and farmers were destitute. Retainers even considered closing the han and
returning it to the Bakufu. Yozan introduced austerity measures, encouraged research
and learning, and promoted industries. He repelled the conservative faction who opposed
his reform. He opened new farmland and installed irrigation. His main strategy was to
add value to local materials instead of selling them in raw form. Aoso, a plant material
for high-quality textile, was transformed into finished kimono by importing weaving
technology. Mulberry plantation was encouraged for producing silk kimono. Lacquer
trees were planted to manufacture lacquer ware and wax. Safflowers were introduced to
produce orange dye. Thanks to Yozan’s reform, the economic situation improved and
Yonezawa Han was able to repay all the debt.
•• Tokushima Han (indigo)—Farmers produced indigo along the Yoshino River in Shikoku
Island and their output gradually grew. But indigo distribution was monopolized by
Osaka merchants who imposed high interests on loans. In order to protect local farmers
and encourage local merchants, Tokushima Han created an indigo exchange and pro-
vided financial and distribution services. The Bakufu objected to this move, prohibiting
official bodies to engage in such activity. In reality, the Bakufu wanted to protect Osaka
merchants who contributed financially to its coffer. In response, the han privatized the
indigo exchange and other services.
•• Takamatsu Han (sugar)—This local government, also in Shikoku, issued local paper
money to promote various industries but its attempts generally failed, and its money
depreciated. After many failures, the han finally succeeded in pilot production of sugar
from sugar beet and commercializing the technology. As sugar production greatly
increased, the han encouraged inter-han trade to expand the market. But again, the
Bakufu intervened to discourage such trade not brokered by Osaka merchants.

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 T he E do S ociety

•• Satsuma Han (trade gains for military buildup)—Satsuma Han in southern Kyushu was
also broke with huge debts in the early nineteenth century. Zusho Hirosato (1776–1849),
Satsuma’s high official, adopted austerity and implemented administrative and agricul-
tural reforms. He intimidated merchant lenders into rescheduling Satsuma’s debt for
250 years with no interest, which was practically cancellation. He started han monopoly
of sugar trade with southern islands as well as illegal trade with China via Okinawa, both
of which were very profitable. After international trade was resumed in 1859, Satsuma
Han vigorously traded with China and the West, and purchased new technology includ-
ing blast furnaces, cannons, western ships and the latest guns. By building wealth and
military capability, Satsuma Han later played the leading role in toppling the Bakufu and
establishing the Meiji government.

Other hans were also successfully engaged in industrial promotion of one kind or another
including Choshu Han (paper, wax), Akita Han (silk and silk dress), Hizen Han (pottery,
coal) and Higo Han (lumber, silk). In the late Edo period there was dynamic competition
among hans to supply nationally marketable products that was either privately driven or pol-
icy triggered. Industrial promotion combined with fiscal reform was the key to the survival
of impoverished hans. But we should not forget that there were also many hans that were
less innovative and fell deeply into economic difficulty and debt. These hans borrowed large
sums of money from private merchants that they never repaid.
Thus, at the local level, some hans produced economic leaders who solved the domain’s
fiscal crisis, promoted local industries and actively engaged in domestic (and later inter-
national) trade. This is in sharp contrast to the central government which was throughout
unable to propose any policy to support and tax the growing national economy. Japan at the
end of the Edo period was ripe for a new set of economic visions and policies that were more
proactive than those put down by the Bakufu leaders.

Education
The popularity of education in the Edo period is often cited as the cause of fast industriali-
zation in the later periods. Education in the Edo period ranged from the recondite study of
ancient Chinese philosophy and literature at government schools to children’s basic educa-
tion at private schools. Education fever was not just in such large cities as Edo, Osaka and
Kyoto but also a nationwide phenomenon. Here, the four main types of learning institutions
are introduced.

1 Bakufu schools—Bakufu schools mainly taught Confucianism, an ancient Chinese

philosophy started by Confucius in the sixth to fifth century bc. It emphasized social
order, proper rituals, the way of good political leadership and respect for the elderly
and superiors. The Edo government vigorously promoted Confucianism as an ideol-
ogy to legitimize and maintain the class society. Fujiwara Seika (1561–1619), Hayashi
Razan (1583–1657) and Arai Hakuseki (1657–1725) were the leading Bakufu schol-
ars. Students had to memorize and interpret ancient Chinese books. How to modify
this foreign doctrine to fit the Japanese reality was one of the important theoretical
questions. Toward the end of the Edo period, the Bakufu also established schools
for Western language (Dutch) and Western technology in medicine, navigation and
military technology.

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 T he E do S ociety

2 Han schools—Hans also established schools to educate their young samurai. Some
even accepted non-samurai students. The curriculums were basically the same as those
of Bakufu schools with Confucianism at the center of learning. Later, as with Bakufu
schools, progressive han schools adjusted curriculums to teach more practical skills
such as military training and foreign language. At the end of the Edo period, there
were approximately 300 hans and 230 han schools, which means about three quarters
of hans were equipped with han schools. Many han schools were transformed into new
educational institutions in the Meiji period.
3 Private professional schools—Eminent scholars often set up their own private schools
and recruited students. Depending on the instructor, various subjects were taught:
Confucianism, kokugaku (research on ancient Japanese literature that later influ-
enced nationalism and anti-foreigner movement), Western languages (Dutch, later
also English), medicine, science and technology, and so on. These schools normally
accepted both samurai and non-samurai students. In the late Edo period, after the ports
were open to the world, they attracted talented and passionate young people with the
desire to contribute to the country. Their eyes were opened to the international situation
and Japan’s precarious position in it. A large number of national leaders in the late Edo
period and the early Meiji period came from these schools. The most renowned among
such incubator schools are listed in Table 2.2.
4 Terakoya (private elementary schools)—These schools were run by self-appointed teachers
to teach the 3Rs (reading, writing, and arithmetic which meant abacus) to small children.

Table 2.2 Examples of private professional schools (late Edo period)

School and Teacher and year Main teaching Prominent students

location of establishment

Kangien Hirose Tanso Confucianism and Takano Choei (Western studies)

(Hita, Bungo 1817 ancient Chinese Omura Masujiro (military reformer)
Han) literature
Narutaki Philipp F. B. Western medicine Takano Choei (Western scholar)
Juku von Siebolt Ito Genboku (medical doctor)
(Nagasaki) (German) Ito Keisuke (medical doctor and botanist)
1824
Teki Juku Ogata Koan Dutch language Fukuzawa Yukichi (founder of Keio
(Osaka) 1838 and Western Univ.) Omura Masujiro (military
medicine reformer) Hashimoto Sanai (Western
studies) Otori Keisuke (Bakufu &
Meiji statesman)
Zoyama Sakuma Shozan Western studies Yoshida Shoin (Shokason Juku teacher)
Shoin 1835 and military Katsu Kaishu (Bakufu official)
(Edo) technology Yamamoto Kakuma (politician)
Shokason Yoshida Shoin Social and political Takasugi Shinsaku (anti-Bakufu fighter)
Juku 1855 (until 1857) philosophy Kusaka Genzui (anti-Bakufu fighter)
(Hagi, Ito Hirobumi (prime minister)
Choshu Yamagata Aritomo (prime minister)
Han)
Keio Gijuku Fukuzawa First Dutch, later Obata Tokujiro (politician and thinker)
(Edo/Tokyo) Yukichi English and Yano Fumio (official and scholar)
Later, (1858, renamed Western political Nakamigawa Hikojiro (official and
university 1868) economy business leader) and many others

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 T he E do S ociety

Initially, terakoya was a charity organization but later evolved into a profit-seeking entity
charging tuition fees. Normally one teacher taught a few dozen children who received indi-
vidual assignments. There was no rigid regulation or guideline on schooling age, but most
children entered terakoya at the age of seven or eight and stayed until the age of twelve or
thirteen. Standard daily curriculum included brush letter writing in the morning and arith-
metic and moral studies in the afternoon. There were monthly and year-end exams as well
as letter writing exhibitions. Children’s education was not compulsory and the Bakufu and
han governments neither intervened nor promoted it. As the general public realized the
importance of studying letters and arithmetic, a large number of terakoya were established
from urban to rural areas contributing to the high literacy among the population.

After the Bakufu fell, the Meiji government took education into the public realm and intro-
duced the national school system. In the eighth year of Meiji (1875), there were about 24,000
elementary schools in Japan, the vast majority of which had been converted from terakoya.
This suggests the rough number of terakoya that existed in the late Edo period. In the same
year (1875), primary education enrollment was 50.5 percent for boys and 18.6 percent for girls.

Box 2.1 Proto-industrialization and population dynamics

Economic historians have noted that certain areas of Europe, such as Flanders in
Belgium and Lancashire in England, were “industrialized” in the seventeenth and
eighteenth centuries even before the Industrial Revolution took off in the United
Kingdom. This industrialization was characterized by rural, family-based produc-
tion of textiles and garments without modern machinery and was often brokered by
urban merchants.
The concept of proto-industrialization was proposed to explain why this happened,
and why it was observed in certain areas only (proto means primitive or early). The
proponents have advanced a hypothesis to explain rural industrialization from the
unique interaction among agriculture, population and commerce. Population growth
is often regarded as given in economic modeling. But in the hypothesis of proto-
industrialization, population dynamics is a crucial endogenous element. F.F. Mendels
and P. Deyon, who proposed this idea, define proto-industrialization as a phenomenon
satisfying the following three conditions:

•• it is a manufacturing activity for market sales, not for home consumption;

•• it is undertaken by peasants in a rural area where soil quality is poor and plots are
small;
•• it is located near an area of commercial agriculture with large farm size and high
productivity.

Proto-industrialization begins as a side job in villages where agricultural productivity

is low. They can sell cloth and garments to nearby rich villages where agricultural
productivity is high. It is a sort of specialization (division of labor) within a relatively
small geographical area: villages with fertile soil produce farm products and villages
with poor soil produce manufactured goods, and they exchange output with each other.
They sometimes also sell their products to larger markets.

33
 T he E do S ociety

Furthermore, the hypothesis of proto-industrialization assumes certain demographic

dynamics in the following sequence:

(1) For some reason, villages with poor soil face a population increase, leading to
food shortages.
(2) Poor peasants engage in the production of garments for sale to relieve the
population pressure.
(3) This increases their income, which prompts them to get married sooner and have
more children.
(4) Population growth continues to keep the peasants just as poor as before, even
though they are more “industrialized.”
(5) The supply of cheap labor is thus increased, and rich farming villages and urban
merchants continue to accumulate wealth. (This widening income gap may pos-
sibly generate capitalists and landless farmers leading to industrialization under
full-fledged capitalism in the Marxian sense. However, this historical linkage is
not convincingly proven empirically.)

According to Saito Osamu (1985), the Japanese data in the Edo period does not support
the hypothesis of proto-industrialization. There is no evidence of systematic popula-
tion increase in the areas where peasants engaged in pre-modern manufacturing. On
the contrary, it is observed that Edo period farmers practiced birth control, sometimes
even killing new-born babies, to manage the population pressure.
Proto-industrialization assumes a rather peculiar population dynamics that may
be applicable to certain European regions in certain periods, but not in the rest of the
world or at other times. Also, there is no evidence that it was linked with or stimulated
the Industrial Revolution that occurred later. However, the idea of population growth
responding to the process of pre-modern early industrialization is an interesting one. In
our age, people’s life style including urban migration, the timing of marriage and the
number of children to be had is clearly influenced by the income level of each person
and the economic situation of the nation.

Notes
1 Historically, Vietnam also had the distinction of Si-Nong-Cong-Thuong (the Chinese characters are
the same, only the pronunciation is different). The idea originally came from Confucius in ancient
China, but the top ranking “Si” in Vietnam meant scholars, not fighting men. Moreover, in China
and Vietnam, the four-way classification merely indicated what type of people were respectable in
society and had no political implications. The Edo government turned this idea into an ideology that
legitimized a class society with samurai on top.
2 This land-based leader–follower relationship is called feudalism as explained in the text. But feudal-
ism had another, more colloquial and negative connotation for people, especially those in the Meiji
period, who looked back to the Edo period with critical eyes. For them, feudal is an adjective that
goes with anything rigid, inhumane and suppressive.
3 Each han separately decided the rice tax rate and the way to collect it. Similarly, the Bakufu levied rice
taxes from the areas directly ruled by it. Rice tax revenue thus belonged to each collecting government.

34
3
T R AN SITION F ROM EDO TO M EI J I

The opening of ports and the fall of the Bakufu

After the establishment of the Edo government in the early seventeenth century, foreign
travel and trade were restricted in steps. From 1639, the Bakufu banned any foreign contact
except highly regulated trade at Nagasaki’s Dejima (tiny artificial island) under strict official
control. In other words, the Bakufu monopolized limited foreign trade. Only Chinese and
Dutch merchants were allowed to trade with Japan, while Korea and Ryukyu (Okinawa) had
diplomatic relations with Japan. Contact or transaction with all other nations was strictly
prohibited. No Japanese were allowed to go abroad or come home from abroad. Under this
isolation policy, the only channel for absorbing Western knowledge, mainly medical and
scientific information, was through Dutch books and products. This situation lasted for about
one-and-half centuries.
However, from the end of the eighteenth century, Western ships began to approach Japan
with an intention to use Japanese ports and even to resume trade. The Russians and the
British were particularly eager but the Bakufu refused to even talk to them. Meanwhile, the
news of the Opium War (1840–1942), in which Britain defeated China, took possession of
Hong Kong and forced China to open its ports, arrived. This was a big shock to the Bakufu.
Ultimately, in 1853, four American military ships (“Black Ships”) led by Commodore
Matthew C. Perry entered Edo Bay. The Bakufu was forewarned about their coming but
could do little to counter it. This was a well-planned US mission for which a negotiating
strategy with Japan had been carefully designed. Perry was convinced that the show of
force, not peaceful diplomacy, was most effective in producing results with the Japanese.
Firing powerful cannons, Perry demanded a “friendship” treaty that allowed American
ships to use Japanese ports for refueling and restocking water and food. The Americans
left, saying that they would return in the following year to hear the answer.1 The entirety
of Japan was thrown into chaos and a fierce debate began as to whether Japan should yield
to the American demand and open its ports or repel foreigners. When Perry and his troops
returned to Edo Bay in the next year, the Bakufu agreed to sign the friendship treaty with
the United States and opened Shimoda Port and Hakodate Port for foreign ships. Similar
treaties were immediately concluded with the Europeans.
The next demand from the US was the conclusion of a full bilateral commercial treaty. In
1858, the Bakufu asked for imperial permission to sign commercial treaties with the major
powers. This was supposed to be a mere formality but Emperor Komei refused to grant
permission. The Bakufu signed the treaties anyway without imperial approval. Politically,
it would have been more advisable to hear out the views of various domestic groups,

35
 T ransition from E do to M eiji

especially influential daimyos, before making such an important national decision—and

actually, free opinions were collected at first—but new Tairo (highest Bakufu official)
Ii Naosuke turned to a more despotic method. In 1859, as ports were opened for international
trade, he suppressed all dissenting voices, jailed his opponents and even executed many of
them. Naturally, this policy was severely criticized and increased anger and violence. Ii was
assassinated in the following year, in 1860, by samurai infuriated by his disregard of the
emperor and submission to foreign pressure.
With the conclusion of the friendship and commercial treaties, foreign diplomats and
merchants began to settle in Japan. However, they were permitted to stay only in designated
foreign settlements and travel only in the vicinities. Free contact or trade with the Japanese
public was prohibited. The largest foreign settlement was Yokohama, a small fishing village
turned into a modern port city for the purpose of fulfilling the treaty obligations.
The opening of Japanese ports led to significant social and economic changes.

1 Foreigners brought new ideas, technology and systems which the Japanese began to
absorb very rapidly. At the same time, the Japanese were also afraid of the superior
military power of the West.
2 Silk and tea suddenly found huge overseas markets. Many villages turned to their
production. The rising output and soaring prices of these commodities enriched rural
farmers who produced them.2
3 Enriched farmers began to buy imported clothes from England instead of wearing
homemade or secondhand clothes. This profligacy even worried high officials of the
government.
4 A new merchant class, called Yokohama merchants, emerged to link Japanese producers
and markets with foreign merchants. As noted above, foreigners were not permitted to
travel outside the foreign settlement and thus needed the help of Japanese merchants
to penetrate the market.
5 As inflation surged, samurai and the urban population were impoverished. The relative
price structure was transformed after the opening of ports. Old industries and merchants
declined and new ones emerged.

The commercial treaties that the Bakufu signed with the West were unequal in the sense
that (i) Japan had no right to decide its own import duties; and (ii) the Japanese court was
not allowed to judge foreign criminals in Japan. In 1866, Japanese import duties were set
uniformly at 5 percent, and this situation lasted until 1899 when the tariff rights were par-
tially regained (the full restoration of tariff rights took nearly half a century, until 1911).
Inability to indict foreign criminals was considered to be a great national humiliation.
The opposition blamed the Bakufu for signing defective treaties. They also criticized
the Bakufu for economic change and inflation, in addition to yielding to foreign pres-
sure without national consensus or imperial approval. However, it should be noted that
no “undeveloped” non-Western countries in the late nineteenth century, including China,
were allowed to have equal relations with the West. The Bakufu did not stand a chance of
getting equality with the West, given the military and economic backwardness of Japan at
that time. In this humiliation and frustration, creation of a first-class society on a par with
the West became a national obsession, not only for regaining pride but also for revising the
unequal treaties.

36
 T ransition from E do to M eiji

The flexible structure of transition politics

After the opening of ports, severe political fights ensued for about fifteen years. To sum-
marize the highly complicated developments, events unfolded over the two key issues of
(i) promotion of open door policy versus anti-foreigner nationalism, and (ii) upholding the
emperor versus supporting the Bakufu. Anti-foreigner radicalism was very strong and prev-
alent at first, but wise daimyos and samurai gradually realized the impossibility of repelling
the foreigners as the West was too modern and powerful. Satsuma and Choshu, the two most
powerful hans, learned this lesson in a hard way by actually exchanging fire with Western
gunships. The political fight gradually shifted to the question of who would end the power
monopoly of the Bakufu and establish a new government to cope with the external crisis.
Japanese political process in the late Edo period to the early Meiji period exhibited a flex-
ible structure that was very unique in latecomer countries that faced the pressure of global
integration (Banno and Ohno 2010ab). The years from 1858 (signing of the commercial
treaties) to the early 1880s was a period in which Japan had to reorganize politics, redefine
national goals and decide on concrete plans to achieve these goals. Despite the exiting of the
Bakufu as a political loser in 1867–68, the dynamism of transition politics did not change very
much. The Meiji Revolution was achieved through flexible politics, in which flexibility was
seen in (i) the pursuit of multiple and evolving goals; (ii) constant regrouping of leaders and
(iii) flexibility of leading groups themselves. Politics was a complex process with many lead-
ers, many phase shifts and changing priorities, far from the image of a solid authoritarian state
under one charismatic leader that single-mindedly pursued industrialization while suppress-
ing democracy. In reality, Meiji Japan was quite different from the typical developmental
states of East Asia in the post-WW2 era such as Korea, Taiwan and Singapore.
National goals continued to evolve. Initially, the political goal of kogi yoron (government
by public deliberation) was intended to replace the Bakufu’s despotic rule. It evolved from a
simple proposal of alliance among four or five influential hans into the idea of a conference
of all 300 hans and even the creation of a bicameral system. As it turned out, this plan which
intended peaceful political reform was interrupted by the Boshin War of 1868–69. The mili-
tary showdown was ignited by the refusal of the Bakufu to be downgraded to a minor power
in the proposed political scheme. In early Meiji, Kido, Fukuzawa as well as former samurai
of Tosa Han upgraded the feudal assembly model to the idea of creating a Western style
constitution and parliament. They were then split into those promoting a British style parlia-
mentary system and those advocating a German style constitutional monarchy. Regardless
of particular form or style proposed, the installation of a government by public deliberation
of one sort or another was a political requirement for legitimizing the Meiji Revolution and
the new government established by it.
On the other hand, fukoku kyohei (enriching economy, strengthening military) in the late
Edo period was the idea that each han should set up a trading house, collect products from
all over Japan for export, purchase guns and military ships from the West with the proceeds
and bolster the han’s military capability to ultimately emerge as a winner in the political
transition. In reality, the hans that could do this effectively—Satsuma and Choshu, and to
some extent Tosa also—became the main powers to topple the Bakufu and occupy central
places in the new government. Under the new government, fukoku was transformed from
the mercantilist idea of trading local products for profit to the notion of industrialization,
i.e., building factories equipped with modern machinery to raise domestic production. As to
kyohei, the armies of the strong hans that had achieved the revolution, but had nothing more

37
 T ransition from E do to M eiji

to do in the Meiji period, began to demand foreign campaigns. Because of this, fukoku and
kyohei, which were initially integrated, became two separate goals—industrialization versus
military expansion—that competed for the same budgetary resource.
Another aspect of flexible politics was the constant regrouping of leaders. Each national
goal stated above had its champions. Industrialization was guided by Okubo Toshimichi
(1830–78), foreign expedition was backed by Saigo Takamori (1827–77), a parliamen-
tary system was strongly proposed by Itagaki Taisuke (1837–1919) and the drafting of a
(German style) constitution was planned by Kido Takayoshi (1833–77)—and supporters
gathered around these leaders. However, no one group could yield sufficient power to carry
out desired policies, and could pursue them only by forming a coalition with one or two
other groups. Dominance of one group invited intervention from other groups, and the defeat
of another group was compensated by the assistance from others. This continuous political
rebalancing hardly resulted in permanent grudges or vengeance against each other. Even
before the Bakufu fell, hans were practicing such flexible diplomacy. This process, which
from outside looked like endless political fights, was surprisingly successful in avoiding
chaos and achieving multiple national goals in the long run.
Moreover, leaders themselves were variable and multifaceted. Initially, virtually every
han was split between open trade and anti-foreigner movement, and between allegiance to
the emperor and to the Bakufu. But in hans that ultimately emerged as winners, all retain-
ers followed the han’s official line once it was set. The policies of Satsuma and Choshu
oscillated between anti-foreigner and pro-foreigner stance, but both chose the open trade,
pro-emperor stance at the end. Even though the two hans fought previously and hated each
other, they decided to join military forces to end the Bakufu’s rule. The amazing thing was
that these policy swings were made by the same leaders changing their minds rather than one
faction driving out another within the han. Such flexibility in leadership is hardly observed
in internal wars anywhere else, then or now. Two sides are usually ensconced in uncompro-
mising positions and do not stop fighting unless one side annihilates the other.

The Meiji government and its goals

As a result of relatively minor battles between the emperor side and the Bakufu supporters
in 1868–69 (one of the fiercest battles was fought in Edo where Ueno Park now stands), the
Bakufu was defeated and the new Meiji government was established in 1868. The emperor
moved from Kyoto to Edo, which was renamed Tokyo (meaning eastern capital).
The Meiji government was run by former young samurai from strong hans in Western
Japan (especially Satsuma, Choshu, Tosa and Hizen3) and a few influential noblemen. The
young emperor, fifteen years old at the time of the Meiji Revolution, was elevated to the
head of state for legitimacy and as a unifying symbol of the new regime. The Meiji govern-
ment had a very clear policy objective of promoting rapid Westernization and modernization
of Japan. At first, the most serious external challenge was to avoid colonization by the
West. But this fear subsided in the early Meiji period as Japan began to aggressively absorb
Western systems and technology under solid national unity and identity. Thereafter, the top
national priority was to catch up with the West in every aspect of civilization, i.e., to become
a “first-class nation,” as quickly as possible.
After a “long, peaceful sleep” (international isolation) imposed by the Bakufu, Japan
suddenly discovered that Europeans and Americans were far more advanced in technology
and industry while Japan was a backward agricultural country. This was a big shock to

38
 T ransition from E do to M eiji

the Japanese. The painful recognition of backwardness and shattered pride was the psy-
chological driving force behind Japan’s industrialization during the Meiji period. In order
to modernize Japan, the Meiji government had three clear goals: industrialization, political
reform (introducing a modern constitution and parliament) and external expansion through
military modernization. These were shared goals among all politicians, officials, academ-
ics, media and even the general public. As explained in the previous section, Meiji leaders
fought over prioritization and the concrete content of these three goals while accepting the
importance of all goals.
The biggest headache for the Meiji government in its early years was the resistance from
conservative groups who disliked radical reforms. The previous samurai class, now deprived
of their rice salary and the privilege of carrying swords, were particularly unhappy with the
new government which was established, ironically, by former young samurai. But step by
step, the new government succeeded in reducing their influence and consolidating power.
It abolished the samurai class and their rice salary, and offered them government bonds
as a compensation whose value rapidly depreciated under inflation. Local autonomy under
the han system with inherited daimyo rule was replaced by a centralized government and
prefectures whose governors were appointed by Tokyo. A new land tax at the initial rate of
3 percent of the assessed land value replaced the old rice tax that was levied on the annual
yield of rice.
In 1871–73, the Iwakura Mission, a large high-level official delegation headed by Iwakura
Tomomi (1825–83; equivalent to the Prime Minister), was dispatched to the US and Europe
for nearly two years. As they departed from Yokohama, the mission counted 107 members
including the Prime Minister, Minsters, officials, secretaries and the students sent abroad.
The main objectives of the Iwakura Mission were to (i) conduct preliminary negotiations
for revising the unequal treaties; and (ii) study Western technology and systems. They failed
miserably in the first objective because the West would not treat Japan equally as long as
its institutions remained “backward.” But the mission succeeded in gaining insights in their
second objective, which helped the new Japanese leaders to map out the future course. The
Mission was very warmly welcomed and widely reported wherever they went.

Industrialization
Among the members of the Iwakura Mission, Okubo Toshimichi was deeply impressed with
Western technology embodied in a large number of British factories he visited. Returning to
Japan, Okubo vigorously promoted industrialization as the Minister of Finance (later, as the
Minister of the Interior). His policies included hiring foreign advisors, hosting of domestic
industrial fairs, and the construction of roads, railroads and agricultural research centers.
Many state-owned model factories were established in military production, silk spinning,
shipbuilding and mining (most of them were rehabilitated mines from the Edo period).
New systems, such as metric weights and measures, the Western calendar, a new monetary
system, banking, and joint stock companies, were introduced. Okubo was assassinated in
1878 but his supporters, especially Kuroda Kiyotaka (1840–1900) and Okuma Shigenobu
(1838–1922), continued his policies.
The Meiji government sometimes confused businesses with inconsistent policies. But more
often, it strongly supported the emerging private sector in establishing domestic industries and
driving out foreign rivals. This policy was called yunyu boatsu (import substitution). With
official assistance, big businesses started to develop. Politically well-connected businessmen

39
 T ransition from E do to M eiji

were called seisho and their business groups were called zaibatsu. Some of them, for example
Sumitomo and Mitsui, dated back to the Edo period, but many others such as Mitsubishi,
Furukawa, Yasuda and Asano emerged in the Meiji period. Some big names included
the following:

Iwasaki Yataro (1835–85)—he was a businessman from Tosa Han who started a mari-
time transport company. Okubo’s government gave him support and monopoly so that
he could drive out foreign shipping firms. Iwasaki made a huge profit with an exclusive
contract with the government to provide military transport to Taiwan in 1874. Iwasaki
was the founder of the Mitsubishi Zaibatsu whose business empire expanded to include
banking, international trade, shipbuilding, coal mining and, later, virtually everything.
He was often criticized for his government connection.
Shibusawa Eiichi (1840–1931)—born in Saitama, he was first a Bakufu retainer serv-
ing the last shogun, then an energetic official at the Ministry of Finance of the new
government, and finally a super coordinator of Japanese industries. Shibusawa helped
to establish hundreds of joint stock companies such as Imperial Hotel, Nippon Usen,
Nippon Steel, Bank of Tokyo, Osaka Spinning and Sapporo Beer as well as business
and social organizations such as the Tokyo Chamber of Commerce, Imperial Theater,
Japan Women’s University and Central Charity Association. Unlike Iwasaki, he did not
form his own zaibatsu.
Godai Tomoatsu (1836–1885)—he was a business coordinator from Satsuma Han. Like
Shibusawa, he contributed to the creation of many companies and business organiza-
tions in Kansai area (Western Japan).
Mitsui Zaibatsu—Mitsui was a big merchant family in the Edo period. Its original busi-
ness was trade in kimono (Japanese dress) and money-changing. In Meiji, the Mitsui
family gained the status of a treasury depositary of the new government, which was very
profitable, and succeeded in internal organizational reform. Banking, coal mining and
international trade (“Mitsui Bussan”) became the main business areas.
Sumitomo Zaibatsu—the Sumitomo group operated Besshi Copper Mine in Shikoku
during the Edo period. The old copper mine was modernized in Meiji. The business
expanded to include coal mines, banking, electrical cables, fertilizer, etc.

Most of the state-owned enterprises (SOEs) were commercially unsuccessful, but they had
strong demonstration effects on emerging Japanese entrepreneurs. These factories also
trained a large number of Japanese engineers under Western supervisors using the latest
machines, who later migrated to other factories or established their own. These SOEs were
later privatized except military establishments. They were sold “cheaply” to business groups
such as Mitsubishi, Mitsui and Furukawa, triggering a political scandal in 1881. However,
it must be reminded that many of the previously loss-making SOEs were restored to profita-
bility through restructuring and additional investment by new private owners. It may be a bit
unfair to criticize them for stealing state assets.
The Meiji period saw the births of many business groups and enterprises that survived and
prospered into the current period. At the same time, and somewhat contradictorily, the ups and
downs of enterprises were extremely volatile from the late Edo to the Meiji period. Economic
shocks such as the beginning of international trade, demand shifts, foreign institutions and

40
 T ransition from E do to M eiji

technology, and changing relative prices led to the decline of old enterprises and the rise of
new ones. Even influential merchants and established producers in the past failed to survive
these shocks unless they undertook bold internal reforms or built linkage with the emerging
merchant class.
Figure 3.1 depicts the attrition of millionaires calculated from the nationwide data in
Miyamoto (1999), indicating how many of the biggest businesses managed to stay in the
millionaires’ list in the following periods. The new rich of the late Edo to early Meiji period
exited very quickly. The speed of disappearance seems even faster for the millionaires that
emerged in the later periods. Among the 231 millionaires in the Edo period, only twenty
survived into the late Meiji period.
This proves, at least in terms of the number of richest business families, that the main
driving force of Meiji industrialization was not the merchants from the Edo period. Meiji
industrialization was attained not by the same business groups expanding over time but by
frequent entries and exits of newcomers. In this sense, Mitsui and Sumitomo from the Edo
period, and Mitsubishi from the Meiji period, which continued to grow and prosper to this
date are the exceptions rather than the rule.

The constitution and parliamentary government

In the political sphere, establishment of a Western style parliament and constitution was a
nationally shared goal whose achievement was absolutely necessary to legitimize the Meiji
Revolution and for Japan to be treated equally by the West. Under this agreed goal, different
views on the timing and content of the proposed constitution generated much political turmoil
as explained in Section 2.

Number of listed business families

250
Late Edo millionaires Company boom period
millionaires
200

End Edo millionaires

150
Early Meiji millionaires

100

50

0
1849 1864 1875 1888 1902

Figure 3.1 Survival of millionaires in the late Edo and Meiji period
Source: computed from Miyamoto (1999), p. 53. Each line indicates how many of the largest business families
of each period continued to stay on the lists in later periods.

41
 T ransition from E do to M eiji

With respect to timing, from 1873 onward, many political groups outside the govern-
ment, including high officials expelled from the government, demanded a constitution as
soon as possible. Political oppositions, intellectuals and rich farmers joined this Freedom
and People’s Rights Movement, which spread to the entire nation. The government cracked
down on this movement and the advocates of an early constitution also at times turned
violent. Meanwhile, the majority of the top government officials wanted to go slow. They
argued that, because Japanese people were only “semi-developed,” careful preparations were
necessary and gradualism rather than radical change was suited for Japan.
As to the contents of the constitution, an acute debate arose on the choice between a more
advanced British-style democracy and parliamentary system and a less democratic German-
style constitutional monarchy. Many intellectuals and progressive politicians favored the
British system, but conservative politicians in the government preferred the German model.
The latter feared that if too much freedom was allowed when people’s political views remain
primitive, violence and instability would result. They pointed to the violence that occurred in
the aftermath of the French Revolution as a thing to be avoided at all cost.
In this regard, the contrasting opinions of Okubo Toshimichi and Fukuzawa Yukichi
are worth attention. After coming home from the official mission to America and Europe,
Finance Minister Okubo submitted the Proposal on Constitutional Politics to the government
in 1873 whose key arguments can be summarized as follows. Democracy and monarchy each
has merits and demerits. Ideally, there is no doubt that democracy is far superior. But the
actual working of democracy is often marred by party politics, and by the tyranny of majority
over minority in the worst case. On the other hand, monarchy functions well if people are
unenlightened and the monarch is excellent, but citizens will suffer enormously if corrupt
officials pursue their personal interests under a cruel ruler. In comparison with Britain, Japan
remains semi-developed and cannot rid itself of feudal customs easily. Monarchy is a thing
of the past, but we are not yet ready for democracy. Moreover, the central government must
have strong authority for the time being to carry out bold reforms. Thus, the most practi-
cal system Japan can now adopt is a constitutional government based on gradualism that
matches the speed of social change. This means constitutional monarchy.
Meanwhile, Fukuzawa, Meiji’s most prominent educator and thinker, argued as follows in
his Outline of the Theory of Civilization in 1875. Countries can be classified into civilized,
semi-developed and barbaric, and Japan belongs to the second group. Democracy and mon-
archy each has merits and demerits. The highest priority for Japan at present is to avoid being
colonized by Western powers and remain independent (up to here, his views are the same as
Okubo’s and hardly unique). To achieve this great objective, Japan must throw away past
traditions and customs and vigorously introduce Western civilization. There are two aspects,
technical and spiritual, to civilization. Technical is easy to copy while spiritual is difficult
to internalize. In adopting these, we must “pursue the difficult first and the easy later; by
first reforming people’s mind, then change politics and laws, and finally introduce tangible
objects” (Fukuzawa, 1962[1875], vol. 1, ch. 2).
In other words, Okubo’s strategy is to design new policies and institutions by taking
people’s backward spirituality as given, while Fukuzawa wants to transform the spiritual
structure of the nation as a matter of priority. The contrast between the pragmatism of Okubo,
the high official, and the idealism of Fukuzawa, the enlightenment thinker, is remarkable.
Their debate is far from outdated today since it contains a fundamental question about the
sequencing of economic development versus political modernization (democratization) in
latecomer countries.

42
 T ransition from E do to M eiji

Under the mounting popular pressure, Emperor Meiji declared in 1881 that a parliamen-
tary government would be established within ten years. To study and prepare the content of
the proposed constitution, Ito Hirobumi, another high official, and his assistants stayed in
Europe for more than a year to consult German and British legal experts. After returning to
Japan, his team drafted a constitution based on the German model while partially incorpo-
rating opinions of foreign legal advisors such as Albert Mosse and Hermann Roesler. The
final draft was submitted to the Privy Council, an organ newly created to assess the draft
constitution, and discussed chapter by chapter in closed sessions. The Meiji Constitution
was promulgated in 1889 and, after an election, the first imperial parliament was convened
in 1890. Japan became the first non-Western country with a functioning constitution (among
the non-Western countries, Turkey also had a constitution but it was shortly suspended).

Foreign policy
The most important diplomatic goal in the Meiji period was to revise the unequal commer-
cial treaties with the West that lacked tariff rights and the right to judge foreign criminals.
This was needed to regain national pride and join the ranks of the “first-class countries.”
But to succeed, Westernization of Japanese society was considered necessary. To show that
Japan was Westernized, the government even built Rokumeikan, a state-run ballroom, and
invited foreign diplomats and business leaders for evening balls with Western music and
food.4 Such superficial Westernization was severely criticized by nationalists and opposition
groups. Nevertheless, over time as Japanese modernization and industrialization proceeded
successfully, treaty renegotiation became possible and the revision was accomplished. Tariff
rights were partially regained in 1899 and completely restored in 1911. The court rights were
reinstated in steps during 1894–99. Japan’s legal humiliation lasting nearly half a century
was finally over.
Another feature of Meiji diplomacy was expansionism. To guard Japan’s independence
and national interests against Western, Chinese and Russian intervention, it was considered
necessary to construct a “Line of Interest,” a sort of buffer zone, beyond Japanese borders.
This practically meant putting Korea under Japanese control. The government was eager
to “open up” Korea, which was maintaining its closed door policy, and force an unequal
commercial treaty in Japan’s favor, just like the West did to Japan earlier. Naturally, Korea
resisted. In 1873, military invasion of Korea was proposed but rejected within the Japanese
cabinet. In the following year, the government sent troops to Taiwan over an incident in
which Okinawa fishermen were killed by the Taiwanese. These external expeditions were
often planned to deflect the anger of former samurai who were deprived of rice salary and
the privilege of carrying a sword. Crafting an external crisis to deflect domestic anger is a
common tactic everywhere.
In the 1880s Japan became more aggressive in its attempt to place Korea under its
influence. Japan’s main rival was China (Qing Dynasty) which considered Korea as its
protectorate. Japan started to aggressively intervene in Korea’s internal politics and stage
military provocation, which led to the Japan–China War of 1894–95. Although the Chinese
naval fleet was larger and more modern than the Japanese, the disciplined and organized
Japanese army and navy had the upper hand. Defeated, China had to pay a reparation of
365 million yen, equivalent to four times the annual budget of Japan, and cede Liaodong
Peninsula, Taiwan and Penghu Islands to Japan. However, Japan had to immediately return
Liaodong Peninsula to China under the joint pressure of Russia, Germany and France.

43
 T ransition from E do to M eiji

Japan was too weak to ignore this demand from these Western powers. The return of
Liaodong Peninsula was another great humiliation in Japanese diplomacy.
After the Chinese were expelled from Korea, Russia came to occupy a large part of
Northeast China (Manchuria) including Liaodong Peninsula. Russia gained territorial and
economic concessions, kept large troops there and built military bases, batteries and ports.
Japan was greatly alarmed. The Japan–UK alliance was formed to deter Russia, and Japan
began to prepare for a final showdown. When the Japan–Russia War (1904–5) broke out,
few people predicted Japanese victory against the huge Russian Empire. To cover the war
cost, Japan issued government bonds in London and New York. At first there were no takers,
but finally the deal was done. Battles were fought on land and at sea. The fall of Russia’s
Lushun Fortress on the Liaodong Peninsula, at great human cost to the Japanese army, and
the defeat of Russia’s Baltic Fleet in the Japan Sea were decisive. Many were surprised that
a non-Western latecomer could beat a powerful White nation.

Box 3.1 The lecture of Natsume Soseki

Natsume Soseki (1867–1916) perhaps was and is the most popular novelist in Japan.
His life largely coincided with the Meiji period. He was an expert in both English
and ancient Chinese literature. His early novels were comical (I Am a Cat, Bocchan)
and sometimes romantic (Sanshiro) or pedantic (Kusamakura). But his later novels
exposed a dark side of modernized Japan, especially individuals who struggle under
human limitations in modernized life without success (Sorekara, Mon). Desperate love
triangles were his favorite theme.
In his famous lecture in Wakayama, “Development of Modern Japan” (1911),
Soseki warned his fellow Japanese against newly emerging complacency. In late
Meiji when this lecture was delivered, Japan already had a functioning parliamen-
tary government and had recently won a victory over Russia. Industrialization was
proceeding rapidly. Japanese people were elated. But Soseki said that Japan’s mod-
ernization was superficial.
Since Japan opened its ports to foreigners in the mid-nineteenth century, Western
impact transformed Japan completely. But all these influences originated in the West,
and Japan only copied them passively without really digesting and internalizing them.
The arrival of Western waves was too fast for the Japanese to make them their own.
Forced absorption of foreign ideas and systems would make the Japanese nervous
and unhappy, but there was no good solution to this problem. This was the essence of
Soseki’s message whose excerpts are cited below. Soseki touched on the fundamental
dilemma of Japanese identity which remains unsolved even today. In the twenty-first
century, Japan is sometimes ill at ease in the company of the advanced Western nations,
while unable to build true trust and friendship with its Asian neighbors.

Development in the West is endogenous, while Japan’s development is exog-

enous. Here, endogenous means emerging naturally from within, like a bud
blooms into a flower in an outward motion, and exogenous means being
forced to take a certain form because of external influences...

44
 T ransition from E do to M eiji

Western societies are evolving naturally but Japan after the Meiji Restoration
and foreign contact is quite different. Of course, every country is influenced
by its neighbors, and Japan was no exception. In certain periods, Korea and
China were models for us. But overall, throughout history, Japan was devel-
oping more or less endogenously. Then suddenly, after two centuries of
isolation, we opened up and encountered Western civilization. It was a big
shock we never experienced before. Since then, the Japanese society began to
evolve in a different direction. The shock was so severe that we were forced
to change directions...

Western tides dominate our development. Since we are not Westerners, every
time a new wave arrives from the West we feel uneasy like a person living in
someone else’s house. Even before we can grasp the nature of the previous
wave, a new wave arrives. It is as if too many dishes are brought in and soon
removed before we can start to eat. In such circumstances, people will inevi-
tably become empty, frustrated, and worried.
(Source: Yukio Miyoshi, ed., Soseki’s Writings on
Civilization, Iwanami Bunko, 1986)

Notes
1 When the American Black Ships left, the Bakufu ordered the Administrator of Izu to quickly build
several new odaiba, or fortified islets, off the coast of Shinagawa. Apparently, these tiny forts were
not enough to stop the Americans and they were never used. Today, the two remaining odaiba can be
seen at the foot of Rainbow Bridge from Yurikamome train.
2 Some economists regard global integration and free trade as the engines of growth. In reality, a sud-
den and unprepared opening of developing economies often leads to bankruptcies of local firms,
deindustrialization, rural impoverishment and widening income gaps. For example, The Least
Developed Countries Report of the UNCTAD (2004) states that a consistent development strat-
egy is the prerequisite for poverty reduction without which export promotion under international
integration alone will not produce desired developmental effects. In this context, the Japanese
experience in which the export of silk and tea enormously enriched the farmers in the late Edo to
the early Meiji “port-opening” period is unique and very different from the cases of most other
latecomer economies.
3 It must be noted that former samurai from Hizen (also called Saga), such as Okuma Shigenobu
(1838–1922), Eto Shimpei (1834–74), Oki Takatou (1832–99) and Soejima Taneomi (1828–1905),
joined the new government by the merit and connection of each person rather than as a former han
team. Hizen Han pursued fukoku kyohei independently from and cooperated little with other strong
hans, thus being unable to become a party to shape the new government.
4 Rokumeikan was located in Hibiya, near where Imperial Hotel now stands. Since most foreign dip-
lomats and business leaders lived in Yokohama, the government even prepared a special late-night
train from Shimbashi to Yokohama to bring them home after the ball.

45
4
IMPO R TING AND ABSO RBI NG
T E C HN OLOGY

Meiji industrialization
The three salient features of Meiji industrialization are very strong private sector initiative
supported by appropriate official assistance, successful import substitution in the cotton
industry, and parallel development of the modern sector and the indigenous sector. These
will be discussed more fully in this and the following chapters.
As noted in the previous chapter, one of the agreed policy objectives of the Meiji govern-
ment was industrialization. The official policies of introducing Western institutions, building
infrastructure, hiring foreign advisors, renovating education and training, establishing state-
owned factories and research centers, organizing trade fairs, assisting zaibatsu and so on,
were all important and played crucial roles. At the same time, it should be stressed that
private sector dynamism was even more essential. Such powerful business leaders and coor-
dinators as Shibusawa, Iwasaki and Godai provided leadership, and large zaibatsu groups
began to form. At the grass-roots level, traditional and newly emerging merchants, skilled
engineers, proud craftsmen, rich farmers and village leaders all over the country became the
driving force of broad-based technical absorption. Without this private sector capability,
even good policies would have failed to produce significant results.
It should also be recalled that many contributing factors to Meiji industrialization were
inherited from the previous Edo period. They included agricultural development, nationally
unified markets, transportation and distribution networks, a strong merchant tradition, the
development of financial services, a well-educated population and experiences of industrial
promotion by local governments yielding various results.
The cotton industry was one of the leading industries of the world in the nineteenth
century. At first, British products dominated the global market. In Asia, India was the main
producer. But Japan absorbed textile technology very rapidly in the late nineteenth century.
After the opening of ports, Japan first imported British cotton clothes as rural demand for
such clothes surged. Later, it imported cotton yarns and wove clothes for the domestic mar-
ket. By around 1900, Japan began to export cotton yarns while importing raw cotton from
India initially, and also from the US later. In the early twentieth century, Japan became
a major exporter of cotton clothes (finished products). Today, international development
institutions such as the World Bank often discredit import substitution policy or at least
remain suspicious about its effect. In this light, Meiji Japan’s brilliant success in turning
its major imports (textile products) into major exports in less than half a century is all the
more striking.

46
 I mporting and absorbing technology

However, the introduction of modern Western technology did not drive out all traditional
technology inherited from the Edo period. In the textile industry as well as in other industries
such as metal-working, printing and food processing, indigenous production methods existed
side-by-side with modern machines and factories. Sometimes the two sectors produced differ-
entiated products for different market segments. At other times they were vertically related with
one sector producing inputs for the other. New technology influenced traditional methods, but
local conditions and requirements also modified imported technology. This pattern observed in
Meiji Japan, in which foreign technology and indigenous technology influenced each other in
the early days of industrialization rather than the former wiping out the latter, is termed the dual
structure or hybrid technology by economic historian Odaka Konosuke (1990, 1999).
By the end of Meiji (1912), shortly before the outbreak of WW1, Japan can be said to
have been successfully industrialized in light manufacturing, especially textiles. But heavy
and machinery industries were still embryonic. Vigorous development of these industries
started later, during and after WW1.

The macroeconomy and industrial development

The Japanese economy underwent several stages after the opening of ports in the late Edo
period. Major developments are explained chronologically below.

1 Initial impact of foreign trade (1850s–60s): foreign ideas, technology, institutions and
products flowed in to radically transform the Japanese society. The resulting shifts in
relative prices and industrial structure forced many of the production regions of various
traditional goods to decline and be replaced by newly emerging regions and products.
Inflation shot up toward the end of the Edo period.
2 Monetary confusion and continued inflation (late 1870s): the Meiji government initially
adopted the US monetary model in which there was no central bank and certified private
banks issued money against their gold reserves. But this system did not work well and
produced confusion in the nascent banking sector. Inflation accelerated as paper money
was printed to finance the military operations to suppress Saigo Takamori’s rebellion in
Kyushu in 1877. As the prices of rice and other agricultural products rose, farmers and
landlords got rich while former samurai were generally impoverished.
3 Matsukata Deflation (early 1880s): Chancellor of Finance Matsukata Masayoshi
adopted a deflationary policy to end inflation and introduce a modern monetary system.
This resulted in establishment of the Bank of Japan as a central bank in 1882, replacing
the failed US monetary model. As the prices of agricultural commodities plummeted,
rural income fell and the number of landless farmers increased.1
4 The first “company boom” (late 1880s): after inflation subsided and modern banking was
installed, there was a rush to establish joint stock companies in the private sector. Exchange
rate depreciation, easy money and low interest rates also encouraged their emergence. Rich
landlords and merchants as well as former daimyos invested in newly issued stocks, but
they were mainly interested in quick dividends rather than long-term business growth.
5 Continued waves of company booms (1890s–1910s): a large number of joint stock com-
panies were established in the late 1890s, late 1900s and during WW1, interrupted by
recessions. Booms and busts became a permanent feature of Japan, a young capitalist
nation. Initially, textile mills and railroad construction and operation were the two most
popular sectors for investors. Later, company creation spread to all sectors.

47
 I mporting and absorbing technology

6 Two wars (Japan–China 1894–95; Japan–Russia 1904–5): these wars were fought as
Japan asserted its political and economic influence in the Korean Peninsula and then
the Northeastern part of China. The Qing Dynasty of China and the Russian Empire
stood in front of Japan’s expansive intention. In both wars, Japan emerged as a win-
ner although the war with Russia was particularly costly in terms of human lives and
budgetary finance. After each war, fiscal activism, instead of a return to fiscal prudence,
was adopted. Large public investment was undertaken to build more railroads and the
national telephone network. In addition, military spending was kept up even during
peacetime. Economic management of Taiwan, Japan’s first colony acquired in 1895,
also began with institution-building and public investment. Local governments issued
foreign-currency denominated bonds to invest in infrastructure for water works, roads,
tramcar networks and so on. As a result, the general budget size (combining central
and local governments) ballooned and the balance-of-payments deficit widened. Gold
reserves (i.e. international reserves) were gradually lost, and the public debt stock rose
to about 40 percent of estimated GDP. Roughly half of the public debt was denominated
in foreign currency.

Choice between fiscal activism and a small government was the main arguing point of
Japan’s first parliament convened in 1890, and the fight between two camps continued
into the twentieth century. From the late Meiji period onward, fiscal activism was pro-
moted by Seiyukai, with the full name of Rikken Seiyukai, a political party established in
1900 by Ito Hirobumi, the drafter of the Meiji Constitution and the first Prime Minister.
Ito’s idea was to create a party to strongly support the government’s policies rather than
insisting on chozen-shugi, or ignoring the demands of opposition parties in the parliament,
an obviously untenable tactic adopted initially by the Meiji government. Seiyukai’s main
support base was rich farmers and landlords who welcomed aggressive public investment
in rural areas.
But fiscal overspending produced by Seiyukai governments naturally led to mount-
ing balance-of-payments pressure as noted above. Macroeconomic belt-tightening was
clearly necessary in the first years of the twentieth century. In reality, this economic crisis
was unexpectedly overcome by the outbreak of WW1 (1914–1918) rather than by ortho-
dox fiscal and monetary austerity. As the European powers started military confrontation,
they stopped exporting machinery and industrial inputs to the rest of the world including
Japan. World demand for manufactured goods shifted to Japanese products despite their
inferior quality, allowing the Japanese economy to enjoy an enormous export-led boom.
But these are events of the following Taisho period which will be dealt with more fully
in Chapter 7.
No reliable GDP statistics exist for this period, but we have some estimates. According
to them, Japanese output was very bumpy with the average real growth rate of 2 to 3 percent
per year. By today’s standards, this is not particularly impressive for a developing country
although there may be a problem of data quality. Nevertheless, low growth may have been a
fact rather than a statistical concoction. Such relatively low growth seems to have been suf-
ficient for a latecomer economy to emerge as a new economic power in the nineteenth to the
early twentieth century. As for the employment structure, the share of agricultural employ-
ment was dominant, at about 70 percent in the early Meiji period, but it gradually declined.

48
 I mporting and absorbing technology

International trade
Regarding trade structure, raw silk—silk yarn rather than finished silk products—dominated
Japan’s exports, followed by tea, cereals, seafood, minerals and coal. Clearly, Meiji Japan
was a primary commodity exporter. Raw silk remained the top Japanese export, not just dur-
ing the Meiji period but in the entire pre-WW2 period up to the 1930s. The largest importer
of Japanese silk and tea was the United States. Stockings made from Japanese silk were very
popular among American ladies until artificial fibers such as rayon and nylon were invented.
The United States, a young developing country at that time, maintained high import
protection throughout the nineteenth century (see Box 4.1). It protected its silk weaving
industry with tariff rates of 45 to 50 percent, but the industry needed silk yarn as an input. An
attempt to increase domestic silk yarn production failed, so the US industry was compelled
to continue to rely on Japanese yarn.
On the import side, dramatic shifts occurred in Japan’s trade structure as the cotton indus-
try succeeded in import substitution as discussed earlier. Initially, finished products (clothes)
were imported. Later, imports shifted to intermediate input (cotton yarn) and then to raw
material (raw cotton). In Figure 4.1, we can see a clear product cycle of this industry mov-
ing from import to domestic production, and finally to export. Domestic production shifted
downstream from spinning to weaving as well as from low to high quality products. At first,
Britain was the main exporter of finished textile products and machinery to Japan. But over
time, Japan increased competitiveness against British textile products and drove them out of
the Asian market.
In early Meiji, Japan’s trade pattern was a “vertical” one typical of a developing
country. It exported raw silk, tea leaves and other primary commodities to Europe and
America while importing manufactured products from them. By late Meiji, Japan devel-
oped a more complex trade pattern. Against Europe and the US, trade remained basically
vertical. But with the rest of Asia, which included China, Korea, India and Southeast

㻔㻵㼚㻌㼙㼕㼘㼘㼕㼛㼚㻌㼜㼛㼡㼚㼐㼟㻌㼎㼥㻌㼣㼑㼕㼓㼔㼠㻕
㻝㻘㻞㻜㻜㻌
㻼㼞㼛㼐㼡㼏㼠㼕㼛㼚
㻝㻘㻜㻜㻜㻌 㻱㼤㼜㼛㼞㼠
㻵㼙㼜㼛㼞㼠
㻤㻜㻜㻌

㻢㻜㻜㻌

㻠㻜㻜㻌

㻞㻜㻜㻌

㻜㻌
㻝㻤㻢㻤㻌
㻝㻤㻣㻞㻌
㻝㻤㻣㻢㻌
㻝㻤㻤㻜㻌
㻝㻤㻤㻠㻌
㻝㻤㻤㻤㻌
㻝㻤㻥㻞㻌
㻝㻤㻥㻢㻌
㻝㻥㻜㻜㻌
㻝㻥㻜㻠㻌
㻝㻥㻜㻤㻌
㻝㻥㻝㻞㻌
㻝㻥㻝㻢㻌
㻝㻥㻞㻜㻌
㻝㻥㻞㻠㻌

Figure 4.1 Production, export and import of cotton yarn

Sources: Iijima Manji, History of Japanese Textile Spinning Industry, Sogensha, 1949, pp. 502–504.

49
 I mporting and absorbing technology

Asia, Japan began to export light manufactured goods such as cotton yarn, cotton clothes,
knitwear, matches, umbrellas, clocks, lamps, glass products and so on. Japan also began
to import materials needed to produce them, especially Indian raw cotton which was
short-fiber. Japan also imported US cotton which was long-fiber. Due to the emergence
of Japan’s cotton industry, India was driven out of the position of an exporter of cotton
products into an exporter of raw cotton (Figure 4.2).
As the export of cotton yarn and the import of raw cotton both rose, the government abol-
ished the cotton yarn export tax in 1894 and the cotton import tariff in 1896. This benefited
modern cotton factories that used Indian cotton as inputs, but hurt traditional producers
who spun domestically produced cotton (Figure 4.3). In order to establish a monopolistic
position in importing Indian cotton vis-à-vis foreign marine cargo carriers, Japanese tex-
tile companies formed a cartel and used only Nippon Yusen (a Mitsubishi-group shipping
company) and Menka Shosha (Cotton Trading House) as the sole carrier and distributor
of Indian cotton to Japan. This secured a stable supply of Indian cotton at low prices for
Japanese textile companies.

How Western technology was transferred

Western technology was imported and internalized in phased but overlapping steps (Uchida
1990). Different technological transfer schemes were adopted depending on project type
and time periods, from simple turnkey contracts and management contracts to engineer-
ing education, selective technical advice, copy production based on reverse engineering
and original invention after studying foreign models. The method progressed sequentially
from easy to more complex as Japanese technological capability steadily rose. In addition,
we should not forget the role of policy support that allowed Japanese firms to climb the
technological ladder.
The earliest method of technology transfer was hiring of foreign advisors. In early Meiji,
especially in the 1870s, new factories and infrastructure were constructed and operated with
significant assistance from foreign engineers and managers. In the late nineteenth century,
there were many unemployed British railroad engineers since the British railroad system had

Figure 4.2 Trade structure

50
 㻱㼤㼜㼛㼞㼠㻌㻯㼛㼙㼜㼛㼟㼕㼠㼕㼛㼚 㻵㼙㼜㼛㼞㼠㻌㻯㼛㼙㼜㼛㼟㼕㼠㼕㼛㼚
㻝㻜㻜㻑 㻝㻜㻜㻑

㻤㻜㻑 㻻㼠㼔㼑㼞 㻤㻜㻑 㻻㼠㼔㼑㼞

㻲㼕㼚㼕㼟㼔㼑㼐 㻲㼕㼚㼕㼟㼔㼑㼐
㻢㻜㻑 㻢㻜㻑
㻿㼑㼙㼕㻙㼒㼕㼚㼕㼟㼔㼑㼐 㻿㼑㼙㼕㻙㼒㼕㼚㼕㼟㼔㼑㼐
㻠㻜㻑 㻾㼍㼣㻌㼙㼍㼠㼑㼞㼕㼍㼘㼟 㻠㻜㻑 㻾㼍㼣㻌㼙㼍㼠㼑㼞㼕㼍㼘㼟
㻲㼛㼛㼐 㻞㻜㻑 㻲㼛㼛㼐
㻞㻜㻑

㻜㻑 㻜㻑

㻝㻤㻢㻤㻙㻣㻜
㻝㻤㻣㻢㻙㻤㻜

㻝㻤㻢㻤㻙㻣㻜
㻝㻤㻣㻢㻙㻤㻜
㻝㻤㻤㻢㻙㻥㻜
㻝㻤㻥㻢㻙㻜㻜
㻝㻥㻜㻢㻙㻝㻜
㻝㻤㻤㻢㻙㻥㻜
㻝㻤㻥㻢㻙㻜㻜
㻝㻥㻜㻢㻙㻝㻜

㻰㼑㼟㼠㼕㼚㼍㼠㼕㼛㼚㼟㻌㼛㼒㻌㻱㼤㼜㼛㼞㼠 㻿㼛㼡㼞㼏㼑㼟㻌㼛㼒㻌㻵㼙㼜㼛㼞㼠
㻝㻜㻜㻑 㻝㻜㻜㻑

㻤㻜㻑 㻻㼠㼔㼑㼞 㻤㻜㻑 㻻㼠㼔㼑㼞

㻱㼡㼞㼛㼜㼑 㻱㼡㼞㼛㼜㼑
㻢㻜㻑 㻢㻜㻑 㼁㻿
㼁㻿
㻠㻜㻑 㻻㼠㼔㼑㼞㻌㻭㼟㼕㼍 㻻㼠㼔㼑㼞㻌㻭㼟㼕㼍
㻠㻜㻑
㻵㼚㼐㼕㼍 㻵㼚㼐㼕㼍
㻞㻜㻑 㻞㻜㻑 㻯㼔㼕㼚㼍
㻯㼔㼕㼚㼍
㻜㻑 㻜㻑

㻝㻤㻣㻟㻙㻣㻡
㻝㻤㻣㻢㻙㻤㻜
㻝㻤㻤㻢㻙㻥㻜
㻝㻤㻥㻢㻙㻜㻜
㻝㻥㻜㻢㻙㻝㻜
㻝㻤㻣㻟㻙㻣㻡
㻝㻤㻣㻢㻙㻤㻜
㻝㻤㻤㻢㻙㻥㻜
㻝㻤㻥㻢㻙㻜㻜
㻝㻥㻜㻢㻙㻝㻜

Figure 4.3 Structure of export and import

 I mporting and absorbing technology

been more or less completed. They often traveled abroad in search of jobs. The salaries of
such foreign advisors were very high and sometimes even higher than that of the Japanese
Prime Minister2 which became a great financial burden on the government. In 1874, the sala-
ries of hired foreign engineers accounted for 34 percent of the current budget of the Ministry
of Industry.
Figure 4.4 indicates the number of foreigners employed by the central and local gov-
ernments. The number—especially the number of engineers—declined significantly toward
the end of Meiji as Japanese engineers steadily replaced foreigners. Since contracts that the
government signed were turnkey projects with fixed terms, foreigners returned home or went
elsewhere when the contract expired. The government took utmost care to prevent important
national projects, such as mines, railroads and shipyards, from falling into foreign hands.
From the mid Meiji onward, foreign teachers, including language teachers, hired by private
universities and other academic institutions (not shown in Figure 4.4) became the dominant
form of foreigners’ employment in Japan.
The second form of technology transfer was training of Japanese engineers. Since foreign
advisors were too expensive to keep, the government vigorously promoted “import substi-
tution” by Japanese engineers. Excellent students were nominated by the government to go
abroad to absorb the latest ideas and technology at universities and colleges in Europe and
America with financial support from the Japanese government. Students were sent to the
most appropriate institutions for the subject and they studied very hard, easily replacing for-
eigners after returning to Japan. However, the amount of Japanese government scholarship
was not very large.
Domestically, Kobu Daigakko (Institute of Technology) was established in 1877 as the
highest academic institution for absorbing Western technology, where foreign professors
taught mostly in English. It was located in Kasumigaseki at the heart of Tokyo where the
Ministry of Finance now stands. It developed from a training school for Japanese operators
at industrial projects under the Ministry of Industry. Later, the Institute was merged into the
Faculty of Engineering of Tokyo University under the Ministry of Education. Henry Dyer, a
British engineer, was contracted as the first president of Kobu Daigakko, where he pursued a
judicious combination of theory and practice, an ideal that had not been realized in his home
country. The institute offered courses in civil engineering, mechanical engineering, ship-
building, telecommunication, chemistry, architecture, metallurgy and mining. The six-year

㻢㻜㻜
㻡㻜㻜 㼃㼛㼞㼗㼑㼞㼟㻌㼑㼠㼏㻚
㻭㼐㼙㼕㼚㼕㼟㼠㼞㼍㼠㼛㼞㼟
㻠㻜㻜
㻱㼚㼓㼕㼚㼑㼑㼞㼟
㻟㻜㻜 㼀㼑㼍㼏㼔㼑㼞㼟

㻞㻜㻜
㻝㻜㻜
㻜
㻝㻤㻣㻡 㻝㻤㻣㻥 㻝㻤㻤㻟 㻝㻤㻤㻣 㻝㻤㻥㻝 㻝㻤㻥㻡

Figure 4.4 Foreign advisors employed by the Meiji government

Source: Umetani Noboru, Hired Foreign Advisors, vol.1, Kajima Research Institute Publishing House, 1968.
Private sector employment is excluded.

52
 I mporting and absorbing technology

program consisted of a preparatory period (mainly language learning), specialized studies

and internship at government projects, each lasting two years. Top students were sent abroad
to study. Kobu Daigakko produced many industrial designers and engineers who built the
Biwako–Kyoto Canal and a power station, Tokyo Station, the Bank of Japan Headquarters,
Nara Hotel, and so on.
In addition, Koto Kogyo Gakko (industrial high schools) played a critical role in equip-
ping Japanese factories with competent mid-level engineers. Tokyo Craftsmen School was
established in 1881 and upgraded, together with Osaka Industrial School, to Koto Kogyo
Gakko in 1897. Four more Koto Kogyo Gakko were created by the end of Meiji, with many
more added during the following Taisho period. Good students who lacked financial means
to go to Kobu Daigakko were attracted to Koto Kogyo Gakko, which taught practical tech-
nology and supplied a large number of engineers and technicians to private enterprises. This
no doubt greatly increased the technical absorptive capacity of the country. However, proud
and ungovernable craftsmen were more influential on the factory floor than newly trained
engineers during much of Meiji. Furthermore, workers were hired by a labor broker who
supplied them to factories on a contract basis. Transition from craftsmen to trained engineers
as main factory labor, and from indirect employment to direct management of workers by the
enterprise, progressed slowly but steadily (Odaka 2000).
In the latter half of Meiji with an increasingly broad base of Japanese engineers, cop-
ying, licensing, joint venture and technical cooperation became the dominant forms of
technology transfer. Graduates from Kobu Daigakko often played an instrumental role in
selecting and importing new technology. In economic ministries and large private firms,
they took initiative in collecting information, purchasing machines, and adjusting them to
Japanese requirements. Besides this, trading houses such as Mitsui Corporation and Takada
Shokai provided customers with product information and technical assistance in ordering
and installing equipment. Many US and European machines were copy-produced by reverse
engineering, but this became illegal by the revisions of the commercial treaties in 1894 and
1899. Thereafter, Japanese firms had to learn technology by more formal and costly ways.
Unlike today’s developing countries which covet foreign direct investment (FDI), there
was relatively little FDI in Meiji Japan (Table 4.1). FDI into Japan was prohibited until the
revision of the commercial treaties in 1899, and Japanese government and businesses contin-
ued to remain hostile to foreign investment even under the revised treaties. This was in sharp
contrast to the industrial experiences of China and India which received large amounts of
FDI in this period. The Japanese government was also afraid of borrowing from foreigners,
especially in early Meiji (Chapter 6). Bytheway (2005) estimates that, during Meiji, FDI was

Table 4.1 Selected foreign investment projects during Meiji and Taisho

Year Japanese name Foreign partner Foreign Remark

ownshp

1893 Standard Oil Standard Oil (US) 100% Later sold to Nippon Oil
1899 Nippon Electric (NEC) Western Electric (US) 54% Later under Sumitomo
1900 Murai Brothers American Tobacco (US) 50% State-owned in 1904
1900 Rising Sun S. Samuel & Co. (UK) 100% Oil business
1901 Singer Mishin Singer Sewing Machine (US) 100%

(continued)

53
Table 4.1 (continued)

Year Japanese name Foreign partner Foreign Remark

ownshp
1902 Osaka Gas Mr A.N. Brady US) 50% Brady capital exits in
1925
1903 Tokyo Electrical Train Mr Malcolm (UK) –
1905 Tokyo Electric General Electric (US) 38% Later Toshiba, 1939
1906 Osaka Glass Private syndicate (UK, Bel, Fr) 56%
Manufacturing
1907 Nippon Steel Armstrong & Vickers (U K) 50% Weapon manufacturing
1907 Imperial Spinning J&P Coats (UK) 60%
1909 Dunlop Rubber Far East Dunlop (UK) 100% Later, 100% Japanese
1910 Shibaura General Electric (US) 24% Later Toshiba, 1939
Manufacturing
1910 Nippon Okijenu & L’air Liquide (FR) 100%
Asechiresu
1910 Lever Brothers Lever & Brothers (UK) 100%
Amagasaki
1910 Nippon Chikuonki Mr. F.W. Hohn (US) – Phonograph
Trading
1917 Yokohama Rubber F.B. Goodrich (US) 50% Presence since 1912
Manuf.
1918 Japan-US Sheet Glass Libby Owens Sheet Glass (US) 35% From 1922, under
Sumitomo
1920 Sumitomo Electric Western Electric (US) 25%
Cable
1922 Asahi Silk Weaving Vereinigete Glanzstoff Fabriken 20% From 1929, under
(Germany) Nicchitsu
1923 Fuji Electric Siemens (Germany) 30% Japanese partner:
Manufacturing Furukawa
1923 Mitsubishi Electric Westinghouse Electric (US) 10%
1925 Japan Ford Ford Motor (US) 100% Previously, sales through
agents
1927 Japan General Motors General Motors (US) 100%
1927 Japan Victor Victor Talking Machine (US) 100% From 1937, under Nissan
1927 Daido Match Sweden Match (Swe) 50% From 1932, under Nissan
1928 Japan Columbia Columbia (UK) 59% From 1935, under Nissan
Phonograph
1928 Toyo Babcock Babcock & Wilcox (UK) 71% Boilers, steam turbines
1929 Japan Benberg Silk J.P. Benberg (Germany) 20% In 1933, merged with
Fiber Asahi Silk weaving
1931 Mitsubishi Oil Associated Tidewater Oil (US) 50% Japanese partner:
Mitsubishi
1931 Sumitomo Alminum Aluminum Co. of Canada (Can) 50%
Smelting
1932 Toyo Otis Elevators Otis Elevators (US) 60% Japanese partner: Mitsui
1932 Japan Submarine Cable Int’l Standard Electric (US) 12% Under Sumitomo
1933 National Cash Register National Cash Register (US) 100%
1937 Japan Watson Watson Computing Tabulating 100%
Recording Machine (US)
1939 Shibaura Kyodo United Engineering (US) – Japanese partner:
Industries Shibaura
Source: Bytheway (2005), pp.166–169.
 I mporting and absorbing technology

a very small part of foreign saving mobilization with the share of only 0.7 percent, while
issuance of government bonds (82.5 percent), municipal bonds (7.8 percent) and corporate
bonds (9.0 percent) was the dominant form of borrowing from abroad. Though quantitatively
small, Bytheway argues that FDI played crucial roles in technology transfer in certain sectors
such as electric machinery, telephone equipment and light bulb production.
In the early twentieth century, a number of automobile and electrical machinery compa-
nies signed licensing agreements and technical cooperation contracts with Western firms.
However, in such cooperation the Japanese partners quickly absorbed needed technology
and often dissolved the relationship with the Western partner.
Japan is said to be a country of monozukuri (manufacturing things). In many European
countries including nineteenth-century Britain, engineers who worked in oily factories did
not have a high status compared with managers, lawyers and accountants who remained in
clean offices. But in Japan, university graduates loved to build, adjust and repair machines
and manage factories. They had no problem working side-by-side with machine operators
on a noisy factory floor. This was true in the Meiji period as well as until the recent past. The
best students chose engineering, rather than law or economics, as their field of specialization.

Labor market
The Japanese labor market in the Meiji period and up to the middle of the twentieth century
hardly resembled the post-WW2 Japanese model where lifetime employment and loyalty to
the company were the norm. In the early days of Japanese industrialization, the labor market
exhibited many of the neoclassical traits in which workers were wage-sensitive and foot-
loose, felt little allegiance to the company, and did not follow managers’ instructions closely.
The Survey of Industrial Workers by the Ministry of Agriculture and Commerce in 1901
found that Japanese workers were frequent job hoppers who did not stay with one company
for long. Moreover, they lacked work discipline and hardly saved from their income. The
Ministry concluded that these lamentable labor characteristics constituted a serious barrier
to industrialization.
According to another survey conducted in 1902 by the Tokyo Metropolitan Police,
29.9 percent of male workers at mechanical factories in Tokyo quit jobs in less than a
year; 17.6 percent lasted between one and two years, and 15.2 percent stayed between
two and three years while only 4.2 percent worked at the same place for a decade or more.
Subsequent annual surveys confirmed that rapid labor turnover, despite fluctuations due
to economic cycles and other conditions, remained virtually the same from 1902 to 1913.
However, from the perspective of technology learning, such disloyal behavior was a
positive factor in Japan’s early industrialization. Among talented and ambitious craftsmen
in the Meiji period, it was customary to absorb as much knowledge as possible at facto-
ries supervised by foreigners and equipped with the latest machines. Frequent migration
across state-owned factories and military mills was a natural means to achieve this. After
learning sufficient technology and operational skills, many craftsmen set up their own
companies, often to supply components and production services to mother factories. By
the early twentieth century, industrial clusters in textile, steelworks, shipbuilding and ferti-
lizers formed in low areas in Tokyo such as Honjo, Fukagawa, Asakusa, Kanda, Shiba and
Kyobashi.3 Similar developments were also observed in Osaka. Many of these industrial
areas saw large-scale anchor firms surrounded by a great number of manufacturing small

55
 I mporting and absorbing technology

and medium-sized enterprises (SMEs). It is noteworthy that these early industrial clusters
formed autonomously without designated industrial zones, factory relocation policy or
other interventions by the state. Market forces prompted skilled engineers and manufac-
turing SMEs to emerge strongly, a feat that many of today’s developing countries try to
achieve by technical training and SME support measures with mixed results.
Company management viewed job hopping by most competent engineers as a great
challenge to long-term business development. As the weight of Japanese industrial activ-
ity shifted gradually from light manufacturing such as cotton textiles using young female
labor to heavy and chemical industries, demand for more faithful and experienced work-
ers grew because the success of the latter depended critically on accumulated skills and
company-specific experience. Thus, around the 1910s, large private firms began to offer
internal incentives such as promotion and/or salary increase to retain workers longer,
although the footloose situation of workers at SMEs and the service sector was hardly
affected. Much later, during the Japan–China War (1937–1945) which led to the Pacific
War (1941–1945), Japanese workers were forced to remain at establishments assigned by
the government as part of total war effort.
Another salient feature of Meiji industrialization was the prevalence of female domestic
workers called jochu (Odaka, 1989). In any rapidly industrializing society, labor migration
from rural villages to cities is activated and Meiji Japan was no exception. Expanding
urban industry and lingering rural poverty and labor surplus were the pull and the push
factors of such migration. The end of Meiji to early Showa was the peak period of jochu
which included young unmarried girls who lived with the family as well as older mar-
ried helpers who commuted. In 1930, toward the end of this period, jochu accounted for
17.5 percent of Japanese non-farm female employment, second only to textile workers,
and 5.7 percent of Japanese households hired jochu. Housemaids were also popular in
other rapidly industrializing countries. The percentage of domestic workers in total non-
farm female employment was 11.4 percent in the UK in 1851, 11.8 percent in the US in
1910, 10.6 percent in Thailand in 1960 and 34.3 percent in the Philippines in 1975. As
income and wages rose and the labor market tightened, the age of jochu came to an end
(the Japanese labor market turned from general surplus to shortage around 1960). The gen-
der gap in wage also persisted over time and across sectors, with female workers receiving
only about 55–65 percent in comparison with male workers in farm employment, textile
work and domestic service, as exemplified by the wage data collected by the Ministry of
Agriculture and Commerce from 1885 to 1920.

Hybrid technology
Odaka (1990) argues that Meiji industrialization was achieved by combining existing tradi-
tional technology and new Western technology in an appropriate manner. He calls this “hybrid
technology.” Although Western technology was far superior to Edo-period technology, the
former did not completely replace the latter. This can be considered as one example of the
“translative adaptation” introduced in Chapter 1.
According to Odaka, different types of industrial evolution can be identified. In Figure 4.5,
intermediate points such as I* and M* can be called hybrid technology4 (M stands for
“modern,” I stands for “indigenous” and the asterisk means modified).

56
 I mporting and absorbing technology

㻲㼍㼏㼠㼛㼞㼥㻌㼟㼕㼦㼑
㻿㼙㼍㼘㼘 㻸㼍㼞㼓㼑
㼀㼑㼏㼔㼚㼛㼘㼛㼓㼥

㻵㼚㼐㼕㼓㼑㼚㼛㼡㼟 㻵 㻵㻖
㻹㼛㼐㼑㼞㼚 㻹㻖 㻹
Figure 4.5 Technology and factory size
M→M  or a completely new technology, the Western model must be imported as a whole; there was
F
no corresponding traditional technology (e.g. railroads, telephone system, electrification).
I→I*→M Indigenous technology was first adjusted and expanded. Later, there was a switch to a new
Western method (e.g. shipbuilding, sake making).
I→M*→M Indigenous technology was first replaced by Western technology but at a small scale that fitted
Japanese reality. Later, the size was expanded (e.g. printing, machine production).

Indigenous and modern technology often coexisted because they played complementary
roles in vertical industrial linkage in which one industry produced an input to the other, or
because their markets were differentiated with, for instance, modern plants producing for
export and traditional ones serving the domestic market. As Figures 4.6 and 4.7 illustrate,
despite the steady growth of modern industries from Meiji to early Showa measured by
output, it was not the largest part of the Japanese economy when measured by employment.
The largest absorber of labor force was still the primary industry whose share, however,
was gradually declining. The share of employment of indigenous manufacturing and service
sectors remained relatively stable at slightly over 30 percent.

㻝㻜㻜㻑
㻵㼚㼐㼕㼓㼑㼚㼛㼡㼟
㻤㻜㻑 㼕㼚㼐㼡㼟㼠㼞㼕㼑㼟

㻢㻜㻑

㻠㻜㻑
㻹㼛㼐㼑㼞㼚
㻞㻜㻑 㼕㼚㼐㼡㼟㼠㼞㼕㼑㼟
㻜㻑
㻝㻤㻤㻡㻙㻥㻜

㻝㻤㻥㻜㻙㻥㻡

㻝㻤㻥㻡㻙㻜㻜

㻝㻥㻜㻜㻙㻜㻡

㻝㻥㻜㻡㻙㻝㻜

㻝㻥㻝㻜㻙㻝㻡

㻝㻥㻝㻡㻙㻞㻜

㻝㻥㻞㻜㻙㻞㻡

㻝㻥㻞㻡㻙㻟㻜

㻝㻥㻟㻜㻙㻟㻡

㻝㻥㻟㻡㻙㻠㻜

Figure 4.6 Manufacturing output in prewar Japan

Source: Matsumoto and Okuda (1997).

57
 I mporting and absorbing technology

㻝㻜㻜㻑
㻵㼚㼐㼕㼓㼑㼚㼛㼡㼟㻌㻔㼠㼞㼍㼐㼑㻌㻒
㼟㼑㼞㼢㼕㼏㼑㻕
㻤㻜㻑
㻵㼚㼐㼕㼓㼑㼚㼛㼡㼟
㻢㻜㻑 㻔㼙㼍㼚㼡㼒㼍㼏㼠㼡㼞㼕㼚㼓㻕

㻠㻜㻑 㻹㼛㼐㼑㼞㼚㻌㼕㼚㼐㼡㼟㼠㼞㼕㼑㼟

㻞㻜㻑 㻭㼓㼞㼕㻘㻌㼒㼛㼞㼑㼟㼠㼞㼥㻘
㼒㼕㼟㼔㼑㼞㼥
㻜㻑
㻝㻤㻤㻡㻙㻥㻜
㻝㻤㻥㻜㻙㻥㻡
㻝㻤㻥㻡㻙㻜㻜
㻝㻥㻜㻜㻙㻜㻡
㻝㻥㻜㻡㻙㻝㻜
㻝㻥㻝㻜㻙㻝㻡
㻝㻥㻝㻡㻙㻞㻜
㻝㻥㻞㻜㻙㻞㻡
㻝㻥㻞㻡㻙㻟㻜
㻝㻥㻟㻜㻙㻟㻡
Figure 4.7 Employment structure in prewar Japan
Source: Matsumoto and Okuda (1997).

Box 4.1 Meiroku Zasshi

Mei is the first syllable of Meiji. Roku means six. Zasshi means journal. Meiroku
Zasshi (Journal of the Sixth Year of Meiji) was a series of publications by Meirokusha
(Society of the Sixth Year of Meiji) in 1874 and 1875. Meirokusha, in turn, was a
free discussion forum founded in 1873 (the sixth year of Meiji) by Mori Arinori,
who later served as the first education minister. Meiroku Zasshi was a collection of
relatively short essays covering a wide variety of issues such as lessons from Western
history, proposals for reforming the Japanese language, religious questions, social
policy and economics. At the outset of each issue, the following message was printed
in archaic Japanese:

Recently, we friends gathered to discuss social issues and foreign situations

in order to deepen our knowledge and enjoy high spirits. As meeting records
have accumulated, we have decided to publish and share them with our col-
leagues at large. While it is only a small booklet, we would be happy if it
helps to improve the knowledge of the Japanese people.

As an example, here is the summary translation of “The Argument against Tariff

Protection” by Tsuda Mamichi (1829–1903), a scholar in Western studies. This article
was published in the fifth volume of Meiroku Zasshi on April 15, 1874.

Our trade deficits were 8 and 7 million yen in 1872 and 1873, respectively.
In addition, we pay 2 million yen annually as salaries for foreign advisors
and teachers. This means that gold and silver flow out of Japan at the rate
of roughly 100 million yen every decade. Our international reserves may be
exhausted in one or two decades.
Pessimists say, “If we lose precious metals like this, how can Japan sur-
vive? We must stop this outflow. Europe used tariff protection in the past.
The US is still practicing it. We must also adopt this policy.”

58
 I mporting and absorbing technology

I disagree with this idea. European economists state clearly that protection
is the worst policy which harms the nation’s welfare. The US is still resort-
ing to tariff protection because American industries are less developed than
European, with higher cost. Therefore, Americans levy high tariffs on imported
goods to promote domestic industries.
But the development level of Japanese industries is far below even that
of the American. Needless to say, comparison with Europeans is out of the
question. It is like a small baby trying to compete with a giant. That is why we
have to pay 2 million yen for foreign teachers. Evidently, copying American
policy is not suitable for Japan. More specifically, there are several reasons
why tariff protection is undesirable.
First, commercial treaties with the West prohibit raising our tariffs.
Second, there is a huge gap in technology between Japan and Europe. For
example, the price of domestic steel is higher than imported steel even after
paying the transportation cost. Protection is not enough to narrow this gap.
Third, Japanese people now like to consume a wide variety of imported
products such as food, clothes and household goods for which domestic sup-
ply is nonexistent. For many goods, no Japanese factories can produce them.
Fourth, under the policy of rapid Westernization, a large amount of imports
is hardly avoidable.
Fifth, Japan is a student learning Western knowledge and technology. To
study more and faster, we need to pay high tuition.
Some say, “If we do nothing, we will lose all international reserves soon.”
But don’t worry. The trade balance may be in surplus or in deficit in the short
run, but there will be no great imbalance on average. The movement is natural
and cyclical. When we first opened our ports, we had trade surpluses for a few
years. Then, imports exceeded exports for the next three to four years. It is
certain that we will have surpluses again in the near future. The natural bal-
ance is always maintained, and this is the condition under which technology
and civilization should progress.

Meiroku Zasshi was Japan’s first modern scholarly journal which greatly stimulated
policy debate among intellectuals. However, the journal was terminated by a gov-
ernment order under the tightened speech control in November 1875. Its publication
lasted only one and half years.

Notes
1 Using an old-fashioned Marxian language, we may say that Matsukata Deflation founded the basis
of Japan’s coming capitalism and industrial revolution by producing the proletariat class detached
from productive assets (including land) and establishing the modern banking system that supported
the expansion of capitalists.
2 In the early 1870s, among the top earning foreigners in Japan, with their position, nationality and
monthly salary, were William Walter Cargill (advisor to the Railroad Department, Ministry of
Industry, British, 2,000 yen), Thomas William Kinder (advisor to the National Mint, British, 1,045
yen), Edmund Morel (advisor to the Railroad Department, Ministry of Industry, British, 850 yen),

59
 I mporting and absorbing technology

and Horace Capron (advisor on the development of Hokkaido, American, 833 yen). Udaijin (equiv-
alent to Prime Minister) Iwakura Tomomi received only 600 yen per month.
3 These industrial areas were severely affected by the Great Kanto Earthquake of 1923. Honjo recov-
ered strongly but Fukagawa, badly damaged by fire, did not. After the quake, key industrial areas
of Tokyo generally shifted toward the south. Omori and Kamata emerged as new industrial clusters.
Additionally, coastal industrial areas were created by landfill in the Keihin Area (between Tokyo
and Yokohama). Asahi Glass, Asano Shipbuilding, Asano Cement, Ajinomoto, Nippon Cable, Fuji
Electric, Tokyo Electric Power, Nisshin Flour, Mitsubishi Oil and Meiji Confectionery gathered in
this area by the Taisho period.
4 Nakamura Takafusa (1997) proposes the concept of new indigenous industry, which is an indigenous
industry modified by Western technology. This corresponds to I→I* in Odaka’s terminology.

60
5
D E VE L OPM ENT OF KEY I NDUSTRI ES

In this chapter, we will examine several important industries of the Meiji period. As noted
earlier, silk reeling was the top export sector of Japan throughout the Meiji and up until
the early Showa period, exporting silk yarns to the United States was the principal market.
At the same time, the cotton textile industry was a dynamically emerging sector shifting
from traditional, largely family-based technology to modern factory production, thereby
achieving import substitution, overtaking the British industry and leading Japan’s Industrial
Revolution. Meanwhile, the machinery industry was gradually taking root but was still rel-
atively weak. Late Meiji was a period of learning for the producers of railroad locomotives,
modern ships, electrical equipment, steel and automobiles. In the early years of the twentieth
century, most Japanese machinery was cheap but low in quality, and could hardly compete
with American or European products.

Silk industry
Silk production had been a traditional industry in Japan dating back to ancient times, perhaps
to the fourth or fifth century ad. During the Edo period, many hans promoted and pro-
duced cloth and kimono made of high quality silk. When Japan opened its ports and resumed
foreign trade in the mid-nineteenth century, Japanese silk suddenly found a voracious over-
seas demand, especially in the United States, mainly as a material for ladies’ stockings. The
export-led silk boom had several important consequences.
First, silk production—mulberry cultivation, silkworm raising and silk spinning—was
greatly stimulated and spread all over Japan, especially in eastern regions. Virtually all
farmers and villages fit for silk production tried to produce silk. This raised rural income sig-
nificantly, together with the production of dried tea leaves, another highly demanded export
product. This greatly changed the rural landscape and livelihood of Japan in the Meiji and
subsequent periods even though one can hardly find any mulberry tree plantation or silk
production anywhere in Japan today.
In many developing countries in the past and present, rapid industrialization and global
integration often impoverishes farmers and widens the income gap between urban rich
and rural poor (UNCTAD, 2004). In late nineteenth-century Japan, however, economic
integration with the mighty West did not generate such an income gap, thanks largely to
the silk boom. The tea export boom and rice inflation also contributed to rural income
enhancement. However, rural prosperity now critically depended on the market gyrations
of these primary commodities. When the prices of silk and/or rice were high, enriched
farmers and rural landowners enjoyed low tax rates (since the land tax was fixed nominally)

61
 D evelopment of key industries

and greater consumption, vigorously absorbed foreign ideas and technology, and staged
a political movement demanding Japan’s first constitution and criticizing the Meiji gov-
ernment for delaying it.1 When commodity prices plummeted, their reform movement lost
momentum and indebted farmers became landless. This was the risk of global integration
for a developing country facing domestic and international market fluctuations, which is
also present in today’s integrated world economy.
Second, a new class of merchants emerged. Under the unequal commercial treaties, Japan
had no tariff rights but, in turn, foreigners in Japan were without travel rights. Foreigners were
confined to the designated foreign settlements and their surrounding areas,2 with Yokohama
as the largest foreign settlement, and could not build their own commercial network in Japan.
Thus they were compelled to rely on Japanese merchants to procure silk and tea for export,
and supply British clothes and other Western goods to local markets. Japanese merchants
who played this role were new traders unrelated to rich merchant families of the Edo period.
They communicated price information, provided short-term trade credit to rural producers,
established new marketing channels, and even assisted in purchasing and installing new
machines and acquiring foreign technology. The so-called Yokohama merchants, and other
new merchants, mediated business between foreign traders and rural producers. Securing
ties with honest and helpful merchants was a life-or-death matter for regions engaged in
the production of export commodities. Renowned silk-producing localities emerged or
expanded in Nagano, Yamanashi, Gunma and Tohoku Region (all Eastern Japan) where such
merchants played critical roles in informing and restructuring producers. When successful,
producers and merchants shared huge profits. Quick and spontaneous emergence of producer-
supporting (rather than cheating) merchants at a time of great economic change was a unique
Japanese feature not always visible in other countries.
To be objective and fair, however, it must be reminded that not all Meiji-period merchants
were truthful. Foreign traders often bitterly complained about the dishonesty and corrup-
tion of some Japanese merchants. Water was sometimes added to silk yarn before weighing
because silk was sold by weight. Foreign buyers had to check whether the merchandise was
dry inside. At one time, the quality of Japanese silk became so low that its demand and price
fell significantly in the global market. In response, the government was forced to impose
quality standards and worried producer associations had to devise ways to ensure quality.
Third, the continuation of silk export was accompanied by the transformation of produc-
tion method and organization. Manual labor was gradually replaced by mechanized spinning
(I  M*: see Chapter 4 for notation). At first, silk production was undertaken by farming
families, which was later joined by mechanized factories (M*  M). To be more precise,
silkworm raising still remained family-based and spread across the country, but silk reeling
became increasingly automated in modern factories. Silk yarn remained the top export item
for nearly eight decades from the opening of the ports in 1859 up to the 1930s providing a
stable source of foreign exchange for Japanese industrialization.

Traditional cotton industry

The production of cotton textile products undergoes the following steps: (i) cotton harvest;
(ii) ginning and cleaning; (iii) spinning (producing yarn); (iv) weaving (producing fabric);
and (v) sewing and cutting (producing garment). Other processes such as knitting, dyeing
and printing may be added. As Odaka Konosuke emphasized (Chapter 4), indigenous and
modern sectors often coexisted in Meiji industrialization, and the cotton industry was no

62
 D evelopment of key industries

exception. For this reason, let us examine the traditional and the modern cotton industries in
turn. This section looks at the traditional production.
Like silk, the cotton industry has a long history in Japan. However, the indigenous method
of using wooden looms and household labor was far less productive than Western technology.
The traditional production was often organized as a putting-out system, where a merchant
concluded contracts with individual farm households to produce specified goods. The mer-
chant provided all materials and sometimes even tools, received finished products and paid
commission per piece. Production took place in farmers’ households using (usually female)
family labor. The question is how this antiquated mode of production survived the onslaught
of British imports and installation of modern factories. Why were they not wiped out?
There were several reasons. First, domestic demand for cotton products rose so fast that,
while imports increased, domestic production also had room to expand. Domestic demand
was rising because (i) farmers were enriched by the silk and tea booms noted earlier, and they
switched from homemade or second-hand clothes to external purchase; (ii) new merchants,
including Yokohama merchants mentioned above, succeeded in establishing a nationwide
sales network and (iii) the price of clothes relative to the general price level declined, which
further stimulated demand.
Another important reason was that Japanese and British cotton products were different
in use and not easily substitutable (Kawakatsu, 1991). Japanese cotton products used low-
count fibers and were thicker, which made them suitable for daily or workplace wearing,
while British cotton products used high-count fibers which were thinner, and were more
fashionable and formal.
While the traditional cotton industry thus survived and coexisted with the inflow of
Western merchandise, the impact of global integration significantly altered its production
organization. Vertically integrated producers that combined the production of raw cotton,
yarn and fabric declined, while specialized weavers using imported yarn prospered. Among
traditional cotton products, demand for plain white cloth fell while high-value, more dif-
ferentiated products such as creased, patterned and colored fabrics found a larger customer
demand. Some cotton-producing villages disappeared while new ones popped up. The sur-
vival and prosperity of traditional cotton regions under the integration shock depended very
much on the existence of helpful merchants who introduced appropriate imported materials
and developed new domestic markets for the producers (Saito and Tanimoto, 1989). Again,
the merchant’s productive role was essential in adjusting to a new environment.
Toward the end of the Meiji period, machines began to be introduced even in the tra-
ditional cotton sector. This was prompted by the need to improve efficiency in the face of
rising wages, cyclical recessions, and the worsening of the terms-of-trade, which means the
falling price of output (fabric) relative to input (yarn). Even though machines were intro-
duced, they were not exactly the same as the Western original. Production scale was smaller
and modifications were often made, including the use of as many wooden parts as possible
in place of steel. These can be considered modifications of the indigenous method (I  I*).

Modern cotton industry

We now turn to the modern cotton industry. This large factory-based production had to be
introduced as an entirely new technology from the beginning (M  M).
In early Meiji, Japan imported a large amount of cotton yarn as an input to domestic
cotton fabric production. The government considered yunyu boatsu (import substitution)

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of cotton yarn to be an important national goal. Model factories in cotton spinning were
established in the 1870s, but these state-owned enterprises did not succeed commercially.
The reasons for this included the lack of capital, the production scale (2,000 spindles) which
was too small for efficiency, the use of water power which was constrained by location and
operation time, and the lack of technical expertise.
The turning point came when Osaka Spinning (Osaka Boseki Kaisha), a private company,
was established in 1883 by the strong initiative of Shibusawa Eiichi, the super business
promoter who assisted establishment of hundreds of business firms and economic organiza-
tions (Chapter 3). Worried about rising cotton yarn imports, Shibusawa decided to create a
new company that could overcome the known defects of state-owned cotton spinning mills.
In particular, Osaka Spinning introduced the following innovations (Abe, 1990):

•• It was a joint stock company subscribed by big merchants and former daimyos who
were personally persuaded by Shibusawa to invest. As for working capital, loans from
the First “National” Bank,3 of which Shibusawa was the president, were made available.
•• It had a sufficiently large capacity of 10,500 spindles attaining economies of scale.
•• It had the use of a steam engine that permitted 24-hour operation.
•• It was located in an urban area which facilitated worker recruitment.
•• Yamanobe Takeo, who studied theory and practice of the textile industry in the United
Kingdom, was appointed as Chief Engineer (see Box 5.1).
•• It used low-cost Chinese cotton instead of domestic cotton.
•• It used advanced machinery, including the adoption of the latest Ring Spinning Machine
instead of the Mule Spinning Machine.

Osaka Spinning was an instant success. Although 1883, the year of its establishment, was a
year of business recession (Matsukata deflation, Chapter 4), the company was profitable from

Figure 5.1 Profits of Osaka Spinning in the early years

Source: compiled from Hanai (2000), pp. 120–121.

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 D evelopment of key industries

the outset (Figure 5.1). The lesson we can draw from the experience of Osaka Spinning is that
competitiveness depends critically on the choice of appropriate technology which includes
the size, location and mode of operation. In addition, the combination of strong manage-
rial leadership (Shibusawa) and deep practical knowledge (Yamanobe) was instrumental.
Without these, purchasing expensive machines alone would not have achieved efficiency.
The success of Osaka Spinning had a powerful demonstration effect. Soon, several spin-
ning factories modeled after Osaka Spinning were established. Largest among them were
Hirano, Amagasaki, Settsu and Kanegafuchi (later renamed to Kanebo), which were con-
centrated in the Kansai area in Western Japan. Initially, their products were sold to domestic
traditional weavers and contributed to import substitution of cotton yarn as Shibusawa
intended. Later, their products were also exported as well as used internally to produce fabric
within these factories. Young female workers were recruited to work in these factories often
under hard and inferior working conditions. Factories competed fiercely to hire and retain
such female workers. Recruiting missions were often dispatched to rural areas. Competent
male textile engineers were in even greater shortage.
As the modern cotton industry emerged to become the mainstay of Japanese manufactur-
ing, it faced two problems. The first was the recession that peaked around 1900, forcing even
large factories to restructure, merge or even close. The number of modern spinning factories
declined from 78 in 1899 to 49 in 1904. After the shakeout, the three largest spinners, Osaka,
Toyobo and Dainihon, began to dominate the industry.
Another problem was the conflict of interest between company owners and management.
The shareholders of spinning companies were rich merchants or former daimyos not inter-
ested in the textile business per se and wanting quick and high returns on their investment.
By contrast, top managers and skilled engineers were well informed about technology and
market trends. Their priority was to invest in technology and capacity to ensure long-term
growth of the enterprise. The former pressed for large dividends while the latter preferred
retention of profits for reinvestment. This tension sometimes escalated to the level where
shareholders demanded the resignation of the management. In the early years of Osaka
Spinning, the profit was divided roughly equally between dividend payments and retention
for further investment (Figure 5.1).

The machinery industry

Meiji industrialization was light manufacturing industrialization led by textiles while the
machinery industry was still feeble and internationally uncompetitive. Japanese machines
were imitations of Western models. The machinery industry still heavily depended on for-
eign technology and imports. “Made in Japan” meant low price and low quality. During
Meiji, machinery was only imported and not exported. Nevertheless, technology was being
absorbed, and preparation for the giant leap in the Taisho and Showa periods (1910s–1930s)
was being made (Sawai, 1990).
Initially, state-owned military mills dominated the machinery industry. Backed by the
central government and its budget, they were large in size and equipped with the newest
machines imported from Europe and America, and directed by hired foreign managers.
By contrast, private companies were smaller and less modern, and used second-hand or
Japanese machines.
But private-sector manufacturing was also growing, albeit gradually. Largest among pri-
vate companies were shipyards and railroad carriage factories (Table 5.1). Medium-sized

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ones included electrical companies such as Shibaura (later Toshiba), NEC, Oki and Hitachi.
Meanwhile, small companies produced miscellaneous components and devices. The input–
output linkage between large and small firms was still weak. Large factories imported most
machines and produced the remaining machines and inputs internally. Domestic procurement
from Japanese subsidiaries and suppliers was insignificant at first. In other words, “supporting
industries” (a term used for component suppliers and material processing firms serving large
assembler firms) did not exist during Meiji.
In Tokyo and Osaka, manufacturing SMEs began to emerge in certain areas and spon-
taneously formed industrial districts. They tended to gather around large anchor factories.
In Shiba area in Tokyo, near Tokyo Tower and Hamamatsu-cho Station today, large anchor

Table 5.1 Largest enterprises by employment size (1907)

No. Enterprise Employees Ownership

1 Ministry of Communications 152,869 State-run

2 Railroad Agency 88,266 State-run
3 Furukawa Mining 30,125 Private
4 Mitsubishi Mining 24,245 Private
5 Kure Naval Factory 21,056 State-run
6 Monopoly Bureau, Ministry of Finance 20,563 State-run
7 Tokyo Army Weapons Factory 19,668 State-run
8 Mitsui Mining 17,472 Private
9 Mie Spinning 13,393 Private
10 Kanegafuchi Spinning 12,204 Private
11 Kaijima Tasuke (coal mining) 12,144 Private
12 Yokosuka Naval Factory 11,937 State-run
13 Osaka Army Weapons Factory 11,545 State-run
14 Mitsubishi Shipbuilding 10,921 Private
15 Hokkaido Coal Mine Steamers 10,201 Private
16 Kyoeki Trading 10,000 Private
17 Fuji Gas Spinning 9,573 Private
18 Osaka Spinning 9,474 Private
19 Fujita Gumi (zaibatsu) 8,837 Private
20 Yawata Steel Works 8,584 State-run
21 Kawasaki Shipbuilding 8,483 Private
22 Yasukawa Keiichiro (coal mining) 7,241 Private
23 Sesebo Naval Factory 6,858 State-run
24 Settsu Spinning 6,450 Private
25 Tokyo Railway 6,373 Private
26 Sumitomo Kichizaemon (mining) 6,114 Private
27 Osaka Shosen (shipping) 5,271 Private
28 Osaka Godo Spinning 4,615 Private
29 Kenshi Spinning 4,114 Private
30 Imperial Hemp Spinning 3,914 Private
...

101 Shibaura Manufacturing (Toshiba) 989 Private

126 Seikosha 700 Private
Source: Ministry of Commerce and Industry, Factory Database, 1907.
Note: Numbers include workers and miners only. Office staff are not counted.

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firms such as Shibaura Engineering Works (private), Naval Weapons Factory (state-owned)
and Mita Manufacturing (state-owned) were located. Surrounding them, small private firms
were established to produce mechanical devices and parts.4 Another industrial district in
Tokyo was Honjo-Fukagawa area on the left bank of the Sumida River. This district special-
ized in metal products such as nuts, bolts, springs and the like. In these industrial districts,
SMEs not only competed for orders but also cooperated in production with each other. If one
factory did not have the right equipment to do a certain work, it would ask a neighboring
firm to do it, and vice versa. Some of the SMEs became subcontractors of larger firms. The
accounting system of SMEs long remained informal and pre-modern.
Capable engineers liked to move from factory to factory for experience and skill building.
Inter-firm migration such as this facilitated technology transfer and emergence of manu-
facturing SMEs. Graduates from the Institute of Technology and technical high schools
(Chapter 4) first worked at state-owned factories or at relatively large private companies.
After acquiring sufficient skills and knowledge, many of them moved to smaller private
companies or established their own. In this way, Western technology was diffused widely
and naturally within the machinery industry.
Japanese managers and engineers were generalists rather than specialists, and job hopping
was very common. Japanese workers were also characterized by their lack of discipline and
low savings. Japanese labor force in the late nineteenth and early twentieth century was more
“neoclassical,” quite different from the faithful labor force in the post-WW2 era. To further
promote industrialization, Japan had to transform these light-footed engineers and workers to
stay in one place in order to let them absorb and develop firm-specific skills and knowledge.
Japan later succeeded in doing this partly during the 1910s and more during the war time
(1937–45, see Chapter 9).
The following sections will look at some of the prominent subsectors within manufacturing.

Figure 5.2 Average duration of male employment in manufacturing

Source: compiled from Sawai (1990), p. 218.

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 D evelopment of key industries

Steel
In mid to late Meiji, Japanese steel production was able to cover only about 20 percent of
domestic demand, with the rest supplied by imports. This figure was much lower than those
of other late industrializing countries in the nineteenth century such as France, Germany and
the United States whose domestic supply ratios ranged from 70 to 90 percent (Suzuki, 2000).
This partly reflected the backwardness of Japanese steel technology, but the lack of tariff
protection, imposed by the unequal commercial treaties with the West, also contributed sig-
nificantly to the penetration of imported steel. Japanese tariff rates were uniform 5 percent
over all goods while the countries mentioned above carried steel tariffs between 20 and
100 percent. The higher transport cost to the Far East, which provided natural protection for
Japanese producers, was not enough to offset the higher cost of domestically produced steel.
It was estimated that Kamaishi, the first Japanese steel mill using blast furnace technology,
established by the government in 1880 but soon privatized, needed at least 30 percent tariff
protection to compete with imported steel.
In 1895, the government decided to build a state-of-the-art steel mill by using part of the
reparation received from Qing Dynasty, China as a result of a victorious war in 1894–95.5
After research, German technology of Gutehoffnungshütte (GHH) was selected and Yawata
in Northern Kyushu was identified as the appropriate location. A large number of German
managers and engineers were mobilized with high salaries for construction and operation.
The first blast furnace of Yawata Steel Works went into operation in 1901, but produc-
tion was often interrupted, output was far below capacity and a loss was incurred. German
technology, without local adjustments, did not ensure smooth operation. The causes were
found to be the lack of coke oven and the unsuitable content of iron ore. The government
additionally built a coke oven and began to select materials carefully. Japanese engineers
from Kamaishi were called to actively adjust the blast furnace and modify the operation
method. By 1905, steel production at Yawata became efficient and smooth. From then on,
Yawata’s capacity was expanded in many aggressive steps to serve as the largest steel mill in
Japan for half a century up to the WW2 period. Yawata is often cited as the proof of Japanese
capability to quickly learn, adjust and internalize imported technology so it works best in the
local context.
As Japan gradually regained tariff rights, steel tariffs were raised to 5–10 percent in
1899 and 10–20 percent in 1911. This stimulated Mitsui and Mitsubishi Groups to invest
in steel production, but Yawata’s dominance and technological edge were not affected by
additional entry.

Railroad carriages and locomotives

Railroad locomotives and carriages are quite different in technological requirement. The for-
mer are far more difficult to manufacture than the latter. Throughout Meiji, about 25 percent
of railroad carriages were imported and the rest were domestically produced. Among domestic
producers, Shimbashi Factory and Kobe Factory, both state-owned, were the largest, which
together accounted for 64 percent of domestically produced railroad carriages.
As for locomotives, all had to be imported at first but the government wanted to pro-
mote domestic production. In 1900, the first railroad locomotive was test-produced through
cooperation of the state and private sector. State-owned Shimbashi Factory provided the

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blueprint to Japan Railroad and Kansai Railroad, two targeted private companies, and
engineers were exchanged between the state and the private sector. In 1912, the Railroad
Agency nominated four private companies to copy-produce locomotives. But since these
companies were still technically incompetent, the government offered handholding support,
making available technology, materials, production management, training (which included
opportunities to study abroad) and the guarantee of official procurement of finished prod-
ucts. In this way, the government pampered the burgeoning railroad industry which, thanks
to such assistance, eventually came to possess world-class locomotive technology during
the inter-war period.
During the Meiji period, railway construction was booming. There were both state-run
and private railroad operators. However, in 1906, the government nationalized virtually
all private railroad companies. This was carried out partly for military reasons and partly
because many of the private railroad operators were unprofitable due to excessive construc-
tion relative to transport demand. Railroads tended to be overbuilt because politicians liked to
promise more and more railroads in their constituencies in preparation for the next election.
Vote-buying such as this is prevalent in any age and country.

Shipbuilding and ocean transport

Among domestic shipyards, two private firms, Mitsubishi Shipbuilding in Nagasaki and
Kawasaki Shipbuilding in Kobe, dominated. Both were former state-owned factories sold
to influential business groups. In the early days, ship repairing was more profitable than
building new ships.
About half of the orders for new ships came from domestic private ship operators, and
the rest were produced for the navy or exported to China, Thailand and other countries.
Under the Shipbuilding Promotion Law of 1896, the government supported the shipbuilding
industry by offering subsidies for companies that built large-sized ships above 700 tons
(later, above 1,000 tons). The construction of naval ships was not very profitable but the
government supplied all materials. Due to the lack of supporting industries, shipbuilders
produced most parts internally.
Approved in the same year, the Navigation Promotion Law subsidized ocean transport
operators if they operated international routes or possessed large ships over 1,000 tons or
fast domestic ships. These thresholds were also raised in steps and the amount of subsidies
was increased over time.
As a result of these conditional (performance-based) but generous subsidies, the ship-
building industry expanded significantly. Japanese ship production, which hardly reached
10,000 tons per year before 1896, rose to 80,000 tons per year by the time of the outbreak of
WW1 (1914). As noted above, Mitsubishi and Kawasaki were the two largest shipbuilders as
well as the largest receivers of state subsidies related to tonnage, ship type, engine type and
horsepower. Osaka Shipbuilding was the third largest but the amount of subsidies received
was much less than the top two firms. Even smaller shipbuilders such as Ishikawajima, Ono
and Uraga built fewer ships and received far less in subsidies. As for ocean transport, Nippon
Yusen, established by the Mitsubishi Group and later merged with a rival firm, dominated. It
also received ample subsidies from the state, with amounts in some years so large as to turn
the operational loss into profitability (Ando, 1979).

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 D evelopment of key industries

Electrical machinery
Shibaura Engineering Works (later Toshiba) was founded by inventor Tanaka Hisashige.
Initially, it was a relatively small operation with 502 workers producing military goods. When
naval factories stopped procuring from Shibaura and started internal production of compo-
nents, Tanaka shifted to the production of electrical machines for private use such as generators
and transformers. When Shibaura faced a financial crisis, Mitsui Zaibatsu came to the rescue.
Shibaura also established business cooperation with General Electric (United States). Similarly,
Mitsubishi Electric Company cooperated with Westin House (United States) and Furukawa
Electric Company worked with Siemens (Germany).
Even with hard efforts for domestic production, imports still dominated the Japanese mar-
ket of generators and transformers in Meiji. Foreign products, mainly from the United States,
accounted for about 75 percent of the total supply in 1911. Toshiba had a market share of
16 percent and produced low capacity generators compared with American products.
There was a debate within the Japanese government regarding whether the national tele-
phone network should be laid privately or by the state. The government finally decided to
build it by itself. The business of supplying telephone equipment to this national project was
considered highly lucrative. To win this contract, Western Electric approached Oki Electric to
produce telephone equipment but Oki refused. Western Electric then set up Nippon Electric
Company (NEC), a joint venture with Japanese partners, in 1898 with the American capital
share being 54 percent. Oki and NEC subsequently competed for the official procurement of
telephone equipment.
NEC was initially only a sales agent for Western Electric products, but soon began to pro-
duce its own products and became more independent from Western Electric. NEC’s success
was due to the availability of foreign technology and capital, secured markets of telephone
equipment through government procurement and the Japanese company’s high technical
absorptive capacity.

Box 5.1 Shibusawa, Yamanobe and others

In 1877, Yamanobe Takeo was a twenty-six-year-old student majoring in economics
and insurance theory in London. One day he received a letter from an unknown gentle-
man in Japan. The sender’s name was Shibusawa Eiichi. The letter said something like
this: “Dear Yamanobe, your name was mentioned by a friend of mine. Japan imports
too much cotton yarn today. We need to establish a domestic spinning industry. We
need people who know both management and technology. Will you please study the
cotton industry? I will create a company.”
Perhaps Yamanobe was annoyed. Who is this man to tell me to change my subject?
But after thinking a while, he decided to follow Shibusawa’s advice. He went to King’s
College where he studied textile industry theory. But theory alone was not enough. He
moved to Manchester, the then world capital of the textile industry. He posted ads in
newspapers: HIRE ME AS COTTON INDUSTRY TRAINEE, WILL PAY, but no
company responded. Finally, he met Mr. W. E. Braggs who allowed Yamanobe to
work and absorb practical knowledge in his factory for eight months. Learning included
technology, marketing and shipping. Yamanobe worked very hard. Shibusawa sent him
1,500 yen to support the study. Shibusawa later recollected that this was a huge sum

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even for him and sending it to Yanamobe was like jumping off the stage of Kiyomizu
Temple (a phrase implying a bold and very risky decision).
When his study ended, Yamanobe placed orders to buy textile machines and steam
engines from renowned manufacturers such as Platt and Hargreaves, and returned
to Japan. In 1882, Shibusawa and Yamanobe selected an appropriate factory site in
Osaka. To establish the company, 250,000 yen was collected from rich merchants and
friends of Shibusawa. Shibusawa’s bank, First National, would lend working capital.
Osaka Spinning was successfully launched in 1883. Yamanobe became the Chief
Engineer of the factory.
Around 1900, there was a severe textile recession. Shareholders demanded
higher and quicker returns. But Yamanobe insisted on long-term development of the
company. Even the General Director criticized him. Being desperate and wanting to
quit, Yamanobe visited Shibusawa’s residence. Shibusawa assured Yamanobe that
he would support him 100 percent and requested him to continue to work for the
company. Convinced, Yamanobe stayed. When the recession ended, Yamanobe was
promoted to the President of Osaka Spinning Company.
Let us meet one more person in the textile industry, Fuji Masazumi, a super factory
renovator of Kanegafuchi Spinning (Kanebo). He graduated from Keio University and
worked in the sales department of Suminodo Factory of Kanebo. This factory suffered
from obsolete machines, a lack of work discipline and low capacity utilization. He
worked 18 hours a day to replace or repair old machines and recruited 500 new workers.
He restored the factory to full operation in three months. He was then promoted to the
Managing Director of Kanebo’s Tokyo Factory. This factory was another disaster. He
repaired, invested and improved. He reduced the workforce from 4,000 to 1,620. After
three years, the factory became very profitable. If Mr. Fuji were still alive, he could be
dispatched to any failing factory in any country.
What do we learn from these stories? Meiji industrialization was achieved by these
powerful and risk-taking individuals brimming with energy, vision and leadership.
Meiji Japan, whether urban or rural, was full of such people, not just Shibusawa,
Yamanobe and Fuji, and Japan relied on them for realizing a latecomer industrial
revolution. New laws, deregulation and level playing fields are perhaps not enough.
If Shibusawa did not write the letter to Yamanobe in London, Japan’s textile industry
may not have taken off. If so, the real question is, how can we generate such wonder-
ful people continuously in a society? Japan also has ups and downs and it currently
seems unable to produce great business heroes or statesmen in sufficient abundance to
overcome economic stagnation.

Notes
1 Under the Movement for Freedom and People’s Rights, it was decided in 1880 that local chapters of the
Movement should draft their own constitution proposals. At least 90 constitutional manuscripts were
prepared by opposition politicians and intellectual groups all over Japan. Spontaneous study groups in
rural areas also participated actively in this drafting, whose proposals were usually more advanced and
democratic than the Meiji Constitution which was actually adopted by the government in 1889.
2 The commercial treaties permitted foreigners to travel freely within ten Japanese miles (about
40 kilometers) of foreign settlements. For foreign residents in Yokohama, this meant free access to a
large part of today’s Kanagawa Prefecture and a small western part of the Tokyo Metropolitan area.

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However, Edo (Tokyo) and Hakone were excluded. To travel outside, an internal passport had to be
obtained, with the purpose of academic research or medical treatment only (not for trading). The
Western diplomatic corps demanded relaxation of this regulation, and a simplified procedure was
later adopted for visiting hot springs in Hakone and Atami.
3 The Meiji government initially tried to create a banking system modeled after the American system
which had no central bank. Private banks were nationally certified to operate as banks and issue
money provided that they held specified amounts of reserves (Chapter 6). The First National Bank
established by Shibusawa, who at that time was a Ministry of Finance official, was the first private
bank to be certified by the government. Subsequent private banks were numbered sequentially up to
the One Hundred and Fifty-third National Bank. Eventually the American model was abandoned and
the Bank of Japan, a central bank, was established in 1882.
4 Later, in 1939, Toshiba was created by merging Shibaura Engineering Works and Tokyo Electric
Company. Today, one can see Toshiba Head Office from Yurikamome train—that is where Shiba
Industrial District was located. However, the area was twice destroyed, by the Great Kanto
Earthquake in 1923 and US aerial bombing in 1945, so no sign of Meiji industrialization remains.
5 However, the closing balance of the Special Account for Japan–China War Reparation in 1902
reveals that only 580,000 yen (0.2 percent) of total reparation amounting to 365 million yen was
allocated to the construction of Yawata Steel Works while 84 percent went to military buildup.

72
6
B UD GE T, FINANCE AN D THE
MAC R O ECONOM Y OF MEI J I

The two wars

One of the key national goals of Meiji was external expansion. Japanese political leaders,
spearheaded by Yamagata Aritomo who served as prime minister in 1889–91 and 1898–1900,
felt that it was necessary to create a sphere of influence around the nation to protect its
interests from interventions of the West or neighboring countries. In late Meiji, the greatest
potential threat to Japan was the eastward expansion of Russia’s Romanov Empire. To guard
its national interests, Japan wanted to construct a “line of interest” beyond its national border.
That specifically meant placing Korea under Japanese influence.
In his speech at the just-established Imperial Parliament in 1890, Prime Minister Yamagata
argued as follows:

There are two ways to secure national independence and integrity. The first is to
protect the line of sovereignty. The second is to protect the line of interest. The
former means the nation’s border and the latter includes areas closely related to
national security. Every country defends both. Under the present circumstance,
to maintain our independence and stand against the Western powers, defending the
line of sovereignty is not enough. We need to protect our line of interest as well.

But China’s Qing Dynasty considered Korea as its protectorate. Japan’s ambition over
Korea naturally clashed with Chinese interests. In Korea, the political situation became
unstable as the Japanese army staged military provocations and the assassination of a
Korean queen. Finally, Japan and China opened fire over Korea in the Japan–China War
(1894–95). Japanese battleships, strategy and discipline won over China’s older method of
fighting. Although Chinese equipment was also modern, its strategy was poorly designed
and the morale of soldiers was low. After this victory, Japan obtained from China repara-
tions amounting to 310 million yen in gold (paid in sterling-denominated checks which
Japan held as gold reserves in London), the territory of Taiwan as Japan’s first major colony
and the Liaodong Peninsula facing the Yellow Sea. However, Japan was immediately forced
to return the Liaodong Peninsula to China under joint pressure from Russia, Germany and
France (led by Russia). Japan felt deeply humiliated at this incident which proved that it was
still a much weaker power than the West.
Even after Japan’s victory over the Qing Dynasty, Korea and the northeastern region of
China, called Manchuria, remained under Russian influence. Russia gained territorial and

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economic concessions and kept large troops in Manchuria. This inevitably collided with
Japan’s expansionist policy. To deter Russia, Japan went into military alliance with the
United Kingdom in 1902. Within ten years of the Japan–China War, another major war,
the Japan–Russia War (1904–5), broke out over the sphere of influence. Most foreign
observers predicted an easy Russian victory. But surprisingly, despite a heavy human toll,
the Japanese army conquered Russia’s mighty Lushun Fortress located on the Liaodong
Peninsula and the Japanese navy decisively defeated Russia’s Baltic Fleet in the Battle of the
Japan Sea. Following this naval triumph, the Japanese government asked the United States
to mediate a peace treaty between Japan and Russia because continuation of the war would
surely lead to a serious fiscal crisis for Japan (the approach to the American government had
been made in advance).
The victory over Russia was regarded as a proof that Japan, a non-Western latecomer, had
finally become a first-class nation on a par with the West. National pride ballooned and the
rest of the developing world took notice. At the same time, Japanese people and media were
infuriated at Russia which paid no war reparation—even though Japan obtained from Russia
the southern half of Sakhalin Island as well as the Liaodong Peninsula which included the
military port of Lushun and the commercial city of Dalian. An angry mob gathered in Hibiya
Park began to attack police stations, a newspaper firm and American facilities. Meanwhile,
the Japanese government was happy just because the war ended before it went bankrupt.
Japan annexed (colonized) Korea in 1910. Meanwhile, in 1917, the Russian Revolution
terminated the Romanov Empire as a communist regime took over.

Fiscal activism and postwar management

What impact did the two wars have on Japan’s industrialization and macroeconomic policy
stance? To consider this, we need to look back a little.
When the first session of the Imperial Parliament was convened in 1890, the hottest issue
was whether Japan should adopt fiscal activism or fiscal austerity. The government wanted
more spending for industrialization and military buildup while the opposition parties, which
held the majority, demanded tax and spending cuts. The latter reflected the voice of voters,
most of whom were rich farmers and landlords obliged to pay the land tax. The govern-
ment responded with the principle of chozenshugi, or ignoring demands of political parties
in policy formulation, a clearly untenable proposition if parliamentary politics was to be
guarded. The first parliamentary session managed to avoid a complete showdown but the
subsequent sessions were not so easy. Gradually, some opposition parties changed tactics
and began to cooperate with the government. Instead of demanding a small government,
they asked for active public spending in their constituencies. On the government side, Ito
Hirobumi, the first Japanese prime minister who formed governments three more times, pro-
posed that a pro-government party should be established rather than permanently insisting
on chozenshugi. Rikken Seiyukai, headed by Ito, was established in 1900 as a conservative
pro-spending party.
During the two wars, military spending sharply increased. Prior to the Japan–Russia War,
even foreign bonds were floated in America and Europe to cover roughly half the war expense.
This practically ended the debate over the fiscal policy stance as the national budget had to
be increased to execute wars. Moreover, even after each war, public spending was expanded
rather than contracted to a previous level. Because of this fiscal ratchet effect, the size of gov-
ernment continued to rise. The term Postwar Management referred to the aggressive public

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 B udget , finance and M eiji macroeconomy

investment and spending programs of both central and local governments after the Japan–
China War and the Japan–Russia War, which included:

•• continued military buildup, with the largest bill for battleship construction;
•• railroad construction;
•• integrated steel works in Yawata (Chapter 5);
•• laying of a national telephone network;
•• management of Taiwan which included colonial administration and business investment;
•• infrastructure such as roads, water supply, urban trams, etc. which was mainly built by
municipal governments;
•• education spending undertaken mainly by local governments.

As a result of continued fiscal expansion, balance-of-payments pressure mounted and

the Bank of Japan was quickly losing gold reserves. Japan prior to WW1 was facing an
increasingly serious macroeconomic crisis (Figure 6.1).

Exchange rate policy

Britain adopted the gold standard in 1821 and all other major Western countries, includ-
ing the United States, also shifted to the gold standard by the end of the 1870s. While the
West was thus on the international gold standard, Japan, at least externally, remained on
the silver standard. Gold, silver and copper coins circulated internally but silver was the

Figure 6.1 Central and local government expenditure

Source: Statistics Bureau of Management and Coordination Agency, Historical Statistics of Japan Vol. 3, pp. 240–241
and p. 289, 1988.

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 B udget , finance and M eiji macroeconomy

means of international settlement. This was mainly because the silver standard was dom-
inant in East Asia where Shanghai was the center of foreign exchange markets.
The price of silver gradually declined against gold in the late nineteenth century. This
meant that the Japanese yen, tied to silver, automatically depreciated against the world’s
major currencies, lowering Japanese costs and providing a favorable condition for export
promotion (Figure 6.2). However, Finance Minister Matsukata Masayoshi, who earlier
imposed what was called Matsukata Deflation to stop inflation and monetary confusion in
the early 1880s, now insisted that Japan should adopt the gold standard as soon as possible
to join the rank of first-class nations. Ignoring opposition, Matsukata introduced the gold
standard in 1897. The initial gold reserves were secured by the reparation gold paid by China
as mentioned above. From this time onward and up to WW1, the Japanese yen was fixed
against major currencies at the parity of two yen to the US dollar.
As a result, automatic depreciation of the yen ended. Japanese inflation converged to
world inflation, which was close to zero. Due to the disappearance of exchange risk and
the confidence that came with the membership of the international gold standard, it became
easier for the central and local governments of Japan to issue foreign currency-denominated
bonds. They did frequently issue such bonds to cover war costs as well as the cost of building
local infrastructure as explained above.

Banking and capital markets

In early Meiji, the Japanese banking system was chaotic, to say the least, and development
of a modern and stable banking system took a long time. The initial policy in 1872 of creat-
ing “national” banks (actually, state certified private banks), copied from the United States,
was not very successful. This decentralized system had no central bank, and each “national”
bank could issue bank notes with the backing of gold reserves. But holding gold reserves
was costly and initially only four banks were set up. Later, the gold reserve requirement was

Figure 6.2 Yen–dollar exchange rate

Source: Management and Coordination Agency, Historical Statistics of Japan, vol. 3, pp. 104–107, 1988.

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relaxed and a total of 153 banks were created. But eventually, this system was regarded as
ineffective and abolished.
The modern banking system began to take root with the creation of a central bank
(Bank of Japan) in 1882, which from then on was the only entity to issue the national
currency. In addition to private commercial banks, the following specialized banks were
created to fund national or important investment projects:

•• Japan Kangyo Bank (later, through merger, Daiichi Kangyo Bank and now part of the
Mizuho Financial Group created in 2000; Kangyo means industrial promotion);
•• Hokkaid Takushoku Bank (bankrupted in 1997; takushoku means development by
opening new land);
•• Industrial Bank of Japan (now part of the Mizuho Financial Group);
•• Bank of Agriculture and Industry (set up in each prefecture; merged into Japan Kangyo
Bank by 1944).

In addition, postal savings, accepted at post offices, began to collect people’s savings.
Insurance companies, agricultural credit unions and urban credit unions also began to function
as financial intermediaries.
Until late Meiji, despite such institutional developments, Japanese banks were not true
financial intermediaries in the sense of taking deposits and making loans. At first, paid-in
capital, reserves and government deposits—not people’s small but numerous deposits—
dominated the liabilities side of the banks’ balance sheet. For early banks, designation as
the government’s fiscal depository was a very profitable business, because banks did not
have to pay interest on official deposits between the time taxes were collected and the time
they were withdrawn against government spending. Only towards the end of Meiji, banks
began to rely more on private sector deposits as a funding source. But even then, many
banks remained unsound on the assets side, with the general lack of information disclosure,
risk management, portfolio diversification or project evaluation. Local banks were often
lending to only one or a few business enterprises, with the bank and the enterprise usually
both owned by the same owner. Such banks were called kikan ginko, which literally trans-
lates as “institution banks” but really means banks subordinated to and financing only a very
small number of businesses. This situation subsequently exploded in an enormous bad debt
problem in 1927 (Chapter 8).
The total number of banks, including all types, rose from the first establishment of two
banks in 1872 to 320 in 1882, then stabilized around 350 for about a decade. But it began to
shoot up in 1893 and reached the peak of 2,358 in 1901 and continued to stay above 2,000
until 1921 (Bank of Japan data). It is highly questionable whether a developing country with
the economic size of Meiji and Taisho Japan needed more than 2,000 banks, most of which
were very small and of dubious quality. The number began to fall thereafter and decline
accelerated due to the banking crisis in 1927 and the wars in the 1930s and 1940s. From
1955 to 1985, during the post-WW2 high growth and subsequent slowdown, the number of
Japanese banks was unchanged and much smaller at 86.
Limited data suggest that agricultural and industrial businesses relied heavily on informal
finance throughout Meiji and even up to early Showa (Teranishi, 1990). In 1888, 92.8 percent
of farmers borrowed from traditional sources that included money lenders, merchants, rela-
tives, and mutual financing schemes. The percentage of informal finance gradually declined,
but even as late as in 1932 it occupied 52.7 percent of farmers’ borrowing. In the same year,

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manufacturers in Tokyo and Kobe sourced 39.2 percent of their external finance through
informal channels. The prevalence of informal finance is a feature of virtually all developing
countries, not just in pre-WW2 Japan.
All this points to the fact that creating a sound banking system in a developing country is a
very difficult and long-term endeavor. The introduction of banking laws and financial dereg-
ulation will not be enough to achieve this. Transformation of commercial banks into genuine
intermediaries between small savers and business investors requires proper institutions and
ample experience in contract enforcement, project evaluation, risk management, prudential
regulation, macroeconomic monitoring, financial innovation and much more.
As for the capital market, the first stock exchanges were created in Tokyo and Osaka in
1878. At first, few stocks were traded and these exchanges functioned mainly as a secondary
market for government bonds. Former samurai who received government bonds in exchange
for the previous rice salary often wished to sell them as they faced financial distress. In
the 1880s, as many railroad companies were established, railroad bonds gradually became the
most important instruments for stock trading. In the 1890s, the shares of maritime transport
companies became popular. After 1906, when private railroads were nationalized, the shares of
textile and food processing companies replaced railroad stocks.

Savings mobilization
If the banking system was still embryonic, where did the funds for Meiji industrialization
come from? Data are incomplete, and economic historians are still debating. Here, let us look
at the estimates provided by Teranishi Juro (1990).
Teranishi estimates the savings–investment balance of Japan from 1899 to 1937 (Table 6.1).
He does not have data for early Meiji, before 1899, but his analysis covers up to early Showa.

Table 6.1 Estimated savings–investment balance by sector

(In millions of yen)

1899– 1903– 1908– 1913– 1918– 1923– 1928– 1933–

1902 1907 1912 1917 1922 1927 1932 1937

Private farms 1 13 4 43 207 23 −12 222

Savings 121 159 175 240 657 523 402 580
Investment 120 146 171 197 450 500 414 358
Non-farm private sector 62 123 −87 175 81 −290 631 931
Savings 180 310 212 752 1724 858 1498 2637
Investment 118 187 299 577 1643 1148 867 1706
Government −59 −233 15 120 −146 −112 −626 −1162
Savings 24 −142 205 317 441 801 251 −298
Investment 83 91 190 197 587 913 877 864
External sector (net) 5 −97 −68 338 143 −380 −6 −10
(Memorandum item)
Land tax 104 115 154 166 290 291 188 145
(In percent of non-farm gross 42.0% 38.4% 28.0% 24.2% 19.4% 13.8% 9.0% 11.3%
investment)
Source: Teranishi (1990), p. 68, p. 70.
Note: the S-I balance of private farms is transfer of surpluses to the non-farm sector through the financial system
while land tax is transfer of surpluses through government budget.

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He classifies the economy into four sectors: private farms, non-farm private enterprises, gov-
ernment and the external sector. He additionally estimates the size of the (agricultural) land
tax. The following interpretation by Teranishi is consistent with his estimates though other
interpretations may be possible.
First, in pre-WW2 Japan, the largest amount of funds for industrialization came from
within the non-farm private sector itself. Retained profits, personal and family savings, and
resources of rich merchants and businessmen seem to have been mobilized for private invest-
ments through self-finance, collected funds, the creation of joint stock companies and so on.
Second, fiscal transfer from agriculture to industry must also have played an important
role to the extent that the land tax paid by rural communities was used to finance public
investment and industrial subsidies. However, Teranishi somewhat downplays the role of
landlords as a major contributor to saving mobilization since the ratio of agricultural tax to
total investment declined over time. Nevertheless, such fiscal transfer may well have been
substantial in early Meiji, a period that Teranishi’s data does not cover.
Third, foreign savings played some role toward the end of Meiji as foreign-currency
denominated bonds were issued by the central and local governments, as discussed above
and explained in the next section.

The role of external funds

Quantitatively speaking, the contribution of foreign savings to industrialization was rela-
tively small during the Meiji period. Almost all necessary funds were raised domestically.
Meiji Japan did not welcome FDI or foreign loans for industrialization, except for the
public-sector borrowing in late Meiji for the purpose of war execution and Postwar
Management as mentioned above. Initially, as a matter of principle, the government rejected
the incurring of external liabilities for fear of foreign control. This was in sharp contrast to
other latecomers, such as Russia and Italy, during the same period. Russia borrowed heav-
ily from financial markets in London to build railroads in the 1860s and 1870s. Italy also
accepted large amounts of foreign investment in all sectors in the late nineteenth century.
In Japan, reliance on foreign saving did increase as Meiji progressed even though it did
not become a major financial source for industrialization. Let us follow the events step
by step.
In early Meiji, in 1870 and 1873, the government issued foreign bonds for railroad con-
struction and the redemption of samurai salaries, respectively. After this, there was a debate
within the government on the desirability of further borrowing for the purpose of creating a
modern monetary system. But the idea was eventually turned down. Foreign borrowing was
not resumed until the late 1890s.
After the victory of the Japan–China War (1894–95) and the receipt of reparation gold
from China, a fixed exchange rate and the gold standard were adopted. This made it easier
for Japan to issue foreign bonds. On the other hand, a pursuit of fiscal activism, accelerated
by the formation of Rikken Seiyukai in 1900 which strongly supported public spending,
required additional financial resources. In order to ameliorate financial crises and credit
shortage, the business community also began to call for external borrowing.
After the end of the Japan–China War, during 1897–1902, the Japanese government issued
foreign bonds in three installments in London, totaling 190 million yen ($95 million) to fund
war cost and public investment. During the Japan–Russia War (1904–5), the government
again issued foreign bonds worth 800 million yen ($400 million) in four quick installments

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to execute the war. These bonds were denominated mainly in British pound or US dollar (the
exchange rates were 2 yen per dollar and 4.87 dollars per pound). Between this war and the
outbreak of WW1, the bond issue was repeated seven more times, mainly to redeem domestic
government bonds and release more funds for domestic industries.
After the Japan–Russia War, Japanese municipalities (Kobe, Yokohama, Osaka, Tokyo,
Nagoya and Kyoto) also began to actively borrow abroad. Municipal bonds and corporate
bonds issued by local government-owned corporations were the two major forms of such
borrowing. Funds raised through these instruments were used for building local infrastruc-
ture such as water works, port facilities, road, urban power and gas supply, and street trams.
Both Teranishi (1990) and Kamiyama (2000) interpret the increase of external public
borrowing of this period by central government and municipalities as a way to finance
balance-of-payments deficits while maintaining fiscal activism. Without external finance,
fiscal and monetary policy stance had to be tightened to avoid macroeconomic calamity, as
many developing countries are urged to do by the IMF today, but the Meiji government did
not want to end vigorous spending for military buildup and infrastructure construction. At
the end of Meiji, central government bonds outstanding, both domestic and foreign, were
less than 40 percent of estimated gross domestic product (GDP), which implied that public
borrowing was still within a manageable range.
As for FDI, inflow remained negligible in terms of both establishment of new enterprises
as well as purchases of existing stocks by foreigners (Chapter 4). At first, FDI was prohibited
except in the designated, tiny foreign settlements. As the unequal commercial treaties with
the West were revised in 1899, restriction on FDI was lifted. But this did not prompt any sud-
den rush in foreign investment as policy makers and popular sentiment remained hostile to
FDI. During Meiji, virtually all mobilization of foreign savings took the form of issuance of
government, municipal and corporate bonds in the European and American capital markets
as explained above, while FDI accounted for merely 0.7 percent of total inflow (Bytheway,
2005). It can safely be concluded that Japanese industrialization in Meiji as well as in the
later, post-WW2 period was driven mainly by domestic investment and not FDI, although
FDI provided limited but important functions in technology transfer in some industries.

Box 6.1 Japan becomes a new threat to East Asia and the world
By the 1910s, the three national goals set in early Meiji—industrialization, political
reform and external expansion—were more or less achieved, and Japan began to con-
sider itself to be part of the first-class world. Achievements of the Meiji period can be
summarized as follows.

•• An industrial revolution was attained in light manufacturing, especially the cotton

textile industry, even though machinery and heavy industries were still weak.
•• Japan now had a Western style legal system equipped with a constitution and
accompanying laws, and a functioning parliament.
•• As the unequal treaties were revised in steps, Japan regained tariff rights and the
right to judge foreign criminals.
•• Japan’s sphere of influence was established as Taiwan and Korea had been
colonized and interventions by China and Russia were repelled.

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In the 1920s, as WW1 ended and the world entered the interwar period, Japan began
to be invited to important international conferences as a member of the “Big Five,”
together with the United States, Britain, France and Italy. But Japan’s accomplish-
ments and emerging assertiveness raised new doubts among both the Western powers
and its Asian neighbors. For the West, Japan was now a dangerous military compet-
itor that might imperil their interests. For the rest of East Asia, Japan was acting as a
new imperial invader threatening their independence. Suspicion and fear over Japan’s
intended action emerged after Japan’s victory over Russia and intensified over time.
In 1915, while Europeans were busy fighting, the Japanese government deliv-
ered the “Twenty-One Demands” to China. These included demands for transferring
German-occupied Chinese territory (Shandong Peninsula) to Japan, expansion of
Japanese interests in Southern Manchuria and Eastern Inner Mongolia, a new industrial
joint venture, prohibition of yielding Chinese territories to other countries, accept-
ance of Japanese advisors and others (“Manchuria” is a term then used to refer to the
northeastern region of China). The Chinese government first resisted the Twenty-One
Demands, but with an ultimatum from Japan, it finally yielded to the pressure. When
China’s protestation against the Japanese demands was ignored at the Paris Peace
Conference in 1919, a large-scale anti-Japanese movement erupted in 1919, starting
with student demonstrations, violence and a general strike in Beijing that spread all
over China (May 4 Movement).
After the Russian Revolution in 1917, major powers sent troops to topple the new
communist government, but the attempt was eventually unsuccessful. Japan sent the
largest number of troops to Siberia and kept them there the longest after all other coun-
tries ended intervention.
These actions raised global suspicion against Japan. Even the United States, a tradi-
tional ally and the largest trading partner of Japan, began to express displeasure.
In fact, a thorny issue arose with the United States regarding the mistreatment
of and discrimination against Japanese immigrants. Japanese migration to the West
Coast of America began in the 1890s, which caused social and economic friction due
to different work and life habits. The Japanese worked too hard, even on Sundays
when most Americans were at church, which was blamed for stealing American
jobs. Anti-Japanese movements intensified. The Japanese government was forced in
1907 to curb Japanese migrants in a Gentlemen’s Agreement. Anti-Japanese legisla-
tion was passed in California in 1913 that restricted various civil rights of Japanese
Americans. A ban on Japanese immigration was enacted in 1924. These events nat-
urally hurt the feeling of Japanese people at home and in America, and worsened the
bilateral relationship.
Thus, Japanese diplomacy in the 1910s and 1920s faced a grave choice. Japan had
to choose between a path toward restoring friendship with the West and East Asia or
continuing to assert its way against regional and global criticism.

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7
W O R L D WAR I AND TH E 1 9 2 0 s

At the beginning of Meiji, the new government declared that, from then on, the Japanese
calendar was to be renewed when and only when the ruling emperor departed. When Emperor
Meiji passed away in 1912, his reign of 45 years, witnessing a great transformation of the
nation from a samurai society to an industrialized and partly Westernized one, came to a close
and a new era was ushered in. The Taisho period (1912–26), or the reign of Emperor Taisho,
who suffered illness, was a relatively short one covering a large part of the 1910s and 1920s.
It coincided with another transformation of Japan from a light manufacturing economy to one
with emerging mechanical, chemical and heavy industries. A great export boom, followed by a
prolonged period of lackluster growth, was the major economic landscape of the Taisho period.
Japanese life was also changing. Though most people continued to eat traditional food and
wore traditional kimono, urban and Western cultures were becoming increasingly popular.
A class of office workers, commuting daily from suburban home by rail and receiving a
monthly salary, emerged. The female workforce found new job opportunities in department
stores, cafés, the film industry and the transport sector, for example as bus conductors. In the
political arena, Taisho Democracy movements demanded universal male suffrage, exits of
unrepresentative cabinets and more rights for workers, women and the underprivileged.

Impact of World War I

When World War I erupted in July 1914, its consequences for the Japanese economy were at
first uncertain. As the European powers began to engage in fighting, their international trade
was suspended. Europe could no longer supply machinery, chemicals and other industrial
goods to the rest of the world. It was feared that Japanese investment would be adversely
affected. In reality, Japan did experience severe shortages of high-quality machines and
industrial materials.
But it soon became evident that WW1 would bring a huge bonanza to the Japanese econ-
omy, at least for the moment, because of the sudden increase in global demand for Japanese
products. An enormous export-led boom was generated as global demand shifted from
European to Japanese goods, and also because the US economy was expanding strongly.
Compared with manufactured products from Europe, Made-in-Japan goods were inferior but
good enough as substitutes for now-unavailable European products.
The Japanese macroeconomy, which had faced mounting trade deficits and gold
reserve losses prior to WW1, was greatly stimulated by a sudden and enormous rise in for-
eign demand. During WW1, the domestic price level more than doubled and real output
surged, with an estimated annual real growth close to 10 percent. On the expenditure side,

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export shot up, import declined slightly, investment increased, but only moderately, and
with a lag (due to the shortage of machinery), and private consumption fell considerably
(Figure 7.1). This situation can be explained as a sharp demand-driven output expansion
without a corresponding capital stock increase. Existing machines were used fully which
raised the “efficiency” of capital. People’s consumption was compressed to make way
for the rising foreign demand, and this was brought about mainly by forced saving under
high inflation. Meanwhile, business profits surged and gold reserves accumulated. Japan
was salvaged from the balance-of-payments crisis by the outbreak of a large foreign war,
without having to resort to fiscal and monetary austerity.1

(a)

(b)

(c)

Figure 7.1 Price movement and the composition of gross national expenditure
Sources: Bank of Japan, Price Indexes Annual, 1985; GNP estimates by Ohkawa, Takmatsu and Yamamoto, in
K. Ohkawa and M. Shinohara with L. Meissner, Patterns of Japanese Economic Development: A Quantitative
Appraisal, New Haven, CT and London, Yale University Press, 1979.

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 W O R L D WA R I A N D T H E 1 9 2 0 s

The export-led boom was a broad-based one benefiting all industries. Among them,
maritime shipping and shipbuilding sectors were extremely profitable and expanded most
vigorously. Between 1913 and 1919, overall manufacturing output expanded 1.65 times,
among which machinery industry jumped 3.1 times, steel 1.8 times and chemicals and tex-
tiles 1.6 times each.
Clearly, this export-led boom was artificial and temporary. It lasted only as long as
WW1 continued, which meant about four years. Despite inferior quality, Japanese products
captured overseas markets and import substitution accelerated domestically under this spe-
cial condition. In retrospect, most of the business expansion was inefficient, excessive and
unsustainable. Mediocre merchants and incompetent producers became suddenly rich and
successful, and rapidly expanded their businesses. A class of nouveau riche called narikin
emerged. In Japanese chess, narikin means a pawn turning into a gold general. They were
often without culture or taste and fond of showing off their material wealth.
Japan participated in WW1 on the pretext of military alliance with Britain (1902–1923,
with Russia as the potential enemy), but without engaging in any serious combat. It just
captured German-occupied territories in Jiaozhou Wan (including Qingdao) in China and a
number of islands in the Southern Pacific, and brought some German POWs to Japan. They
were in general treated well and courteously.

Collapse of the bubble

When WW1 ended in 1918, a small business setback occurred. But the Japanese economy
continued to do well in 1919. Then came the big crash of 1920. The war bubble finally ended
and the postwar recession began. The prices of many commodities fell dramatically. In 1920
alone, the price of cotton yarn fell 60 percent, that of silk yarn 70 percent and the stock mar-
ket index plunged 55 percent. Unlike the post-WW2 world where prices show downward
rigidity, prices in those days were flexible in both directions. Macroeconomic adjustment
was brought about mostly through large price changes rather than output fluctuation. One of
the reasons for this was the behavior of most producers who tried to increase sales to offset
falling prices, which collectively worsened the price decline. The lack of competitiveness
and overcapacity of the Japanese economy, previously hidden under irrational exuberance,
was exposed. Most narikin went bankrupt. Their happy days were short.
Throughout the 1920s, Japan experienced a series of recessions and banking crises.
The most serious bank runs occurred in 1927 (Chapter 8). The economy slowed down sig-
nificantly compared with the war boom period, but no severe contraction of output was
recorded. Domestic demand was not buoyant but steady and sustaining. Recessions were
frequent but short-lived. Prices remained flexible. Trade deficits returned and persisted,
which was financed by the drawing down of the previously accumulated gold reserves. In
the 1920s, the sky above the Japanese economy was neither sunny nor pouring. It was as if
thick clouds gathered and stayed above the economy, depressing the economic mood of the
country—somewhat like the recent period since the 1990s.
Faced with the onset of a recessionary period, it is worth noting how the Japanese govern-
ment reacted. It had two policy options: generously rescue weakened industries and financial
institutions saddled with bad debt, or have the courage to get rid of inefficient businesses
and banks to restore industrial strength despite transitional pain. The Japanese government
opted for the first. The Bank of Japan provided emergency loans to ailing banks and firms to

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avoid bankruptcies and unemployment. This policy eased the short-term pain but implanted
a time bomb in the Japanese economy that was to explode several years later, as we will see
in Chapter 8.

Development of heavy and chemical industries

Even under the cloudy sky of the 1920s, new sectors were growing. Heavy and chemical
industries (HCIs) expanded strongly despite relatively weak aggregate demand. HCI growth
was broad-based and included steel, chemicals, electrical machinery, general machinery
and manmade fiber (rayon). Import substitution proceeded rapidly in these areas until, by
the 1930s, Japan could produce most of these products domestically with sensible quality.
Some engineered products, such as locomotives and ships, came to match global front-
line technology. This was a big achievement in comparison with Meiji industrialization in
which light manufacturing was the main pillar.
There were several reasons for strong HCI growth.
First, the WW1 boom ignited these industries under artificial protection from European
products, as explained above.
Second, policy support was available. Fiscal activism, including military buildup, contin-
ued especially under Seiyukai Party governments (Chapter 9). Furthermore, high tariff policy
for emerging HCIs was adopted. In 1899, freed from uniform 5 percent tariffs imposed by the
unequal treaties, Japan began to raise tariffs on manufactured products. The government also
promoted the formation of industrial cartels to avoid excess competition and overcapacity.
Third, electrification spread with the development of hydraulic power generation.
Construction of hydraulic power plants occupied the largest share of private investment fol-
lowed by railroad construction. As a result, electricity surplus was created in Kansai area in
Western Japan. Power companies introduced discriminatory pricing by charging very low
tariffs to large corporate customers. Once a dam, a power plant and transmission lines were
completed, the marginal cost of producing electricity was almost nil. Discriminatory pric-
ing helped to raise the operation ratio and the revenue of power companies. This in turn
stimulated the growth of power-intensive industries such as chemicals, fertilizer, rayon and
aluminum refinery.
Fourth, foreign technology was absorbed via FDI. Japanese companies including NEC,
Shibaura, Mitsubishi Electric, Furukawa and Nissan tied up variously with American and
European giants such as General Electric, Westinghouse, Siemens, Ford, GM, Dunlop and
Goodrich in the fields of electrical machinery, automobiles, rubber tires and so on. Business
cooperation took many forms including the creation of a Japanese subsidiary, joint venture,
equity participation, technology licensing and other technical cooperation.
Fifth, vertical linkages were created between material producing and using sectors. Growth
of the steel industry supported steel-using industries such as shipbuilding and mechanical
engineering, and vice versa. Similar vertical interdependence emerged with chemicals, ferti-
lizer, rayon and aluminum which stimulated both producers and users.
The use of tariff protection for heavy industrialization, mentioned above, deserves addi-
tional remarks. After examining a large number of historical cases, Chang (2002) finds
that all industrializing nations in Europe, America and Asia in the past had adopted “infant
industry promotion” by keeping high tariffs until domestic firms grew and became compet-
itive. Japan was no exception. After the 5 percent uniform tariffs were repealed in 1899, the

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average tariff rate on non-zero tariff goods, calculated roughly as tariff revenue over total
such imports, rose sharply (Figure 7.2). If we ignore the periods of WW1 and WW2, when
trade in general and trade in manufactured goods in particular were severely limited, we can
conclude that Japan maintained relatively high tariffs from the beginning of the twentieth
century to the 1970s during which Japanese HCIs were catching up with the West. The fact
that Japanese industries were protected for so long is not surprising, given similar practices
in other latecomer economies of the nineteenth and twentieth century.
There is another important point here, namely: tariff protection becomes critical when and
only when an economy progresses from the light manufacturing phase to heavy industrial-
ization. When a country is mainly engaged in labor-intensive, low-skill production such as
garments, footwear, food processing and electronics assembly, output and export can grow
even without protection. But when it embarks on mechanical engineering and capital-intensive
material production that require skills and experience, large upfront investment, long-term
commitment and R&D, newcomers are usually unable to compete with global giants unless
temporary support is provided. The lack of such support, or improper application of it, may
lead to a middle income trap, among its many other causes. True, protection is a risky measure
and many governments simply abuse it without producing any results. But historical experi-
ences show that only those countries that master its proper use are likely to succeed in heavy
industrialization and proceed to high income, not the ones that refuse to learn it (Ohno, 2013).

䠄%䠅
25

20

15

10

0
1868
1872
1876
1880
1884
1888
1892
1896
1900
1904
1908
1912
1916
1920
1924
1928
1932
1936
1940
1944
1948
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012

All items Nonzero tariff items

Figure 7.2 Estimated tariff protection

Source: Ministry of Economy, Trade and Industry. Tariff revenue is divided by import volume of respective goods.

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 W O R L D WA R I A N D T H E 1 9 2 0 s

From this perspective, Japan regained the tariff right from the West just when it was
needed, that is, when Japan was ready to move from cotton textile industry to HCIs. It should
also be added that, given the subsequent development of HCIs, Japan used this regained tool
quite effectively.

Emerging new zaibatsu

With the development of HCIs, a new type of zaibatsu emerged in the 1920s and 1930s.
Compared with old zaibatsu such as Mitsui, Sumitomo, Mitsubishi and Yasuda, new zaibatsu
were HCI-based without much involvement in banking, commerce or light manufacturing
such as cotton spinning. They invested aggressively in the Japanese colonies of Korea and
Manchuria. New zaibatsu did not have a bank as core business, and instead raised funds
by issuing stocks. Their business empire depended heavily on official support and political
connection. The largest among them were Nissan, Nicchitsu and Mori.
Nissan was established in 1928 by Ayukawa Yoshisuke who specialized in management
and company acquisition rather than engineering. Nissan was a short form of Nihon Sangyo,
the company’s full name which means Japan Industry. Raising capital from the stock market,
business was diversified into mining, machinery, automobile, chemicals and fishery. Nissan
invested heavily in Manchuria. Hitachi and Nissan Motors belong to this group.
Nicchitsu was established in 1908 by Noguchi Shitagau. The full name was Nihon Chisso
Hiryo or Japan Nitrogen Fertilizer. The group’s main business was electricity-intensive chemical

Figure 7.3 Gross capital formation

Source: Koichi Emi and Yuichi Shionoya, Capital Formation, Long-term Economic Statistics vol. 4,
Toyokeizai Shimposha, 1971 (Part III, Tables 1 and 9).
Note: Percentage of total real investment in 1934–36 price.

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industries such as fertilizer, rayon, medicine, explosives and metal refining. Micchitsu invested
heavily in Korea.
Mori was established during the 1920s by Mori Nobuteru, who cooperated with Suzuki
Saburosuke, the founder of Ajinomoto. Its main businesses included iodine, fertilizer,
aluminum refining, electrical machinery and explosives.
Other new zaibatsu included Riken, which focused on chemical and medical research, and
Nisso, which produced sodium hydroxide.
Because new zaibatsu did not have their own bank or trading house, financing and inter-
national trade functions were often provided by the subsidiaries of traditional zaibatsu such
as Mitsui, Mitsubishi, Sumitomo and Yasuda. When Nissan purchased whole automobile
plants from the United States, it asked Mitsubishi Trading Company to bring them to Japan
(see below). The four zaibatsu banks—together with the Industrial Bank of Japan—were also
active as underwriters or collateral trustees of corporate bonds issued by not only group com-
panies but also companies belonging to other groups or independent companies. Corporate
bond issue was a particularly important way of raising funds for power generation, railroad
and paper where its share occupied 50–60 percent of total financial needs of each sector
(Kikkawa, 2002, pp.173–176) (Figure 7.3).

Automobile production
The development pattern of the Japanese automobile industry was unique among latecomer
countries. Instead of inviting foreign automotive giants to form an initial industrial cluster,
the Japanese private sectors, from the outset, produced vehicles through copy production,
trial-and-error, or technical cooperation with foreign partners. US car makers did invest in late
Taisho Japan but they were in time forced to retreat due to the emergence of Japanese com-
petitors and introduction of unfavorable policy. Moreover, instead of allowing only one or a
few car makers to dominate in a relatively small domestic market and attain scale economy,
as in the case of most other latecomer countries, Japan has had about ten domestic private
producers since the pre WW2 period variously competing and aligning with each other. Even
today, most of the original brands are present and globally competitive (Figure 7.4).
Cars began to be imported to Japan in 1899. There were initial attempts to build vehi-
cles, but production was experimental and very small in scale. Imported models of Ford and
General Motors were dominant in the nascent Japanese market. However, the Great Kanto
Earthquake of 1923 suddenly increased the popularity of motorized cars in Japan as several
thousand Model T Ford trucks were imported to augment transport capacity. Seeing this
trend, Ford established a knock-down assembly plant in Yokohama in 1925 and General
Motors followed two years later by building a similar plant in Osaka.
Nissan and Toyota were not the first companies to produce cars in Japan, but they emerged
as the most serious car makers in the 1930s. They adopted very different approaches to
acquire technology and boost production. Nissan opted for the fast way of purchasing exist-
ing plants and learning directly from foreign partners while Toyota chose the hard way of
going it alone from scratch (Francks, 2015, pp. 97–102, pp. 220–223).
Ayukawa, the founder of new zaibatsu Nissan, was an aggressive business manager inter-
ested in expanding his empire through purchases, mergers and acquisitions (M&A), direct
transfer of foreign technology, and extensive business and official connections. His initial
casting firm manufactured motors for boats and agricultural machines as well as compo-
nents for Ford and General Motor cars. In 1933, Ayukawa acquired the Datsun factory of

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Toyota 1937
1998
1935
Daihatsu 1907
1930 2001
Hino 1910 1941
1918 Renault
1999
Nissan 1933
1931 2016
Mitsubishi 1970
1917
Honda 1948
1947 1963 GM GM
1998 2006
Suzuki 1920 2000 2008
1952 1955
Mazda 1920
GM 1979 GM 2015 Ford
1931
1971 Ford 2006 in steps
Isuzu 1916 1937
1929
Subaru 1917 1953
1999 2005
1946 GM GM

Start automotive production Control relation

Start motorcycle production Dissolution

Figure 7.4 Timelines of Japanese automobile producers

Sources: websites of automobile companies. Years of automotive and motorcycle production are indicated.
Unmarked years show other landmark events.

DAT Motors and combined it with his casting firm to create the Nissan Motor Company.
Mitsubishi Trading supported Nissan to import a whole set of the latest machinery and
equipment from the United States to replicate mass-production assembly lines. American
engineers were hired to teach the most advanced design, construction and operation meth-
ods for the plant. In 1935, Ayukawa decided to move into the production of military trucks.
Through its connection with General Motors, Nissan found an American company willing to
sell a complete truck plant together with blueprints. Mitsubishi Trading again helped Nissan
to bring the entire equipment to Japan and also to purchase additional equipment. It should
be noted that automobile production was not the exclusive business area of Nissan as it also
covered mining, metallurgy and mechanical engineering, with Hitachi as its core company.
Toyoda Kiichiro was the eldest son of Toyoda Sakichi, the founder of Toyoda Loom.
He visited the massive production lines of Ford Motors in Detroit and was greatly impressed.
He wanted to create a Japanese car maker independent of foreign giants. Though the weaving
machine company was against this crazy idea, he began visiting Japanese factories, uni-
versities and government offices, purchased German and American equipment, and reverse
engineered the latest GM Chevrolet. Recognizing Kiichiro’s early results, the Toyoda Board
finally approved establishment of the Automotive Department in 1933. Kiichiro declared that
the first Toyota car would roll out within one year. His engineer friends helped, American
models were further analyzed, a large factory was built in what was to become Toyota City,
and additional equipment was imported. The engine was modeled after General Motors,
the chassis was Ford-based, and the design was copied from Chrysler. After many failures,

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the team succeeded in casting the cylinder block and cylinder head of the engine. The first
Toyota car was ready in May 1935—five months behind schedule. After WW2, automobile
production was firmly established as the firm’s core competency.2
In the 1930s the military and the Ministry of Commerce and Industry became increas-
ingly eager to promote home production of military trucks. The Automobile Manufacturing
Industry Law of 1936 offered generous incentives such as tax holidays, import duty exemp-
tion and financial access to license holders. A license was required to produce more than
3,000 vehicles and applicants must have majority Japanese ownership. Toyota and Nissan
were the only companies that were granted licenses, and they switched to production of
military trucks following the official instruction and demand. Meanwhile, increased tariffs
on completely built units and knockdown components, as well as restricted access of foreign
subsidiaries to foreign exchange, made it difficult for Ford and General Motors to stay in the
Japanese market. They stopped operation in 1940 and 1941 respectively.
Among other Japanese automobile manufacturers, Daihatsu, founded by univer-
sity researchers and producing tricycles, was the oldest. Hino and Isuzu were created by
government-instructed mergers and specialized in commercial vehicles. Mitsubishi, as part
of a large zaibatsu, had interaction with the group’s shipbuilding and aircraft production.
Meanwhile, Subaru, Suzuki, Mazda and Honda had engineer-type founders and moved into
automobile production by expanding the original lines of business which were the produc-
tion of aircraft, weaving machines, pumps and motorcycles, respectively. Among these,
Honda starting automobile production in 1963, was the latest comer.

Exchange rate volatility

In the pre-WW1 period, from the 1880s through 1914, the world economy enjoyed price
stability and free trade under the international gold standard. Japan joined the gold standard
and fixed its exchange rate to the major currencies in 1897. Soon, Japanese prices converged
to the world level. But this global fixed exchange rate regime was smashed by the outbreak
of WW1, and the Japanese yen started to float in 1917.
After WW1, major powers made a number of attempts to restore the prewar gold standard
system without much success. Britain returned to gold in 1925 but abandoned it in 1931. The
gold standard of the late nineteenth century could not be re-established partly because there was
less free trade and more protectionism than before, rendering the global economy less integrated,
and partly because governments now cared more about domestic macroeconomy, especially
unemployment issues, than the external commitment of gold convertibility. As a result, global
monetary cooperation needed for restoring the international gold standard was hardly possible.
Japan also tried to return to the gold standard at the prewar parity of two yen to the dollar.
Throughout this period, “Return to Gold” (kinkaikin or, literally, lifting the restriction on
gold export) became a national economic goal. The government seriously considered restor-
ing a fixed exchange rate a number of times, in 1919, 1923 and 1927, but failed to do so for
various reasons such as an earthquake and bank runs. Each time the government announced
such policy intention, expectations drove up the yen because the actual yen was more depre-
ciated than the prewar parity. But the yen fell back when the policy was not realized. The
business community blamed domestic banks and foreign exchange traders, especially those
in Shanghai, for disruptive speculation. Exchange rate instability may have further damaged
the Japanese economy faced with slow growth, but it cannot be cited as the main cause of
prolonged recession.

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Japan finally returned to gold in January 1930 under the Minsei Party government of
Prime Minister Hamaguchi and Finance Minister Inoue, for whom Return to Gold was the
highest priority. But the timing coincided with the US stock market crash and the beginning
of the Great Depression. Japan was forced to abandon gold after two years. The international
gold standard has never been resurrected since.

Shidehara Diplomacy
As noted in Box 6.1, Japan began to emerge as a serious threat to both the West and East
Asia by the end of the Meiji period. After WW1, Japan tried to allay these fears and rebuild
good relationship with the West, especially the United States, and East Asia. Shidehara
Kijuro (1872–1951), twice served as Foreign Minister under Minsei Party governments in
1924–1927 and 1929–1931, initiated so-called Shidehara Diplomacy pursuing friendship,
reconciliation and non-military means to solve bilateral problems. Thanks to him, Japan’s
foreign policy in the 1920s was less belligerent compared with before or after.
In 1921, the Washington Conference for Naval Disarmament was convened in the United
States, and Japan was invited to attend. The Japanese delegation went to Washington with
both hope and concern. The global reduction of naval capacity was highly welcome for Japan
which was facing a serious budget crisis. But Japan also feared that other powers might
use the Conference to harm Japan’s interests. The Conference put upper limits on principal
battleships of the major naval powers. In terms of tonnage, possession of principal battle-
ships among the United States, the United Kingdom, Japan, France and Italy was restricted
proportionally to 5, 5, 3, 1.67 and 1.67 respectively. The Japanese delegation was happy
to sign this agreement even though the navy wanted more battleships. In addition, through
this agreement, Japan wanted to show good faith to the Western powers as a peaceful and
dependable nation.
The signing of the Nine Powers Treaty had another important impact on Japan coming
out of this Conference. This treaty recognized the sovereignty of China, prohibited territorial
invasion of China through military means by any country and agreed to share economic inter-
ests of major powers in China under the policy of “open door and equal opportunity.” Japan
welcomed this treaty as it was interpreted to implicitly recognize Japan’s special interests
in Manchuria and Mongolia (eastern part of Inner Mongolia). The infamous Twenty-One
Demands to China (Box 6.1) were also accepted, albeit with some modifications, by the
international community. However, these “acceptances” were valid only so long as Japan
refrained from using military force to invade China or rob interests of other powers in China.
Shidehara believed that a good relationship with the United States, Japan’s most impor-
tant trade partner, was critical. He also felt that Japan, as a new first-class country and a
member of the Big Five, had the moral obligation to strive for global peace and prosperity.
As for China, he wanted to protect Japanese economic interests by diplomatic negotiation
rather than military invasion. Shidehara’s idealism was evident in his parliamentary speech
delivered in January 1925.

At present, there is clearly a global movement toward solving all international

issues through understanding and cooperation among concerned powers, and not by
narrowly self-serving policies, excessive use of militarism or interventionism. …
Japan is no longer permitted an isolated and independent existence in the Far East,
interested only in its own affairs. As a major member of the League of Nations,

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Japan now bears a heavy responsibility for promoting world peace and happiness
of the human race. Japan must participate in the discussions of all these important
issues, even if they have only indirect influence on Japan’s own interest. The fact
that Japan must bear such responsibilities is beyond question. It is necessitated
by the force of history. The great progress of history is making us take up these
responsibilities.

However, the Japan–US relationship gradually deteriorated due to the problem of Japanese
immigrants on the US Pacific Coast, especially in the States of California, Oregon and
Washington (Box 6.1). Because Japanese (and to some extent also Chinese) immigrants
worked very hard and had different cultures, they were discriminated against by white
Americans. The rights of American citizens of Japanese origin were gradually deprived.
Their schools were segregated, their freedom was restricted and their property was con-
fiscated. In response, the Japanese government agreed to stop sending immigrants to the
United States but demanded fair treatment of Japanese Americans already there. This
issue soured the bilateral relationship.
Shidehara’s policy of no military intervention in China was severely criticized by the
military and the hardliners as “coward’s diplomacy.” Even the mass media echoed this
sentiment and blamed Shidehara for being too soft on China. From 1927 to 1929, when
Tanaka Giichi of Seiyukai Party was in power and Shidehara was out of government,
Japan sent troops three times to China in an effort to prevent the Northern Campaign of
Chiang Kaishek’s army from unifying China. Prime Minister Tanaka also organized the
Eastern Conference, a meeting among Japanese officials rejecting Shidehara Diplomacy
and reaffirming aggressive policy stance toward China.
Finally, in 1931 when Shidehara was Foreign Minister for the second time, the
Manchurian Incident broke out. Kantogun, the Japanese army stationed in China, began to
invade Northeastern China in clear violation of the “open door, equal opportunity” policy of
the Nine Powers Treaty. This military operation was carefully planned and executed inde-
pendently from Tokyo, which made it evident that the Japanese government could no longer
restrain the army. Shidehara’s immediate call for peace was ignored, and the US government
condemned Japanese action. Shidehara Diplomacy ended this way.

Box 7.1 Taisho Democracy

Roughly coinciding with the Taisho period of 1912–26, various social movements
demanding more representation and human rights became active. This included pro-
tests against unelected or corrupt governments, women’s liberation, equal rights
for the discriminated underclass who were the progeny of the eta and hinin people
(see Chapter 2 and Q & A section in the appendix), universal male suffrage and cul-
tural freedom. These movements were collectively called Taisho Democracy.
One of the most eminent intellectual leaders of Taisho Democracy was Yoshino
Sakuzo, Professor of Political Science at Tokyo Imperial University. He published
many articles in popular magazines to promote his version of democracy called min-
pon shugi. It asserted that democracy could be installed and fostered even under the
Meiji Constitution that bestowed sovereignty only to the emperor. Yoshino argued
that establishing democratic institutions was not enough and that it was essential to

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constantly improve the actual implementation of constitutional government. For this

purpose, he stressed the role of the elite class in guiding the mass. Yoshino also sup-
ported universal (male) suffrage. By expanding the voter base from a few rich people
to the general public, he hoped that corruption and money politics would cease and
politics based on broader national vision would begin. In retrospect, it must be admit-
ted that Professor Yoshino was a little too optimistic in this expectation given the
subsequent development of Japanese politics even after all adult men were allowed
to vote (Chapter 9).
On the political role of the elite, Yoshino wrote:

Some may argue wrongly that the elite class has no place in democracy. But this
is not so. Evidently, if a small number of people form an exclusive class and
monopolize politics independently from the people, this will produce many bad
results. But if the elite humbly mingle with the general public, accept the nominal
status of serving and following them but in substance guide them spiritually and
for public good, they will play the role of the truly wise. … Democracy will not
develop in a sound way if uninformed people literally rule. Formally, the major-
ity must always be the basis of political activities. Yet they need intellectual
leaders in their minds. They must rely on a small number of wise and capable
people. A great nation will emerge when the majority is guided intellectually by
the few who are wise. The elite have this responsibility in a modern state.
(“Discourse on the Principle of Constitutional Government and the
Way to Fully Develop its Potentiality,” 1975[1916])

In 1925, the Universal Suffrage Law was enacted, extending voting rights to all males
at and above 25 years of age regardless of income. But in the same year, the Peace
Preservation Law was also passed to crack down on communists and anarchists. This
was regarded as one step forward and a giant leap backward on a road to democracy. It
should however be recalled that other major powers had similar internal security laws
at that time: it was not uniquely Japanese. The extension of suffrage to women had to
wait until 1945.
In 1913 and 1914, people protested against corrupt and unrepresentative govern-
ments. In 1924, three political parties joined force against the ruling government to
promote universal male suffrage, military budget cuts and Shidehara Diplomacy, and
they won the election. From then on, the leader of the political party having the largest
number of parliamentary seats formed the government (instead of appointing an old
politician or military general). When the policies of the incumbent government failed,
the leader of another party replaced him. Seiyukai and Minsei Party were the two
contesting parties in the late 1920s and 1930s. At election, voters often chose the party
professing an economic, social or foreign policy that seemed most appropriate for the
time instead of consistently supporting any one party. This two-party mechanism was
not formally institutionalized in constitution or law but actually practiced, and was
called kensei no jodo (the normal way of constitutional government).
Thus, regarding the actual evolution of politics, the great achievement of Taisho
Democracy was alternate succession of party cabinets from 1924 to 1932. This practice
was terminated by pressure from the military and a series of political assassinations,
after which old politicians and military men were again appointed as prime ministers.

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Notes
1 Later, the Japanese economy was similarly rescued out of an imminent recession following the
Dodge Line stabilization measures of 1949 when the Korean War broke out in 1950. As procurement
of both military and non-military goods by the US military, in combat on the Korean Peninsula,
suddenly arose, Japanese industries enjoyed great business expansion and high profits (Chapter 10).
2 The name of the firm and products was changed from Toyoda, the founder’s family name, to Toyota
in 1936 as a result of competition for a new emblem. The latter sounded better and had a lucky
number of strokes when written in katakana. The name change also demonstrated the company’s
resolve to shift from a personal business to a socially oriented one.

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8
T H E B A NKING CRISIS OF 1 9 2 7

Proliferation of Kikan Ginko

Industrialization requires investment, which in turn requires finance. Investment projects
of zaibatsu-affiliated firms were financed by loans extended by leading banks within each
group. Joint stock companies could also raise funds from the capital market. However, small
enterprises not affiliated with or supplying to any zaibatsu group or large firms had no access
to big banks or the stock market, and had to rely on either informal finance or loans from a
small local bank. The number of such small banks increased dramatically during the 1890s
from less than 400 to well over 2,000. These banks contributed significantly to the growth of
numerous industrial establishments all over Japan. However, unregulated and unmonitored,
they also posed serious future risks to the financial system.
Kikan ginko (literally, institution bank, which does not explain much) is a term describ-
ing a bank serving only one or a few firms. It was captured and subordinated by the
parent firm and has no management independence. Naturally, such banks had many struc-
tural weaknesses which included (i) non-separation of ownership and management, in
which the same boss often owned and managed the firm and the bank; (ii) no information
disclosure; (iii) no portfolio diversification and (iv) no capacity to assess and manage
risks and evaluate projects.
Why were kikan ginko created? Suppose a renowned family in a certain rural district
wants to start a business. The family establishes a company but wants to keep it under its
full control without going public or borrowing from someone else. To finance its activities,
the family sets up a bank. As the family is well known locally, people gladly deposit their
savings with the bank, believing it is safe without knowing its true financial situation. In this
way, many kikan ginko were established all over the country. In the 1900s and 1910s, over
2,000 such banks existed which was clearly too many.
When the Japanese economy was booming during WW1, even dubious banks prospered.
But when the postwar recessions started, kikan ginko faced a mounting bad debt problem.
Since their balance sheets were not open to the public, outsiders could not judge the mag-
nitude of the problem. As noted earlier, in the early 1920s as the war bubble crashed, the
government and the Bank of Japan supported weak banks and firms with emergency loans
rather than restructuring them immediately. Overcapacity and bad debt were concealed
without elimination.

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The earthquake bill problem

On September 1, 1923, the Kanto Region was shaken by a huge earthquake which recorded
7.9 on the Richter scale. Tokyo and Yokohama were very badly damaged. The main cause
of destruction was fire which started at countless places. Most Japanese houses were made
of wood and the quake hit just before noon when most families were preparing lunch. One
hundred thousand lives were lost and another 43,000 people were missing. Residential
damage totaled 700,000 units. Foreign observers praised Japanese people for remaining
calm and orderly in this calamity, an observation repeated many times in subsequent dis-
asters. The reality, however, was that many Korean people were caught and murdered by
private patrol groups based on false rumors.
The Japanese Archipelago sits where four massive moving plates meet on the earth’s
crust. This produces earthquakes as well as volcanoes and hot springs. While scientists try
to forecast areas that are likely to be hit by the next large tremors, it is practically impos-
sible to avoid earthquakes anywhere in Japan. Earthquakes are classified into two types.
The first type occurs when huge plates run into each other with one of them sinking slowly
into the earth. This dynamism accumulates enormous strain which is released suddenly as
an earthquake. These quakes are big, deep down and affect a large area. The second type is
smaller in magnitude and impacts a smaller area but, since it is shallow, local damage could
be immense. Such quakes are caused by the movement of active faults on or near the sur-
face, of which there are many in Japan. The Great Kanto Earthquake of 1923 and the Great
East Japan Earthquake of 2011 were of the first type. The Kobe Earthquake of 1995 and the
Kumamoto Earthquake of 2016 were of the second type.
Back to 1923. Immediately after the Great Kanto Earthquake, the Bank of Japan extended
special emergency loans to commercial banks. This was done in the form of re-discounting
earthquake bills.
Firms routinely settle their accounts using commercial bills. Upon delivery of products,
the buyer issues a commercial bill, or a promise to pay with agreed interest at a certain date,
say, three or six months later. The supplier usually takes the bill to a bank, which provides
cash after subtracting expected interest (this is called discounting). The bank may hold the
bill until maturity, sell it to other banks, or take it to the central bank to similarly “cash it”
(this is called re-discounting). This facility permits supplier firms to obtain cash immediately
while allowing banks to earn interest by offering this service.
The Bank of Japan announced that any commercial bills originating in the earthquake-
affected areas would be re-discounted limitlessly and unconditionally (i.e., without normal
quality check). The Bank of Japan thus tried to sustain post-quake economic activities by
supplying enough liquidity and preventing delayed business payments from paralyzing the
entire financial system. This temporary rescue was justifiable for the intended purpose, but
it also had a serious side effect.
Re-discounting of commercial bills with no question asked by the Bank of Japan offered
a great opportunity for firms and commercial banks that had accumulated bad debt unre-
lated to the earthquake. They happily took advantage of this facility to exchange bad debt
for good cash. If the emergency re-discounting was truly directed to firms affected by the
earthquake, some firms suffering severe damage might have to close but most of them
should be able to resume operation after a while, and the central bank should be able to
redeem most of the earthquake bills. But in reality, even after two years, only half of the
earthquake bills were settled by issuing companies. The rest was a stock of non-performing

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debt unrelated to the Great Kanto Earthquake with little chance of redemption. If no cor-
rective measure was taken the central bank would incur large losses. This was called the
“earthquake bill problem.”

Illiquidity versus insolvency

There are two types of inability to repay which are fundamentally different and require very
different solutions. One is the liquidity problem in which one is temporarily out of cash
and cannot repay now, but if we wait long enough there will be a future stream of income
or assets to clear the debt. The solution to this problem is delayed payment or a new loan,
which is technically called debt rescheduling. The other is the solvency problem in which
the borrower is unable to repay either now or later because there is no expected income or
asset to be generated in the future. The only solution to this problem is cancellation or, more
technically, debt forgiveness. The budget constraint is secure (i.e., expenditure and revenue
match over time) in the former but it is breached in the latter.
The trouble is that, at the moment inability to repay is detected, it is difficult to tell
whether the problem is illiquidity or insolvency because of uncertainty surrounding future
income streams. The response of an average creditor is to assume illiquidity first, which is
less serious, and pray for full repayment with added interest over time. But the generous
lender will usually be disappointed, and the borrower’s insolvency has to be finally admitted.
All or part of the money is now lost. The solution therefore proceeds from debt rescheduling
to debt forgiveness. This tendency is observed for personal advances, commercial loans, or
even a sovereign debt crisis.
In their analysis of the Bank Runs of 1927, Takahashi and Morigaki describe the
“fundamental causes of the financial crisis” as follows:

Although the Japanese economy grew strongly in quality and quantity during WW1,
the banking system remained pre-modern with many internal defects. When exces-
sive speculation ended in 1920, both government and private businesses made the
mistake of implementing only temporary rescue measures hoping that the next
boom would bail them out. But the economic malaise was deeply rooted, and tem-
porary measures only made things worse. In addition, the Great Kanto Earthquake
of 1923 harmed our economy, and improper policies increased exchange rate insta-
bility which further aggravated the economy. Corporate profits fell significantly,
bank management became chaotic and rigid within the outdated banking system,
and Japanese banks, including many of the large ones, were on the verge of collapse.
(Takahashi and Morigaki, 1993[1968], p. 7)

Their argument suggests a large degree of insolvency built deeply into the Japanese corporate
and banking systems.
The Bank of Japan accumulated unpaid earthquake bills to the tune of 431 million yen, of
which 100 million yen was deemed unrepayable. Commercial banks also held un-rediscounted
bad debt. In order to “normalize” these earthquake bills, the government prepared two laws.
The first law would permit bad bills held by commercial banks, up to 170 million yen, to be
rescheduled for 10 years with government bonds as collateral. The second would allow the
government to provide the Bank of Japan up to 100 million yen to write off its losses related

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to the earthquake bills. In other words, the bad earthquake bills would partly be converted into
long-term debt with delayed repayment, and partly be forgiven using the government budget.
Parliamentary debate on these laws began in January 1927.

The initial wave of the banking crisis

Finance Minister Kataoka Naoharu was eager to pass the earthquake bill laws, but the
opposition parties, especially Rikken Seiyukai, criticized him for bailing out big banks and
businesses with taxpayers’ money. They demanded that the government disclose the amount
of bad bills and the names of banks that held them (very little was known at that time: there
were only rumors). They even argued that the government’s true intention might be to help
political friends. In the debating process, the size of the bad debt gradually came out—
200 million yen of which half was held by the Bank of Taiwan1 (see below). People were
shocked at the size of non-performing loans.
On March 14, 1927, Minister Kataoka was pestered with questions in the Budget
Committee of the House of Representatives. He was frustrated at the questioner who did not
understand the nature of the problem and wanted to debate endlessly. To make the point that
the situation was very serious, he announced the latest news that crossed his desk: “Today,
at around noon, very regrettably, Tokyo Watanabe Bank finally went bankrupt.” This was an
unexpected bombshell for the financial market, as well as the people at large. Immediately,
depositors queued up in front of banks to withdraw their money. Many banks in the Tokyo
area closed. This was the first shock wave of bank runs. However, it was a relatively small
crisis in the Tokyo area only. The worst was yet to come.
In reality, Tokyo Watanabe Bank was not bankrupt, technically speaking. It was having
trouble getting liquidity but the problem was solved quickly. But the bureaucrat carrying
memos to the Finance Minister forgot to cancel the first report. Some suspected that Tokyo
Watanabe Bank must have been happy with the Finance Minister’s “misstatement.” It may
have wanted to close but needed a good excuse. Now the bank management could blame
Minister Kataoka instead of themselves.
Many people criticized, and still criticize, Minister Kataoka for the slip of the tongue
that ignited the 1927 financial crisis. But it is very clear that, with or without his remark, the
Japanese financial system faced a grave long-term problem. The true cause of the bank runs
was structural, as Takahashi and Morigaki explain. We cannot blame just one individual
for everything.

Suzuki Shoten and the Bank of Taiwan

Suzuki Shoten was a trading company of the narikin type (Chapter 7), growing rapidly dur-
ing WW1 through speculative business in steel, wheat and ships. Its main office was in
Kobe and its general manager was Kaneko Naokichi. In 1919 and 1920, Suzuki’s turnover
even surpassed those of big zaibatsu trading houses such as Mitsui and Mitsubishi. It had
strong connections with Taiwan, especially the Taiwan Colonial Administration, the Bank
of Taiwan, and Taiwanese sugar businesses, and was given the monopoly right to market
Taiwan-made camphor.
With the bursting of the war bubble, Suzuki Shoten faced a bad debt problem like any
other narikin business. It asked the Bank of Taiwan, its main bank, to extend rescue loans.
The Bank of Taiwan was a special bank playing the double role of Taiwan’s central bank as

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well as a commercial bank. Despite its semi-official status, it actively lent to mainland Japan,
especially Suzuki Shoten (Figure 8.1). Even with Suzuki’s mounting difficulty, the Bank of
Taiwan was unable to terminate its relationship with the company because it was too large in
the loan portfolio. This situation was described as kusare en, or an unhappy but inseparable
relationship which is usually reserved for a love relationship. The Bank rolled over Suzuki’s
existing debt and provided new loans, delaying the final solution and accelerating the debt
snowball. This was the kikan ginko problem writ large. As the saying goes, if you have a
small debt to a bank and your business fails, you are in trouble; if you have a huge debt that
goes bad, the bank is in trouble.
By the end of 1926, the largest part of the unsettled earthquake bills was attributable to
the Bank of Taiwan (48.4 percent) and Suzuki Shoten was accountable for 70 percent of it.
Thus, normalizing the earthquake bills practically meant solving the Bank of Taiwan–Suzuki
Shoten problem.
On March 26, 1927, the Bank of Taiwan finally refused any more lending to Suzuki
Shoten. This news sent another shockwave throughout Japan because it revealed the des-
perateness of the situation beyond anyone’s imagination. People had expected that the
government would somehow manage this problem, because the Bank of Taiwan was a
special bank and Suzuki was too big to fail (this is called a moral hazard problem). No one
predicted that the government would let the Bank of Taiwan give up on Suzuki. When this
became reality, the second wave of bank runs started, this time in the Kansai area including
the cities of Osaka, Kobe and Kyoto where Suzuki’s activities concentrated.

The BOJ demands government guarantee

By 1927, the Bank of Taiwan’s balance sheet was irregular. On the asset side, bad loans
to Suzuki loomed large. On the liabilities side, instead of a large number of people’s small
deposits as with normal banks, the Bank of Taiwan relied very heavily on interbank “call”
money (short-term borrowing from other commercial banks) as well as loans from the Bank

Figure 8.1 The balance sheet of the Bank of Taiwan

Source: Takahashi and Morigaki, 1993, p. 113.

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 T he banking crisis of 1 9 2 7

of Japan. As soon as the breakup between the Bank of Taiwan and Suzuki was reported,
other commercial banks immediately withdrew their call loans from the Bank of Taiwan.
The only way for the Bank of Taiwan to survive was to ask for more rescue loans from the
Bank of Japan.
At this time, even the Bank of Japan refused to extend additional loans to the failing Bank
of Taiwan unless a new law was passed to cover the future losses of the central bank. For a
long time, under political pressure, the Bank of Japan had been generously helping troubled
banks. But this undermined the Bank of Japan’s own financial soundness. Now at this crit-
ical moment of financial crisis, for the first time the Bank of Japan asserted independence
from the government and declined to play the role of the “lender of last resort.” The gov-
ernment was thus forced to quickly prepare a special law (actually, an emergency imperial
edict because the parliament was out of session) to satisfy the Bank of Japan’s demand. The
edict instructed the following: (i) the Bank of Japan may extend special loans to the Bank of
Taiwan without collateral until May 1928, and (ii) the government will compensate the Bank
of Japan for losses related to such loans up to 200 million yen.
An imperial edict must be approved by the Privy Council and signed by the Emperor. The
government expected an easy approval. But the Privy Council, an imperial advisory board
dominated by conservative politicians who did not like the government’s conciliatory pol-
icy toward China (“Shidehara Diplomacy,” Chapter 7), unexpectedly rejected the proposed
edict. This caused the Bank of Japan to stop lending to the Bank of Taiwan, forcing the Bank
of Taiwan to close on April 18, 1927. On the same day, Omi Bank, specializing in cotton
business and also heavily burdened by unsettled earthquake bills, also closed. The closure of
these two banks started a chain reaction of bank runs all over Japan. This was the third and
most severe financial panic of 1927.
On April 20, the Wakatsuki Cabinet (Kenseikai) fell and the Tanaka Cabinet (Seiyukai)
was appointed. Takahashi Korekiyo, the new finance minister, tried to calm the panic psychol-
ogy and financial markets. On April 22, Takahashi ordered all banks to “voluntarily” close
for two days (until a moratorium was in place) and implemented a three-week “moratorium”
on virtually all financial obligations. This unusual peace-time moratorium, or temporary sus-
pension of debt repayments, was to protect banks from massive deposit withdrawals (except
for small withdrawals that were permitted to cover people’s living expenses). Takahashi also
ordered quick printing of additional currency notes, even those with one side left blank to
save printing time, to be stacked and showed off over the bank counter to reassure depositors.
Calm returned, and things went back to normal when the moratorium expired—except, of
course, for the banks that closed and the depositors who lost their savings.

The consequences of the banking crisis

The economic impact of the Financial Crisis of 1927 was negative but not catastrophic. The
banking sector had to be restructured, but real growth and the manufacturing sector did not
suffer very much. Macroeconomic statistics showed little sign of a serious downfall. The
worst for the macroeconomy would come a few years later, for other reasons (Chapter 9).
The most significant consequence of the bank runs of 1927 was financial concentration.
The government liquidated or merged unsound banks into about two dozen new banks.
Among the 36 banks closed in 1927, fifteen banks were reopened, eight were merged, five
were bankrupted, and one was still in a restructuring process after a year. In the restruc-
turing process, unlucky people who had deposits at restructured banks on average lost

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35–50 percent of their savings. The government encouraged further mergers of remaining
small banks by imposing a minimum capital requirement and other regulations. Naturally,
people also shifted their savings from small local banks to more well-known banks. The
number of commercial banks fell from more than 2,000 in 1919 to 625 in 1932. Deposits
were increasingly concentrated in the “Big Five” banks: Mitsui, Mitsubishi, Sumitomo,
Yasuda and Daiichi. By 1931, they collectively accounted for 38.3 percent of total bank
deposits and 29.6 percent of total bank loans (Figure 8.2).
Elimination of small kikan ginko was a good thing for modernizing the Japanese banking
system. From another perspective, however, this reduced the supply of bank credit to small
enterprises. As deposits were concentrated in big banks, these banks had more money than
they could lend out. Special laws were passed for liquidity injection and increasing com-
pensation for the Bank of Japan’s losses up to 500 million yen. These created a situation of
general excess liquidity and low interest rates.
In comparison with today, the financial framework of the 1920s was clearly inadequate.
Information disclosure was not mandated, deposit insurance did not exist, capital adequacy
ratios were not imposed and bank supervision and regulatory mechanisms were not in place.
Moreover, the Bank of Japan did not fulfill its role as the lender of last resort.
But on this last point, some questions remain. Should the Bank of Japan be blamed for
worsening the financial crisis because it did not provide liquidity to the Bank of Taiwan
at the critical moment? We need to consider the following aspects before a final judgment
is given.
First, the Bank of Japan had been forced to rescue too many banks against its will and
against its own financial soundness. At some point, it had to reassert its political independ-
ence. While the immediate consequence of letting the Bank of Taiwan fall was severe,
endless provision of emergency loans might not have been the right answer.

(a) Deposits (b) Loans

Figure 8.2 Share of big five banks

Source: Takahashi and Morigaki, 1993, p. 249.
Note: Share of Big Five is shown in dark gray. End of year data. The data of 1931 is for end June 1931.

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Second, among the general public and the opposition party, political resistance to inject-
ing public money into a few big banks was so strong. For this reason, the Bank of Japan also
had to take a tough stance toward the Bank of Taiwan.
Finally, bank closures are painful in the short run but, if properly handled, they will ensure
the soundness of the remaining banks and of the whole financial system in the long run.

Box 8.1 Hamaguchi Osachi and Koizumi Junichiro

Below are excerpts from Banno Junji’s essay, “Hamaguchi Osachi and Koizumi
Junichiro,” which appeared in Ronza, a popular magazine, in October 2001. It com-
pares the economic policies of the Hamaguchi government (1929–31) and the Koizumi
government (2001–6). Hamaguchi’s policy is also discussed in Chapter 9.

Regarding economic structure, Japan in the 1920s faced the same problems
as today [2000s]. In particular, the question of how to cope with the impact
of the bursting of the WW1 bubble was very similar to the question we are
now facing after the bursting of the Heisei bubble in the 1990s. In the 1920s,
as at present, the economy stagnated because the policy makers avoided and
delayed the resolution of the problem for fear of short-term pain.
The situation of the 1920s, including the problem of how to cope with the
non-performing loans and the policy decision to return to the gold standard,
has many similarities with the economic problems that the current Koizumi
government faces. Then as well as today, the Japanese economy, artificially
supported by fiscal stimuli, was driven to a policy impasse. There was no way
out except to adopt the gold standard in order to eliminate inferior firms and
encourage technical innovation by efficient firms.
However, the mass media’s evaluation of the policies of the Hamaguchi
government—as well as its Finance Minister Junnosuke Inoue who car-
ried out austerity measures—is fairly negative. Partly because of the global
depression into which the Japanese economy was plunged immediately after
the return to the gold standard, today’s media tend to focus only on the pain-
ful side of the economic policies of Hamaguchi and Inoue. By contrast, they
happily approve the policies of Finance Minister Takahashi Korekiyo who
subsequently resurrected fiscal expansionism, and argue that the Koizumi
government should not repeat the mistake the Hamaguchi government made.
Is this the correct lesson to take from history? …
The highly regarded fiscal policy of Takahashi boils down to the issuance
of government bonds to cover the war expenses of the Manchurian Incident
and the active spending to help rural districts out of recession. This was called
Jikyoku Kyusai (correct and rescue the situation), or more recently, Tomen
no Keiki Taisaku (recovery policies for the moment). This was considered
doubly effective for building infrastructure and for creating jobs … But it is
hard to argue that this policy alone improved the productivity and competi-
tiveness of Japanese firms, leading to the economic boom.

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If we examine more closely, we find that the lopsided evaluation between

Inoue and Takahashi comes from looking only at the macroeconomic aspects
of their fiscal policies. The assessment from microeconomic aspects of how
the private sector responded is totally lacking.
As I argued earlier, Japan in the 1920s desperately needed structural
reforms in order to reduce the bad assets of the post WW1 period and cul-
tivate new competitiveness. It is true that unemployment and bankruptcies
surged with Inoue’s fiscal policy under the Hamaguchi government. But
we must also realize that, during this period, many firms implemented
comprehensive restructuring and consolidation, industrial structures were
reorganized, and export industries underwent management rationalization
and technical progress. Only after this intensive joint effort by management
and labor to improve efficiency, the Japanese economy was able to recover
in the following period …
If this historical lesson is correctly learned, the Koizumi government
should be able to effectively apply this lesson to the current situation. I have
argued many times that today’s Japan must learn from the Hamaguchi gov-
ernment and the Minsei Party led by Hamaguchi. Japan really needs to create
another Minsei Party.
Economic reforms always come with pain. Unemployment will visibly
increase and bankruptcies will surge. The economy may fail to recover soon.
Under these circumstances, a political party which is willing to take responsi-
bility and pushes reforms forward is needed. The lesson of the prewar period,
as I interpret it, is that we must learn from the Minsei Party and re-create such
a party today. The Seiyukai Party—in other words, the Liberal Democratic
Party—can hardly carry the torch of structural reforms.

Note
1 As of end 1926, on the eve of the bank runs, the total amount of unsettled earthquake bills was
207 million yen, with the Bank of Taiwan holding 48.4 percent of it. Other banks with large shares
included the Bank of Korea (10.4 percent), Murai Bank (7.4 percent) and Omi Bank (4.5 percent)
(Takahashi and Morigaki, 1993[1968], p. 146).

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9
T H E 1930 s AND THE W AR ECONOM Y

The Showa Depression, 1930–32

During 1930–32, Japan experienced the deepest economic downturn in its modern history.
This depression had far more serious consequences than the 1927 financial crisis (Chapter 8)
on all aspects of Japanese life including economic, social and political. It was caused by the
simultaneous occurrence of two factors.
Externally, Black Thursday, the Wall Street stock market crash in the United States in
October 1929, and the ensuing economic depression, spread to the world and exerted a severe
negative impact on the Japanese economy as well. The Great Depression thus engulfed all
capitalist countries resulting in sharp price declines and surging unemployment.
Internally, the Minsei Party government (July 1929–April 1931), featuring Prime Minister
Hamaguchi Osachi, Finance Minister Inoue Junnosuke and Foreign Minister Shidehara
Kijuro, adopted a deflationary policy to eliminate inefficient banks and firms as well as to
prepare the nation for the return to the prewar gold parity (i.e. restoring a fixed exchange rate
of two yen per dollar).
Throughout the 1920s, restoration of the gold standard, which worked well to secure price
stability and spur growth in the late nineteenth century, was an important economic agenda
for the world as well as for the Japanese government. In Japan, the return to gold was planned
a number of times but each time it had to be postponed by the occurrence of an unexpected
event such as the Great Kanto Earthquake and the banking crisis. Finally, in January 1930,
the gold standard was restored and the yen was re-fixed at the previous parity by the hands of
Finance Minister Inoue who in preparation adopted macroeconomic austerity to deflate the
Japanese economy. Inoue’s argument was as follows.

Our economy remains highly unstable because of the export ban on gold
[the yen’s non-convertibility to gold and the resulting exchange rate fluctuation].
We must liberalize gold export as soon as possible. But we cannot liberalize gold
export without preparation. What is required in preparation? The government
must tighten the budget. The people must accept this fiscal austerity and they
themselves must reduce consumption. If that happens, prices will start to fall and
imports will begin to contract. That will create an upward pressure on the yen
in the foreign exchange … We face a recession without an end in sight. If noth-
ing is done, we will sink deeper. In the past, Japan often overcame recessions
with the help of external stimuli. But the current situation does not permit such
a hope because the European economies are severely weakened by the last war.

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Under such circumstances, we should not hope for foreign demand to bail us out.
Recovery must be generated by our hands. There is no way out except through
our own austerity.
(Essays of Junnosuke Inoue, Vol. 1, 1935)

Unluckily, Inoue’s stern deflation policy coincided with the beginning of the Great Depression
in the world economy. With internal and external shocks reinforcing each other, Japan was
plunged into a very serious deflationary spiral with surging unemployment. Popular discon-
tent against Inoue’s policy mounted but Inoue never relented. Inoue’s engineered deflation
was continued for two years until the Minsei Party government was replaced by a Seiyukai
government in December 1931.
In Britain, John Maynard Keynes, a Cambridge intellect and the father of macro-
economics, asserted in 1925 that his country should not return to gold at the prewar
exchange rate because the equilibrium exchange rate—an exchange rate that would bal-
ance internal and external price levels—had shifted after WW1 as a result of international
price divergence. He warned that the British recession would worsen if an overvalued
exchange rate was chosen for fixing. Keynes calculated that the pound would be overval-
ued by 10 percent at the prewar parity. Similarly in Japan, Ishibashi Tanzan, an economic
journalist at Toyo Keizai Shimposha, argued for a return to the gold standard at a new, more
depreciated exchange rate.
However, Inoue’s idea was that Japan needed forced recession. He concluded that
unprofitable firms and banks survived throughout the 1920s without merger, consolidation
or liquidation because the government and the Bank of Japan generously helped them. He
knew very well that deflation was painful but he believed it was necessary to remove inef-
ficient industries. Many people blamed—and still blame—him for pursuing an aggressive
deflationary policy when the world was reeling from the Great Depression. But Inoue never
changed his view until he was assassinated in 1932. Perhaps his idea was economically
sound but the timing and degree of execution were unfortunate.

Social instability and the rise of fascism

The Showa Depression wreaked havoc on Japanese society. Its main consequences were
as follows.
First, as in previous recessions, macroeconomic downturn was felt primarily in falling
prices and not so much in output contraction. Estimated real growth was actually positive
during this period. As prices fell, manufacturers rushed to produce more to maintain earnings,
keep factories running and retain workers. But clearly, this behavior collectively accelerated
the oversupply of all manufactured goods and therefore the deflation. From 1929 to 1931, the
wholesale price index fell about 30 percent, agricultural prices fell by 40 percent, and textile
prices fell by nearly 50 percent (Figure 9.1).
Second, rural impoverishment became severe around 1931 and continued into the mid
1930s even after the industrial sector recovered. To make matters worse, in 1934, rural com-
munities were hit by famine. In the Tohoku (northeastern) Region of Japan, rural poverty
generated many undernourished children. Some farmers were forced to sell their daughters.
This ignited great anger and popular criticism against the government and big businesses
which seemed to be doing nothing and caring little about this rural disaster.

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Figure 9.1 Wholesale price level
Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 4, 1988.
Note: No data are available for agriculture and textile before 1929.

Figure 9.2 Average income of farm households (including non-farm income)

Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 2, 1988.
 T H E 1 9 3 0 s A N D T H E WA R E C O N O M Y

Third, cartelization and rationalization were promoted under official guidance. As free
markets seemed to deepen the depression, mutual agreements on output restrictions were
adopted. This practice quickly spread to virtually all material industries including cotton
yarn, rayon, carbide, paper, cement, sugar, steel, beer and coal.
Fourth, the fascist movement emerged. Fascio is an Italian word used then to denote polit-
icized military and right-wing groups with the aim of establishing a totalitarian regime. Amid
economic despair, much blame was placed on party governments and their policies. Both the
Minsei Party and the Seiyukai were despised. Even ordinary people, who normally hated milita-
rism, were disappointed with the performance of “democratic” party governments and became
more sympathetic to the “Reform Movement” advocated by the military and nationalists.
In the 1930s, political and intellectual preference was gradually shifting from eco-
nomic liberalism to the state management of the economy. There were several reasons for
this, including (i) rising popularity of Marxism; (ii) the apparent economic success of the
Soviet Union which practiced state planning; (iii) the Showa Depression as evidence of
failed capitalism; (iv) the view that deflation was aggravated by unregulated and excess
competition and (v) general disappointment with the major political parties in economic,
external and anti-terrorism policies. Many considered that the days of the American-style
free market were over and that, from then on, state control and industrial monopoly would
be required for building a competitive national economy.
Another aim of the military and right-wing groups was active external expansion. They
criticized “Shidehara Diplomacy” which to them seemed too soft on China and too concilia-
tory to the United States. Their primary goal was to defend Japanese interests in Manchuria
and Mongolia (more precisely, the eastern part of “Inner” Mongolia as viewed from China).
However, military invasion of China would violate the agreement with the Western powers
on the internationally agreed policy of “open door and equal opportunity” in China. Scrapping
this agreement would carry the risk of spreading military confrontation to all China and
Southeast Asia, and even to the entire world.

The Seiyukai and the Minsei Party

The Seiyukai (full name: Rikken Seiyukai) was established in 1900 by the union of Ito
Hirobumi, a leading politician and the first Prime Minister of Japan, and former opposition
parties that decided to cooperate with the government. Its main policies were (i) fiscal activism
with an emphasis on public investment in rural and industrial infrastructure; (ii) acceptance
of military buildup and expansion; and (iii) pleasing a narrow voter base (rural landlords and
urban rich). It was a party supportive of a big government that allocated public money and
subsidies. Seiyukai literally means “Association of Political Friendship.”
The Minsei Party (full name: Rikken Minsei To) was originally called the Kenseikai
(1916), which merged with another party in 1927 to become the Minsei Party. Its main
policies were (i) economic austerity and industrial streamlining (a free economy and small
government); (ii) return to prewar gold parity and (iii) international cooperation and peaceful
diplomacy, especially with the United States. Its support base consisted of intellectuals and
the urban population. Minsei literally means “People’s Politics.”
Japanese voters in prewar Japan did not always vote for the same party. Their allegiance
switched from one party to another depending on the prevailing issue at each election
(Table 9.1). The Seiyukai was a big spender and it also did not hesitate to align with the

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military to oust Minsei Party governments. The Minsei Party seemed more democratic and
peaceful but it pursued an economic policy of belt-tightening and forced deflation. When
an economic crisis was the greatest issue, people overwhelmingly voted for the Seiyukai
in 1932. When uncontrolled military expansion in China was resented, they shifted support
to the Minsei Party in 1936. After the voter base was enlarged in 1925, smaller “proletariat
parties” (social democrats) also emerged with farmers and workers as the support base.
As explained earlier, Finance Minister Inoue Junnosuke of the Minsei Party govern-
ment (1929–31) was deeply committed to the policy of deflation and returning to gold. This
caused a severe depression but he never relented or regretted his position. People became
greatly frustrated with his policy. Finally, the government (the second Wakatsuki Cabinet)
was removed in the aftermath of the October Incident (see below) and was succeeded by a
Seiyukai government (the Inukai Cabinet) on December 13, 1931.
As soon as the new government was sworn in, Finance Minister Takahashi Korekiyo
completely reversed Inoue’s policies. On the very first day of the new cabinet, Takahashi
ended the gold standard and floated the yen which immediately depreciated. In addition,
fiscal expansion financed by government bond issues (called “Spending Policy”) was
adopted. Monetization of the fiscal deficit, in which the Bank of Japan bought up newly

Table 9.1 Two major political parties in prewar Japan

Seiyukai Minsei Party

Establishment Established in 1900 by Ito Hirobumi Kenseikai established in 1916;

and former opposition party Minsei Party created by merger
members as pro-government party; of Keiseikai and another party
disbanded in 1940 (Seiyu Honto) in 1927; disbanded
in 1940
In power 1900–1, 1906–08, 1911–12, 1918–22, (1924–25), 1925–27, 1929–31
(1924–25), 1927–29, 1931–32
Support base Big businesses, landlords and well- Intellectuals and urban middle class
to-do farmers
Economic Fiscal activism, big government, public Free market, small government, return
policy investment for industry and rural to the prewar gold parity, exit of
infrastructure and development inefficient firms through austerity
Rights of Not interested Elevate the rights of farmers and
working class workers when possible
Distinctive Takahashi Korekiyo floated and Inoue Junnosuke pursued deliberate
finance depreciated yen, adopted easy money deflation policy to re-fix yen at the
minister and and fiscal expansion to recover prewar exchange rate (1929–31)
his policy economy, later reversed (1931–36)
Foreign policy Initially peaceful (until around 1925), Opposed military invasion of China,
but later supportive of military to protected Japanese interest through
undermine Minsei party; sent troops diplomacy, promoted global
to China to defend Japanese interests disarmament and cooperation with
the West
Problem Opportunism to align with military Sustaining severe deflation policy in
undermined democracy and party the midst of global economic crisis
politics
Note: the table shows key features of the two parties from the late 1920s to the mid 1930s. The government of
1924–25 was a coalition of the Keiseikai, the Seiyukai and the Reform Club.

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issued government bonds, was tried for the first time in Japanese history. Money supply
expanded and interest rates were lowered.
Thanks to this policy turnaround, the Japanese economy began to recover in 1932 and
expanded relatively strongly until 1936, the last year of the non-war economy. Among major
countries, Japan was the first to overcome the Great Depression of the 1930s. Fiscal and
monetary expansion worked well. But the yen’s sharp depreciation might be interpreted as a
“beggar-thy-neighbor” policy. It was a policy that could offend other countries since Japan
promoted its exports at the cost of reduced competitiveness of its trading partners.
For these achievements, Takahashi was called “Japanese Keynes.” He adopted the
Keynesian policy of fiscal and monetary expansion to fight an economic downturn even
before John Maynard Keynes wrote his epoch-making treatise on the General Theory of
Employment, Interest and Money1 in 1936! Even today, Takahashi’s policy is admired while
Inoue’s policy is widely criticized as stubborn and misguided. But this view can be chal-
lenged. Banno Junji, specializing in prewar Japanese politics, argues that Inoue’s deflation
policy, which eliminated inefficient firms and banks, provided the precondition for eco-
nomic recovery of the mid 1930s. Thus, in his opinion, both Inoue and Takahashi were
needed (see Box 8.1).
Around 1934, when Japanese industries were firmly on a path to recovery, Takahashi
began to go back to a tighter budget, which seemed an appropriate decision. But the army and
the navy continued to demand more spending despite escalating fiscal pressure. Takahashi
resisted their demand and was assassinated by a military group in the February 26 Incident
in 1936 (see below).
Both Inoue and Takahashi served as a Governor of the Bank of Japan before assuming the
job of Finance Minister, but their personalities differed significantly. Inoue was a slim and
intellectual graduate from the Imperial University. Takahashi was fat and had a nickname of
Daruma, a round doll made after a famous Zen monk. He received little formal education and
had a rough life when he was young. Japanese people naturally liked Takahashi who looked
friendlier and who always saved Japan from economic crises.

Political terrorism and invasion of China

From 1931 to 1937, Japanese politics was gradually overtaken by the military. Many bloody
incidents occurred, each undermining the foundation of party politics and democratic gov-
ernment. Within the army and the navy—especially the army—a few ultra-nationalist groups
formed with the purpose of rejecting a party-based political system, uniting the nation under
the emperor, introducing economic planning and saving the rural poor. They staged many
assassinations and coup attempts. Here is a brief chronology of this dismal period.
In 1931, the Manchurian Incident (September 18th Incident) broke out in which several
military officers of the Kantogun (Japanese army stationed in China), especially Ishihara
Kanji and Itagaki Seishiro, started a military invasion of Manchuria (Northeastern China)
by blowing up a railroad track and blaming it on the Chinese. Ishihara’s theory was that
Japan had to take Manchuria in order to prepare for a full war against the United States. The
incident was initiated without informing the central government or the army headquarters
in Tokyo. Foreign Minister Shidehara instructed Kantogun to refrain from further military
action but Ishihara’s group ignored this. The Chinese side adopted a non-resistance strategy,
and Manchuria was soon occupied by Japanese troops. This incident clearly showed that the

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party government could no longer restrain the military. Separately, in the same year, there
were the March Incident and the October Incident in Tokyo, two military coup attempts that
were detected and aborted.
In 1932, the Blood Society, each of whose members was ordered to assassinate one politi-
cian or business leader, killed Inoue Junnosuke (former Finance Minister) and Dan Takuma
(CEO of the Mitsui Group). In the May 15th Incident, young navy officers gunned down and
killed Prime Minister Inukai Tsuyoshi (Seiyukai). In the same year, the State of Manchuria,
a Japanese puppet state, was established. Japanese occupation of Manchuria was studied and
criticized by the League of Nations, which led Japan to withdraw from the League in 1933.
The years from 1933 to 1935 were relatively “quiet” thanks to the economic recovery and
fewer domestic and international incidents. But this proved to be a temporary calm before
the big storm.
In 1936, the February 26th Incident, the most serious coup attempt in prewar Japan,
occurred. Nationalistic army officers led their troops to stage a military coup on a snowy
morning in Tokyo. They wanted to remove the incumbent government and establish a new
regime. Takahashi Korekiyo (Finance Minister), Saito Makoto (Interior Minister) and
Watanabe Jotaro (Army Training Director) were assassinated. The coup group occupied
central Tokyo for four days. The army headquarters first approved the coup but later dis-
owned it because the emperor angrily and unequivocally ordered the military to put down
the rebellion. The coup thus failed, and radical factions within the military that staged or
supported it lost political power. But other military factions continued to marginalize party
governments and gained influence over Japanese politics.
During many of these incidents, the Seiyukai behaved opportunistically, often supporting
the military in order to attack its rival, the Minsei Party. It was a risky tactic because the
goal of radical military groups was to remove all political parties including the Seiyukai
(Banno 2004). The Seiyukai also criticized the “Organ Theory of the Emperor” advocated
by Professor Minobe Tatsukichi of Tokyo University, an academically well-established doc-
trine that justified party governments under the Meiji Constitution, to corner the Minsei Party
government before an election.2 By contrast, the Minsei Party more consistently opposed the
military. Nevertheless, both the Seiyukai and the Minsei Party were seriously discredited in
the eyes of the public because they were considered equally corrupt and incompetent. For
farmers and workers who rejected the market mechanism and demanded economic control
and pro-poor and pro-labor policies, both parties seemed too bourgeois (pro-business). In this
way, the general public and burgeoning proletariat (i.e., social democratic) parties began to
partially sympathize with the military. They did not welcome aggressive invasion of foreign
countries, but they liked the anti-capitalist reform agenda advocated by the fascist groups.
Then, in 1937, the Japan–China War started. On July 7, Japanese and Chinese troops
had a skirmish at Marco Polo Bridge near Beijing (then called Beiping). The incident was
a minor one but the Konoe Cabinet in Tokyo decided to send more troops to China. Thus
began a full-scale war with China, which lasted until 1945. After the Japan–China War
erupted, the entire nation was mobilized for war purposes. The military took over Japanese
politics, and political parties were emasculated and subsequently disbanded. This was a
complete defeat and end of prewar democracy.
When did Japan cross the point of no return toward a total war? There are diverse views,
but in the opinions of many, it was probably the Manchurian invasion in 1931. With this
incident, Shidehara’s peaceful diplomacy was abandoned and the military’s influence
began to increase. The forceful establishment of the puppet state of Manchuria in pursuit

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of Japan’s interests violated the principle of “open door and equal opportunity” which was
the most important agreement on China among major powers throughout the 1920s. After
this invasion, Japan’s international isolation was unavoidable. Party governments were too
weak to reverse this trend. While some factions within the Seiyukai and the Minsei Party
tried to join forces to oppose militarism, their attempts did not materialize. Counting from
the Manchurian Incident, the period 1931–45 is sometimes called the “Fifteen-Year War,”
which is understandable from the viewpoint of international relations. However, for ordinary
Japanese people, the sense of wartime did not really exist until 1937 when the Japan–China
War started and a large number of controls began to be introduced to limit their civilian life.
Some argue that Japanese people and parliament in this period were suppressed by the
military, and they were deprived of necessary information and the right to criticize external
military activities. However, this view is not correct up until 1937. In Japanese printed media,
a large number of essays and columns were found that criticized the military and its foreign
invasion and called for the formation of a national anti-fascism front. In the parliament,
many speakers provoked and condemned military leaders. The Social Mass Party, represent-
ing the voice of workers and farmers, increased their parliamentary seats at every election.
However, the situation changed dramatically after the Marco Polo Bridge Incident of July
1931. Once a total war began, all efforts toward democracy came to nil and everything had
to be reorganized for the purpose of executing the war.

The war economy, 1937–45

The military leaders thought—or at least hoped—that the war with China would be short. But
in reality, it lasted for eight years. Without a realistic vision or strategy, the war front expanded
endlessly and fighting escalated. Within China, the Nationalists and the Communists were
fighting at first but later joined forces to resist Japanese invaders.
Until 1936, the Japanese economy basically remained market-oriented despite calls for
more economic planning. But with the outbreak of the Japan–China War in 1937, national
economic management was significantly transformed for war execution. One by one, new
measures were introduced to control and mobilize people, enterprises and resources. Most
Japanese firms remained privately owned as before but were heavily regulated in production,
investment, finance, employment and so on, to contribute to the war effort.
In 1937, the Planning Board (kikakuin) was created. This board, directly under the
Prime Minister, was responsible for comprehensive policy design for wartime resource
mobilization. The brightest bureaucrats from various ministries were gathered for this
purpose. Without nationalizing enterprises, it basically played the same role as state plan-
ning committees in socialist countries. Special laws for military expenditure, financial
control and regulating tradable goods were implemented. The bulk of military spending was
gradually shifted from the general budget to the new special account for military expendi-
ture, and government size began to increase due to the skyrocketing military spending. In
1937, the government budget was 4.74 billion yen, of which military spending occupied
69.0 percent. This would eventually rise to 86.16 billion yen by 1944, of which military
spending was 85.3 percent, and mounting fiscal deficits were financed mainly by issuing
public bonds (Ito, 2007).
In 1938, the Planning Board issued the Resource Mobilization Plan, which was Japan’s
first economic plan. In the same year, the National Mobilization Law was also approved. The
Plan and Law were put into practice over the following years as the war intensified.

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In 1940, the New Regime Movement was initiated by Prime Minister Konoe Fumimaro.
This movement was started in response to the Japanese invasion of Southeast Asia and Nazi
Germany’s victories in Europe. It was felt that a strong one-party monopoly of power was
needed. All existing political parties were dismantled and replaced by the monolithic Taisei
Yokusankai (Imperial Rule Assistance Association), an administrative organ created by the
government to oversee and mobilize people for war.
In 1943, the Military Needs Company Act was adopted. Designated private companies
were placed under official control. The government approved top management and produc-
tion plans and imposed penalties for non-compliance. At the same time, these companies
were provided with necessary inputs on a priority basis.
The primary objective of economic planners was to maximize military production with
limited domestic resources and imports. Key military goods were ships and warplanes, and
energy and materials to produce and operate them (toward the end of the war, as Japanese
ships and sea transport capacity were destroyed, airplane production became the only pri-
ority). In order to boost heavy industries, consumption was greatly squeezed and light
industries were strongly suppressed. The textiles industry, previously the leading industry
of prewar Japan, was virtually eliminated and converted to military use. People were forced
to live without new supplies of clothing or footwear. Steel products in structures, streets and
households were stripped and used as the metal source for building more airplanes and ships.
As the war continued, food rationing, forced enterprise mergers and forced factory labor
were adopted in increasing intensity.
At first, the two crucial variables in wartime planning were foreign exchange reserves
and the availability of energy and raw materials (and the ability to transport them by sea).

Figure 9.3 Production of military goods

Source: Nakamura (1989), p. 21.

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Figure 9.4 Supply of consumer goods per head

Source: Nakamura (1989), p. 22.

Until around 1940, the question was how to maximize military output subject to these two
constraints. After that, because Japan could no longer trade with other countries, the problem
shifted to the physical transportation of natural resources from the Japanese colonies and
occupied areas in Northeast and Southeast to mainland Japan.
It was considered that the resources from the “Yen Bloc” (Korea, Taiwan, Manchuria
and the rest of occupied China) were not sufficient. In July 1941, to secure more resources,
the Japanese military began to invade Southeast Asia beginning with French Indochina
(i.e., Vietnam). This military campaign angered the United States, prompting it to impose an
oil embargo and asset freeze on Japan. If oil import from the United States were to be cut off,
Japan’s existing oil reserves would last only two years. At this point, Japan began to prepare
for a war with the United States. Diplomatic efforts to maintain peace were attempted but
failed. With the Pearl Harbor attack in December 1941, Japan started the Pacific War against
the United States and its allies.
Japanese leaders did not have any clear idea regarding how to fight a war against the
United States, let alone how to win it. However, they were encouraged by the brilliant victo-
ries of Nazi Germany in Europe. To them, the totalitarian states of Japan, Germany and the
USSR seemed far superior to American capitalism and individualism.
Immediately after the outbreak of the Pacific War, Japan invaded a wide area of Southeast
Asia but soon began to retreat under allied counter-attacks led by the Americans. Japanese
ships and planes were quickly lost while the United States built an increasing number of
them. From late 1944 to the end of the war, American aerial bombing, which consisted
largely of incendiary bombs, destroyed virtually all major cities in Japan (except Kyoto).

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Figure 9.5 Maritime transport during the Pacific War

Source: Nakamura (1989), p. 30.

In March 1945, US troops landed in Okinawa and obliterated Japanese resistance within
three months in fierce and civilian-involved fighting. In August 1945, two atomic bombs
were dropped, in Hiroshima and Nagasaki, and the USSR entered the war against Japan.
A few days later, Japan surrendered.
Whatever the political and social causes of Japanese militarism, the main economic rea-
son for Japan’s defeat was the collapse of its war economy due to the lack of material and
energy inputs. Japan lost virtually all its means of sea transport and could not carry industrial
inputs from its colonies and occupied areas to the mainland (Figure 9.5).

Collective social psychology: lessons from prewar Japan

The question of why Japan trod its aggressive military path and ended up with total war
against China, the United States and most of the world is not easy to answer succinctly
or convincingly to all who are interested in this question. Nevertheless, at the end of this
dismal chapter, it may be useful to cite several social tendencies and reactions that led
Japan, an emerging industrial power, eventually to this disastrous course. This is important
for understanding not only prewar Japan but also other rising nations at any time because
similar social psychology and traps seem to be at work in them albeit with different degrees
and inflections.
First of all, it must be said that a nation rapidly rising in economic power becomes arro-
gant, militaristic and expansionist toward its neighbors. Such a nation always comes up with
theories and interpretations justifying its behavior, but scientifically assessing or refuting
them will not stop aggression because it comes from a deep and collective human instinct for
which convenient justification is easily invented.3

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People and various organizations—political parties, business associations, academics,

media and civil organizations—initially take diverse positions on external aggression of the
military, from passionate support to strong opposition. Doves and hawks coexist even within
the military. Not everyone supports militarism at first.
Over time, however, as unfortunate news and events unfold, an appeal to patriotism
and inflamed hatred against “unforgiveable enemies” gradually wins over pacifist voices.
The government sometimes even resorts to an unwise tactic of directing blame towards
foreigners, which later backfires. Mass psychology and emotion begin to rule. Oppositions
continue to fight but become quieter and eventually lose.
Ignited by emotional “nationalism,” the media and general public often become more
belligerent than the government which wants to manage the level of external friction and
prefers a diplomatic solution. Once such social momentum is unleashed, it becomes very
difficult for anyone to stop. Popular sentiment becomes a constraint on foreign policy rather
than its support.
Finally, the government also gives in to militarism and begins to actively prepare and exe-
cute war. Dissents are annihilated, debate ends and military objectives dominate all policies.
The government turns to restrict people’s freedom and suppress their living standards for the
just cause of war.

Box 9.1 The origin of the Japanese system

Many of the characteristics of the post-WW2 Japanese economy originated during the
war period of 1937–45. The main features of this model include long-term relationship
and active official intervention as represented by such elements as:

•• heavy and chemical industrialization drive

•• administrative guidance (gyosei shido)
•• the subcontracting system in manufacturing (shitauke seido)
•• separation of ownership and management
•• lifetime employment and seniority wage
•• enterprise-based (not profession-based) trade unions
•• financial keiretsu and mainbanks
•• “window guidance” and the “convoy system” conducted by the Bank of Japan
•• food control system
•• foreign exchange budget and foreign exchange surrender requirement.

All of these policies and systems were deliberately adopted by the government in the
late 1930s through the early 1940s in order to effectively execute the war. Before that,
the Japanese economy was more “neoclassical,” characterized by freer entry, short-term
contracts and high labor mobility.
These wartime features were largely retained even after WW2 and worked rela-
tively well in the 1950s and 1960s, when Japan was growing rapidly. However, after
Japan reached high income, they became obsolete and negative, so it was argued,
as barriers to quick and flexible adaptation in the age of globalization and ICT.
Among the items listed above, the last one was abolished long ago but the remnants
of all others still exist in the Japanese economy to varying degrees even today.

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However, there is a debate among economists regarding the interpretation of the

Japanese system. The majority of Japanese economists insist that Japan should go back
from wartime regulation to the free market model because the relational and interven-
tionist system was originally alien to Japan. These may have played a historical role
in certain decades of the twentieth century, but the country does not need them any
more—although some beneficial aspects, such as priority placed on job security, could
be retained. Okuno Masahiro, Okazaki Tetsuji and Noguchi Yukio are leading advocates
of this view (Okazaki and Okuno, 1993; Noguchi, 1995).
But a minority voice says that Japan needed a system based on a long-term relation-
ship with or without war. When an economy graduates from the light industry stage
featuring garments, footwear, food processing and simple assembly of electronics prod-
ucts, and moves to heavy industrialization and machinery production, free markets may
not be the best choice. Official support and long-term trust become indispensable for
industries that require large initial investments, high technology and a developed intra-
firm labor market. As Japan began heavy industrialization in the 1920s and 1930s,
the free economic system inherited from the Meiji period was considered inappropri-
ate and had to change. The war provided a good excuse for accelerating this change.
But even without the war, Japan had to adopt a new system anyway. Hara Yonosuke
presents such a view (Hara 1996). According to him, the free economy of Meiji was
unusual and foreign, and the relational and interventionist system, dating back to the
Edo period and even before, is more normal for Japan.
If this view is correct, implications for today’s developing countries are as follows.
Light manufacturing such as garment and electronics assembly can be promoted by free
trade and an open and undiscriminating FDI policy. But if the country hopes to absorb
technology vigorously, have advanced manufacturing capability and climb the industrial
ladder from middle income to high income, more proactive industrial promotion, featur-
ing a strong state encouraging and assisting private dynamism, will become necessary.
Japan, Taiwan and Korea all adopted this method in the past and reached high income.
By contrast, no Southeast Asian economies—Malaysia, Thailand, Indonesia, Philippines,
Vietnam and others—seem to have broken this “glass ceiling” and internalized their indus-
trial power. They are trapped in middle income. If latecomer countries are now banned
from taking proactive industrial measures because of the commitment to and constraints
under the World Trade Organization (WTO), free trade agreements (FTAs), World Bank
policy matrices and so on, their level of industrialization may forever remain low, charac-
terized by short-term and simple contract manufacturing and processing, never reaching
a higher level of technology.

Notes
1 J. M. Keynes, The General Theory of Employment, Interest and Money, Macmillan, 1936. Keynes
criticized the classical contention that unemployment could be automatically solved through the
market mechanism. Using analytical tools such as liquidity preference, shortage of investment oppor-
tunities and aggregate supply and demand, he showed the possibility of involuntary unemployment
in a world where uncertainty ruled. Public investment was advocated as a remedy for this situation.
Keynes’ theoretical contribution revolutionized economics, which led to the creation of the discipline
of macroeconomics and the system of national income statistics.

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2 The organ theory of the emperor considered the state as a legal entity with a power to rule in which the
emperor was its highest organ. This was the standard theory of the Meiji Constitution. The idea that
the emperor’s power was derived from and exercised within the Constitution was in line with the spirit
of constitutional monarchy as well as the intention of Ito Hirobumi, the principal author of the Meiji
Constitution. However, this theory angered the nationalists who regarded the emperor as divine and
beyond the constraints of the Constitution.
3 Many political and intellectual leaders of Meiji Japan, including Fukuzawa Yukichi, Yamagata
Aritomo, Kuga Katsunan and Aoki Shuzo, oscillated between the “Asia is One” anti-West doctrine
and the “Japan is not Asia” doctrine that justified Japanese superiority and colonialism in the region.
Banno (2013) says this is not surprising because these doctrines were used to support Japan’s foreign
policy for each moment—whether to resist Western advances or invade neighboring countries—and
the lack of time consistency in their statements should not cause any wonder because doctrines were
only the means and not the end.

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10
POST WAR RECOVERY 1 9 4 5 – 4 9

Physical war damage

After the war defeat, Japan was occupied by the allied forces. In reality, the United States
was the only country that ruled Japan from 1945 to 1952. The occupying force was called
the Supreme Commander of the Allied Powers (SCAP) or, more commonly, the General
Headquarters (GHQ). The GHQ was headed by US Army General Douglas MacArthur. The
occupation of Japan was indirect in the sense that the Japanese government continued to exist
and function to the degree that it often negotiated or even resisted American orders. Another
feature unique to Japan was that it was occupied by only one country, unlike Germany which
was geographically partitioned and governed directly by four winning forces (United States,
United Kingdom, France and the USSR). This meant that Japan could avoid the risk of being
divided when the Cold War began.
The United States conducted a postwar survey on the effectiveness of various military
attacks against Japan during the war. It found that two factors contributed greatly to Japan’s
defeat. The first was a sea lane blockade as the vast majority of Japanese military and com-
mercial ships were sunk, and the country lost the means to transport energy and materials
between the mainland and the colonies or occupied areas. Without inputs, production came
to a halt. This was the primary reason for the collapse of Japan’s war economy.
Another factor was strategic bombing which intensified toward the end of the war.
Virtually all major Japanese cities were subject to US aerial bombing. The largest air raid was
launched in the eastern sections of Tokyo in the early hours of March 10, 1945 which, within
a few hours, trapped and killed approximately 100,000 civilians in a field of fire. Atomic
bombs were dropped on Hiroshima (90,000–120,000 immediately killed) and Nagasaki
(60,000–70,000 immediately killed). However, bombing did not reduce Japan’s production
capacity as much as expected, though it had a strong psychological impact. The US report
concluded that the sea lane blockade was more effective than the strategic bombing. It also
argued that bombing should have targeted railroads rather than urban dwellings.
The Japanese government also produced a report on war damage.1 Comparing before and
after the Pacific War, it estimated that 25.4 percent of total national physical assets were lost
(this includes direct damage by bombing and shelling as well as indirect loss due to scrap-
ping, removal and inability to maintain). Most of the losses were incurred toward the end of
the war. The ratios of destruction by asset type were as follows: ships (80.3 percent), indus-
trial machinery (34.2 percent), structures (24.6 percent), industrial materials (23.9 percent),
residences (20.6 percent), communication and water supply (15.9 percent), electricity and
gas (10.8 percent) and railroad and road vehicles (9.9 percent).

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Figure 10.1 Industrial production index

Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 2, 1988.

Thus, two-thirds of machinery stock and most railroads survived despite heavy air raids.
However, surviving factories and railroads were inoperative due to the lack of energy and
materials. In 1945 and 1946, output collapsed to only 20 percent of the wartime peak, or
30 percent of the prewar peak which was recorded between 1934 and 1936. The lack of
inputs was the reason, not the lack of capacity.

Shortage and inflation

Economic planning was continued even after the war ended and up until 1949. In a crisis
situation, previously for executing war and now for resuscitating the economy from severe
shortage, economic control had been used to complement paralyzed private sector activity.
As during the war, necessities were rationed and the government directed production and
procurement of key inputs. Prices were controlled, subsidies were provided and the economy
was still tightly regulated. However, compared with wartime, controls became less effective
because of the emergence of a large number of black markets.
Shortages were most severe and living standards were lowest in 1946, one year after the
end of the war. As food became extremely scarce, it was feared that many would starve to
death. Average calorie in-take per head hovered around 2,000 calories/day during 1934–44
but it plunged to 1,793 calories/day (88 percent of 1934–36) in 1945 and 1,449 calories/day
(71 percent of 1934–36) in 1946 before recovering to nearly 2,000 calories/day by 1949. The
urban population fared much worse than this average number shows while the rural popula-
tion did not suffer very much from food shortage (Shimizu, 2007). As soldiers and civilians
returned home from war fronts and former colonies, unemployment became a serious
problem. Joblessness was expected to reach 10 million. However, neither mass starvation
nor massive unemployment materialized, because the idle population was absorbed largely

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in informal and agricultural sectors. These sectors provided temporary jobs and a food
sharing mechanism.
Many urban residents worked in the informal sector to survive.2 They also had to travel to
rural areas in super crowded trains to exchange their remaining property, such as kimono and
clothing, for food with farmers. Because food rations were so small, everyone was forced
to violate the law and go to illegal markets to survive. It is reported that Judge Yamaguchi
Yoshitada of the Tokyo District Court was so law-abiding that he refused to disregard the
Food Control Law. He ate only rationed food. In October 1947, he died of starvation.
To cope with output collapse and unemployment, the Japanese government printed money
to finance subsidies while imposing price controls. This strategy could not be sustained for
long. Monetization of fiscal deficits created triple-digit inflation from 1946 to 1949. Black
market prices rose even faster, especially in the early period. This was the highest inflation
that Japan ever experienced in its history.
Foreign trade was strictly controlled and any international transaction had to be approved
by the GHQ. Private foreign trade was prohibited. For each commodity, the GHQ decided
the dollar price and the yen price separately, creating different exchange rates for individual
products. Thus, Japan between 1945 and 1949 had a multiple exchange rate system. Exchange
rates for exports (150–600 yen per dollar) tended to be more depreciated than exchange rates
for imports (125–250 yen per dollar).
The volume of international trade was also very limited. Apart from controlled trade,
the United States provided generous humanitarian and economic aid to Japan amounting to
cumulative $1.95 billion during 1946–50, which helped to ameliorate the shortage of food,
medicine and consumer goods. The Japanese economy was barely standing with two arti-
ficial supports, namely government subsidies and American aid. These supports had to be
eventually removed before Japan could walk on its feet again.

The basic problems of 1946

Immediately after the war defeat, two young officials, Okita Saburo and Goto Yonosuke,
organized a study group to discuss ways to rebuild the Japanese economy from the war
damage. Actually, the study group was under preparation toward the end of the war. Okita
and Goto were electrical engineers stationed in China, but they knew Japan would soon lose
the war. They returned to Tokyo to organize a study group.
The first meeting of the study group was held on August 16, 1945, one day after Japan’s
defeat. The topic was the impact of the Bretton Woods Agreement concluded a year earlier
and the creation of the International Monetary Fund and the World Bank. Following this,
study meetings on various topics were organized every week with the attendance of promi-
nent officials and academics. Okita and Goto served as the secretariat summarizing the key
points of each meeting and drafting a report. The study group began informally but was later
officially recognized as the Special Survey Committee of the Ministry of Foreign Affairs.
The interim report was produced in late 1945 and the final draft was delivered in March
1946. With minor revisions, the final report was published in September 1946.
The report, “The Basic Problems of Japan’s Economic Reconstruction,” is an excellent
specimen of Japanese development thinking.3 It has 193 pages in two parts. The first part
analyzes new global circumstances and the historical and geographical position of defeated
Japan. War damage is carefully examined and some positive aspects are also noted. The
second part contains proposals for promoting industries and targeting exports, sector by

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sector. Real sector issues dominate, while monetary and fiscal problems are discussed only
briefly. The report urges Japan to have a comprehensive and concrete recovery strategy
whose core content must be industrialization, technology improvement and a dynamic
transformation of trade structure. Priority industry must be analyzed carefully, and realistic
and concrete promotion programs must be devised. Comparative advantages in textile and
agriculture are now lost because of the expected emergence of the rest of Asia. Japan must
aim at skilled labor-intensive industries.
Here are some direct quotes from the Report (the two page numbers refer to Japanese
original and English translation respectively).

•• The major causes for such reproduction on a regressed scale are found in the sluggish
domestic production of coal and in the shortages of raw material imports. (p. 63/p. 66)
•• In capitalistic free competition many Japanese industries will be overwhelmed by gigan-
tic modern foreign industries, and Japan’s industrial structure will thus be deformed.
This will make it necessary to adopt State policies that will keep at least basic industries
intact. (p. 81/p. 85)
•• A national posture will have to be assumed in which all the people do not seek an affluent
consumer life but are content with minimum standards of living, consume conservatively,
and increase savings—thereby contriving to recover economic power and not seeking
financial assistance from the outside world for consumption purposes. (p. 85/p. 88)
•• A comprehensive and specific year-to-year reconstruction program will have to be
formulated in order to revive the Japanese economy from the extreme destitution in
which it finds itself now. The waste of economic power that would result from allowing
laissez-faire play to market forces will not be permitted in order that all the meager
economic power remaining may be concentrated in a direction toward reproduction on
an enlarged scale and that the process of reconstruction may be expedited. (p. 92/p. 94)
•• The principal role in Japan’s economic reconstruction will have to be played by
manufacturing . . . Therefore when the Japanese political and economic systems
have been democratized and their aggressive character wiped out, the nation’s
heavy industries should be allowed to grow to a considerable extent . . . As Japanese
heavy industries are certain to be subjected to international competition in the future
on the one hand, and because the benefit of adequate governmental protection as
experienced in the past will become difficult to obtain on the other hand, they will
have to cultivate—through the rationalization of management and the elevation of
technological levels—the ability to withstand the competition from foreign goods in
terms of production costs as well. (pp.111–112, 114)

Strategic orientations of this report—real-sector concerns, long-term industrial goals, select-

ing priority sectors, serious attention to concrete details, desire to produce new dynamic
comparative advantages, and so on—are common to Japan’s development cooperation phi-
losophy even today. And it is quite different from the strategy often advocated by the IMF
and the World Bank that puts macroeconomic stabilization, liberalization, openness and
good governance before pragmatic discussion of leading sectors for output recovery and
growth. For example, when Professor Kaneda Tatsuo submitted policy recommendations
to Kyrgyzstan (Kaneda, 1992), when Professor Ishikawa Shigeru wrote a diagnostic report
on Vietnam (JICA, 1995), when the Japanese government made a new proposal to Africa
(JICA and JBIC, 2008) and when the present author advises the Ethiopian government

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(GRIPS Development Forum, 2016), the logical sequence is very similar to that of the Basic
Problems report. While initial conditions and targeted industries may differ from one coun-
try to another, procedure to identify and study them remains common.
Many people were inspired by the Basic Problems Report even though its recommenda-
tions were not formally adopted by the government. Indirectly, however, the idea that “limited
resources must be selectively used for restarting an expansionary reproduction cycle” was
put into practice via the Priority Production System directed by Professor Arisawa Hiromi,
one of the members of the study group (see below).

Stopping inflation
Inflation peaked in 1946 and persisted in triple digits until 1949 (see Figure 10.2). The cause
was clear: monetization of the fiscal deficit. The fiscal deficit in turn was generated by the
following two policies. First, subsidies were directed mainly at industrial inputs such as
coal, steel, copper and fertilizer but some were targeted at consumer goods, especially food.
Price controls were imposed, and the government provided production subsidies (called
“compensation for price gaps”) to cover the losses incurred by private producers. Second,
the Recovery Financial Fund (fukkin) loans were poured into designated priority industries,
in particular the coal industry. They were provided by the Ministry of Finance financed by
issuance of government bonds (fukkin bonds). Most of the bonds were directly purchased
by the Bank of Japan, which increased money supply.
Economists debated, and still debate, the merits and demerits of these policies. From the
viewpoint of stopping inflation, massive subsidies and policy loans were clearly undesirable

Figure 10.2 Retail price inflation in Tokyo

Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 4, 1988.

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and had to be terminated as soon as possible. But from the viewpoint of real sector recovery,
a delicate balance had to be struck between fighting inflation and sustaining output. Cutting
these subsidies and loans immediately might have killed all remaining industrial activities.
The first attempt to stop inflation was the deposit blockade of 1946. The government
suddenly announced that (i) everyone now had an upper limit of 500 yen per month for
the withdrawal of bank deposits; and (ii) circulating paper notes would be annulled unless
they were deposited at the bank. Thus, people were forced to keep their money at the
bank while inflation continued. This reduced money supply to one-third and slowed infla-
tion temporarily. But people naturally felt betrayed by the government and the credibility
of monetary policy was lost. Soon, inflation accelerated again because the root cause—
subsidies and fukkin loans—was not removed.
After the failure of the deposit blockade, different approaches to disinflation were pro-
posed and hotly debated. Contested ideas included the following.

1 Accepting inflation—in July 1946, Finance Minister Ishibashi Tanzan stated that
budget deficits and high inflation were acceptable as long as they prevented further
output decline and unemployment. According to him, the present inflation was caused
by supply shortage rather than excess demand. Macroeconomic policy must support
producers and workers. A sound budget in such a situation meant accepting fiscal
deficits and high inflation.
2 Shock approach—in January 1948, Kimura Kihachiro, a socialist Member of Parliament,
argued quite the opposite. He considered price stability as the precondition for output
recovery. As long as inflation continued, hoarding of goods in anticipation of higher
prices would never cease. This would reduce supply and raise prices even more. A bold
anti-inflation policy was required to stop this vicious circle. The United States govern-
ment in Washington also shared this view.
3 Gradualism—the Economic Stabilization Board, as well as General MacArthur of the
GHQ, feared that big-bang stabilization would devastate Japanese industries and lead
to social crisis. They hoped to lower inflation step by step using subsidies, fukkin loans
and American aid, and reducing these support measures over time.
4 Conditional shock approach—Professor Arisawa Hiromi of Tokyo University recog-
nized that an anti-inflation policy would reduce output temporarily. But he also knew
that inflation had to be eliminated to end speculation and hoarding. He proposed that
output should be raised by the planning method to 60 percent of the prewar level, then
a strong anti-inflation package should be adopted. Output would probably fall back to
about 30 percent of the prewar level, but people could somehow endure this level, which
actually prevailed in 1946. If the anti-inflation policy was implemented too soon, with-
out such initial output recovery, the shock would be too severe.

The policy that was eventually adopted turned out to be close to what Professor Arisawa
proposed.

Priority Production System, 1947–48

The Priority Production System (PPS) refers to a policy of concentrating scarce resources in a
few strategically important sectors to jump-start an economy. Although it is called a “system,”

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it is actually a policy based on planning method. Recovery of key sectors is expected to have
positive spillover effects on the entire economy.
Arisawa was a member of the personal advisory group of Prime Minister Yoshida Shigeru.
In July 1946, General MacArthur said that he would allow Japan to import a small number
of goods.4 Yoshida ordered bureaucrats to prepare a wish list for imports, but the list they
produced was too long. Yoshida asked his advisors to shorten it. The following five items
finally remained: steel, coal (anthracite), heavy oil, rubber and buses.
MacArthur would not allow Japan to import heavy oil, an item in short supply globally.
But Arisawa urged Prime Minister Yoshida to renegotiate with the GHQ, by promising that
if Japan was permitted to import heavy oil, the Japanese government would ensure that
30 million tons of coal would be produced. Heavy oil was an input to steel production, and
steel was needed to rehabilitate coal mines. For Japan, coal was the only energy source avail-
able domestically. If enough coal was produced, surplus could be distributed as an energy
input to other industries.
MacArthur agreed to let Japan import heavy oil under this condition. Arisawa, who
proposed the idea, became the chairman of the subcommittee responsible for producing
30 million tons of coal.5 Arisawa’s method was meticulous. He summoned the general direc-
tors and chief engineers of all coal mines in Japan to gather necessary information. Based on
available coal deposits, veins, extraction speed, working hours and so on, he calculated the
supply capacity. On the demand side, he estimated the possible coal use by the Americans,
power companies, railroads and industries.
“Dig 30 million tons of coal” became a national slogan. The Minister of Commerce and
Industry visited the Joban Mine to cheer workers and be photographed. In the streets of large
cities, the daily output of coal was posted. An evening radio program sent words of thanks
to hard-working coal miners all over Japan. The government secured inputs for coal mines
using subsidies and fukkin loans, and offered special housing for coal miners. Although the
delivery of imported heavy oil was delayed, the production goal of coal was more or less
realized. Domestic coal production in 1947 was 29.32 million tons. The output of key indus-
tries other than coal fell slightly short of targets in 1947. The economy began to rebound.
The PPS was continued in 1948 and most targets were achieved in that year. But inflation
was still high.

US policy in occupied Japan

Japan was under US occupation from 1945 to 1951. Japan regained independence after the
San Francisco Peace Treaty was signed in September 1951 and became effective in April
1952. During the occupation period, US policy toward Japan shifted significantly.
Initially, the objective of occupation was demilitarization of Japan. The United States
wanted to cripple the Japanese economy so it would never be able to produce military goods
again. No heavy industry was to be allowed, and remaining machines were to be stripped
and shipped to the rest of Asia as reparations in kind. However, these policies were not
actually implemented. The GHQ was also keen to introduce democracy in Japan since the
lack of democracy, such as business monopolies, absence of workers’ rights and exploitation
of poor farmers, was considered to have propelled Japan’s militarism. The following three
democratic reforms were executed by the order of the GHQ.

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 P ostwar recovery 1 9 4 5 – 4 9

•• Zaibatsu breakup—big businesses were accused of helping militarism during the war.
Group companies were broken up into separate entities. However, this policy was later
reversed and a new type of industrial group, called keiretsu, emerged. Keiretsu is a
collection of business establishments without a holding company.6
•• New labor laws—the new laws guaranteed workers’ rights to organizing labor unions,
collective bargaining and basic working conditions.
•• Land reform—the initial plan of 1945 was rejected by the GHQ and a more radical plan
of 1946 was adopted. It was implemented mainly in 1947 and 1948 affecting 6 million
families, of which 2 million were losers. All farmland holdings above 1 ha (4 ha for
Hokkaido) were confiscated and sold to actual tillers. The sales price was low and high
inflation quickly eroded its real value. This increased the land ownership of farmers
from 54 percent to 91 percent, which was good from the viewpoint of justice and equity,
but land was now divided into too many small plots, which was bad for efficiency.
Family farming on a small scale has become the dominant trait of Japanese agriculture
ever since.

In addition, a new constitution was drafted and implemented on May 3, 1947 under the
pressure and guidance from the GHQ. Japan now celebrates May 3 as a national holiday.
Compared with the Meiji Constitution of 1889, the following features are noteworthy:

•• Sovereignty rests with the people.

•• The emperor is a symbol of Japan with no political functions.
•• Renunciation of war and non-possession of military forces (Article 9).
•• Guarantee of basic human rights.
•• Separation of power among legislative, administrative and judicial branches.

In particular, Article 9 is unique to Japan and has caused many heated arguments ever since.
The full text of Article 9 runs as follows:

Aspiring sincerely to an international peace based on justice and order, the Japanese
people forever renounce war as a sovereign right of the nation and the threat or use
of force as means of settling international disputes.
In order to accomplish the aim of the preceding paragraph, land, sea, and air
forces, as well as other war potential, will never be maintained. The right of bellig-
erency of the state will not be recognized.

Although the possession of armed forces is explicitly prohibited by this Article, Japan later
established the Ground, Maritime and Air Self-Defense Forces (SDF) in 1954. The gov-
ernment explained that the constitution did not rule out self-defense, and that the SDF was
a minimal power and not military forces. Hardliners want to revise Article 9 so Japan can
legally own military forces without an acrobatic interpretation of the constitution.7 Others
want to keep Article 9 as it is and abolish the SDF.
Around 1947, US occupation policy shifted dramatically because of the start of the
Cold War. The US government now wanted to strengthen Japan as a capitalist ally and
an anti-communist base. Besides that, generous economic aid to Japan was becoming too

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 P ostwar recovery 1 9 4 5 – 4 9

burdensome for American taxpayers. Remilitarization and the economic recovery of Japan,
including rebuilding of heavy industries, were promoted. Socialist and labor movements
were discouraged. The establishment of the SDF mentioned above was also in line with this
revised US strategy.
It must also be noted that a policy gap existed within the US government. Washington
demanded free markets and big-bang macroeconomic stabilization in Japan as soon as possi-
ble, but General MacArthur and his GHQ staff in Tokyo, who were dubbed “New Dealers,”
a group of people who supported official intervention at the time of the Great Depression in
the 1930s, preferred gradualism with appropriate state roles.

Dodge Line stabilization of 1949

This debate within the US government was ended when Washington sent Joseph Dodge to
Tokyo in early 1949. Dodge was the president of Detroit Bank and a strong believer in the
free market economy. He ordered the following austerity measures to terminate inflation. His
policy package was called the “Dodge Line”:

•• stop fukkin loans;

•• abolish all subsidies and raise public utility charges;
•• strengthen taxation and cut expenditure;
•• achieve a “super-balanced budget”—the primary balance should be zero, which means
the normal budget should be in surplus;
•• unify multiple exchange rates at 360 yen to the dollar.

In addition, Professor Carl C. Shoup, an American fiscal expert, was also dispatched to Japan
to introduce a new tax system. His advice was adopted in 1950. It was a system with heavy
reliance on direct taxes, especially income and corporate taxes, that became a key feature
of the Japanese tax system for a long time to follow.8 As a result, Japan had no broad-based
indirect tax, such as VAT or general consumption tax, until 1989.
The Dodge Line stabilization was very successful in stopping inflation. But as feared, the
negative shock on economic activity was severe and people expected a serious recession fol-
lowing austerity measures. Indeed, output soon began to decline. The Bank of Japan ignored
the instruction of Dodge and supplied liquidity to ameliorate the coming recession. Professor
Arisawa, the inventor of PPS, also felt that stabilization measures were adopted too soon. He
hoped that Dodge should have waited another year, until 1950.
We do not know how serious this recession would have been because another big event
intervened. The Korean War broke out between North Korea, backed by China, and South
Korea, backed by the West, in June 1950 and lasted until 1953. It was one serious inci-
dent of the Cold War turning hot. Whatever the political implications of this war might
have been, its impact on the Japanese economy was positive. The US forces regarded
Japan as a supply base and procured great amounts of military and non-military goods and
services such as metals, machinery, textiles, construction, and maintenance and repair ser-
vices for automobiles and machinery. For Japanese industries, this was tantamount to a
sharp increase in external demand, just as the great export boom experienced during WW1.
The recession caused by austerity measures ended quickly and the Japanese economy began

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to expand. Minor inflation also returned, but price stability was restored when the Korean
War ended.
The Dodge Line stabilization also had important systemic implications. The Japanese
economy had been under state planning since 1937 and economic control was maintained
during the postwar recovery period of 1945–49. The achievement of price stability and the
abolition of price controls and subsidies finally allowed Japan to return to a market economy.
Japan was now ready for economic deregulation, and the role of government could be reduced.
However, this by no means meant a return to a completely free economy as many elements of
official intervention remained even after the end of planning (Chapter 11).
Among academics, Joseph Dodge is sometimes appreciated for ending inflation and
restoring economic freedom, and sometimes criticized for implementing a shock therapy
(although its undesirable effect was cancelled by the Korean War). But most Japanese people
then would have thanked him rather than blamed him.

Box 10.1 Arisawa Hiromi and Okita Saburo discuss postwar

recovery
Below is an excerpt from a dialogue that took place in 1986 between Arisawa Hiromi
(1896–1988) and Okita Saburo (1914–1993), two gentlemen who were deeply involved
in the postwar recovery policies as explained in the main text (quoted from Arisawa,
1989, pp. 33–34).

Okita: What was your opinion on the nationalization of the coal industry [pro-
posed around 1946–47]?
Arisawa: As for me, I never thought of nationalizing it.
Okita: Wasn’t it at the time of Minister of Commerce and Industry Mizutani
Chosaburo, when a law on the nationalization of coal mines was proposed?
Arisawa: I never thought of nationalization. As a matter of fact, Japanese coal mines
were already operating under government’s directives. Therefore, coal
mines were virtually under state control. Germany nationalized coal pro-
duction, and I discussed the matter extensively in many articles. But I had
no intention of nationalizing our coal mines. Of course, if some unexpected
situation arose, nationalization would have been an option. But what was
the point of nationalizing only coal?
Okita: Around that time, there was a debate over the so-called Chukan Antei Ron
[intermediate stabilization, which means gradual disinflation] between you
and Mr. Kimura, a socialist Member of Parliament. Your idea was to stop
inflation after the government permitted output to recover to a certain level
relative to the prewar size. But Mr. Kimura regarded disinflation as the
prerequisite for output recovery. That was the key point in the debate. You
wrote in an article that the two views differed in the prioritization of policies.
It certainly was a big difference, from the viewpoint of your “economics of
transition.”

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 P ostwar recovery 1 9 4 5 – 4 9

150

100 Shock approach

60
PPS

30

1934-36 1946

Figure 10.3 Priority Production System in theory (production index)

(1936 = 100)
200
180
160
140
PPS
120
100
80
60
40
20
0
1936

1937

1938

1939

1940

1941

1942

1943

1944

1945

1946

1947

1948

1949

1950

1951

1952

All mining & manufacturing Iron & steel Coal

Figure 10.4 Priority Production System in practice (production index)

Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 2, 1988.

Arisawa: Regarding the disinflation policy, my view at that time was to adopt the
Priority Production System first to let the production recover to 60 percent
of the prewar level, then stop the inflation by bold measures. If big-bang
disinflation were introduced before output recovery, it would have plunged
the Japanese economy into a tremendous confusion, so it should not have
been done. In either case, inflation stabilization would cause the output to

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decline. The crucial point was how deep we would sink. Bold stabilization
measures were unavoidable, but the timing must be chosen wisely, at a
time when the Priority Production System proceeded further and the output
reached 60 percent of the prewar level.
My view was that bold stabilization would surely cause output to
decline. Under the worst scenario, the output might even decline to a half.
I insisted on a recovery to 60 percent of the prewar level, because if you
had that level, the subsequent output decline would take it to 30 percent of
the prewar level. Since output actually fell to that level immediately after
the war and people could somehow survive, to me that was the minimum
acceptable level.
Before Mr. Dodge arrived in Japan, I went to see Mr. Fein, financial
advisor of the GHQ’s Economic and Science Bureau. His position was that
Japan needed a big-bang anti-inflation program. I told him that it was too
early to implement it. He tried to persuade me into early stabilization, but
I never relented. The logic I have just explained was behind my insistence.

Notes
1 Economic Stabilization Board, A Comprehensive Report on the War Damage of Japan Caused by the
Pacific War, 1949.
2 The informal sector refers to the collection of jobs that are not officially registered or permitted, such
as street peddlers, personal service providers and household works in contrast to legally sanctioned
enterprises and cooperatives. Since it operates in a grey zone between legal and illegal, its status
remains uncertain, being subject to official round-ups and confiscation, and without protection of
workers’ rights or contract enforcement. For the same reason, there is little incentive for physical
asset formation. An informal sector tends to emerge in a country in crisis or whose market economy
is underdeveloped or temporarily paralyzed.
3 This report is now available in English translation—see Saburo Okita, ed., Postwar Reconstruction
of the Japanese Economy, University of Tokyo Press, 1992.
4 During the war, the Japanese government guaranteed compensation for any losses incurred by indi-
viduals or firms engaged in military production. In July 1946, the GHQ ordered the cancellation
of this guarantee which drove a large number of firms into bankruptcy and default. Prime Minister
Yoshida appealed to General MacArthur on the difficulties caused by this decision, to which
MacArthur responded by allowing Japan to import certain products to ameliorate the situation.
5 In parallel, the Ministry of Commerce and Industry was contemplating a similar plan. Some argue
that the idea of PPS originally belonged to the Ministry, not Arisawa, but the truth is difficult
to tell.
6 Zaibatsu is a group of large companies operating in many sectors that are owned by one holding
company dominated by an influential family. Keiretsu is a looser collection of companies without a
holding company at the top, whose member companies are related to each other through cooperation
in finance and technology, mutual shareholding, staff rotation, monthly lunch meetings of general
directors and the like. In postwar Japan, holding companies were prohibited by the anti-monopoly
law until 1997 when they were again permitted. A pyramidal subcontracting structure in the automo-
bile and motorcycle industries is also called a system of keiretsu companies.
7 More recently, the second Abe Cabinet (2014–) is working toward a more active military role of
Japan in self-defense and international contribution. In July 2014, the Right of Collective Self-
defense (the SDF to assist US forces under enemy attack) was approved by a cabinet decision.
In July 2015, parliament passed a bundle of laws to allow the SDF to go abroad (until then, ad
hoc laws were created for individual operations in different countries). Prime Minister Abe also
talks about the possibility of constitutional amendment.

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 P ostwar recovery 1 9 4 5 – 4 9

8 Prior to the Shoup reform, the tax system was revised in 1937, 1938, 1940 and 1947. Wartime Japan
was moving toward strengthening direct taxes with its share in central government revenue rising from
22.8 percent in 1935 to 53.9 percent in 1940. This should be construed as an effort to raise sufficient
revenue for war execution under the situation of suppressed consumption and disappearance of inter-
national trade. The Shoup reform in 1950 continued in this direction but his strong influence in firmly
installing a direct tax-based system in postwar Japan can hardly be disputed. This is so even when
many individual items in Shoup’s advice were weakened in the tax revision of 1953.

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11
T H E HIGH GROWTH ERA

From devastation to high income

After the postwar recovery (1945–49) and the Korean War (1950–53), the Japanese
economy entered a period of high growth. From the mid 1950s to the early 1970s, average
real growth was approximately 10 percent. This high and sustained growth—interlaced by
short recessions—greatly transformed the Japanese economy and society. In 1945, most of
the major Japanese cities were destroyed by US bombing. In the 1950s reconstruction was
under way and Japan rejoined the international community. In the 1960s as growth further
accelerated, Japan built fast trains and hosted the Summer Olympic Games. By 1970, Japan
overtook West Germany in economic size and became the second largest economy in the
capitalist world after the United States. This was the second time Japan accomplished mirac-
ulous growth from the very bottom to the top. The industrial revolution of Meiji took half a
century, but this miracle took only about two decades (Figure 11.1).

Figure 11.1 Real GDP growth

Source: Cabinet Office website.
Note: Fiscal year based growth (April to March). Gaps exist in the definition of GDP in 1981 and 1995 due to
revisions of the System of National Accounts.

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 T he high growth era

It should be noted that post-WW2 growth momentum did not stop until Japan reached
high income. While problems and short-term business cycles were encountered along the
way, no structural impediment emerged that was serious enough to stall Japan’s growth at
middle income. This is in sharp contrast to the situations seen in many emerging and devel-
oping economies today that seem to have been stuck in “middle-income traps.” Productivity
increase was high, continuous and institutionalized. Consumption and investment were
strong. The macroeconomy and the speed of global integration were well managed. Negative
aspects of high growth, such as pollution and urban congestion, were overcome eventually
if not immediately. Externally, US-led global economic growth and stability combined with
fixed exchange rates and trade liberalization worked very favorably with Japanese exports.
Post-WW2 Japan chose to be under the American nuclear umbrella for national security.
Japan regained independence with the signing of the San Francisco Peace Treaty in 1951 and
its implementation in 1952. At the same time, the Japan–US Security Treaty was concluded
in 1951 (and renewed in 1960), and Japan became a faithful US ally in the Cold War.
There are many issues to be discussed in this remarkable period. The remainder of this
chapter will focus on rationalization, shifting policy focus, global reintegration, macro­
economic management, private dynamism, industrial policy and social transformation.

Rationalization
During the period of 1945–49, economic planning of the war years was basically retained,
and Japan was practically a closed economy. The principal policy objective at that time was
quantitative recovery. Recovery was pursued at any cost, ignoring efficiency. Generous
subsidies, fukkin loans and US aid were provided (Chapter 10).
By the early 1950s, the Japanese economy entered another phase. An upward trend in
economic growth had been secured thanks to the Priority Production System and other sup-
port measures. High inflation was stopped thanks to the Dodge Line stabilization. Shortages
and black market prices began to disappear. Private international trade resumed. As a result,
Japan reached a stage where it could finally end planning, heavy subsidies and tight controls
initiated in 1937 and restore the market mechanism as a central economic force. However,
this was not necessarily an installation of a free market economy as many past legacies, such
as exchange control, import protection, foreign currency surrender requirement and adminis-
trative guidance, were to be removed only gradually, as explained below.
There was a global inflation associated with the Korean War and, due to proximity to
the war front and involvement in war procurement, Japanese inflation was higher than the
world average (Figure 11.2). Between 1949 and 1951, Japanese wholesale prices (covering
industrial inputs) rose 64 percent and consumer prices rose 8.5 percent. In the same period,
wholesale prices in the United States and the United Kingdom increased only 16 percent and
11 percent, respectively. The new fixed exchange rate of 360 yen to the dollar was consid-
ered appropriate when it was established in 1949. But with the appearance of Korean War
inflation differentials, the yen became overvalued and Japanese industrial inputs overpriced.
Coal and steel, the two priority goods previously targeted by the Priority Production System,
were among the most expensive. The “problem of high prices of coal and steel” emerged,
reducing the competitiveness of all other industries that used them as inputs. Japanese indus-
tries now had to strive for efficiency and competitiveness. The days of physical expansion
under generous support and international isolation were over, and the challenge for cost
reduction and higher quality began.1

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 T he high growth era

To cope with difficulties caused by the overvaluation in the early 1950s, three policy
options were theoretically possible: (i) yen devaluation; (ii) deliberate deflation through mac-
roeconomic austerity and (iii) productivity improvement. At this time, the private sector and
the government of Japan jointly chose the third option. Firms were determined to reduce
cost and restore competitiveness by investing in newer and better technology. Option (i) was
not even considered because it was just after Japan had unified exchange rates and joined
the global fixed exchange rate system in 1949 as part of the overall reconstruction strategy.
Japan felt it politically and diplomatically embarrassing to leave the newly installed global
economic system so soon. Option (ii) was partly adopted by maintaining a relatively tight
macroeconomic policy stance, nudging Japanese enterprises to adopt new technology without
waiting for an official bailout. But this tightness was not as devastating as the austerity meas-
ures introduced by Finance Minister Inoue in the late 1920s to the early 1930s (Chapter 9).
Gorika, a Japanese word for rationalization, means improving productivity through
investment in new technology and machinery and reorganizing production and management
for efficiency. This became the hottest economic issue in the early 1950s. The government
recognized the need for gorika and issued a cabinet decision, an official report and incen-
tives for gorika. During the Korean War boom, many companies accumulated profits as
American military procurement soared. Such retained profits were the main financial source
for introducing new technology and machinery, which were supplemented by tax, tariff and
depreciation allowance privileges to promote such investment. However, labor unions often
opposed rationalization because they feared this slogan would be used as an excuse for laying
off workers and imposing hard working conditions.

Figure 11.2 Japanese industrial prices relative to US prices

Source: Kosai (1995), p. 56.

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 T he high growth era

Some industries succeeded in rationalization but others failed. Between coal and steel,
the former turned out to be a loser and the latter a winner. Both contributed to a rise in
overall productivity—the coal industry by disappearing and the steel industry by becoming
more competitive. The coal industry was especially hard hit because the world energy source
was shifting dramatically from coal to oil, which was then cheaper. Unlike coal which was
abundant at home, Japan had little domestic supply of oil. It had to import 90 percent of oil
in the early postwar period, and the ratio would subsequently rise to as high as 99.7 percent.
The steel industry adopted integrated steel making in place of fragmented old processes.
Shipbuilders introduced the latest methods including arc welding, block construction, photo
marking and automatic gas cutting. The fertilizer industry diversified gas sources and prod-
uct types, and shifted to synthetic organic chemistry. Artificial fibers such as nylon and
vinylon also began to be produced. Power companies were reorganized geographically,
hydraulic power plants were built with the latest construction equipment and World Bank
loans were mobilized to erect large-scale thermal power plants. In assembly-type indus-
tries such as automobile and electronics, new technologies were adopted and innovations
were made. Toyota modernized its factories beginning in 1951 and Sony produced transistor
radios in 1953.
The policy stance of the government was also crucial in promoting rationalization.
As Korean War procurement ended and imports surged, Japan began to face intermittent
recessions and balance-of-payments crises in 1951–54. The Bank of Japan raised interest
rates, and the government budget and the fiscal investment and loan program (FILP)2 were
tightened. The intention of these policies was to lower inflation to near zero (finally!) and
encourage industries to reduce costs further. This was quite different from the policy stance
adopted after the end of the WW1 export boom in the 1920s. At that time, the main policy
objective was to rescue weak firms and banks. In the 1950s, by contrast, Japanese enterprises
were asked to become more efficient or leave. When an artificial boom ends and the business
condition worsens, an appropriate degree of macroeconomic tightness is perhaps needed to
prepare for the subsequent period of sustained high growth.
Another important fact about the early 1950s was the creation of new policy instruments
suitable for the age of active industrial policy for guiding and supporting private dyna-
mism instead of compulsory state planning. To replace the price controls, subsidies and
fukkin loans of the early recovery period, the government introduced a foreign exchange
budget (for allocating scarce foreign exchange), capital control, regulation for technol-
ogy import, privileges and incentives for priority industries, establishment of new policy
banks such as the Japan Development Bank, the Long-term Credit Bank and the Export–
Import (Exim) Bank for supplying long-term investment funds, as well as a number of
laws for promoting rationalization as mentioned above. Equipped with these policy tools,
the government in general and the Ministry of International Trade and Industry (MITI—
see below) in particular were now ready to assist industrial development. Some even argue
that the high growth of postwar had Japan already begun in the early 1950s. However, it
is more appropriate to regard these years as a preparatory period for high growth to come
in the mid 1950s and beyond.

From politics to economics

The year 1960 was a dividing year in postwar Japan. A major labor dispute at Mitsui
Miike Coal Mine, located in Kyushu and operated by the Mitsui Group, came to a climax.

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 T he high growth era

The management announced a lay-off program of workers targeted at labor union leaders
to carry out rationalization. In protest, coal miners, their families and sympathizers occu-
pied hopper facilities. The company in turn locked out workers. This was considered an
ultimate fight between all capitalists and all workers in Japan, in which the miners lost
eventually. Another big event in 1960 was a renewal of the Japan–US Security Treaty.
The Kishi Nobusuke Cabinet of the Liberal Democratic Party (LDP) tried to force it
through parliament despite nationwide protests. A huge demonstration was staged around
the parliament and one female student was killed. But the treaty was renewed and the
Kishi government subsequently resigned for causing the mess.
With these two events, the days of direct ideological confrontation in Japan between cap-
ital and labor as well as between allegiance to the United States and the Communist block
were over. Japan was to stay in the capitalist camp and labor was to cooperate for economic
growth. The new LDP government of Ikeda Hayato refocused national attention from poli-
tics to economics by launching the “Income Doubling Plan.” He proposed to double Japan’s
Gross National Product (GNP)3 in ten years which required an average annual growth of
7.2 percent. Japan actually grew faster than this and Ikeda’s goal was achieved within six to
seven years, far sooner than expected.
From 1955 to 1970, labor productivity in the manufacturing sector annually rose 10.0
percent, wages at large and medium firms (employing 30 workers or more) rose 10.2 percent,
and wages at small firms rose 10.9 percent. As living conditions improved greatly for almost
everyone, social stability and labor discipline were maintained. Virtually all Japanese people
came to feel that they belonged to the middle class. Under these circumstances, political
radicalism gradually gave way to a more cooperative management–labor relationship. There
were some remnants of student and left-wing movements calling for violent revolution into
the early 1970s, but they lost the support of the general public.

Reintegration into the world economy

In 1951, US occupation ended and political independence was restored, which became
effective in 1952. The milestones of Japan’s reintegration into the world economy
included membership of the IMF and the World Bank in 1952, membership of the General
Agreement on Tariffs and Trade (GATT, the predecessor of WTO, although Japan was
not immediately given full rights), and membership of the United Nations in 1956. A little
later, in 1963, Japan became the GATT Article XI country which prohibited the use of
import restriction for balance-of-payments reasons, and the system of foreign exchange
allocation was also terminated. In 1964, Japan was admitted to the Organization for
Economic Co-operation and Development (OECD) and assumed the IMF Article VIII
status, which means Japan was no longer permitted to use exchange restrictions on
current-account transactions (i.e., for import protection). Also in 1964, Japan hosted the
Tokyo Olympics. For any emerging nation, hosting Olympic Games boosts national pride
and enhances its standing in the international community.
Meanwhile, trade liberalization proceeded gradually and in steps. As discussed above, the
Dodge Line stabilization and the return to the market mechanism in 1949 did not immedi-
ately remove all controls. On the contrary, many measures continued to regulate markets, and
one of them was import protection. Japan’s trade barriers had been high during the 1920s and
1930s, and international trade was nonexistent during the Pacific War (1941–45) and severely
restricted under the US occupation (1945–51). When private trade was restored in the 1950s,

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 T he high growth era

tariff protection remained high. However, the Japanese government was determined to lower
tariffs in an effort to rejoin the world economy and implement the GATT Kennedy Round
that required comprehensive tariff reduction by all member countries. Transition to a more
liberal trade system was also necessitated for political and diplomatic reasons.
Japan’s trade liberalization mainly in the 1960s had the following features. First, it
was executed gradually and in a well-planned manner with prior announcement. Second,
tariff reduction was closely linked with promotion measures to strengthen competitiveness.
Third, the government used international commitments to avoid domestic political capture.
Removal of import barriers was carried out under the strong “ownership” (policy initiative)
of the Japanese government in consultation with the business community. Since trade liber-
alization plans were pre-committed and regarded as non-negotiable, producers had to make
efforts in improving efficiency rather than lobbying for an extension of protection. Official
support was provided according to actual performance, such as export volume, rather than
political connection. Producers competed fiercely with each other, but competition was man-
aged by the government so as to prevent elimination or bankruptcy of any firm. Murakami
(1984) termed such officially guided coexistence of competition and cooperation among
leading producers as “compartmentalized competition.” Postwar Japan employed trade lib-
eralization as a device to force domestic industries to become competitive, which is an ideal
way to combine industrial policy and international integration. But its success required a
very high institutional capacity including the competency of MITI to conduct arms-length
intervention and deep trust and close communication between the government and the pri-
vate sector. For most developing countries, this is not an easy task.
Although trade barriers were thus gradually reduced, capital control was not abolished
during the high growth period. It was removed step by step from the 1970s onwards. The
most important step in liberalizing capital transactions was the Foreign Exchange Law of
1980, which belongs to a later period than the one we are discussing.
Japan joined the World Bank in 1952 and borrowing started in the following year. It
soon became the World Bank’s second largest borrower after India. Japan continued to bor-
row from the World Bank until 1969 using all loans for building industrial infrastructure
such as power plants, highways and the Shinkansen (bullet trains). Unlike current global
development policy, no part of the loans was directed toward education, healthcare, rural
development or other social-sector programs. In a procedure called “two-step loans,” World
Bank funds were made available first to the Japan Development Bank, which on-lent them
to proposed industrial projects. It is also worth noting that World Bank loans covered less
than 1 percent of Japan’s total domestic investment demand. Japan in the high growth period
financed its enormous investment demand almost entirely from domestic savings. There
was virtually no receipt of FDI, let alone portfolio capital (investments in Japanese bonds
and stocks), from abroad. Though development funds were generated at home, Japanese
firms were extremely eager to import advanced technology from abroad, and the government
strongly supported it.

Macroeconomic management
During the 1950s and 60s, macroeconomic management had the following features.
The government budget was generally sound and in surplus. In addition, the size of
government relative to GNP gradually declined, especially during the 1950s (Figure 11.3).
Monetization of fiscal deficits was prohibited. In fact, no government bonds were issued in

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postwar Japan until 1965. For this reason, there exist no statistics on government bonds or
their interest rates prior to that time.
The fixed exchange rate of 360 yen to the dollar was maintained from 1949 to 1971. The
Bretton Woods exchange rate system permitted occasional realignments of exchange parities
when “fundamental disequilibria” existed.4 Britain, West Germany and France made use of
this clause, but Japan never considered changing its exchange parity. Some people argued
that the yen became increasingly undervalued in real terms because Japanese productivity
rose faster—and thus Japanese costs became lower—compared with other industrial nations.
However, it must be recalled that Japanese productivity and wages were rising at similar
high speeds, about 10 percent per year each, during the high growth period, which is exactly
what should be expected in a world of well-functioning fixed exchange rates (McKinnon
and Ohno, 1997). An emerging nation in the process of rapid industrial catchup naturally
expands its global market not only because of cheapness of its products but more because
of increasing product diversity, improved quality and aggressive marketing which wins the
hearts of world consumers. Exchange rate adjustments alone can hardly reverse the dyna-
mism of a rising nation driven by productivity and deep structural change. This was true for
postwar Japan as well as China in more recent decades.
Monetary policy of the Bank of Japan was constrained by its commitment to the Bretton
Woods fixed exchange rate system. Technically, this is called the “endogeneity” of monetary
policy in a fixed exchange rate regime. A fixed exchange rate does not automatically happen; it
must be supported by the central bank which uses its policy instruments to keep the rate at the
pre-set level. In postwar Japan, this policy constraint exhibited itself in the following manner.
Because there was no free international capital movement during the high growth period,
a balance-of-payments deficit essentially meant a trade deficit (imports exceeding exports).
When the Japanese economy overheated and imports surged, the Bank of Japan tightened
domestic financial markets by raising short-term interest rates as well as through “window
guidance” (telling commercial banks to reduce new loans). This made it difficult for firms to

Figure 11.3 Central government revenue and expenditure

Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 3, 1988.

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 T he high growth era

borrow from banks. Since Japanese firms in this period depended heavily on bank loans for
business expansion, this had an immediate negative effect on investment. As the economy
cooled down, imports fell and the balance-of-payments pressure eased. Every time the econ-
omy grew too strongly, the Bank of Japan resorted to this policy. This was called the “ceiling
of the balance of payments” or “stop–go policy” which was the standard policy procedure
until the mid 1960s (Figure 11.2).
In sum, the Bank of Japan chose domestic macroeconomic tightening (monetary con-
traction) for balance-of-payments adjustment. In contrast, West Germany adopted a quite
different mode of macroeconomic adjustment. The Deutsche Bundesbank frequently inter-
vened in the foreign exchange market and occasionally even adjusted the Deutsche Mark
exchange rate in an upward direction. As a result, West Germany accumulated international
reserves through purchasing dollars, while Japanese international reserves remained small
until the mid 1960s (after that, the Bank of Japan also intervened aggressively in foreign
exchange and rapidly accumulated dollar assets).
Under the Bretton Woods international monetary system, Japanese wholesale prices
(representing industrial inputs) were quite stable. From 1951 to 1971, the wholesale price
index rose at an annual rate of 0.7 percent. This remarkable price stability was a global
phenomenon also observed in the United States and West Germany. The early post-WW2
period was thus a time of historically unprecedented global price stability. Japan “imported”
this stability from the United States by maintaining a fixed exchange rate and gradually liber-
alizing trade. Consumer prices rose slightly faster, at an annual rate of 4.4 percent. This was
called “creeping inflation” and considered a problem, but it is impossible to have zero infla-
tion on all prices when productivity—and cost—diverges across different sectors.5 During
the same period, nominal wages rose 10 to 11 percent, nominal GDP rose 14.5 percent, and
money supply (measured by M1) rose 15.9 percent per annum. Meanwhile, real GDP grew
an average of 9.4 percent per annum. These were impressive macroeconomic achievements.

($ billion, excluding gold)

20
18
16
14
12
10
8
6
4
2
0
1949
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976

Figure 11.4 International reserves

Source: International Monetary Fund, International Financial Statistics, various issues.

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 T he high growth era

Private dynamism
The postwar high growth was the result of re-ignited private dynamism that existed in the
Japanese economy for a long time but was suppressed during the wartime. Given the artifi-
cially low starting point due to war defeat and supported by favorable international conditions,
the Japanese private sector developed very rapidly both in quality and quantity. In this section
we will take a look at monozukuri and kaizen which forged Japan’s unique manufacturing
and served as factors behind strong investment, consumption and productivity growth during
the high growth period.
Monozukuri, which literally means “making things,” is a term used to describe a specific
value upheld by the majority of Japanese craftsmen as well as modern manufacturing firms.
It is a sincere attitude toward production with pride, skill and dedication. It targets perfec-
tion, innovation and customer satisfaction as the ultimate goal of business enterprise, often
disregarding company books and balance sheets. It is a spiritual quest similar to sword prac-
tice or a tea ceremony rather than a sheer profit-making venture. Japanese firms are surely
after profits but they try to pursue them by conforming to monozukuri principles, not by
any means. Allegiance to monozukuri spirit can instruct and discipline Japanese managers
and engineers without any commandment from God, laws or government authorities. This
attitude can be traced back to the Meiji, Edo and even earlier periods. In postwar Japan,
excellent manufacturing firms were established or run by people full of monozukuri spirit
including Matsushita Konosuke (the founder of Panasonic), Honda Soichiro (the founder of
Honda), Ibuka Masaru and Morita Akio (the co-founders of Sony), as well as countless, but
less famous, leaders of small and medium enterprises.
Even today, monozukuri spirit is alive and well in a vast majority of Japanese firms. Its
characters, which become particularly visible when they go overseas, include the follow-
ing. First, Japanese firms abroad are more manufacturing-oriented than Chinese, Korean,
Singaporean or American firms which are more active in trade, property development,
finance or professional services. Over half of Japanese overseas investors are manufactur-
ers, and many others provide producer-supporting services such as business loans, logistics
and industrial parks. Second, they routinely pursue zero defect, cost reduction and on-time
delivery (called quality-cost-delivery (QCD) requirement). Third, the Japanese aim at
long-term business relations and prosperity; they are usually the last to arrive in frontier
countries but, once invested, they will not leave even with difficulties—whether political
turmoil, recession, flooding, terrorism, or street violence. Fourth, because of this long-term
orientation, most firms are willing to train local workers and teach local suppliers beyond
the immediate need of operation, even at the risk of losing trained engineers through job
hopping and talent poaching. Fifth, Japanese firms on average have a better record of com-
plying with local laws and regulations regarding contracts, safety, labor rights, environment
and so on even when they are unreasonable or inconsistent.
As one of the efforts toward respectable monozukuri, postwar Japan invented kaizen
(meaning “improvement”) which is a way of continuously improving efficiency at gemba—
factories, shops, offices or farms where work actually takes place—through teamwork and
without spending any money on new equipment. The purpose of kaizen is to eliminate
muda, or any waste that does not add value whether it is overproduction, waiting, trans-
port, processing, inventory, movement or defects (“seven muda” of the Toyota Production
System). Kaizen usually starts with such mundane instructions as “Keep the factory floor
and toilets clean,” “Remove all unnecessary tools and materials” and “Place necessary

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 T he high growth era

things in marked positions for easy pickup,” which are collectively taught as “Five S” (Seiri,
Seiton, Seiso, Seiketsu and Shitsuke, translated as Sort, Straighten, Shine, Systematize and
Standardize; other English renditions also exist). These are easier said than done but can
produce miracles in productivity and cost reduction when everyone’s mindset has been
transformed and order and cleanliness rule the workplace. After learning Five S, firms
normally proceed to quality control circles (QCCs), equipment layout, mieruka (visualiza-
tion), suggestion system, automation, total quality control (TQC), total quality management
(TQM), total productive maintenance (TPM) and other tools of productivity enhancement
(GRIPS Development Forum, 2009).
Japan’s kaizen movement began in the late 1950s when a new quality control method
was imported from the United States. The management theories and lectures of Professors
W. E. Deming and J. M. Juran had enormous impact. They were quickly assimilated
and modified to create a uniquely Japanese way of efficiency improvement. Unlike the
American original which relied heavily on statistics collection, the adapted method empha-
sized process orientation, worker participation and hands-on pragmatism. Kaizen spread
rapidly to Japanese companies, large and small, to form the foundation of monozukuri.
The movement was propelled by the dynamism of Japanese firms craving concrete instru-
ments for achieving rationalization and competitiveness. It was assisted by three non-profit
organizations—­the Union of Japan Scientists and Engineers, the Japan Productivity Center
and the Japan Management Association—which sponsored lectures, foreign tours, awards
and other measures (Kikuchi, 2014). Subsequently, kaizen spread abroad as Japanese man-
ufacturing firms expanded their production bases to the rest of the world. Kaizen is now
one of the most common tools of Japanese industrial cooperation in developing countries.6
Quantity, not just quality, also supported economic growth in the 1950s and 1960s.
Investment demand of Japanese firms was very strong in order to realize rationalization,
modernization, scaling up and industrial linkage. Heavy industries greatly expanded as
investments in mechanical sectors such as automobile, shipbuilding and electrical equip-
ment induced investments in material and energy sectors such as steel, petrochemicals and
thermal and nuclear power generation. Computers and numerical control were introduced to
manufacturing, telecom, banking and transport services. High-rise buildings, highways and
Shinkansen lines (fast trains) began to be constructed. Because corporate saving and share
issue were hardly enough to satisfy extremely strong investment demand, bank loans became
the dominant mode of raising investment funds. To respond to huge loan demand, commer-
cial banks often lent out more than their deposits and covered the gap by borrowing from the
Bank of Japan in a situation dubbed as “overloan.” Gross capital formation hovered around
30–40 percent of GNP, peaking at 40.5 percent in 1961. Large firms merged to become
even larger to enjoy scale merit and prepare for the removal of import protection. Zaibatsu
groups, disbanded under US occupation, re-formed to become keiretsu, characterized by
mutual cooperation without a holding company as a command post (see Chapter 10).
High growth was also accompanied by vigorous private consumption. Postwar recovery,
land reform and high productivity growth enhanced people’s income and desire for better
material life. Even if workers were currently poor, they could look to a much better future
for them and their children as wages rose about 10 percent per year. Households purchased
popular consumer durables such as black-and-white TVs, refrigerators and washing machines
in the late 1950s (“Three Sacred Treasures”), and color TVs, coolers (air-cons) and cars in the
late 1960s (“Three Cs”). Motorization advanced rapidly as private cars overtook taxis in 1964,
trucks surpassed railroads in freight transport in 1966, and car registration reached 10 million

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in 1967. As markets and production expanded, costs and prices declined, which further stim-
ulated demand. The mass production system also generated a white-collar middle class who
purchased these goods. This virtuous circle continued until the early 1970s.
There is still an argument about the true cause of high growth in the 1950s and 1960s.
Some say that vigorous investment was the key. Others insist that it was export-driven.
Still others, including Yoshikawa (1997), believe that the most important force was robust
consumption. However, it is very difficult to single out one factor as the only cause since
all variables were interrelated. Private consumption was certainly the largest component
of expenditure GNP, at 50–60 percent, yet the engine of growth cannot be ascertained
just by size.

MITI and industrial policy

The Ministry of International Trade and Industry (MITI) was created in 1949 by merging the
Ministry of Trade and Industry, the Coal Agency and the International Trade Agency. Later
in 2001, it was renamed to the Ministry of Economy, Trade and Industry (METI). Despite
the name change, its broad authorities and functions remained essentially the same. MITI,
the Ministry of Finance and the Economic Planning Agency (dissolved in 2001) formed the
government trio to promote industrialization but the authority of MITI was broadest and
most powerful.
From the mid 1950s to the early 1970s, MITI played a role in Japanese economic devel-
opment, but economists still debate what exactly its role was. Was high growth achieved
because of MITI or despite it? Some insist that MITI’s policies were crucial for rapid growth
while others argue that they were counterproductive, only to be overpowered by strong pri-
vate dynamism. Still others say that MITI policies were neutral and insignificant. It is easy
to cite Japanese industries that prospered without official promotion such as consumer elec-
tronics, cameras, motorbikes, pianos, watches and calculators. Others such as coal, aluminum
refining, nuclear fusion and mainframe computers failed even with official support. But it is
not so easy to draw a negative conclusion about MITI from this, because growth potential
differed across industries and also because MITI often assisted “sunset” sectors, such as coal
and aluminum refinery, for smooth downsizing and transfer of labor to other sectors.
As for the automobile industry, there was both rejection and acceptance of official inter-
vention. MITI tried to merge automobile firms prior to trade liberalization because Japanese
carmakers seemed too small and too numerous to compete effectively with the American
Big Three. But car companies refused MITI’s meddling, remained separate and did very well
subsequently (see Box 11.1 on Honda at the end of this chapter). At the same time, it should
be recalled that the automobile industry was protected with high tariffs in its early stage of
development, and protection was lifted only gradually and when Japanese firms became
competitive enough. The government also effectively supported numerous small-sized com-
ponent suppliers which ultimately strengthened large car assemblers.
There are econometric studies on the effectiveness of MITI policies, but results remain
inconclusive. Some studies ask whether targeted industries on average achieved higher
growth than those without support while controlling for other factors. But for the reasons
mentioned above, such a test cannot properly assess MITI’s policy objective and outcome.
Using statistical methods to estimate the impact of industrial policy is generally difficult
because convincing “counterfactual” evidence (how Japanese industries would have devel-
oped without MITI’s intervention) does not exist. The tentative conclusion of this book,

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based on a large number of facts and cases, is that private dynamism was the primary engine
but policy also played a useful role in the postwar high growth period. This conclusion is
basically the same as for Meiji industrialization much earlier.
Many of the industrial promotion measures adopted by the Japanese government were
no different from those widely practiced elsewhere in the world. They included preferential
taxes and subsidies; low-interest policy loans; assistance for technology import and R&D;
small and medium business promotion; entry restriction and licensing for certain sectors;
coordination of output, investment and exports; building infrastructure and industrial zones
and areas; and geographic planning. While these were similar to policies adopted in other
countries, MITI implemented them far more effectively than others. In addition, MITI
also had a set of softer instruments for sharing information and encouraging, nudging and
coordinating actions among various stakeholders. They included the creation of visions
and targets; shingikai (deliberation councils); close links with and active use of business
associations; administrative guidance and human networks through personnel rotation and
amakudari (assumption of high posts in private firms under MITI’s supervision after early
retirement from MITI).7
MITI’s policy is sometimes explained as targeting industries whose markets were expand-
ing and whose productivity would rise rapidly (the “income elasticity criterion” and the
“productivity criterion”). But this explanation is a bit too simple and obvious. Certainly, all
governments would like to do this if it were possible. The real question is how MITI suc-
cessfully collected relevant information, avoided wrong choices and mobilized private firms
to action. In selecting priority industries, MITI did not rely on rigid formulas or econometric
models. It fully utilized soft and often informal channels listed above to talk to businesses.
What is most amazing is the fact that crucial information and agreements naturally emerged
in MITI’s daily contacts with the private sector. MITI also knew the diverse intentions of
individual firms and mediated among them. It can even be said that MITI and private firms
chose “winners” jointly for promotion. Industrial targeting of this type, backed by intense
public–private interaction, is quite different from the often-criticized “picking the winner”
strategy by a government with limited knowledge on industrial trends or firms’ intentions,
which usually leads to a disaster.
Among MITI’s information mechanisms, deliberation councils and bottom-up decision
making are worth special mention. As a collective decision making body, deliberation
councils can be set up at various levels including central government and ministries as
well as local governments. MITI used, and still uses, deliberation councils actively to
draft policies. They are orchestrated by MITI which selects a chairperson and invites
relevant stakeholders from businesses, academia, media, consumers, NPOs and so forth.
The most important deliberation council of MITI is the Industrial Structure Deliberation
Council that formulates long-term industrial policy orientation. It also sponsors a large
number of deliberation councils on specific industries and issues. For long, they have
functioned well as a collective decision making process. However, some criticize deliber-
ation councils as a rubber stamp device because MITI picks the agenda, participants and
procedure, and sits as an overseeing secretariat.
Unlike many governments and ministries whose decisions are generated at the top,
MITI’s policy making was—and is—bottom-up. It typically starts with MITI’s junior offi-
cials gathering and analyzing data, drafting reports and conducting intensive hearings with
stakeholders, especially the business community. Collected information is used as an input
for subsequent discussions in a relevant subcommittee and deliberation council under MITI.

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 T he high growth era

Throughout the process, deputy division directors (officials in their mid-thirties) serve as the
hub of information flows both inside MITI and between MITI and the private sector, thus
having a considerable voice in shaping the final outcome (Okimoto, 1989).
Regarding concrete policy actions, SME promotion and strengthening part and compo-
nent suppliers can be cited as examples of successful interventions.
Japan’s SME promotion dates back to the early postwar years with the establishment
of the SME Agency in 1948. Starting from business consultation, many support measures
were subsequently added. By now Japan has one of the most sophisticated systems of SME
support in the world serving as a model for Taiwan, Korea and other countries. The key
policy objective has shifted over time from protection of weak SMEs against exploitation
by large companies to creation of self-standing and globally competitive SMEs, as the
number of excellent SMEs increased and the recognition that SMEs were the source of
Japanese industrial strength rather than a problem spread. Accumulated measures are sum-
marized in the Guidebook for Using SME Support Measures, an annual free publication to
help SME owners locate appropriate policy measures. It covers priority measures of the
year, management support, financial support, accounting and tax support, commerce and
local economy support, sector-specific support, and inquiry and consultation windows over
340 pages (2016 edition). Note that these are measures under the SME Agency only. Many
more measures are available from local governments, business associations and NPOs,
commercial and local banks, JICA and JETRO.
Shindan (enterprise diagnostics and advice) and shindanshi (officially certified business
consultants) are the critical mechanisms guiding SMEs to improve operation and intro-
duce available policy support. In 1952, MITI began to certify outstanding consultants and
actively mobilize them in SME support. In 1954, the Japan SME Management Consultants
Association (J-SMECA) was founded as a professional association of shindanshi, head-
quartered in Tokyo with a branch in every prefecture of the country. Shindanshi must pass
theoretical and practical examinations and registration must be renewed every five years. In
1962 SME University was founded in Tokyo for shindanshi training, with eight more cam-
puses added over the years, where economics, finance, accounting, management, business
operations, IT and SME policy were taught with continuous updating and emphasis on the
actual practice of business consultation. In 2016 the number of registered shindanshi was
about 23,000 which is annually increasing. Many shindanshi also work as industrial experts
in developing countries.
SME loans have been provided by the Development Bank of Japan (DBJ), the Exim
Bank, commercial banks, local banks and credit unions. For financial institutions, reports
submitted by shindanshi were an important information source in evaluating projects and
providing loans to SMEs. Loans and management advice of DBJ were often combined with
technical advice by MITI’s Machinery Industry Bureau. Even when applications for DBJ or
SME loans were rejected, financial institutions told firms how to improve them for the next
round in what Professor Suehiro Akira calls the “Return Match Game.” In this way, man-
agement advice, technical support and financial access were integrated, and the government
and financial institutions actively coached SMEs instead of just serving as a neutral judge.
To enhance “supporting industries,” which is a Japanese term for part and compo-
nent suppliers, MITI enacted the Law on Temporary Measures for Promoting Machinery
Industries in 1956 and the Law on Temporary Measures for Promoting Electronics Industries
in 1957. These “temporary” five-year laws were extended a few times to improve SMEs
that produced intermediate inputs for large automotive and electronics assembling firms.

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 T he high growth era

Incentives included low-interest loans from DBJ and other banks as well as customs duty
exemption and accelerated depreciation of approved equipment, which were made availa-
ble for designated processes and products such as machining, molding, forging, welding,
gears, nuts and bolts, bearings, valves and so on. Other than technical support, these laws
also contributed to the modernization of management of SMEs and their business associ-
ations. Many industrial experts believe that these laws, though long expired, effectively
defined and executed key policies for supporting industry promotion, and should therefore
be carefully studied by industrial officials of developing countries that are considering
introducing similar policies.
MITI was very eager to incentivize importation of technology and advanced equipment,
but Japan was generally reluctant to open its market for FDI for fear of foreign manufactur-
ing dominance. Like Korea but unlike a vast majority of today’s developing nations, postwar
Japan did not welcome or rely on the domestic presence of foreign manufacturers as it wanted
to rebuild an industrial base by Japanese firms alone. For the same reason, issues such as
local contents requirement and requirement for technical transfer or export–import balance
were not raised in postwar Japan. As Japan opened its trade and investment gradually and in
steps along with GATT commitments, MITI used this “national emergency” as an excuse to
press Japanese producers to quickly upgrade technology and enhance competitiveness, and
policies were mobilized to help firms that did this. This can be viewed as an ideal way of
combining a global integration process with domestic industrial promotion, although not all
governments can do this because it requires high policy competency.

Social transformation
Before the high growth period, the basic lifestyle of the Japanese people in terms of food,
clothing and housing changed very slowly. Before WW2, most people ate traditional food
such as rice, miso soup, pickled vegetables, fish and natto beans; drank green tea and sake;
wore kimonos, geta (wooden sandals) and zori (another kind of sandals); and lived in
wooden houses divided by sliding paper doors. People slept on tatami mats with futons.
But all this changed dramatically during the 1960s. Bread, coffee and Western food became
common. Few people now wore kimonos except on New Year Holiday and other special
occasions. Concrete and steel-built apartments with blinds and curtains became popular.
Urbanization progressed. Large families were replaced by nuclear families. Individualism
began to replace group orientation. Among all periods of Japanese history, the postwar high
growth era brought the greatest changes in lifestyle.
For a long time (except during WW2), the labor surplus persisted and wages remained
depressed in Japan. But high growth brought a critical change. Around 1960, labor sur-
plus turned to labor shortage. The so-called “turning point” in the Arthur Lewis model was
finally reached.8 The job offer/job seeker ratio stayed around 1 until 1959 but began to rise
in 1960 until it reached 6 to 7 for middle and high school graduates in 1970. The unem-
ployment rate also declined from over 2 percent to nearly 1 percent during the 1960s. As
the labor market tightened, young workers were highly demanded by urban industries as
“golden eggs.” Special trains and ships were organized to transport fresh graduates from
middle and high schools in rural areas to big cities as new workers. They worked hard in
urban SMEs and service sectors and supported Japan’s high growth, but employment oppor-
tunity at large companies with high salary and job security were closed to them. This “dual
structure,” in which good jobs were reserved for university graduates while others had to

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endure harsh conditions, was a serious socio-economic problem of the postwar Japanese
economy. Similarly, SMEs working under a large company to supply components were
squeezed by unreasonable demands for cost reduction, prompt delivery and unstable orders.
Up until 1960, wage levels at SMEs were only about half or less of those at large firms, but
this gap narrowed over time due also to acute labor shortage, reaching 60–70 percent of
large firms by 1970.
Despite this dual structure, from an international perspective, it must be admitted that
postwar Japan succeeded in achieving fast growth and income equality simultaneously.
There was no major social group in Japan that felt so aggrieved economically as to resort to
violence or social disruption. Surely, there were some unhappy workers and a few radical
students but they hardly represented the voice of the mass. Instead, Ichioku Sochuryu (all
100 million belong to middle class) was the sentiment of the day, and statistics bear this out.
According to the World Bank’s combined and standardized Gini data, which measures the
degree of income inequality ranging from zero to one, the Gini coefficient of Japan declined
from 0.37 (moderate) in 1962 to 0.33 (quite equal) in 1972—compared with the Chinese
Gini that remained about 0.3 (quite equal) in the 1960s and 1970s but shot up to 0.48 (highly
unequal) by 2007. Among East Asian miracle economies, Japan, Korea and Taiwan experi-
enced equal or equalizing income during their high growth periods while China, Thailand,
Philippines and Malaysia had unequal or polarizing income during fast growth. More
recently, Indonesia and Vietnam seem to be joining the latter group.
Income equalization in postwar Japan was the result of many factors. Spontaneous labor
migration from rural to urban areas mentioned above, whether permanent, temporary or sea-
sonal, had a strong effect of converging income under the circumstances of general labor
shortage and rising wages. Policies of supplying public housing, schools and transport infra-
structure in expanding cities as well as strengthening and protecting SMEs also contributed.
Politically, the Liberal Democratic Party which ruled from 1955 (see below) secured rural
votes by offering subsidies, public investment and agricultural price control and protection
in favor of farmers. Tokyo taxes were channeled to build railroads, highways, ports and air-
ports in rural constituencies. Some of these measures may have caused inefficiency but they
certainly equalized income and stabilized society.
During the high growth period, environmental destruction associated with rapid motoriza-
tion and industrialization became intolerable. Rivers and sea coasts were black with sludge
and fish died. Skies were grey with car and smokestack fumes, and incidents of respiratory
diseases soared. Grass-roots movements arose against corporate irresponsibility and official
negligence, which culminated in four principal lawsuits against pollution hazards as shown
in Table 11.1. All of these lawsuits ended with the victory of the plaintiff consisting of
affected residents.
The Japanese government and business community, which initially turned blind eyes to
environmental damage, gradually had to acknowledge the seriousness of the problem. The
Basic Environment Law was enacted in 1967 and the Environmental Agency was established
in 1971. Policy finally shifted from growth-first to environmental protection. Air and water
quality gradually improved. Environmental technology was researched and energy con-
servation was targeted. After many decades, Japanese cities with highways, steel mills and
petro-chemical complexes are now relatively clean with low CO, CO2, SOX, NOX and PM
levels. A high price was paid, but Japan finally overcame the economic growth–environment
dilemma. Many Japanese firms and local governments have developed technology and sys-
tems to cope with environmental problems which they want to market inside and outside Japan.

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Table 11.1 Four major pollution lawsuits of postwar Japan

Cause and symptoms Accused Final ruling

Minamata Disease First reported in 1956. Water Chisso The plaintiff

(Minamata City, contaminated by organic mercury Corporation won in
Kumamoto causing numbness, speech disturbance, March
Prefecture) narrowing of vision field, mental 1973
disorder, loss of muscle coordination
and other neurological disturbances.
Itai-itai Disease First reported in 1955. Water pollution Mitsui Mining The plaintiff
(Jintsu River, by cadmium causing severe pain. “Itai- and Smelting won in
Toyama itai” means “it hurts, it hurts.” Company August
Prefecture) 1972
Niigata Minamata First reported in 1965. Water pollution Showa Denko The plaintiff
Disease (Agano by organic mercury, with same won in
River, Niigata disturbances as Minamata Disease. September
Prefecture) 1971
Yokkaichi Petrochemical complexes from the late Mitsubishi The plaintiff
Asthma 1950s causing air pollution by SOx Petrochemicals, won in
(Yokkaichi City, and other substances. Major symptoms Showa August
Mie Prefecture) included sore throat, coughs, Yokkaichi 1972
respiratory organ troubles, vertigo, Sekiyu and four
nervous diseases and eye irritation. other companies

In Japan, inequality and environmental destruction, which are two common problems
in rapidly industrializing society, were prevented by appropriate policy interventions albeit
with much delay and damage in the case of the environment.
In the political sphere, two conservative parties merged to become the Liberal Democratic
Party in 1955, which has since dominated Japanese politics except for a few short breaks.
The LDP lost the prime minister’s seat from 1993 to 1996 and from 2009 to 2012 but sub-
sequently regained it. The situation in which the strong and conservative LDP overpowers
weak opposition parties has been called the “1955 Regime.” In many aspects, the LDP is
much like the Seiyukai Party in the prewar period. Its support base is rural. The LDP dis-
tributes public money for rural investment and farm subsidies. With the coming of Prime
Minister Kakuei Tanaka (in office during 1972–74), the LDP’s ruling style characterized
by rural money politics for winning votes became firmly established, and it still continues
today. Many LDP politicians want to continue building Shinkansen (bullet trains), airports
and highways despite the severe budget crisis.
In comparison with prewar politics punctuated by dramatic power shifts and frequent
crises, the postwar political structure in general and the 1955 Regime in particular have
been more static (Banno, 2004). The absence of an opposition party that can challenge the
ruling party, such as the Minsei Party in the 1920s and 1930s, partly explains this. In a situa-
tion where no serious political competition existed, LDP-led Japan assured national security
by becoming a faithful US ally and staying within the US nuclear umbrella, and confined
domestic agenda to such issues as growth, trade negotiations, environmental protection and
social welfare while suppressing ideological dissent or capitalist–labor confrontation. This
led to a political regime in which serious debates and power shifts rarely occurred.

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Box 11.1 Honda Soichiro: a postwar business hero

Postwar Japan produced many business heroes. Among them, Honda Soichiro (the
founder of Honda Motor Company), Matsushita Konosuke (the founder of Panasonic)
and Ibuka Masaru and Morita Akio (the co-founders of Sony) are among the most well
known. They were all engineer-inventors who started in a tiny factory with a great
vision and desire to produce new and better products to conquer the Japanese—and
world—market. They encountered many failures and hardships but persevered until
great success was reached. They were driven by unquenchable monozukuri (making
things) spirit, not by the desire for a high salary, quarterly profits or balance sheets.
After building a business empire, each became a philanthropist and made contributions
in education, culture, environmental protection or economic diplomacy.
Honda Soichiro (1906–91) was the son of a blacksmith in Shizuoka in Central
Japan. From early on, he learned the skills of bellowing, using furnaces and casting
metal from his father. The boy was crazy about mechanical things. When his father
opened a bicycle shop, Soichiro was happy to assist him as a repairman.
After finishing at secondary school, Soichiro worked at an automobile repair com-
pany. After six years, when Soichiro was twenty-one, he was promoted to direct the
company’s Hamamatsu branch. But he was not satisfied with just repairing automobiles,
and he started to experiment and produce new parts. In those days, virtually all cars
were imported or produced by American carmakers in Japan, and domestic production
of automotive parts was an important goal for the industry. Soichiro tried to self-produce
piston rings, a crucial engine component, but it was not easy. After realizing that expe-
rience must be supported by theory, he went to Hamamatsu Technical College to study
metallurgical and mechanical engineering for three years.
After the war defeat, in 1946, Soichiro established his own company to produce
motorbikes which later became Honda Giken Kogyo (Honda Motor Company).
Honda’s first motorbikes, the Dream (146cc) and the Cub (50cc), were instant hits.
Around 1954, Honda faced a crisis due to fierce competition and technical problems
with its products, but the crisis was overcome by the efforts of Fujisawa Takeo, the
company’s competent marketing manager.
Soichiro wanted to join—and win—the Tourist Trophy (TT), an international
motorbike race in Great Britain. He organized a special team to manufacture a very
powerful motorbike for this race. In 1959, Honda participated in the TT for the first
time. Two years later, in 1961, Honda won a sweeping victory by grabbing the first to
fifth prizes in both 125cc and 250cc classes. Around the same time, Honda introduced
the Super Cub, a popular 50cc motorbike with an efficient engine. It became an even
bigger hit with Japanese and world consumers.
In the 1960s, Honda began production of automobiles. This move was prompted
by the MITI’s plan to consolidate Japanese auto makers to only a few to compete
with American Big Three. If this policy was implemented, newcomers such as Honda
would be excluded so Soichiro rushed to enter this game before this happened. The
first popular small car, N360, sold well but was later criticized as a defective product.
In 1970, a tough environmental law was enacted in the United States requiring
automobiles to drastically reduce emissions. Honda became the first car company in

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the world to clear this standard in 1972 by inventing the Compound Vortex Controlled
Combustion (CVCC) engine. This proved that Honda had frontline technology in auto-
mobiles as well as in motorbikes. Honda’s move also stimulated other Japanese auto
manufacturers to produce fuel-efficient, low-emission cars.
Here are some words of Honda Soichiro:
“The General Directors of this company have all been unruly and unpredicta-
ble, including myself. So all of you must work very hard to sustain the company.”
(Addressing the company gathering at Honda’s 35th Anniversary, 1983.)
“All General Directors raised issues with me. Any General Director who doesn’t
do this is useless.” (Recalling the time when GD Kume and GD Kawamoto both
advocated a water-cooled system when Soichiro insisted on an air-cooled system, in
developing the CVCC engine.)
“Don’t be a victim of the company. You must work in order to enjoy your own life.”
(To new recruits.)
“Everyone dreams and hopes for a success. I believe a success comes only 1 percent
of the time, supported by the 99 percent of failures. The final success is attained by
challenging the new world with pioneer spirit and after the repeated use of failures,
reflection and courage.” (At the time of receiving an Honorary Doctor’s Degree from
the Michigan Institute of Technology, 1974.)
“It’s OK. Your greasy hand is good. I very much like the smell of grease.” (When a
worker tried to shake hands with Soichiro but, realizing his own greasy hand, quickly
withdrew it.)
(Sources: Miyamoto, 1999 and Honda Soichiro
Study Group, 1998)

Notes
1 The Economic White Paper of 1956, published by the Economic Planning Agency. Economist Goto
Yonosuke remarked a famous phrase, “We are no longer in the Postwar Phase.” This meant that an
“easy” recovery from an artificial bottom created by the war was over, and growth from now on had
to be generated by conscious efforts in productivity and economic transformation. However, many
mistook this message as implying that the hardest time was over and a bright future was upon them.
2 The fiscal investment and loan program (FILP) is a mechanism in which people’s small funds
collected through state institutions and credit mechanisms, such as postal savings and pension con-
tributions, were mobilized for investments and loans having a public nature such as housing, small
enterprise promotion and regional infrastructure. During the high growth period when more funds
were paid in than withdrawn, the FILP grew to a size as large as about the half of the general budget
and was used for various projects in close coordination with the general budget.
3 In those days, Gross National Product (GNP), or values produced at home and abroad by “domestic
residents” (those who were in Japan for six months or more), was the popular indicator of economic
size instead of Gross Domestic Product (GDP), or all values created within Japanese territory regard-
less of official residence or nationality of firms or individuals, which is commonly used today. The
main differences between GNP and GDP are treatment of wages, interests and dividends earned
abroad. In the case of Japan, GNP and GDP are roughly the same.
4 The Post-WW2 Bretton Woods international monetary system was established by the Bretton Woods
Agreement in New Hampshire, United States in 1944 and managed by the International Monetary
Fund, an institution also created by the Bretton Woods Agreement. It was a US dollar-centered fixed
exchange rate system under tight capital control, with the possibility to adjust exchange rates under
certain conditions.

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5 Different inflation in different sectors does not necessarily imply disequilibrium. If wage and other
factor prices are the same across all domestic businesses, sectors with high productivity growth can
achieve cost reduction relative to sectors with low productivity growth. Japanese consumer prices rose
while wholesale (industrial) prices remained stable because productivity grew faster in machinery,
automobile, electronics, and so on, than food, housing and services purchased by consumers. This
phenomenon is technically proven in the Balassa-Samuelson Theorem in international economics.
6 A question frequently raised about kaizen is whether it works in societies quite different from
Japanese which features teamwork, patience and collective decision making. The question is under-
standable, but the fact is that kaizen is already practiced widely in Southeast Asia, India, Western
and Eastern Europe, America, Latin America and Africa, each of which has a very different culture
from Japanese but produces similar immediate and remarkable results in productivity improvement
and cost cutting. There is no society in which muda elimination, when done properly, fails to produce
wonders in workplaces.
7 For more on MITI’s policy measures, see Johnson (1982), Itoh et al. (1988), Komiya et al. (1988)
and Okimoto (1989).
8 The Lewis model divides the economy into the traditional sector (rural agriculture) and the modern
sector (urban industries). It assumes labor surplus in rural areas, which prompts labor migration from
villages to cities as the modern sector expands and requires more labor. When this process progresses
sufficiently, a new phase, called the turning point, is reached at which surplus labor disappears and
a wage hike becomes necessary to employ more workers.

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12
E C ON OM IC M ATURITY AND
SL OW DOWN

Japan’s high growth came to an end in the early 1970s. Annual growth fell to an average
of about 4 percent in the 1970s and 1980s, and further down to near zero in the 1990s
(see Figure 11.1 in the previous chapter). The government called this “stable growth.” Why
did growth slow down in the early 1970s?
One important fact that we should keep in mind is that growth slowdown in this period
was common to all industrial countries in North America and Western Europe. The reasons
for slowdown must have therefore been at least partly global though domestic factors may
also have played a role. Moreover, inflation accelerated in all industrial countries in the
1970s. This also points to a globally common cause. Let us look at the domestic and interna-
tional causes of Japan’s slowdown respectively.

The end of catching up

On the domestic side, transition to lower growth was natural and inevitable because the
Japanese economy had caught up with the US and European economies and matured. During
the catching up process, a developing country can (selectively) import technology and
systems that exist in the developed world. But when you become part of the developed
world, you can no longer copy others but must create something new in order to grow.
Naturally, clearing your own path is harder and slower than following someone else’s path.
Measured in income per head (in actual dollars, not purchasing power parity—or
price-adjusted—dollars; see below), the gap between Japan and the United States was
1 to 14 in 1950, 1 to 6 in 1960 and 1 to 2.5 in 1970. This narrowing of bilateral income dif-
ference was the result of Japan’s much faster growth compared with the United States. In
the 1970s, the fluctuating yen–dollar exchange rate began to disturb this income compar-
ison. The income ratio was 1 to 1.3 in 1980 and 1 to 0.93 in 1990, which means Japanese
income was temporarily higher than US income in that year. But since Japanese prices
were in general much higher than in the United States, this does not necessarily mean
Japanese people had attained a higher living standard than Americans in 1990.
To make adjustments for different price levels, the concept of purchasing power parity
(PPP) is used. The same amount of money can buy much in countries with low prices and only
a little in countries with high prices. For example, consumers in Vietnam, where prices are
low, could enjoy much higher living standards than consumers in Japan, where prices are high,
if they had the same income measured in a common currency. The real income of Japanese
consumers must therefore be discounted by the extent that Japanese prices are higher than

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Vietnamese. This adjustment is necessary to correctly compare income and living standards
across countries. Measured by this PPP criterion, Japan’s per capita income surpassed that of
Italy in 1966 and that of Britain around 1975. Japan did not overtake the United States, West
Germany or France but came close to them by the mid 1970s. Thus, it can be said that Japan
was firmly in the highest income group by the 1970s.
Another way to measure income is by affordability of consumer durables (Figure 12.1).
It took 10.7 months of average Japanese salary to buy a new car (the basic model of Toyota
Corolla) in 1966, but workers had to work only 4.0 months to buy a similar car in 1974.
In 1991, a new car could be had after 2.4 months of work. By the mid 1970s, virtually all
Japanese households were equipped with washing machines, refrigerators, vacuum cleaners,
telephones and color TVs. Automobiles and air-conditioners were not as widely owned as
these items because they were not considered necessary or useful for some households.

The oil shocks of 1973–74 and 1979–80

On the external side, there were two major economic shocks in the 1970s that were common
to all countries: the oil shocks and the beginning of general floating of major currencies.
The price of crude oil was low and stable, at around $2–3 per barrel, for a long time
in the post-WW2 period. However, in the autumn of 1973, the Organization of Petroleum
Exporting Countries (OPEC) decided to raise it dramatically to $11 per barrel and reduce
oil export to industrial countries by about 10 percent. The oil price was again raised to about
$30 per barrel in 1979–80. Both of these price increases were associated with political and
military situations in the Middle East with the first oil shock resulting from the Fourth Middle
Eastern War and the second from the Iranian Revolution.

Figure 12.1 The ratio of households owning consumer durables

Sources: Cabinet Office, Trends in Household Consumption, 2003, and others.

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 E conomic maturity and slowdown

Many of the advanced countries depended heavily on imported oil with the average
import ratio of 67 percent of domestic demand. Among them, Japan’s foreign oil dependency
was particularly high at 99.7 percent. The first oil shock caused both wholesale prices and
consumer prices in Japan to surge beyond what could be explained only by the oil impact
(see Figure 12.2). Between these prices, wholesale prices rose faster. Japanese people
panicked and tried to hoard as many daily necessities as possible, including toilet paper,
detergent and kerosene. But this stocking behavior collectively generated empty shelves in
supermarkets, despite the fact that the flow supply was sufficient to cover the flow demand.
Seeing empty shelves, people panicked even more. Shortages spread from consumer goods
to industrial inputs. Speculative hoarding by traders and brokers was suspected of further
accelerating the price increase, which was then called kyoran bukka (crazy prices). Workers
demanded high wage hikes. In 1974, Japan registered its first negative growth in the post-
war period of –0.5 percent (slightly different numbers exist due to subsequent revisions).
“Stagflation” was the term that economists used to describe the simultaneous occurrence of
business recession and high inflation.
Compared with the first oil shock of 1973–74, the second oil shock of 1979–80 had a
relatively minor impact on the Japanese economy. Inflation rose but not very much, and the
economy continued to grow.
On close examination, Japanese money supply was increasing rapidly prior to the first
oil shock and inflation already began to accelerate in the early 1970s. Monetary expansion
was caused by the Bank of Japan’s foreign exchange intervention to support the dollar. It
aggressively bought dollar assets and sold yen assets, typically Japanese government bonds,
which artificially increased demand for dollars (see the next section for why the Bank of
Japan did this). The injection of yen assets into the economy had the effect of pushing up
money supply. Moreover, fiscal policy was also very active at the time of the first oil shock.
Prime Minister Tanaka Kakuei’s “Japanese Archipelago Rebuilding Plan,” announced in
1972, called for massive public investments to build highways and Shinkansen (fast trains)
to connect planned industrial areas across Japan with urban centers. Such fiscal activism

Figure 12.2 Money supply and inflation (increase over 12 months)

Source: International Monetary Fund, International Financial Statistics, various issues.

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 E conomic maturity and slowdown

stimulated the economy, and land speculation became rampant along proposed routes of
large-scale transportation projects. These monetary and fiscal policies were already nudging
Japanese prices upward when the OPEC crisis hit.
After the first oil shock and “crazy prices” erupted, Tanaka’s “Rebuilding Plan” had to be
abandoned. Monetary policy was also gradually tightened. The Bank of Japan was severely
criticized for being expansionary and fueling inflation in the early 1970s. In response, it
converted to “monetarism”—a school of macroeconomics that taught that money and only
money was the cause of inflation, always and everywhere. The Bank of Japan began to target
monetary growth to avoid future inflation.
As part of structural reform, the government tried to reduce national energy consumption
and promote “rationalization” (i.e. downsizing and closure) of energy-intensive industries
including paper and aluminum refining. The national campaign was launched to turn off
unnecessary lights, set the room temperature lower in winter and higher in summer, and
discourage commercial neon signs. However, serious energy saving would require an overall
improvement of energy efficiency, not just turning off lights more frequently. This would
take time because new technology and large investment were required. Japan’s effort to
economize energy relative to the size of economic activity turned out to be brilliantly suc-
cessful in the long run. By the early 1980s, Japan became the most efficient energy user
among industrial countries. The Japanese automobile companies also succeeded in mass pro-
ducing energy-efficient cars, many of which were exported to overseas markets, especially to
the United States (see the story of Honda at the end of Chapter 11).
Many papers and books were written on the nature and cause of the oil shocks in the 1970s.
There were two distinct and diametrically opposed interpretations, and it must be admitted
that the final verdict has not yet been reached even today. Economists such as Jeffrey Sachs,
Michael Bruno and Barry Bosworth took the position of the supply shock view. Hans Genberg,
Alexander Swoboda and Ronald McKinnon advanced the global monetarist view.
The supply shock view was an obvious and more popular view that argued that the oil
shocks were supply shocks caused by OPEC’s political power. Consider an upward-sloping
aggregate supply curve and a downward-sloping aggregate demand curve in a standard mac-
roeconomics textbook.1 As the oil price is jacked up artificially, the resulting cost inflation
moves the aggregate supply curve up and to the left, causing higher prices and lower out-
put, namely, “stagflation.” If trade unions additionally succeed in an aggressive wage hike,
inflation will rise even further. According to this view, inflation is generated by supply-side
factors and its solution must also be sought on the supply side, for instance, by coping with
energy shortage and real wage rigidity.
The global monetarist view is quite different and insists that high inflation of the 1970s
was caused by global monetary expansion, which in turn was caused by the breakdown of
the Bretton Woods fixed exchange rate system. As the Japanese and European central banks
tried to buy up dollars to prevent sharp appreciation of their currencies against the dollar
during 1971–73, the money supply was increased in all major economies. Global excess
liquidity ignited commodity price inflation even before the first oil shock occurred. The
oil shock was the final phase and not the cause of high inflation, which was created by the
oversupply of global money. OPEC is always aggressive, but its attempt to raise oil prices
succeeds only when there is too much liquidity in the world that sustains oil inflation. Thus,
in this view, stagflation in the 1970s should be explained by a monetary factor. More spe-
cifically, it was the result of the built-in instability and eventual collapse of the international
monetary system of the early post-WW2 period.

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Floating of major currencies

From 1944 to 1971, the world was on the dollar-based and US-centered Bretton Woods
system of fixed exchange rates. It achieved unprecedented global price stability, high growth
and trade liberalization in the 1950s and the early 1960s. But the system began to strain in
the mid 1960s.
The fate of the system critically depended on the macroeconomic policy of the United
States. As the US government adopted an expansionary policy stance to finance welfare
spending, the war in Vietnam and the space race with the Soviet Union, inflation emerged
and spread to the world in the 1960s. The United States was producing higher inflation than
the rest of the world wanted to import. Despite fixed exchange rates, the dollar was under
downward pressure and corresponding upward pressure on gold and European and Japanese
currencies developed. As gold reserves at the Federal Reserve System (US central bank)
dwindled, the US government introduced two-tier pricing of gold for foreign governments
and free markets separately.
Finally, in August 1971, President Richard Nixon announced that the dollar was no longer
to be fixed to gold or other currencies. This ended the Bretton Woods system and major
currencies began to float immediately. President Nixon also imposed temporary price con-
trols and stiff import surcharges. These were supposed to fight inflation and ameliorate the
balance-of-payments crisis the United States was facing. Surprised Japanese officials and
media called this the “Nixon Shock.” To avoid appreciation of home currencies (the loss
of export competitiveness), the Bank of Japan and central banks in Europe intervened mas-
sively in the foreign exchange market to buy and prop up the dollar.2 This dramatically
increased money supply in each country.
Between 1971 and 1973, there was an international effort to re-establish a fixed exchange
rate system at new levels (with a more depreciated dollar). In December 1971, the mone-
tary authorities of major countries gathered in Washington DC to set new exchange rates
(the Smithsonian Agreement). The yen was set at 308 to the dollar. But these rates could
not be maintained for very long. In early 1973, under another bout of heavy speculative
attacks, the Smithsonian rates were abandoned and major currencies began to float again
with no prospect of returning to fixed rates. Floating exchange rates have continued well
into the twenty-first century.
Monetarist economists—such as Milton Friedman—predicted that freely floating
exchange rates would move smoothly and help international adjustments. However, it was
soon discovered that floating currencies in reality were volatile and injurious to national
economies. In 1985, the Group of Five (G5)—the United States, Japan, West Germany,
France and the United Kingdom—jointly intervened to lower the too-high dollar (the Plaza
Agreement). But it fell too much. In 1987, the Group of Seven (G7)—G5 plus Italy and
Canada—again intervened to stabilize the dollar (the Louvre Accord). Such joint interven-
tions have been tried occasionally when needed to correct extreme currency movements.
Among major central banks, the Bank of Japan has been particularly averse to excessive yen
appreciation and often intervened unilaterally to buy up the dollar. This has resulted in rapid
accumulation of international reserves to the highest level in the world. Meanwhile, from
the 1970s, European countries cooperated toward the creation of a regional monetary union,
which produced the euro in 1999 and its paper notes and coins began to circulate in 2002.
The Japanese economy is highly vulnerable to the fluctuation of the yen–dollar exchange
rate for several reasons. First, the yen is a lone floater as there is no yen zone in Asia—unlike

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the euro area in Europe or a large number of dollar-using nations in the world for the United
States. Second, most of Japan’s trade and virtually all of its financial transactions are con-
ducted in dollars. Third, Japan, as a large creditor country, has accumulated a huge amount
of unhedged dollar assets in the form of US government bills and bonds, whose values depre-
ciate whenever the dollar falls. Fourth, Japanese industries exhibit relatively low exchange
pass-through (domestic prices change little when the yen rises or falls) and Japanese manu-
factured products contain high domestic value-added (domestic materials and components).
When the yen appreciates, their costs also rise with the yen almost proportionately, leading
to the loss of competitiveness. When this occurs, Japanese output and investment stagnate,
prices and wages are suppressed, and financial strain is created. This is called endaka fukyo,
or high yen-induced recession.

Delayed systemic reform?

Some argue that the Japanese economic system of the 1950s and 1960s, based on long-
term relations and active official intervention and featuring the main bank system, lifetime
employment, seniority wages, cooperative management–labor relations, administrative
guidance and the like, became obsolete by the 1970s. According to them, this system func-
tioned reasonably well while the country was in the catching up phase, but it was no longer
appropriate when Japan became a mature industrial society. Japan should have shifted deci-
sively toward a more market-based, less officially guided system during the 1970s. But two
major global shocks of oil price hikes and the beginning of floating currencies intervened,
which kept the Japanese government too busy coping with these macroeconomic problems
instead of launching systemic transformation. Moreover, trade friction with the United States
and Europe intensified (see below) which further diverted policy attention. As a result, the
Japanese economy failed to cast off many legacies of old times such as over-regulation and
the lack of incentives for innovation. This has become an institutional barrier for Japan’s
further development.
Noguchi (1995) criticizes Japan’s current economic regime which promotes production
rather than consumers’ welfare, suppresses competition and uses social policies to reduce
popular dissent and dissatisfaction as the “1940 regime,” a system created to execute war but
has no place in today’s Japan. Similarly, Ota (2010), who served as the Minister of Economy
and Fiscal Policy in 2006–8, strongly supports economic deregulation and fiscal discipline.
She condemns any attempt to revive old-fashioned fiscal activism and random subsidies.
However, there is another view that cautions against admiring and uncritically adopting
an American-style free economy. Advocates such as Hara (1996) assert that long-term trust
and official support are two ingredients that are critical in any society that wants to move
from an early light manufacturing and simple assembly phase to a fuller, more technology-
based heavy industrialization. The free market of Meiji had to inevitably evolve into a more
relational and guided market economy as Japan mastered heavy and mechanical industries
in the mid-twentieth century, with or without war. All latecomer countries of yesterday
and today need such modification to their domestic economic system so development will
proceed smoothly and without social crisis. Disapproving all relational and state-guided
systems as obsolete is too simplistic and without a historical perspective, especially when the
world now clearly recognizes the instability and harm that unregulated global markets can
bring through asset bubbles, speculative waves, currency attacks and income gaps.

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Therefore, Japan’s transition to a freer market economy, if it is to be done, must be done

carefully and selectively without throwing away desirable Japanese features such as long-
term perspective, teamwork, monozukuri spirit and the balanced sense of efficiency and
equity together with the bath water.

Trade friction with the United States

Japan’s main external problem in the 1950s to mid 1960s was how to reduce emerging trade
deficits. Phrases such as “the ceiling of the balance of payments” and “stop–go policy”
(Chapter 11) reflected this problem. Around the mid 1960s, however, the problem changed
180 degrees. Japan now had to reduce the rising trade surplus as a top priority. A trade sur-
plus was politically undesirable as it angered the United States, especially the US Congress
and industrial lobbies. In the 1980s, Japan began to record the largest trade surplus and the
United States had the largest trade deficit in the world, year after year. Furthermore, the
size of Japan’s surplus and that of the American deficit were similar. Japanese saving was
used to finance American overspending, and that became the largest financial flow in the
world economy.
After the oil shocks of the 1970s, the Japanese economic structure moved away from
heavy and energy-using sectors to lighter and more mechanical sectors. Industrial activities
shifted from Ju-ko-cho-dai (heavy-thick-long-large) products such as steel, cement and
petrochemicals to Kei-haku-tan-sho (light-thin-short-small) ones. In the process, electron-
ics and automobiles emerged as two major export items. Japan was leading the world with
such products as semi-conductors, cameras, calculators, TV sets, video machines, Walkman
music players and energy-efficient cars. Productivity tools developed since the 1950s,
including the Toyota Production System, were embraced with renewed zest to strengthen
Japanese competitiveness once again under the new global reality of higher energy prices
and floating exchange rates.
The history of Japan’s trade friction with the United States—and, to a lesser extent, with
Western Europe—is long and highly politicized. It began in the 1960s, when Japan was
exporting cheap textile products (the “one-dollar blouse”) to the US market. In response to
American complaint, Japan was forced to adopt “voluntary” quotas on textile export. From
then on, a stream of Japanese products came under attack: steel, TV sets, machine tools, auto-
mobiles, video players, semi-conductors and so on. From the 1980s, in addition to pressure
to export less, the United States began to demand that Japan buy more from America includ-
ing farm products such as oranges and beef, automobile parts and construction and financial
services. Moreover, US trade negotiators argued that the Japanese economic system was
inefficient and closed to imports, and thus must be reformed. What started as complaints on
individual products ultimately spread to the universal criticism of the economic system of
America’s major trading partner.
The idea that the American trade deficit was caused by Japan’s unfair trade practices, and
that its reduction required bilateral diplomatic negotiations (not automatic market mecha-
nisms), was behind the tough stance of the US trade negotiators. A too cheap yen was also
regarded as part of the problem, so currency adjustments were also negotiated. Every five to
seven years when the US trade deficit with Japan became politically intolerable, the United
States demanded two things: (i) the yen must appreciate; and (ii) Japan must buy more from
and sell less to the United States. This occurred in 1971–73, 1977–78, 1985–87 and 1993–95.
Each time, trade tension rose between Japan and the United States, and the yen was sharply

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appreciated as the US Treasury Secretary, and sometimes even the President, talked up the
Japanese currency. Such American economists as Paul Krugman, Fred Bergsten and Laura
Tyson provided theoretical support to this approach.
But was this view correct? Other economists strongly rejected the tough trade-cum-
currency negotiation approach as seemingly obvious but economically wrong. Komiya
(1994) and McKinnon and Ohno (1997) argued that neither trade talks nor exchange rate
adjustments could “correct” bilateral trade imbalance and, if implemented, they would
only cause additional problems (the Hypothesis of the Syndrome of the Ever-Higher Yen).
This view was certainly in the minority in the United States but had broad support among
Japanese businesses, officials and economists.
McKinnon and Ohno (1997) argued that the US trade deficit was a long-term structural
problem caused by the savings shortage of both the American government and house-
holds. Trade and currency negotiations with Japan or any other trading partner could hardly
remove the true cause of this US-made problem. The fundamental solution must come from
the American side by spending less and saving more, and mobilizing domestic policies to
encourage this trend. Japan’s external opening to the world (not just to the United States)
would do it good, but this would have little impact on Japan’s trade balance which is deter-
mined by the relative savings–investment position of each country at the macro level.3 Japan
and the United States should conclude bilateral agreements to solve trade disputes at the
micro or sectoral level (or take them to the WTO) and refrain from using the yen–dollar
exchange rate for commercial policy purposes (see Box 12.1 at the end of this chapter for
Komiya’s similar argument).
In the 1990s, the Japan–US bilateral policy pattern further evolved. In the mid to late
1990s, the US economy was soaring with an IT boom and an asset bubble while the Japanese
economy was stagnant due the bubble collapse (Chapter 13). The usual US demand to open
up Japan and appreciate the yen was in recess, even though the Japan–US trade gap was
very large. It was feared that a further destabilization of the already weak Japanese economy
would damage the world economy and backfire against the United States.4 In particular, the
collapse of Japanese financial systems would have an adverse effect on the international
financial system. In the late 1990s, some Japanese officials and economists even hoped for a
sharp depreciation of the yen to boost the lackluster economy, as fiscal and monetary stimuli
had all failed. But this was not actually implemented, not only because the authorities did
not have the power to dictate a floating currency but also because the move would anger the
Americans. In the meantime, the US government continued to send very ambiguous signals
on the desired movement of the dollar. It repeated that the strong dollar policy would be
maintained but the exchange rate should be determined by the market.
Another important fact is that China overtook Japan as the largest trade surplus country
vis-à-vis the United States around 2000 and, as a consequence, trade friction similar to what
Japan experienced in the past had emerged between China and the United States (Figure 12.3).
As long as the American savings shortage remained the same, some other country would be
obliged to provide a sufficiently large trade surplus with the United States (i.e. a loan to
America), if Japan were not to do it. As predicted, the United States strongly demanded an
appreciation of the Chinese renminbi (RMB) to “correct its gross undervaluation” and dimin-
ish Chinese competitiveness. Since China was still a middle income country with significant
capital control, the situation was not exactly the same as Japan. China also had skirmishes
with the United States over human rights, intellectual property rights, cyber-attacks and the
like which Japan did not have. But the American complaint pattern over unfair trade practices

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 E conomic maturity and slowdown

Figure 12.3 US bilateral trade balances with Japan and China

Sources: US Bureau of Economic Analysis, National Economic Accounts, and US Census Bureau, US
International Trade Data.

and an undervalued currency remains basically the same. Thus, China now faces more of the
blame from the United States than Japan.5 Earlier, Japan was criticized because it was too
strong. Since the 1990s, Japan has been weak and stopped drawing much attention from for-
eign governments. This change is described as “Japan bashing” turning to “Japan passing.”
The Japanese like self-depreciation and are very sensitive to how others perceive them.
In July 2005, China revalued the RMB by two percent and officially moved from the
fixed exchange rate system to the basket currency system with unannounced basket con-
tents. However, the actual mode of currency management did not change very much. The
RMB still remains virtually pegged to the dollar and its speed of crawl has been controlled
and very slow—it rose slowly until mid 2015 when it began to fall. In light of China’s
unbending inclination toward state control and gradualism, this is quite expectable.

Fiscal expansion and consolidation—and expansion again

During the high growth period of the late 1950s to 1960s, the central government budget was
generally sound. It was in surplus and no government bonds were issued until 1965. However,
in the mid to late 1970s, fiscal expansion to stimulate the economy was re-activated, financed
by the issuance of new government bonds. These bonds were initially of ten-year maturity
but bonds with shorter maturities were later added. Public debt quickly accumulated.
The seriously worried Ministry of Finance launched an initiative for fiscal consolidation
in the 1980s. A tighter budget and bold expenditure cuts were planned. Fiscal and adminis-
trative reforms were proposed and partly carried out. For this purpose, two recommendation
reports were drafted with somewhat different policy directions.

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 E conomic maturity and slowdown

The Second Ad Hoc Commission on Administrative Reform (Dai Ni Rincho, 1981–83),

an official advisory body chaired by former Keidanren President Doko Toshio, recom-
mended expenditure cuts without resorting to tax increases. His recommendations also
included greater international contributions through increased ODA and military spending,
reduction of healthcare costs and private-sector initiatives. Mr. Doko himself was a man
of self-discipline and modest living. He ate only a small dried fish for breakfast, setting an
example of cost reduction for the government to follow.
Subsequently, the Maekawa Report was prepared in 1986–87 by the Advisory Group on
Economic Structural Adjustment for International Harmony, a private group advising Prime
Minister Nakasone. The Group was headed by former Bank of Japan Governor Maekawa
Haruo. It recommended expansionary fiscal and monetary policies to boost domestic demand,
economic deregulation and reduction of the trade surplus to avoid further friction with the
United States. His low interest rate policy was later criticized as causing an asset bubble.
Additionally, Professor Komiya Ryutaro severely criticized Maekawa’s recommendation for
trade surplus reduction, arguing that the surplus was a macroeconomic phenomenon that
should be left to market forces (see Box 12.1 below).
Thanks to the efforts of the Ministry of Finance and the emergence of an asset bubble in
the late 1980s, fiscal balance gradually improved. However, the situation would radically
change in the 1990s. With the bursting of the asset bubble in 1990–91, the Japanese economy
was plunged into a long recession. A series of fiscal stimuli were tried in increasingly large
amounts and public debt began to accumulate again (Chapter 13).

Box 12.1 Prof. Komiya and the Japan–US trade friction

Professor Komiya Ryutaro (1928– ) is one of the most prominent and out-spoken econ-
omists in Japan. After graduating from Tokyo University, he conducted research at
Harvard University, Stanford University, Aoyama Gakuin University and others. He
was a professor as well as the Dean of the Faculty of Economics at Tokyo University.
He also served as the President of the Research Institute of Economy, Trade and
Industry (RIETI), the MITI’s policy think tank.
Professor Komiya’s main research area has been international economics. In
addition to theoretical works, he has written many books that openly criticized the
policies of the Bank of Japan as well as the Japanese and US governments. In 1983,
he co-authored a two-part book that mercilessly blamed the behavior of the Bank
of Japan when the world transited from the fixed exchange rate system to general
float in the early 1970s (Komiya and Suda, 1983). In his 1994 book, Economics of
Trade Surplus and Deficit, he flatly dismissed the idea that Japan’s trade surplus
was generated by the closed nature of Japanese markets. He argued that the trade
gap was fundamentally a macroeconomic phenomenon of the savings–investment
balance. He asserted that, unless the United States adopted internal policies to
increase its own saving rate, no trade negotiation or exchange rate manipulation
would “resolve” the trade gap issue. He also reproached the Maekawa Report as com-
pletely wrong-headed. This view is quite close to the Hypothesis of the Syndrome
of the Ever-Higher Yen of McKinnon and Ohno (1997) presented in the main text.

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 E conomic maturity and slowdown

Here are some extracts from his 1994 book.

•• Let me reflect on why I am writing this book. My current position is roughly as

follows. For more than a decade since around 1983, Japan’s huge current account
surplus and America’s huge deficit—or Japan’s trade surplus with the US—have
been a cause of economic “friction” between the two countries. Against this trade
surplus of Japan, the US has aggressively demanded that we reduce the surplus
and open up the Japanese market.
To me, first of all, these demands for reducing the surplus and opening the
markets—or more precisely, the ideas behind these demands—seem extremely
illogical and unreasonable. Japan’s response to the United States in the so-called
Maekawa Report in 1986 was also highly inappropriate.
Second, from the viewpoint of economics, the debate over the bilateral current
account imbalance is full of elementary mistakes. Stupidity and nonsense rule
over this debate. And I believe it is my mission as an economist to correct such
mistakes and nonsense.
Third, I consider myself an internationalist and not a nationalist, and I am
proud of it. But I cannot endure a situation where Japan is unduly criticized by
the international community based on misunderstanding, prejudice and malice. I
want to refute such criticisms and correct these misguided ideas. (pp. 3–4)
• Recently, there is a re-emergence of the idea that yen appreciation can reduce Japan’s
trade surplus. But this idea is fundamentally mistaken. The exchange rate can adjust
only the cyclical part of the surplus, if at all. In a floating exchange rate system, the
(real) exchange rate is endogenous [determined by the interaction of many variables]
and cannot be manipulated to an arbitrary level. (p. 106)
• In general, the impact of the real exchange rate (in other words, the terms
of trade) on savings and investment is ambiguous . . . As a first approximation,
I propose to presume that the terms of trade has no direct relationship with the
trends of S [saving] and I [investment] in each economy . . . Existing theoretical
and empirical studies on savings have not considered the effects of changes in
relative prices or the terms of trade on the trend of savings, because such an
inquiry is theoretically a very remote one. (pp. 180–181)

Notes
1 In the diagram measuring the price level vertically and income horizontally, a downward-sloping
aggregate demand curve is derived from the IS–LM analysis, representing the demand side of the
national economy. An upward-sloping aggregate supply curve is constructed from the supply side
reflecting the production function and the labor market. An equilibrium is found where these two
curves intersect. An oil shock, if it is to be regarded as a supply shock, shifts the aggregate supply
curve upward to the left. The equilibrium point moves in such a way that the price level rises and
income declines.
2 For eleven trading days following the Nixon Shock, the Bank of Japan intervened heavily in the
currency market to fight off massive speculative attacks, thereby losing 4 billion dollars of foreign
reserves. Then, it gave up and let the yen appreciate. European central banks gave up much sooner
before losing foreign reserves significantly.

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 E conomic maturity and slowdown

3 Denoting exports by X, imports by M, savings by S and investment by I, the current account is

expressed as X − M = S − I and this is an identity relationship. In words, the current account must
by definition be equal to the gap between a nation’s savings and investment. While the current
account is the sum of the merchandise trade balance, the services account (including cross-border
payments of wages and interest) and the transfer account (official grants and private remittances),
the difference between the current account and the trade balance was small and stable for Japan. For
this reason, the two concepts are used interchangeably in this chapter as in most practices.
4 In executing economic policies, the US government traditionally abhors an upward movement
of long-term dollar interest rates and a decline of the Wall Street stock index, both of which are
supposed to dampen investment and consumption and reduce economic growth. Lower economic
growth bodes ill for the next election. When such a risk is suspected, the US often softened or post-
poned its demands on the Japanese side.
5 In January 2017, President Trump re-intensified criticism against Japan and China as unfair surplus
countries with undervalued currencies. His criticism is far more extreme than before but his mindset
is fundamentally the same as traditional trade negotiators.

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13
T H E ASS ET BUBBLE AND
PR O L ONGED RECES SI ON
Post-bubble stagnation and the debate over reforms

Japan experienced an asset bubble in the late 1980s. After the bubble collapsed in 1990–91,
the Japanese economy was plunged into a long period of deflation and recession. Growth
became near zero and sometimes even negative. For the first time in the postwar period,
general price levels declined persistently. Economic statistics remained gloomy and, more
importantly, consumers and producers became pessimistic. Some said that Japan was still a
very high income country. Others said that sources of the next growth were being prepared
under the disguise of recession, and pointed to some companies that were doing very well.
But overall, it can hardly be denied that Japan’s economic performance in the 1990s and the
early years of the twenty-first century was less than hoped for.
The 1990s became Japan’s Lost Decade. Naturally, the main argument among Japanese
economists was why this recession persisted and what should be done to end it. More spe-
cifically, the key question was whether or not bold structural reforms and deregulation
measures, which were supposed to revive economic dynamism, should be undertaken at
a time when the overall economy was very weak. Some argued that painful reforms were
necessary precisely when we faced a recession. Others argued that structural reforms should
not be carried out under poor economic conditions. Instead, they argued that fiscal and
monetary stimuli should be mobilized for lifting the economy before such reforms were
attempted. The debate continued well into the twenty-first century with variations and added
aspects. The policy actually adopted was that of fiscal activism and aggressive monetary
injection into the macroeconomy with forced zero or negative interest rates, interlaced with
occasional and modest postures for fiscal consolidation.
The business situation picked up in some years thanks to strong demand in the United
States and/or China and a transitory yen depreciation, but growth impetus was never suf-
ficient to put the Japanese economy on a robust development path (see Figure 13.1). In
other years there were shocks originating abroad—the Asian financial crisis in 1997–98,
the IT bubble crash in 2001, the global financial crisis in 2007–8, which was particularly
severe and pulled Japanese growth well into the negative range, and the Euro economic
and political crises starting from 2011. Japan also faced internal problems including the
banking crisis culminating in 1997–98, the Kobe Earthquake in 1995, the Great East
Japan Earthquake and the Fukushima nuclear accident in 2011, and intermittent political
instability. While most other Asian economies, especially China, were growing strongly,

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 T he asset bubble and prolonged recession

Figure 13.1 GDP growth

Source: Cabinet Office.

Figure 13.2 Real income per head relative to the United States
Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre (2003);
updated to 2014 using International Monetary Fund, World Outlook Database.

Japan’s real income per capita steadily declined relative to its neighbors (see Figure 13.2),
and so did its economic and political clout in the region. Japan’s Lost Decade turned into
the Lost Quarter Century.

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 T he asset bubble and prolonged recession

The occurrence of the asset bubble

Japanese stock prices began to rise in the early 1980s and peaked in 1990 at more than
five times the 1980 level. Then, it started a long period of decline with medium-term
fluctuations (Figure 13.3). Japanese land prices also rose throughout the 1980s until they
more than doubled. The turning point for land prices came a year later, in 1991. Since
then, the land price index has continued to decline. Urban land prices rose more and fell
harder in comparison with rural land prices (Figure 13.4). There are two explanations of
why this asset bubble emerged.
The first was a structural one associated with bank deregulation. Previously, Japanese banks
were tightly regulated by the Ministry of Finance. There was little incentive to innovate, but

Figure 13.3 Nikkei 225 stock index average

Source: Bank of Japan Time-series Data Search.

Figure 13.4 Urban land price

Source: Japan Real Estate Institute.

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 T he asset bubble and prolonged recession

as long as banks followed official instructions, they were assured of adequate profit margins
and protection against bankruptcy. This rigid regime was removed in the early 1980s in an
effort to liberalize the Japanese financial sector under the pressure of globalization and a rising
stock of government bonds. As competition began, extra bank profits associated with pro-
tection vanished. At the same time, large corporate customers moved away from domestic
bank loans to other funding such as retained profits, corporate bond issuance and access to
international financial markets. As Japanese banks lost lucrative corporate customers, they
rushed to find new—untested and more risky—borrowers and projects such as small and
medium business loans and property investments, especially urban office buildings and rural
resort development. But they lacked the capacity to properly assess and monitor these borrow-
ers and projects. When the economy was booming in the late 1980s, they over-lent. Careless
business strategies and potential problems were concealed. When the bubble ended, loans that
banks had made became a huge mountain of bad debt (Yoshitomi, 1998).
The second cause was monetary; easy money in the late 1980s generated and sustained
the asset bubble. The yen appreciated sharply in 1985, which triggered the Bank of Japan
to lower short-term interest rates and increase money supply. This was the Bank of Japan’s
traditional policy response to a high yen which aimed at stimulating export and investment
to offset the negative impact of yen appreciation. Many later blamed then Bank of Japan
Governor Sumita Satoshi, who implemented this policy, for easing too much and for too
long. But because domestic price inflation was close to zero at that time, the Bank of Japan
could not find a good reason to tighten money and end the asset boom everyone was enjoy-
ing. There was a signaling problem—when asset prices rise but goods prices remain stable,
is monetary policy too generous or not? The data shows that the annual growth of broad
money (M2+CD) accelerated to more than 10 percent during 1987–89. In retrospect, this was
too high for an economy growing at about 4 percent. Succeeding Bank of Japan Governor
Mieno Yasushi, who assumed the office in December 1989, deliberately tightened money
and raised interest rates to end the bubble, and it did collapse quickly. Some criticized Mieno
for his brutality, but can an asset bubble go on forever? It had to end some time, and usually
the sooner the better.
These two explanations are not mutually exclusive. Bank deregulation explains why
reckless projects began to be financed and monetary expansion explains why the bubble
continued for so long. These were structural and macroeconomic reasons that complemented
each other to produce the rise and fall of the asset bubble.
During the rising phase of the bubble in the late 1980s, many queer phenomena were
observed. Those who owned land became very rich while those without land faced little
chance of buying their home, which increased the sense of inequality and social injustice.
Enriched people bought luxury goods and consumed lavishly, travelling all over the world
to snap up landmark towers and art objects in a situation similar to the narikin boom during
WW1 (Chapter 7). Students chartered a luxury cruiser to organize a graduation party in the
Bay of Tokyo. Discotheques became popular with the youth where girls displaying large
fans danced on the stage. Since vacant land was more valuable than built-up land, the yakuza
(Japanese mafia) was hired to illegally demolish buildings and forced owners to sell the land.
Sometimes the yakuza drove a truck into a house to destroy it.
Too many office towers were built in urban areas, which remained empty or unfinished
for many years to follow. A large number of amusement parks and resort hotels were also
developed. Among them, the only hugely successful one turned out to be Tokyo Disneyland
while others subsequently got into financial trouble. Some were transferred to new owners

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 T he asset bubble and prolonged recession

for restructuring, including Huis ten Bosch (Dutch theme park in Nagasaki), Phoenix Seagaia
Resort (seaside complex in Miyazaki), and Alpha Resort Tomamu (winter sports resort in
Hokkaido). Thanks to the building boom, a large number of male construction workers from
the Middle East, especially Iran, came to Japan. Some of them had work permits but oth-
ers did not. Every weekend they gathered in Ueno Park in Tokyo to enjoy themselves and
exchange information.
But after the bursting of the asset bubble, these phenomena all disappeared.

The Lost Decade

GDP statistics and other business indicators such as industrial production, machine order,
housing starts and wage and unemployment reveal that business conditions were not uni-
formly poor during the first decade following the end of the bubble. The Japanese economy
declined three times, in 1992–93 immediately after the bubble collapse, in 1997–98 follow-
ing the consumption tax hike1 and the banking crisis, and in 2001 amid the US and global
IT recession. However, economic performance in intervening periods was not so bad. There
were times when the Japanese economy appeared to improve. In 1996, Japan’s real growth
registered 3.5 percent which was the highest among the G7 countries. But each time the
recovery was short-lived. Not surprisingly, small businesses faced greater difficulties than
large enterprises in sales, corporate finance and other aspects. Banks no longer lent to SMEs.
The big question is, why did the Japanese economy remain so weak for so long after the
bubble burst? Economists debated but no consensus view emerged. One explanation was
purely cyclical. Since the bubble created large overcapacity, it would take time to reduce
the capital stock and inventory to normal levels. But a decade seems too long for such
stock adjustment. Another explanation was related to non-performing loans held by finan-
cial institutions. Because banks failed to get rid of bad debt, and because the government did
not introduce proper measures, financial intermediation was impaired which hurt the real
economy. This vicious circle continued until a bold action to clean up the banks’ balance
sheets was taken toward the end of the decade (see below).
Another popular explanation was that Japan’s economic system had become obsolete.
Japan’s long-term relational systems, such as lifetime employment, seniority wage, keiretsu
groups, sub-contracting, administrative guidance and so on, might have worked well during
the 1950s and 1960s, but they became ineffective in the age of rapid change and glo-
balization. Some argued that Japan must face a third major transformation (the first was
Meiji revolution and the second was post-WW2 reforms). But others cautioned that Japan
should not adopt the American system uncritically because many Japanese systems were
still useful—see Box 9.1. Yet another explanation pointed to the long-term changes in
Japanese society. The nation had a rapidly aging population and snowballing government
debt. People became uncertain about the future regarding income and jobs, the rising tax
burden and the sustainability of medical care and pension schemes. This pessimism slowed
down consumer spending and business investment.
Externally, the emergence of China as the factory of the world and other newly indus-
trializing economies, and the “hollowing-out” of Japanese manufacturing (the exodus of
factories and jobs to other countries), were cited as a great threat.
It is highly probable that Japan’s long stagnation was the combined result of all these
problems in mutual interaction even though the exact weight of each is difficult to determine.
But if one ultimate cause behind these problems is to be named, that must be the lack of

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political will and leadership. Japan did not have a prominent leader who could identify key
national issues, explain the situation to the people in honest and persuasive language, design
and implement long-term solutions, and assume full responsibility for this. Japan’s prob-
lems listed above are not particularly colossal or intractable in comparison with problems
faced by other countries. The uncertainty and anxiety permeating in Japanese society must
be explained by the low quality of leadership rather than the size of the problems. Japanese
people just did not believe that their leaders had the courage and capacity to cope with these
“normal” problems. This was the situation prevailing in the first Lost Decade. Unfortunately,
the political and economic landscape did not improve significantly in the following decades.

Financial crisis and monetary policy

In the post-bubble period, Japan’s monetary authorities faced two challenges. The first was
coping with non-performing loans, which took as long as a decade to clean up. The second
was reviving the macroeconomy, which remains unfulfilled even to this date.
In the early 1990s after the asset bubble collapsed, Japanese financial institutions that
previously lent recklessly to SMEs and property development projects got into trouble. The
declining land and stock prices seriously hurt the balance sheets of commercial banks and
jusen (nonbank institutions specializing in real estate loans). Japanese financial institutions
often required land as loan collateral and engaged in mutual stock holding, but the values
of both assets plummeted. Bad debt further rose as the recession continued and corporate
bankruptcies increased. As non-performing loans accumulated, many Japanese banks faced
difficulty in observing the Bank for International Settlement (BIS) capital adequacy require-
ment, which said that a bank’s capital must be at least 8 percent of its risk assets, properly
weighted, if it was to engage in international business. If this ratio fell below 4 percent, the
bank was not allowed to conduct even domestic business and had to close.
In 1995 and 1996, the mounting bad debt at jusen became a political problem. But this was
only the beginning. Toward the end of 1997, the fear of commercial bank defaults was wide-
spread. When Yamaichi Securities and Hokkaido Takushoku Bank went bankrupt, the fear
turned into reality. In the following year, the Long-Term Credit Bank and the Securities and
Credit Bank also fell. For survival, remaining banks scrambled to improve their BIS ratios by
reducing risky assets. This was done by lending less, especially to SMEs. This led to a credit
crunch in the real economy, causing more bankruptcies and further worsening the quality of bank
assets. This vicious circle continued from late 1997 to early 1998. Japanese banks were consid-
ered untrustworthy, and the “Japan premium,” an additional charge to Japanese banks when they
borrow internationally, surged. People wondered which bank would fail next. Worried savers
shifted their deposits from seemingly risky banks to bigger and safer ones and postal savings.
In response to the 1997–98 banking crisis, the government created the Financial
Supervisory Agency in October 1998 and the Financial Restructuring Commission in
December 1998. They were merged to become the Financial Services Agency in 2000. The
government also prepared “public money” up to 60 trillion yen (12 percent of GDP) to deal
with the bad debt problem, recapitalize banks and manage the closure of weak banks. As a
result of financial deregulation and crisis, Japanese banks also began to merge. In the 1970s
and 1980s under the old regulated regime, the number of commercial banks was very stable
at eighty-six, among which twenty were relatively large. They began an active merging
process in 1999 that ultimately produced three Mega Banks—Mitsubishi UFJ, Mizuho and
Sumitomo Mitsui—by 2006.

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 T he asset bubble and prolonged recession

The Bank of Japan responded to the 1997–98 banking crisis by providing ample liquidity.
Subsequently, it adopted a “zero interest rate policy” in April 1999 in an effort to revive
the overall economy. This meant that the short-term interbank rate (the call rate), which
the Bank of Japan directly controlled, was lowered to zero except for a very small technical
margin. The Bank of Japan tried to end this abnormal policy in August 2000, but as the
economy further worsened it was forced to return to zero interest. The official discount rate
was also reduced to a very low level, from 6 percent in 1990 to 1.75 percent in 1993, and
to 0.10 percent in 2001. The financial panic subsided in early 1998, but general recession
persisted into the 2000s.
Even with the zero interest rate policy in place, pressure on the monetary authorities to
do more to stimulate the economy did not let up. Some argued for a more drastic increase
of money supply by any means. To do so, the Bank of Japan was advised to purchase
more risky assets including bank and corporate bonds, foreign bonds and mortgage bonds.
Traditionally, it bought and sold only government bonds for safety reasons. Another group
of economists proposed inflation targeting. According to them, the Bank of Japan should
announce a positive inflation rate for the next two to three years and be responsible for it.
This was considered necessary to change people’s expectations about future inflation. Paul
Krugman (Princeton University), Alan Meltzer (Carnegie-Mellon University), Ito Takatoshi
(Tokyo University) and Itoh Motoshige (Tokyo University) supported this idea. But others,
including Bank of Japan economists Okina Kunio and Ueda Kazuo, were skeptical. They
argued that, even if the Bank of Japan tried, there would be little impact on expectations
because the monetary transmission mechanism was broken. Worse, if people’s expectations
suddenly shifted for whatever reason, after too much liquidity was injected, the resulting
inflation would become uncontrollable.
Anomaly in Japan’s monetary transmission mechanism deserves special attention.
Normally, the central bank controls monetary base (deposits by commercial banks at the
central bank, plus cash) which influences money supply and commercial bank lending, the
two important intermediate targets for macroeconomic management. This in turn impacts on
production and investment. This is the monetary transmission mechanism by which a central
bank stimulates or restrains overall economic activity. However, the relationship between
monetary base on the one hand and money supply and commercial bank lending on the other
became unstable in post-bubble Japan. As Figure 13.5 shows, these variables moved more or
less in tandem in the 1980s. But a disconnect emerged after the bubble collapse in 1990–91.
Monetary base was pushed up by the Bank of Japan gradually but in increasingly large doses.
But even a massive injection of monetary base did not lead to any visible increase in money
supply, and commercial bank lending remained flat or even declined. When interests were
zero or negative, there was no penalty (foregone interests) for holding dead cash so banks did
just that. Excess deposits by commercial banks at the central bank ballooned without turn-
ing into business loans or investment. Japan’s monetary transmission mechanism is broken.
Unless this is fixed, pumping more money into the financial system will add little impetus
for growth.
Another issue related to monetary policy was a call for yen depreciation. Some insisted that
aggressive monetary expansion coupled with an official statement to welcome a weak yen
would depreciate the yen, improving Japan’s international competitiveness and stimulating
export and domestic business. The government and the Bank of Japan sometimes appeared
to endorse this strategy, and the yen actually depreciated moderately when such policy inten-
tion was announced. But currency depreciation is a controversial beggar-thy-neighbor policy

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 T he asset bubble and prolonged recession

in which Japan gains at the cost of other countries. If the United States, China or any other
large trading partner opposes the yen’s weakening, this policy will have to end. Moreover,
exchange rate adjustment is unable to solve the long-term structural problem of any country,
and often diverts attention from the real cause of economic weaknesses (Chapter 12).
For a long time, the Bank of Japan intermittently intervened in the foreign exchange
market to curb yen appreciation when it was deemed excessive. Since 2011, however, it

Figure 13.5 Monetary base, money and bank lending

Source: Bank of Japan Time-series Data Search.

Figure 13.6 International reserves

Sources: Bank of Japan Time-series Data Search, and State Administration of Foreign Exchange, China.

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 T he asset bubble and prolonged recession

has refrained from pushing up the dollar to keep the yen cheap in the currency market. This
policy shift is reflected in Japan’s international reserves which peaked at $1.296 trillion in
2011 and have fallen slowly since then. China dramatically overtook Japan as the largest
collector of international reserves in the world in 2006 and continued to accumulate up to
$3.843 trillion by 2014. But even China stopped purchasing dollars and began to sell them
in the foreign exchange market in order to counter the recent declining pressure on RMB
(Figure 13.6).

Unstoppable fiscal activism

Fiscal policy has been expansionary since the 1990s, although some say that it has not been
expansionary enough relative to what they think is adequate. At the end of fiscal year 2015
(March 2016), outstanding government debt stood at 1,066 trillion yen amounting to twice
GDP (Figure 13.7). This is the highest ratio among major industrial countries2 although it
stabilized, temporarily, in recent years thanks to relatively strong tax receipts. Budget deficit
is bound to grow in the long run even with effort in spending cuts because fiscal expenditure
is dominated by two mandatory and constantly increasing components, namely, servicing
of past debts and social security payments, which respectively occupied 24.4 percent and
33.1 percent of total expenditure in fiscal year 2016. It is uncertain whether this public debt
explosion can be slowed down and reversed in the future. Moreover, the above figure does
not include short-term debt or contingency liabilities (amounts that are unknown at present
but must be paid in the future for rescuing the bankrupted social security system, cleaning up
the nuclear disaster, coping with natural calamities, etc.) International rating companies have
downgraded Japanese government bonds in recent years.

Figure 13.7 Government debt as percent of GDP

Sources: Ministry of Finance, and Cabinet Office.

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The government is often torn between the need for fiscal consolidation and the wish for
more macroeconomic stimuli. But most of the time, fiscal policy tended toward expansion
because weak business situation at hand is politically more critical (for the next election) than
restoring a sound budget in the distant future. There has always been a strong political pres-
sure for additional fiscal stimuli to avoid a “deflationary spiral” (price deflation and output
recession enforcing each other). Many contended that no reform was possible unless and until
the economy improved. Others were comforted that Japanese government bonds were debt
owed mostly to Japanese people, which was less worrisome than debt owed to foreigners.
But the effectiveness of fiscal policy under such circumstances is an open question.
Opponents of fiscal activism countered that Japan had already tried fiscal stimuli many
times since the early 1990s, but the economy had failed to recover strongly. They argued
that old-fashioned fiscal spending driven by local politics and lobbyists that built expensive
but underused highways, bridges, airports and Shinkansen (fast trains) would only benefit
construction companies while national debt snowballed. Did Japan really need three giant
bridges to span the Inland Sea? Did Kansai Region need three airports next to each other?
Further fiscal stimuli, which would add to the already huge government debt, might actually
lower growth due to greater pessimism over fiscal vulnerability and unsoundness. The current
political system in which votes are secured by channeling fiscal spending to rural supporters
should be ended, it is said.
There were attempts to cope with the fiscal time bomb. The Koizumi government
(2001–6, Liberal Democratic Party) set limits on infrastructure and social welfare spending
but succeeded in slowing down the speed of debt accumulation only for one year, in 2003.
From 2009 to 2012, three consecutive governments of the Democratic Party of Japan cut
“unnecessary” public projects randomly and arbitrarily but did not touch the social welfare
spending which was the largest and most rigid part of public expenditure. The second and
third governments of Abe Shinzo (2012–, Liberal Democratic Party) returned to monetary
and fiscal activism (see below).
In 2012, the parliament passed a plan to raise the general consumption tax in steps but
it was only partially implemented. The tax was raised from 5 to 8 percent in 2014 but the
subsequent increase from 8 to 10 percent was put on hold (until 2019) due to weak business
conditions. Welfare “reforms” are under way to increase people’s payments and decrease
their receipts, but it is questionable whether this is really a solution or mere acceptance of the
worsening social welfare balance sheets. In 2014–15, business profits and corporate income
tax receipt both rose thanks to the “success” of Abenomics, which slightly reduced the need
to issue new government bonds. But this improvement may be temporary.
It is unclear what Japan’s gigantic fiscal debt will bring in the future. The debate between
fiscal activists and sound budget campaigners goes on. Innovative ideas, such as issuance of
unredeemable public bonds or the Fiscal Theory of Price Level (don’t worry about budget deficit,
inflation will solve it later), are occasionally floated but their relevance to reality is in question.
Joseph Dodge, who imposed a super-balanced budget on occupied Japan in 1949, or traditional
IMF conditionality, would surely require Japan to tighten its budgetary belt despite short-term
pain and protests. But Japan is not under US occupation or IMF financial rescue. Alternatively,
hyperinflation or unilateral debt cancellation would instantly solve the problem, even at great
costs to certain people, but such sweeping measures are difficult to propose, let alone adopt, in
peace time. Meanwhile, domestic politics does not seem to generate any policy option to pay
short-term cost first to achieve long-term gain later. Perhaps that is the crux of the problem.

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Earthquakes
Japan, sitting on where four tectonic plates meet and shove each other on the earth’s crust,
is continuously hit by large and small earthquakes. In the last few decades two large quakes
caused particularly serious human and physical damage.
On January 17, 1995, an active fault under the port city of Kobe moved to destroy urban
dwellings and structures resulting in 6,437 fatalities, which were mostly due to collapsing
houses. The physical damage of this earthquake was estimated at 9.9 trillion yen or 2.0 percent
of GDP, and the recovery budget amounted to 3 trillion yen or 0.6 percent of GDP. As the
damage was too big to be coped with by official hands alone, popular movement emerged to
help natural disaster victims through NGOs and volunteering.
On March 11, 2011, a much greater, deeper and widely impacting earthquake occurred
off the eastern coast of Japan, generating tsunami and killing 18,446 people due mainly to
drowning. The estimated stock damage of this earthquake was 16.9 trillion yen or 3.6 percent
of GDP, and the recovery budget for the first five years was 19 to 23 trillion yen or 4.0–4.9
percent of GDP. This did not include the costs related to the Fukushima nuclear accident.
The handling of this earthquake by the Kan government (Democratic Party of Japan), includ-
ing formulation of the reconstruction plan, response to the radiation problem, power shortage
and future energy policy, was severely criticized as inept and haphazard.
The human and physical damage of these earthquakes was immense. In terms of eco-
nomic growth, however, the impact of an earthquake is usually hard to detect from annual
statistics. This is because the negative effect of lost production capacity is offset by the posi-
tive effect of increased private and public investment for recovery and reconstruction. Gross
National Happiness certainly fell, but Gross Domestic Product did not show any visible
sign of decline. In the case of the Great East Japan Earthquake, production fell temporarily
and slightly in 2011 due to supply chain disruption and depressed national psychology, but
recovered soon as vigorous reconstruction investments started. This even caused serious
shortage of construction workers and materials. Global recession, yen appreciation and slow-
down of Chinese or US economies will have much greater impacts on Japanese growth than
natural catastrophes.

Aging, labor shortage and widening gaps

Japanese society is rapidly aging because old people live longer and young people are not
eager to marry or have babies. Such trends are also visible in other countries, but Japan is
the global leader in koreika (aging) and shoshika (producing fewer children). The Japanese
population peaked around 2008 at 127 million, then began to decline gradually. Depopulation
is expected to continue well into the future. The share of working-age population (aged 16 to
64) started to decline much earlier, peaking at 70 percent around 1995, then falling to about
60 percent at present. This means fewer workers must support more retired people through
higher tax burden and social security contributions. A shrinking and aging population also
means lackluster domestic demand, reduced saving, low growth and skyrocketing medical
and pension bills. Japanese society, once based on communal spirit and intra-family care for
the young and the old, no longer functions that way.
A related problem is kasoka, or accelerated decline and aging of population in rural
areas to the extent that basic transport, medical and commercial services are no longer
rendered. The problem of disappearing communities permeates in virtually all cities, towns

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and villages in rural Japan. This is caused by migration of young people to large cities for
education and job opportunities, in addition to gradual passing away of remaining sen-
ior citizens. Revitalizing rural communities has become one of the top priorities of any
Japanese administration.
Labor shortage has become apparent in recent years. The unemployment rate has steadily
fallen from 5.1 percent in 2009 to 3.1 percent in 2016. Many businesses, especially small
ones, find it difficult to recruit enough workers. Labor shortage is widespread in all sectors,
and especially acute in such service industries as construction, transportation, food cater-
ing, elderly care and childcare. Scarcity of construction workers is aggravated by strong
reconstruction demand in the aftermath of the Great East Japan Earthquake in 2011 and con-
struction toward the Tokyo Olympics in 2020. Japan has traditionally accepted only a small
number of foreign workers except those with highly professional skills or Japanese ethnic
origin. This was largely because of the fear that a rapid increase in foreign workers may lead
to social friction and problems such as crime and failure to integrate with Japanese society.
However, the immigration policy now has to be reconsidered because labor shortage is a
structural problem that is not likely to go away soon, and Japan must therefore rely heavily
on foreign workers in the future.
Another serious problem is emerging social gaps. Japan in the 1960s attained high
growth and income equalization simultaneously until most people felt that they belonged
to the middle class (Chapter 11). After the bursting of the bubble, this happy memory
was replaced by a sad combination of little growth and perceived inequality. Surveys con-
ducted every three years by the Ministry of Health, Labor and Welfare show that income
before tax and subsidies is rapidly becoming unequal, although there is no evidence of
widening income gaps after income redistribution through tax and social welfare systems is
taken into account. For income after redistribution, the Gini coefficient, which ranges from
zero (perfect equality) to one (perfect inequality), declined slightly from 0.3812 in 2002 to
0.3759 in 2014. The Ministry interprets this as evidence of effective redistribution policies.3
Despite this, poverty is on the rise even after income redistribution. Japan’s poverty ratio
(relative definition counting the number of people below 50 percent of median income)
increased during the last three decades from 12.0 percent in 1984 to 16.1 percent in 2014,
which is second highest among advanced countries after the United States. Popular perception
is that Japan is rapidly becoming an unequal society. In recent surveys, about 70 to 80 percent
of respondents concur with this assessment.4 In their view, this fact is most visible in wage
gaps, followed by distinction between regular and non-regular workers (next paragraph), dif-
ferentiated job opportunities, increase in low-income families and social service gaps between
urban and rural areas. In Japan, inequality is associated mainly with increasing poverty rather
than the existence of a very few extremely rich people (Tachibanaki, 2016).
Inequality in work places is most apparent in unequal treatment between regular workers
who enjoy permanent status and non-regular workers such as part-timers and workers with
short-term contracts. The ratio of non-regular workers has risen rapidly from about 20 per-
cent in 1990 to 40 percent in 2014. The prolonged recession increased management’s desire
to cut labor cost and have an option to reduce workforce at times of slow business, as well
as workers’ reluctant acceptance of such inferior positions. Even if their job description is
the same, non-regular workers receive lower wages, to the tune of only 63 percent of the
wages of regular workers (Ministry of Health, Labor and Welfare survey, 2014), little or no
benefits and promotion prospects, and job insecurity. Female workers and youths account
for the bulk of non-regular workforce, who tend to be trapped in the second-rate status with

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little prospect of moving up to regular positions. This generates long-term problems such as
the inability to marry for financial reasons, less production of children, low lifetime saving,
continued poverty into old age and the next generation, and extreme hardship for single,
divorced or widowed mothers. Even seemingly protected regular workers are forced to work
hard to keep their position under strong cost-cutting pressure. Unpaid overwork is a common
practice, often leading to job-caused illness and suicide.
In response, the Japanese government is promoting equality between regular and
non-regular workers, urging wage increases and fewer working hours to company manage-
ment, helping female labor to take up more jobs and high positions and, through all these,
achieving a better work–life balance for Japanese workers.

Abenomics
After the relatively strong government of Koizumi Junichiro (2001–6), a series of
weak and short-lived governments ensued, three by the long-ruling Liberal Democratic
Party (LDP—Abe, Fukuda and Aso) and three by the Democratic Party of Japan
(DPJ—Hatoyama, Kan and Noda). Japan had six prime ministers in just as many years. In
2009, people voted for untested DPJ to replace unimpressive LDP leaders by fresher faces,
but new governments proved even worse than traditional ones. A hoped-for two-party
regime in which LDP and DPJ would compete for power was not realized. Disappointed,
in 2012, people voted back an LDP government led by Abe Shinzo, who held the top office
earlier but had to resign due to illness. Fully recovered, Abe emerged as a vigorous and
very powerful prime minister in his second and third term, introducing many initiatives
and visiting a large number of countries. His energetic way, in stark contrast with incapac-
itated opposition parties, won the hearts of Japanese people even though they did not fully
agree with many of his agendas. Abe was a conservative politician interested in boosting
national pride, active engagement in regional security, opposing Chinese military advances
and pursuing Japanese business interests at home and abroad. He began to yield strong
and unilateral power over his party and central government in place of the collective and
bottom-up decision making of the past. As of 2017, LDP, in coalition with Komeito Party,
has absolute majority in both Houses,5 which allows it to pass any law it pleases subject to
time, popular sentiment and the absence of serious political scandals.
Abenomics was the most prominent economic initiative of his government. As soon as
Abe came to power for the second time in December 2012, he launched the initiative for the
purpose of ending deflation and reviving growth. Although Abenomics contained nothing
really new, it was presented far more effectively than any other previous economic package.
It consisted of three “Arrows”—aggressive monetary policy in “different dimension,” flexi-
ble (i.e., active) fiscal policy and new growth strategy. In March 2013, Abe appointed Kuroda
Haruhiko as Bank of Japan Governor who immediately began to execute the Monetary Arrow
of Abenomics. Kuroda declared an inflation target of 2 percent, to be attained in two years,
and promised to double monetary base and the central bank’s government bond holding, also
in two years. With this monetary expansion, the extremely high yen was also to be corrected.
For the Fiscal Arrow of Abenomics, investment in infrastructure was increased under the
slogan of revive economy first, consolidate budget later. To implement the Growth Arrow,
the Japanese Economy Revitalization Headquarters and the Industrial Competitiveness
Conference were established, and the Cabinet approved the Japan Revitalization Strategy

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featuring three Roadmaps and three Plans in June 2013. From then on, it became customary
to add, adjust or otherwise revise the Growth Arrow of Abenomics annually around June.
Abenomics was enormously successful in its first several months in uplifting national
psychology, pushing up the stock market and depreciating the yen. These collectively
improved business sentiment and conditions. Corporate profits rose, tax revenue increased
and unemployment started to fall. Abe naturally took full credit for these improvements.
The Monetary Arrow of Abenomics was particularly praised by such foreign and domestic
economists as Joseph Stiglitz, Paul Krugman, IMF Managing Director Christine Lagarde,
US Fed Chairman Ben Bernanke, Takenaka Heizo, Hamada Koichi and Ito Takatoshi.
However, there were also skeptics such as George Soros, Okina Kunio, Ueda Kazuo and
Kono Ryutaro who pointed to future risks and uncertainties associated with such a bold
monetary move as well as the problem of the broken monetary transmission mechanism
(as mentioned previously).
One problem associated with inflation targeting was that the Bank of Japan was only a
small part of factors that determined the inflation rate. Actual inflation rose somewhat, then
fell back to the zero-to-negative range, missing the 2 percent target by a wide margin. The
Bank of Japan extended the deadline beyond the second year, shifted to negative (rather
than zero) interest rate policy, introduced a policy rule centered on long-term interest rates,
then finally admitted that 2-percent inflation might be unrealistic for some time to come.
Unmoving prices were blamed on the declining global oil price (which was actually good
for the Japanese economy), the negative impact of (modest) consumption tax increase and
uncertainty surrounding the growth potential of emerging economies.
Yet, most criticism of Abenomics was directed to the Growth Arrow. Macroeconomic
policy is not an end in itself but a means to prepare a congenial environment for strong
and sustained economic growth. The growth policy therefore should take center stage, but
the Growth Arrow of Abenomics was ambiguous, spread-out and continuously shifting.
The original version announced in June 2013 had three Roadmaps and three Plans, which
branched out to twelve pillars, thirty-seven items and fifty-six sub-items. They were revised
and expanded annually. Proposed actions were not unreasonable but too general and too
many without prioritization or implementation details. Many coincided with initiatives fre-
quently adopted by past governments. It may even be said that the Growth Arrow was just
a long and evolving wish list whose execution depended on concrete projects of individual
ministries that might or might not be proposed or approved. Line ministries rushed to come
up with projects that were likely to be approved under the Growth Arrow, carrying such key
words as women, childcare, rural area revitalization, foreign trainees, inbound tourism, over-
seas expansion of SMEs and so forth. However, these projects were not properly integrated
or structured for achieving concrete targets. After several years of adjusting the Growth
Arrow, the initial appeal of Abenomics as a Japan revival plan seems to have been lost.
The book comes to a close here, under this somewhat pessimistic tone, leaving the eco-
nomic development of Japan as an unending story. After traveling a few centuries since the
Edo period, with many twists and turns as well as successes and failures, Japan has reached
a stage where obsession with material wealth—catching up with the West or competing with
China—is no longer desirable or feasible. Yet mature Japan has many spiritual, communal
and other non-material values that are unique but were mostly pushed aside in the race to
high technology and income. Whether they can be reactivated to produce a new society is
yet to be seen.

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Box 13.1 The future of manufacturing SMEs

Small and medium enterprises (SMEs) in the manufacturing sector have been a great
value creator in post-WW2 industrialization. While Japan’s big-name car, electron-
ics and machinery makers are globally well known, they heavily rely on the supply
of materials and components produced by manufacturing SMEs. Such materials and
components require precision, zero defects and on-time delivery, and contribute far
more to the product value than final assembly. Japan has many industrial areas where
manufacturing SMEs congregate such as Ota Ward of Tokyo, Nagoya and its surround-
ing areas in Aichi Prefecture, Higashi Osaka, Sakai, Kobe, Amagasaki, Kitakyushu,
Suwa and Okaya, Ota and Isezaki, and so on. Some component manufacturers operate
independently but many are organized as regular suppliers in a pyramidal keiretsu
relationship led by a large parent company.
However, small manufacturers have been in trouble since the bursting of the asset
bubble. From around 1990 to most recent observation (2012–13), manufacturing
SMEs in Japan shrunk 44 percent in number of establishments, 36 percent in employ-
ment and 23 percent in output. Difference in these numbers implies that the average
size of firms rose as smallest ones were eliminated or merged. This is a nationwide
phenomenon replicated in virtually all industrial areas mentioned above. Multiple rea-
sons are cited for this, including the prolonged post-bubble recession, severe pressure
for cost reduction, exodus of large customer companies abroad, recurrent yen appre-
ciation, aging and declining population, high corporate income tax, competition with
emerging economies, labor shortage, global economic crises, and so on. Among these,
the particularly unique problems facing Japanese manufacturing SMEs are declining
orders in the domestic market and the lack of young workers who join and take over
the factory. Many SMEs have closed because retiring owners could not find anyone to
inherit the business.
For distressed SMEs, one way to survive and even to prosper is to go abroad. This
is certainly not the first time Japanese manufacturers have gone abroad, but the pre-
vious waves of overseas investments were carried out mostly by globally well-known
giants or their subsidiaries that were encouraged or forced to go with them. Most
SMEs remaining in Japan then were passive producers receiving orders and blueprints
from large customers and producing and delivering products promptly and in perfect
quality. They had high skills and technology but little capacity for making dynamic
strategies such as proposing and designing new products, seizing new customers and
markets, finding international partners, recruiting foreign managers and engineers,
utilizing IT and social networking services, registering and protecting intellectual
properties, etc. SME owners spoke only Japanese and seldom travelled abroad. But
after the global financial crisis of 2008 (which Japanese call the “Lehman Shock”),
even such machikoba (small local factories) had to consider going abroad because
orders for their products suddenly vanished. Even so, they had no knowledge or expe-
rience to succeed in unknown foreign markets. This situation was very different from
manufacturing SMEs in Germany (“Hidden Champions”), China or Taiwan which
were equipped with full corporate functions to forge ahead in global markets.
Traditionally, the Japanese government had been hesitant to promote overseas
investment of manufacturing SMEs for fear of “hollowing out” of the Japanese

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industrial base. But seeing the enormous size and irreversibility of the Lehman
Shock, it switched to actively supporting such investment. In 2010, the Minister
of Economy, Trade and Industry began to host the Conference for Supporting
Overseas Business Expansion of SMEs, which compiled and revised a policy
guideline in 2011 and 2012, respectively. For the first time, the Japan International
Cooperation Agency (responsible for development aid) and the Japan External
Trade Organization (in charge of trade promotion) were also tasked with assisting
Japanese manufacturing SMEs to venture abroad. Not only the central govern-
ment but local governments, business organizations and NPOs were also mobilized
to execute this policy. It soon became a major pillar in Japan’s SME assistance
package. Information dissemination, business consultation, matching with foreign
partners and suppliers, business support abroad and negotiating and creating busi-
ness ties with foreign provinces and cities are among the standard measures. Some
institutions provide “hands-on” support, or customized and intensive support to
overcome initial difficulties for a small number of carefully selected SMEs.
Not all manufacturing SMEs in distress are advised to go abroad. Even with official
assistance, international business is a huge challenge for firms with little experience.
Prior screening is necessary to pick eligible firms from those that are better off home or
those that are truly hopeless. The most important criterion is whether the company boss
has a strong will and a reasonable initial plan to start the process. When proper selection
is made, there is a good chance that machikoba will grow into a larger and more dynamic
enterprise in an entirely new environment. This means that Japanese manufacturing
will prosper and develop in different soils and cultures. From the viewpoint of devel-
oping countries, arrival of high-precision Japanese SMEs is very welcome for learning
skills and technology, offering gainful employment to youths and overcoming middle
income traps. Vietnam and Thailand are the most popular destinations for Japanese man-
ufacturing SMEs, and Indonesia is additionally popular among Japanese SMEs in the
automotive sector. On the receiving side, domestic firms in these countries often crave
partnering with Japanese SMEs that will help them with technology and marketing.
Let us look at a few actual cases. Firm A, a precision metalworking factory in Higashi
Osaka, hired several gino jisshusei (technical intern trainees who stay in Japan for up to
three years) from Vietnam starting in 2004. They were diligent and excellent workers.
Soon they were hired as full timers. In 2014, the firm decided to build a branch factory
in Ho Chi Minh City by dispatching its Vietnamese staff to their fatherland.
Firm B, a hand tool maker in Tokyo, invested in Vietnam in 1997 while also assist-
ing other Japanese SMEs to come to Vietnam by offering business services and rental
factory space. It expanded its own Vietnamese factory in 2008 and built a new rental
factory complex nearby in 2014. A naturalized and highly experienced Vietnamese
engineer was recruited from Gunma Prefecture to implement these expansions.
Firm C, a metal parts manufacturer in Nagoya, shares its unused factory space in
Bangkok, Thailand with other manufacturing SMEs from Nagoya. It provides multi-
ple and flexible support to Japanese SMEs coming to Bangkok, for example, through
trading services, matching with local Thai suppliers and a branch office in Nagoya.
In all of these cases, human and inter-firm networking and government support
programs contributed, with different intensity and effectiveness, to minimize initial
investment cost and risks of overseas investment by Japanese manufacturing SMEs.

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Notes
1 In April 1997, the Hashimoto Cabinet, backed by the Ministry of Finance’s desire to restore fiscal
soundness, raised the general consumption tax from 3 to 5 percent. The economy weakened imme-
diately and the tax hike was blamed. However, it is strange that such a small tax increase had such a
huge economic impact.
2 In 2015, the ratio of general government (central and local governments) gross debt to GDP of
Japan was 248 percent, which was highest in the world (IMF World Economic Outlook Database,
October 2016). The other countries whose public debt stock was greater than GDP were Greece
(177 percent), Italy (133 percent), Portugal (129 percent), Cyprus (109 percent), Belgium
(106 percent), United States (104 percent) and Singapore (103 percent).
3 The Ministry of Health, Labor and Welfare’s data show that, before redistribution, the Gini coef-
ficient rose significantly from 0.4983 (2002) to 0.5263 (2005), 0.5318 (2008), 0.5536 (2011) and
0.5704 (2014). But after redistribution, it was quite stable at 0.3812 (2002), 0.3873 (2005), 0.3758
(2008), 0.3791 (2011) and 0.3759 (2014).
4 In the survey conducted by the Yomiuri Newspaper in March 2007, for example, 81 percent felt that
gaps were widening while 3 percent did not think so. Don’t Knows and no response accounted for
the remaining 16 percent.
5 As of this writing (April 2017), LDP holds 61.9 percent and Komeito holds 7.4 percent of 475 seats
in the House of Representatives, and LDP has 47.1 percent and Komeito has 8.3 percent of 242
seats in the House of Councilors. The term of the House of Representatives is four years, with the
last election taking place in December 2014. The term of the House of Councilors is six years with
half elected every three years, with the last batch elected in July 2016.

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Q UE ST IONS AND ANS W ERS

Below are some of the questions raised by students in my class over the years, followed by
my answers. Some questions were quite difficult to answer and compelled me to do addi-
tional research. I am not entirely confident whether all my answers can stand the scrutiny of
the latest academic research. I list them nonetheless because questions raised by foreign stu-
dents often throw new light on old questions that are too familiar to the Japanese. Many are
on the Edo and Meiji period, partly because my students actually asked many questions about
these early periods, and partly because of my uneven recording. It should also be noted that
many of the class discussions have already been incorporated in the main text of this edition.

1 When did Japan feel it had finally caught up with the West?
It happened two times—around the 1910s, and around 1970.
The first time was when Japan felt that it finally joined the group of “First Class”
nations. It won an (unexpected) victory against the Russian Empire in 1905, and
the industrial revolution in light manufacturing was also completed, overtaking
the British textile industry in the global market. Japan had also acquired two main
colonies of Taiwan (1895) and Korea (1910) and secured certain territorial and eco-
nomic interests in Northeast China. Renegotiations of unequal commercial treaties
with the West had been made in steps until they were all corrected in 1911. The
national goals of the Meiji period, to become a strong Westernized nation diplomat-
ically, economically and militarily, were more or less realized. After WW1, Japan
was regularly invited to major international conferences as one of the “Big Five”
nations along with the United States, the United Kingdom, France and Italy.
The second time was when Japan grew very fast for a quarter century from the
devastation of war defeat and largely caught up with the United States and Western
European nations in per capita income. By around 1970, modern infrastructure
such as the Tokyo Tower, highways and fast trains had been built, the Olympic
Games were held in Tokyo in 1964, the first time ever in Asia, and such modern
industries as steel, automobile and electronics had attained—or were attaining—
global competitiveness.

2 Has Japan ever been a socialist economy?

Japan has never been a socialist economy in the ownership sense. That is to say, in
all periods, production was undertaken mostly by individuals, families or private

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firms. The government did not organize farmers and workers into collective units
in any significant way. Even during the wartime of 1937–45, the government chose
to control and direct private companies toward the war effort without nationalizing
them.
But in the sense of economic management, the above-mentioned wartime was
a period of rigid planning based on physical inputs and outputs. The period of
recovery from the war damage in 1945–49 was also characterized by continued
official planning and directives, although black markets emerged and prospered
at the same time. Japan was a planned economy from 1937 to 1949 although
ownership remained private. This clearly shows separability of ownership and the
allocative mechanism.
During the high growth era of the 1950s and 1960s, the Japanese government
was guiding the private sector in a milder form, which was neither free market nor
socialist planning.

3 In world history, kings and emperors usually did not last very long.
Political upheavals could easily end their rule, bringing in another
dynasty or empire. Why has Japan’s imperial family lasted so long?
According to the oldest official record of Japanese history (Kojiki, or Ancient
Chronicle, 712), Japanese islands were created and inhabited by a group of gods
who descended from heaven, and their progeny became the imperial family. The
Meiji government determined that transformation from god to human in the impe-
rial family occurred on February 11, 660 bc, when Jimmu, the first human emperor,
assumed power. In 1940, the war government celebrated the 2,600th anniversary
of this event. Apart from the legend, however, we do not know the exact date or
circumstances of the rise of the imperial family, whose consolidation of power
occurred in the seventh century ad.
During the war years in the late 1930s and up to 1945, schools taught that the
Japanese imperial family was an unbroken divine lineage from time immemorial.
This bestowed superiority on the Japanese people who were ruled by such an aus-
picious family. But even counting from the seventh century, it must be admitted
that continuation of the same ruling family for more than thirteen centuries is very
unique in world history. Some argue that the imperial family is not really of one lin-
eage because of the family feud in the fourteenth century, but we are mainly inter-
ested in its political, not genetic, continuity. The emperor had real political power in
the eighth century, but his power declined quickly in the subsequent centuries. Why
was the Japanese monarchy never abolished by warlords or shogun?
The first samurai leader who came to national power was appointed by the
emperor in 1192 with the official title of Seii Tashogun (Great General Who
Conquers Foreign Enemies). This approval procedure was a political conveni-
ence, but it was followed by all subsequent top samurai leaders with the same
honorary title. For a new military leader who was challenged by his compet-
itors and needed legitimization of his rule, the use of imperial authority was
extremely useful. For him, there was no need to topple the emperor who resided
in Kyoto, composed poems, performed rituals and was militarily impotent. Once

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the tradition began in which a new political leader had to be formally appointed
to Seii Taishogun by the emperor, it became firmly entrenched. The political
cost of ousting the emperor was far greater than the cost of operating under his
nominal authority. The Meiji government also resorted to this political practice
when it wanted to consolidate power.
Another important factor is that Japan was never invaded or occupied by for-
eigners except by the Americans during 1945–52. This means that no external force
had the chance to wipe out the imperial family. Although the Americans first con-
sidered the possibility of judging and executing the emperor as a war criminal, they
decided not to, being afraid of nationwide riots that such action might trigger. The
same political consideration was at play.

4 What was the system of land ownership in the Edo period? Were
farmers permitted to own land?
Under the pre-modern political system of the Edo period, which was a kind of feu-
dalism, the shogun gave land to daimyos to govern in exchange for their loyalty.
Farmers were considered to be part of the land and were not allowed to move, and
no land sale or rental was officially permitted. Under such a system, the modern
concept of land ownership is difficult to apply. However, Tanaka Keiichi, an Edo
scholar, says that the prohibition of land title transfers was ineffective. Farmers
actually bought and sold land without any punishment and some even left the vil-
lage to avoid repression or in search of better life. I am sure such practices did exist
but how widespread it was remains an open question. Officially, all land directly or
indirectly (through hans) belonged to the shogun. But within each han, the daimyo
had the right to govern and tax his land. Moreover, each village had autonomy as
long as it paid rice taxes. In such a society, it is difficult to say precisely who owned
the land.

5 Why could the bakufu suppress military uprisings by hans?

Tokugawa Ieyasu, the first shogun, was a very clever man. To end the warring
years, a number of institutions were installed at the beginning of the Edo period
making a revolt against the central power virtually impossible. For example, a
heavy financial burden was imposed on daimyos through obligatory residence in
Edo every other year, assignment of public works and ad hoc taxation. Meanwhile,
daimyo’s wives and children were to always reside in Edo as potential hostages.
Strict bans and restrictions were imposed on travel, shipbuilding, type of weap-
onry, construction of castles and bridges, and so on. Powerful hans were given
land away from Edo, and Tokugawa families and friendly hans (former followers
of Tokugawa Ieyasu) were given locations of military importance. Moreover, the
physical sizes and locations of hans were changed at the bakufu’s will at any time,
and mutual surveillance and checks were forced on daimyos. All samurai leaders
and their retainers were given positions in a complicated ranking system where
upper samurai had absolute authority over lower ones. Under this system, any sign
of disobedience led to the termination of the daimyo’s reign and his family.

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 Q uestions and answers

6 Why was only the Dutch language used for Western studies by
Edo scholars?
Because the Netherlands was the only Western country that the bakufu granted the
right to trade with Japan (the other officially permitted trading partner was China).
For this reason, all technical and medical books imported from the West were in
Dutch. Studying the Dutch language was equivalent to learning Western technol-
ogy. Among Western countries, the bakufu allowed only the Netherlands to trade
with Japan because the Dutch were Protestant. Catholic countries such as Spain and
Portugal sent aggressive missions to convert the Japanese to Christianity, which
was disliked by Japanese rulers. Meanwhile, the Dutch were more interested in
commercial profit than religious activity. The Dutch also seem to have made up the
story that the Spaniards and the Portuguese were planning to invade Japan or seize
gold and silver mines in Japan.

7 I understand that Edo society was a conservative class society,

but was there any mobility among the classes through marriage
or any other means?
Officially and in principle, no class mobility was allowed. Distinction between the
ruling class (samurai) and all others was especially strict while differences among
the ruled—farmers, craftsmen and merchants—were less so. In reality, however,
there were certainly cases of poor and lordless samurai becoming farmers, and rich
merchants with merits or large donations being upgraded to samurai. Despite such
records, there are no reliable statistics that prove the frequency of such transition at
the national level.

8 Was dissatisfaction with unequal land distribution one of the main

reasons for farmers’ uprising?
No, that was not the main reason. From the mid-seventeenth century onwards, the
main reasons for farmers’ revolts (called ikki) included protestation against a heavy
tax burden, corrupt officials, han’s policy and bakufu’s policy. The typical actions
in uprisings included direct appeal to the government (which was illegal and pun-
ishable), collective abandonment of land to escape to another area, and attacks on
the residences of targeted officials. Some researchers insist that farmers’ uprisings
in the Edo period were well planned and followed pre-set rules and procedure, and
participants were highly disciplined. They were not spontaneous violence without
leaders. Toward the end of the Edo period, as the number of poor and landless peas-
ants increased, many uprisings against rich merchants and rural landlords occurred.
Their houses were attacked and destroyed.

9 Was Japan linguistically unified in the Edo period?

We can say yes by the standard of today’s developing countries. Although there
were different dialects and nuances in pronunciation, which made oral commu-
nication across different regions sometimes difficult, these were all variations of

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 Q uestions and answers

the same Japanese language. Grammar and written language were uniform across
all regions. The important thing is that, through the use of one language, Japanese
national identity had been firmly established. In fact, this was true even before the
Edo period. To put it differently, linguistic differences did not cause social division
or ethnic conflict in Japan. However, it must also be pointed out that there were
ethnic minorities who did not integrate into the Japanese society. For example, the
Ainu (indigenous) people in Hokkaido and the Okinawa people in the southwest-
ern islands spoke different languages and had separate cultures. There were also a
small number of hunters living in mountains who did not mingle with the Japanese
majority. These people were not counted as Japanese then.

10 What is Confucianism?
There were many ancient Chinese philosophers, but the most famous ones are
Confucius (551–479 bc) and Lao-tse (sixth century bc? His existence is not proven).
Their ideas are called Confucianism and Taoism, respectively. They both taught
how humans should live and behave, but had quite different orientations. Confucius
taught virtue and discipline in social life including how to properly perform rituals
and ceremonies, respect parents and serve your lord, and how kings and emperors
should rule. Meanwhile, Lao-tse emphasized natural experience and alignment with
the universe. He instructed how to achieve things without effort, feel the mystery of
being, perceive the world without leaving the house and so forth. These two saints
had enormous impacts on East Asian societies such as China, Korea, Japan and
Vietnam for the next 2,500 years.
Confucius wanted to become an advisor to a truly wise king, but he never found
one. All his life, he traveled with his disciples and taught them through discussion.
This method is similar to that of Buddha, Jesus and Socrates. The disciples wrote
down his words in Lun-yu (Rongo in Japanese pronunciation) which became the
best-selling textbook and a subject of serious research (the meaning of his terse
words is often unclear) for a long time. My favorite lines from Lun-yu go like this:
“Learning without thinking is useless, thinking without learning is precarious”;
“Clever words and superficial smiles carry little virtue”; “You shall always remem-
ber the ages of your parents. One, for celebrating. Two, for fearing.” Confucianism
was introduced in Japan in the fourth or fifth century ad, but it remained unpopular
until the Edo bakufu reactivated it as an official doctrine. Its teachings were suitable
for maintaining social order in a class society.

11 How was the relationship between Japan and Korea during

the Edo period?
Toward the end of the warring period, in 1592–93 and 1597–98, the army of
Toyotomi Hideyoshi, then the supreme military commander of Japan, twice
invaded and devastated Korea but failed to occupy it due to Chinese military
intervention and declining morale of Japanese samurai who did not clearly see the
purpose of the campaign. Tokugawa Ieyasu, the first Edo shogun, tried to mend
the strained bilateral relations by ordering Tsushima Han, situated on two islands
between the two countries, to negotiate with the Korean government. This resulted

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 Q uestions and answers

in commercial trade between Korea and Tsushima Han as well as an agreement to

exchange official letters and receive Korean envoys to Japan. The bakufu wanted
to maintain stable ties with Korea for national security reasons. Perhaps the reasons
on the Korean side were similar.
Korean missions to Japan were diplomatic and symbolic ones, expressing
political goodwill on the occasions of assumption of power by a new shogun or
the birth of a shogun’s son. Korea was not one of the two countries permitted to
trade with Japan. Even though gifts were exchanged, they did not amount to very
much in Japan’s total trade. Twelve such missions were dispatched from Korea
to Japan throughout the Edo period with decreasing frequency. Japanese people
watched with great curiosity the passing foreign mission of several hundred people
as it paraded from Shimonoseki to Edo via the Inland Sea and over land. However,
reciprocal missions from Japan to Korea were not sent (there were missions only
from Tsushima Han).

12 Tell us more about the outcast class in the Edo period.

There were two types of outcast people in the Edo period: hinin (literally, non-
human) and eta (meaning unclean). These discriminatory words existed from long
ago, but the bakufu institutionalized certain people at the bottom of the society by
giving them organization and functions.
The hinin were beggars who lived in designated districts in urban areas. They
were usually organized and policed by managers who were internally elected or offi-
cially appointed. There were also unorganized hinin as well. Some mobility existed
between the hinin and normal people. For example, the latter could become beggars
through poverty.
The eta were people whose profession was to process dead animals such as horses
and cattle, and supply raw materials for the leather industry. They were also forced
to perform criminal executions. These were considered unclean jobs. However, eta
people were also engaged in other professions including farming. The eta were also
organized by managers at the han level.
Discrimination against these people continued even after the Edo period. To
eliminate unjustified prejudice, Zenkoku Suiheisha (the National Level Society) was
created in 1922 and Buraku Kaiho Domei (the League for Liberating Discriminated
People) was organized in 1955. Legally, of course, the present Japanese constitution
and laws guarantee equal rights to all. But even today, we cannot say that prejudice
against the formerly discriminated has been eradicated completely. The movement
for ending social discrimination continues.

13 By the early Meiji period, why did Japan feel that it no longer
faced the risk of colonization?
When Japan was forced by the West to open its ports (1853–54), the possibility of
colonization was considered real. But by Meiji Restoration (1868), Japan worried
less about military invasion by Western powers. Instead, the national goal of catch-
ing up fast with the West had emerged. What happened during these fifteen or so

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years? It is difficult to answer succinctly, but the following factors might have been
at play.
First, despite social confusion, Japan retained national unity and policy auton-
omy. A devastating civil war was avoided, and the internal war turned out to be
short and small-scale. The state machinery continued to function after the change
of government. Second, Japan was importing and absorbing Western technology
very rapidly, and military and economic capabilities were being enhanced. Seeing
this, Westerners became mainly interested in securing commercial interests rather
than using military means to occupy and colonize Japan. At any rate, Japan was
too far from their homelands to mobilize large-scale forces, and Americans were
busy with their own Civil War.
There was also rivalry among the Western powers in Japan, especially between
the British and the French, who tried to intervene and influence domestic politics.
This prevented the dominance of any single foreign country and benefited the
Japanese side.

14 How many foreign advisors were employed in the Meiji period?

Even though their salaries were very high, can we say that their
productivity was also high?
In the Meiji period, officially or privately employed foreigners numbered in the
hundreds in any year, but their composition changed over time. In the first ten
years of Meiji (1868–77), most foreign advisors were hired by the government and
numbered between 300 and 600 in any year. Subsequently, the number of officially
contracted foreigners declined sharply while the number of privately hired ones
increased. Nearly half of those hired privately were teachers and professors at aca-
demic institutions, many of whom were English teachers at private universities. By
nationality, the British dominated followed by the French and the Germans. There
were also a large number of Americans, but most of them were professors and
teachers. There were very few American engineers.
Here are some statistics in the Report on the Outline of the Ministry of Industry
compiled in 1931. In early Meiji (around 1872), Yokosuka Shipyard employed
twenty-eight foreigners (all French), the Railroad Agency had eighty (mostly
British), the National Mint had twenty (mostly British) and Ikuno Mine had fifteen
(all French). These four state-run bodies alone accounted for 143 foreigners. But
not all were top-notch engineers with advanced technology. They included factory
operators, accountants, secretaries and doctors as well.
It is reasonable to believe that these foreigners were worth the money. But it is
difficult to precisely measure their labor productivity since their task was to bring
something entirely new to Japan. Without British help, Japan could not have laid
its first railroad. Does this mean their productivity was infinite? Can we measure
the contribution of any new industry to growth when the economy is propelled by
many other factors? The return on foreign advisors also depended on how quickly
the Japanese side could take over the new enterprise. Had the Japanese never
learned, new industries would have forever depended on foreign management and
instructions, which would have been very costly. In reality, this did not happen.

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15 Tell us about schools that taught practical engineering.

Establishment of Koto Kogyo Gakko (High-level Industrial Schools) to supply
mid-range industrial instructors and factory supervisors was proposed by Gottfried
Wagener, a German engineer hired by the Meiji government, and Tejima Seiichi, a
Ministry of Education official. Tokyo Shokko Gakko (Tokyo Craftsmen School) was
set up by the Ministry of Education in 1881. It recruited students among high school
graduates aged 16–17 through nationwide examination, except those with good past
grades who were accepted without examination. Mechanical engineering and chemi-
cal engineering were offered with more courses added later. The name of this school
changed several times, including Tokyo Kogyo Gakko (Tokyo Industrial School).
Unlike Kobu Daigakko (Institute of Technology) where foreign instructors taught
top engineers mainly for the government, all teachers at Tokyo Kogyo Gakko were
Japanese except Mr. Wagener who taught ceramics and glass making. Most Japanese
teachers came from the Faculty of Science of Tokyo University. The school faced
administrative and financial troubles initially, but operation stabilized around 1890 as
Mr. Tejima took over the school. Tokyo Kogyo Gakko became the leading institute for
producing industrial instructors, factory managers, engineers and entrepreneurs (educa-
tion of industrial instructors was later delegated to another institution). After its campus
near Asakusa was destroyed by the Great Kanto Earthquake in 1923, the school relo-
cated to O-okayama (Meguro-ku, Tokyo). It is now the Tokyo Institute of Technology.
Besides Tokyo, publicly run Kogyo Gakko (Industrial Schools) were established
in Osaka (1901), Kyoto (1902), Nagoya (1905), Kumamoto (1906), Sendai (1906),
Yonezawa (1910) and Akita (mining course only, 1910) with a total of eight schools
during the Meiji period. After Meiji, twenty-three more Kogyo Gakko were created.
After WW2, most of these schools were transformed into faculties of engineering
of national universities. Japan also has private industrial schools but most of them
were established after WW2.

16 In what respect was the Meiji Constitution ambiguous?

Here are some translated excerpts from the Constitution of the Empire of Japan
promulgated in 1889. Underlined parts were controversial or subject to different
interpretations.

Article 1. The Empire of Japan shall be reigned over and governed by a line of
Emperors unbroken for ages eternal.
Article 3. The Emperor is sacred and inviolable.
Article 4. The Emperor is the head of the Empire, combining in Himself the rights of
sovereignty, and exercises them, according to the provisions of the present Constitution.
Article 5. The Emperor exercises the legislative power with the consent of the Imperial
Diet [Parliament].
Article 55. The respective Ministers of State shall give their advice to the Emperor,
and be responsible for it.

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 Q uestions and answers

Article 3 may look like deification of the emperor which is unique to Japan, but
it is in fact a direct copy from a typical European constitution. This line was inserted
on the advice of Karl Friedrich Hermann Roesler, a German legal advisor to the
Meiji government. It means the ministers, and not the emperor, bear the responsi-
bility for the consequences of any policy.
The intention of the original drafters of the Meiji Constitution, especially Ito
Hirobumi, was to place the emperor within the state mechanism and under this
constitution, as Article 4 makes it clear. But conservative members of the Privy
Council, a body created to review the constitution draft, demanded that the under-
lined part in Article 4 should be deleted, which Ito strongly resisted. He argued
successfully that there would be no constitutional government if the emperor was
placed outside its framework. However, much later in the 1930s, Ito’s interpretation
and its developed form, Tenno Kikan Setsu (The Organ Theory of the Emperor),
were criticized by the military and rightwing groups. As a result, the emperor was
elevated above the state and the constitution.
Article 5 says that the parliament must give “consent” to the Emperor’s legisla-
tive decision. In the Japanese original, the term shonin (approve) was first proposed
but it was replaced by a weaker term, kyosan (humbly support).
The problem with Article 55 was that it was unclear whether individual min-
isters or the cabinet as a whole were to advise the emperor, especially on military
matters. If a joint cabinet decision was required, the Minister of Army or Navy
must discuss the issue with other ministers, especially the Ministers of Finance and
Foreign Affairs. This would certainly put a damper on any proposed military action
for fiscal or diplomatic reasons. If not, he could advise the emperor directly and
independently.
The Meiji Constitution also said little about the precise relationship between
the legislative and executive powers. This permitted adoption of a party cabinet (a
government formed by the political party that had the largest parliamentary seats)
as well as chozen naikaku (government of appointed generals and bureaucrats that
included no elected representatives). Other strong political players in prewar Japan,
such as genro (old politicians with past merits) and the Privy Council itself, which
later became a permanent advisory organ for the emperor, were not even mentioned
in the constitution. As a result, the Japanese government was run through competi-
tion among many groups with the exact role of each undefined.

17 How did Meiji Japan mobilize investment capital?

There were super businessmen such as Shibusawa Eiichi and Godai Tomoatsu
who introduced the Western system of joint stock companies and encouraged their
rich friends to invest in stocks. Shibusawa also used his First “National” (actually
private) Bank to finance working capital of burgeoning firms. Prominent business
leaders such as these contributed to the establishment of many large companies. In
addition, expansion of foreign demand for silk and tea and domestic demand for
rice, along with their rising prices, enriched rural Japan permitting self-financing
of industries by well-to-do farmers, landlords and merchants. From the late 1880s,
Japan experienced waves of “company booms” during which many modern joint
stock companies in textile and railways were created. All of the above were methods

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of mobilizing domestic savings. There was very little foreign participation in the
capital of these companies. In fact, foreigners’ investment in Japanese enterprises
(foreign direct investment, or FDI) was prohibited until the commercial law was
revised in 1899. Even then, policy and popular opinion remained hostile to FDI.
According to the estimates by Teranishi Juro (Chapter 6), savings mobiliza-
tion within the domestic private business sector, including creation of joint stock
companies and self-financing, seemed to have played the largest role. Moreover,
resource transfer from agriculture to industry through the fiscal system (i.e., the
land tax) cannot be ignored. While Teranishi’s dataset does not cover years before
1900, savings mobilization through the land tax must have been significant in the
early Meiji period.

18 It is not easy for my country to issue foreign bonds. Why could

the central and local governments of Meiji Japan issue them in
global financial markets?
Because Japan joined the International Gold Standard, a world monetary sys-
tem that no longer exists. During most of the nineteenth century and up to 1914
(outbreak of WW1), the world was on a gold standard orchestrated by the United
Kingdom. The period of 1879–1913 was called the Classical Gold Standard
(or International Gold Standard) because all major Western countries participated in
it. Under this system, each central bank was obliged to fix the value of its currency
in gold, and freely exchange paper money with gold upon request. This meant that
exchange rates were also fixed. As long as these obligations were honored, paper
money of any country was as good as gold. Trade was liberalized and capital was
highly mobile. National economies operated under the same financial mechanism
led by London. Prices and interest rates converged globally. For thirty-five years,
there was no realignment of exchange rates among major countries.
Japan joined this system in 1897 with gold reserves received from China as war
reparation. Even though Japan was only a “developing” country then, its money was
accorded with high trust in the global market, allowing its central and local govern-
ments to issue foreign bonds denominated in sterling or dollar in world financial
centers with little risk premium. American railroad bonds were also popular among
British investors. Today, there is no such institutional backing of developing coun-
try monies. Their confidence must be secured by political stability, good policy and
sufficient foreign exchange reserves.

19 Import substitution failed in many countries. Why did Meiji Japan

succeed in the import substitution of cotton textile industry?
High capacity to absorb new technology, the existence of innovative business
leaders, the growing supply of Japanese engineers and appropriate official support
were all important (Chapters 4 and 5). In addition, market discipline imposed by a
low uniform tariff of 5 percent may have been a factor. This made high protection
impossible and forced manufacturers to improve competitiveness rather than lobby
government. But simply listing these conditions cannot explain why they existed in

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 Q uestions and answers

Meiji Japan. A government that can effectively manage commercial rents and stim-
ulate industries, together with a very dynamic private sector, are not the features
commonly seen in developing countries today. For a possible explanation of these
dual strengths of Meiji Japan, see the Umesao Hypothesis in Chapter 1.

20 Can we say that wars with China (1894–95) and with Russia
(1904–5) accelerated Japanese industrialization?
As explained in Chapter 6, these two wars had the effect of increasing the economic
size of the government. After each war, government, including both central and
local governments, became eager to promote industries and build infrastructure.
Meanwhile, military spending was not held back after these wars. Such aggressive
public spending stimulated domestic businesses in the short run. Whether it also con-
tributed to the long-term sound economic development of Japan is an open question.
Fiscal activism produced macroeconomic instabilities such as balance-of-payment
pressure and the loss of gold reserves. It was strong foreign demand associated with
WW1 (1914-18), rather than the wars with China and Russia, that had an enormous
impact on Japanese business activities (Chapter 7).

21 Please tell us about inflation in the Meiji period.

Japan’s prewar overall price index is available only from 1901. But we can use the
price of rice as a proxy to study the general trends in the earlier period. Inflation and
monetary confusion, which started after ports were opened to trade with the West
in 1859 (not shown in Figure A.1) was ended by Finance Minister Matsukata’s
deliberate deflation policy in the early 1880s. While Matsukata Deflation was the
longest (three years) and proportionately largest deflation in the Meiji period, other
smaller and shorter (usually one year) deflation episodes can be detected as well.
Throughout Meiji, the general trend in the rice price was upward. From 1873 to
1912, the average annual increase was 4 percent. After Japan joined the interna-
tional gold standard in 1897, also thanks to Matsukata’s initiative, the yen was fixed
to the pound, dollar and other major currencies, and Japanese inflation began to
trace global inflation, which was low.

22 What happened to factories damaged by the Great Kanto

Earthquake of 1923?
Before the earthquake, key industrial areas of Tokyo were Honjo, Fukagawa,
Asakusa, Kanda, Shiba and Kyobashi on the central and eastern coasts (Figure A.2).
Large textile mills and their component suppliers congregated, and steel mills, ship-
builders and fertilizer plants were also located. These areas were seriously affected
by the earthquake. Honjo recovered strongly but Fukagawa, severely damaged by
fire, did not. Oji, which featured textile mills, continued to grow with a stable sup-
ply of power from Oji Electric Company.
After the Great Kanto Earthquake, Tokyo’s main industrial activities shifted
toward southern coastal areas. Omori and Kamata emerged as new industrial areas.

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 Q uestions and answers

Additional industrial areas were formed by land fill in Keihin Area (between Tokyo
and Yokohama). Large producers including Asahi Glass, Asano Shipbuilding,
Asano Cement, Ajinomoto, Nippon Cable, Fuji Electric, Tokyo Electric Power,
Nisshin Flour, Mitsubishi Oil and Meiji Confectionery gathered in this area during
the Taisho Period.

Figure A.1 Rice price in semi-log scale (Yen/koku)

Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 4, 1988. A koku is about
150 kilograms.

Figure A.2 Tokyo’s industrial areas in the Taisho period

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 Q uestions and answers

23 Please explain the Security Maintenance Law.

This was a law to crack down on people, groups, associations or political parties
that denied the National Regime (i.e., sovereignty of the emperor) or private prop-
erty ownership. It was enacted in 1925 and revised (strengthened) in 1928 and 1941
until it was finally abolished in 1945. The death penalty was introduced in the 1928
revision. The definition of illegal activities in this law was so ambiguous that anyone
whom the government considered undesirable could be arrested. Targeted subjects
included (underground) Communist Party members, Koreans protesting against
Japanese rule, certain religious groups and lawyers defending arrested socialists.
Between 1925 and 1945, over 70,000 persons were arrested by this law, and 10
percent of them were persecuted. Instead of executing socialists, the authorities
preferred to convert them into avid nationalists with “Japanese spirit,” and they had
developed a highly elaborate method for persuasion and conversion.
In Japan, no one was sentenced to death by this law. Richard Sorge, a German
national, and Ozaki Hotsumi were charged with spying for the Soviet Union and
sentenced to death, but this was in combination with other laws and not by this law
alone. However, after WW2, the Japan Communist Party indicated that, while no
one was legally sentenced to death by this law, 194 persons died during investiga-
tion involving torture and mistreatment, and an additional 1,503 persons died in jail.
In Korea, then a Japanese colony, over 23,000 persons were arrested and 45 persons
were executed by this law. Application of the law was more severe in Korea than
in Japan.

24 Who were the members of the Privy Council that rejected the
proposed imperial edict at the time of the banking crisis in 1927?
The Privy Council (Sumitsuin in Japanese) was originally established in 1888 to
deliberate on the draft of the Meiji Constitution (see Question 16 above). After the
constitution was promulgated, it became a permanent advisory body to the emperor.
Members were chosen from a group of genkun (old politicians who had merits
in establishing the Meiji government) and “experienced” statesmen. The members
were generally conservative and disliked the idea of government run by political
parties. They also supported strong military stance against China and criticized
Shidehara Diplomacy which tried to restrain military intervention in China.
On April 14, 1927, the government submitted an imperial edict draft, which per-
mitted the Bank of Japan to rescue the Bank of Taiwan to contain the banking crisis,
to the Privy Council for review. The Council’s deliberation committee noted several
“inconsistencies” in the draft edict and advised its rejection. The edict was subse-
quently voted down in the general session of the Privy Council. This was because
the members of the Council objected to Shidehara Diplomacy of the incumbent
government.
One of the characteristics of Japan’s prewar politics was the multiplicity and
ambiguity of authority for making important decisions, which included the power
to start and end a war. The constitution clearly stipulated that the sovereignty
rested with the emperor, but he was not responsible for policy consequences.
All responsibility was borne by his advisors. The government, either the entire

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cabinet or individual ministers, were to advise the emperor on policy matters. The
military often believed that it had the exclusive right to make military decisions
and advise the emperor on military issues. The Privy Council also advised the
emperor. In addition, as democracy grew, elected officials and political parties
also claimed authority in making decisions. Such decentralization of power in
prewar Japan was in sharp contrast to the case of Nazi Germany where Hitler
alone had supreme power.

25 What happened to the Bank of Taiwan after its closure in

April 1927? Was it liquidated?
No, the Bank of Taiwan survived the 1927 financial crisis. As discussed in Chapter 8,
the government passed the law to cover the loss up to 2 million yen incurred by
the Bank of Japan. Taxpayers’ money was injected into the Bank of Japan by as
early as June 1928 to cancel the bad bills held by the Bank of Taiwan. This money,
in the main, was used to repay the Bank of Taiwan’s interbank “call” (short-term)
loans to other commercial banks. As a consequence, the entire financial market was
greatly eased. The Bank of Taiwan even expanded its business during the wartime,
extending loans to China and Southeast Asia. After Japan’s war defeat, it was finally
abolished by the order of the US occupation forces.

26 What did political parties do to prevent the takeover of power by

the military in the 1930s?
Up until political parties were emasculated in 1937 and finally dissolved in 1940,
major parties in the 1930s were the Seiyukai and the Minsei Party, plus a number
of small but emerging social democrats such as the Social Mass Party. It must first
be noted that these parties did not always fight with rising militarism, as positions
held by individual statesmen shifted across time and factions. Even so, we can
say on average that they constituted an important force to restrain militarism. The
Seiyukai aligned frequently with the army to pursue its partisan interest, but there
were also groups within it that tried to cooperate with the Minsei Party to oppose
militarism. The Minsei Party was far more consistent in challenging the military’s
undemocratic ways, but it too failed to amass sufficient power internally and with
other parties to form strong enough opposition. Social democrats were naturally
against wars, but they too were sometimes attracted to the military’s argument that
rich capitalists must be punished and the life of poor farmers and workers should be
elevated. On the military side, not all commanders and officers were “militaristic”
as some endorsed democratic rules while others completely ignored them. Political
developments in the 1930s were quite complex (Chapter 9).
In 1934–36, two strategies were proposed to cope with the rise of militarism.
The first was establishment of a special temporary mechanism with the partici-
pation of all stakeholders (including the military) to supersede normal legislative
and/or executive functions until the emergency was overcome. The second was a
merger or coalition of the Seiyukai and the Minsei Party to create a super dominant
government. The first idea was adopted as the Cabinet Council which, however,
was unable to stop militarism. Only its secretariat office survived and was later

192
 Q uestions and answers

transformed into the powerful Planning Board to execute war. The second idea was
not implemented due to feuds among politicians and party factions. Meanwhile,
some statesmen bravely and openly criticized the military in parliamentary
sessions. Anti-military speeches by Saito Takao (Minsei Party) in 1935, 1936, 1938
and 1940, and by Hamada Kunimatsu (Seiyukai) in 1937, are particularly famous
examples. These can be heard on recorded tapes.

27 Was the Pacific War unavoidable?

This is a big question. Each reader should form his or her opinion after reading this
book or attending my lectures. There may not be a simple and uniform answer.
The Pacific War (1941–1945), a total war with the West and especially the
United States, was the final stage of Japan’s economic and territorial expansion
toward neighboring Asia that began in the Meiji period. Japan’s interest was mainly
directed first to Korea, then its adjacent areas in China (Manchuria or Northeast
China). Wars with Qing Dynasty China (1894–95) and with the Russian Empire
(1904–5) were fought to secure these areas. In the 1930s, as the Japanese army sta-
tioned in China started to ignore and act independently from the Tokyo government,
conflict expanded to entire Manchuria as well as Northern and Central regions of
Coastal China. In 1937 this aggression ignited a total war with China. As the war
prolonged, Japan turned to Southeast Asia to obtain more food, energy and mineral
resources. The Japanese military advanced to North Vietnam in 1940 and South
Vietnam in 1941, which angered the United States enormously. It immediately
imposed an oil embargo on Japan. The Japanese government and military chose to
declare war against the United States, with no clear winning strategy, before Japan’s
oil reserves ran out. With the Pearl Harbor attack in December 1941, the Pacific
War began.
In this long and advancing story of outward expansion, it is difficult to locate
only one date in which Japan made the wrong and irreversible decision. Any
nation with rising military and economic power tends to behave aggressively.
Mistakes had been accumulated since the Meiji period. It is even harder to argue
what concrete action could have saved Japan from the disastrous course. Some
say the Manchurian Incident of 1931 was critical. Others point to 1941, but this
may have been too late for turning back. Between 1931 and 1941, Japan seemed
gradually pushed and pulled toward a world war without clear diplomatic thinking
or long-term planning.

28 My country stagnated after the shock approach was taken to stop

inflation after the collapse of the Soviet Union. Wasn’t Japan lucky
because the Dodge Line austerity measures in 1949 were followed
by an external demand increase from the Korean War?
You are quite right. As I discussed in class (Chapter 10), many were fearful of
severe recession as a result of abrupt ending of recovery spending and produc-
tion subsidies by the order of Joseph Dodge, an economic expert dispatched by
Washington. The Japanese economy began to shrink as these measures were taken.
But the Korean War that broke out in June 1950 suddenly increased US demand

193
 Q uestions and answers

for Japanese military and civilian goods, more than offsetting the negative effect of
the shock approach. It is sad that the Japanese economy was rescued, not once but
twice, by a foreign war in the twentieth century—this time and at the time of WW1.
Today, no developing country can expect such timely demand compensation from
abroad so it must carefully choose the size and speed of belt-tightening measures to
cope with domestic economic crisis.

29 When the bubble economy was forming in the late 1980s, were
Japanese people and policy makers aware of it?
They were not clearly aware that an asset bubble was forming. Although many
people felt something strange was going on, few analysts said that the economic
upswing was only temporary and very dangerous. The Ministry of Finance tried to
prop up the stock market whenever it started to fall. The Bank of Japan should per-
haps bear the main responsibility for fueling the stock and land markets, but it was
politically difficult to tighten monetary policy and end the good time that everyone
was enjoying. While asset prices were soaring, consumer prices remained stable.
Only after the bubble collapsed, did everyone know it was a bubble. This is almost
always the case with any bubble around the world and across ages.

30 What did the Bank of Japan do after the Great East Japan
Earthquake in 2011?
Despite the physical damage to financial institutions, “the settlement system and
financial institutions, including the Bank of Japan, continued to operate reliably
after the quake and maintained normal functions. This was mainly thanks to the
great effort made by financial institutions in the affected area to restart operation
and respond to the needs of depositors and enterprises. Moreover, cumulative past
improvements on emergency response operations made by the settlement system
and financial institutions also contributed to minimize the damage” (Report of the
Bank of Japan’s Bureau of Settlement Mechanism, June 2011).
The Bank of Japan set up the Emergency Response Headquarters fifteen minutes
after the quake hit on March 11, 2011. It supplied extra cash to financial institutions
in affected areas. The computerized interbank settlement and transaction system
(BOJ Net) continued to operate normally. Twenty-nine commercial bill exchanges
(about half) in affected areas closed immediately but all except three reopened
within ten days. Tax and pension payment services at damaged financial institutions
were provided temporarily by the Bank of Japan branches. Paper notes damaged
by the earthquake and tsunami were exchanged. The central bank and government
also requested financial institutions to allow depositors to withdraw money with
minimum identification requirement even if they had lost bankbooks. The number
of inoperative financial institution branches in affected areas were 310 (among about
2,700 in all) on March 16, which was reduced to seventy-two by June 21.
Unlike the time of the Great Kanto Earthquake in 1923, the central bank did not
indiscriminately re-discount commercial bills to supply liquidity in affected areas.
The financial system continued to operate more or less normally despite the serious
damage inflicted by the earthquake and tsunami.

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Figures and tables, which are separate from the main discussion in the text, are indicated by page
numbers in italics. Boxes are indicated in bold.

Abe Shinzo 174 Bretton Woods exchange rate system 138

Abenomics 174–175 bubble economy: Lost Decade following 162–163,
aging population 172–173 166–167; occurrence 164–166, 194
agriculture 24–26, 27 budgets: in 1950s and 1960s 136–137; in Edo
alternative residences (sankin kotai) 28 period 26–27; tightening of 134
anti-inflation policies 123 business cooperation 70, 85
Arisawa Hiromi 122, 123–124, 126, 127–129
assassinations 110 capital markets 76–78
asset bubble: Lost Decade following 162–163, cars: ownership 88; production 88–90, 141,
166–167; occurrence 164–166, 194 146–147
austerity measures 126–127 cartels 26, 27, 29, 85, 107
automobiles: ownership 88, 140–141; production cash crops 25–26
88–90, 141, 146–147 Chang, Ha-joon 85–87
Ayukawa Yoshisuke 87, 88–90 China: invasion of 109–111; Japan–China War
(1894–95) 48, 73–74, 189; Japan–China War
Bafaku: fall of 35–36; revenues 27; suppression (1937) 109–111; relations with Korea 43–44;
of military uprisings 181; system 23–24 Shidehara’s relationship with 91–92; trade
balance-of-payments 48, 80, 83, 134, with United States 157–158
137–138, 156 chozenshugi 48, 74
Bank of Agriculture and Industry 77 civilization, views of Fukuzawa 42
Bank of Japan: 1927 financial crisis and 99–100, class mobility 182
101–102; asset bubble 165; creation of 77; coal industry 124, 127, 132, 134–135
earthquakes 97–98, 194; exchange rates colonization, end of fears of 184–185
137–138; zero interest rate policy 168 commerce: in Edo period 28–30; treaties
Bank of Taiwan 98–100, 192 35–36, 43
Bank Runs of 1927 97–100 commercial bills 96–98
banking crises 98, 100–102, 191–192 company booms 47
banks: bankruptcy and merging 167; competition 135–136
deregulation 164–165; as financial Confucianism 183
intermediaries 77; kikan ginko 77, 95, 101; constitution: Meiji period (1868-1912) 42–43,
Meiji period 76–78; SMEs and 143–144 186–187; plans for 38; postwar (1947) 125
Banno Junji 102–103 consumption 113, 140–141
“The Basic Problems of Japan’s Economic cooperation between businesses 70, 85
Reconstruction,” 120–122 cotton textile industry 46, 49–50, 62–65, 188–189
Black Ships 35 currency flotation 154–155
Blood Society 110
bonds: corporate 88; foreign 79–80, 188; Daihatsu 90
government 136–137 daimyo system 21–23

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Dan Takuma, assassination of 110 environmental issues 145–146, 147

deflation 47, 104–105, 133 exchange rates: fixed 132–133, 137–138,
Deming, W. E. 140 154–155; policy 75–76; volatility 90–91
democracy: Japan–China War and 110; Taisho expansionism 43, 73–74, 80–81
92–93; United States and 124–125; views of Export–Import (Exim) Bank 134, 143
Fukuzawa 42; views of Okubo 42 exports: pre WWII 49–50, 51; wartime
depopulation 172–173 83–84
deposit blockade (1946) 123
depreciation 168–170 farmers: land ownership 181; life 24; uprisings
depression (1930-32) 104–105 26, 182; see also agriculture
deregulation, of banks 164–165 Fascism 105–107
devaluation 133 fertilizer industry 134
development 175 feudalism 22
Development Bank of Japan 143–144 finance, informal 77–78
diplomacy 80–81, 91–92 Financial Services Agency 167
disinflation 128–129 “first-class nation” 38–39, 74
Dodge, Joseph 126, 127 fiscal activism 48, 74–75, 85, 152–153, 170–171
Dodge Line stabilization (1949) 126–127, fiscal consolidation/expansion 158–159
135–136, 193–194 fiscal deficits 27, 122–123
Doko Toshio 158–159 fiscal investment and loan program (FILP) 134
domestic society 4–6 food shortages 119–120
domestic workers 56 Ford 90
dual structure technology 47, 56–58 foreign advisors 50–52, 185
Dutch language 182 foreign bonds 79–80, 188
foreign direct investment (FDI) 53–55,
earthquakes: bills 96–99; Great East Japan 79–80, 85
Earthquake 172, 194; Great Kanto Earthquake foreign exchange 112–113, 134
88–89, 189–190; post 1990 172 foreign expedition 38
East Asia, Japan as threat to 80–81 foreign settlements 36
economic system: origins of 115–116; possible foreigners, radicalism against 37
obsolescence 166; reform of 155–156 free market economy, transition towards
economy: ‘catching up’ with West 38–39, 155–156
179; deregulation 155; growth 48, 131–132, French Indochina 113
150–151; Lost Decade and 166–168; maturity friendship treaties 35
of 150–151, 155; post-war controls 119–120; Fuji Masazumi 71
pre-war crisis 48; slowdown of 84–85; fukkin loans 122–123, 126
transformation of 18–19; transition to free fukoku kyohei 37–38
market 155–156; wartime 111–114 Fukuzawa Yukichi 42
Edo period (1603–1867): agriculture 24–26, Furukawa Electric Company 70, 85
27; bakufu-han system 23–24; budgets
26–27; class mobility 182; commerce 28–30; General Agreement on Tariffs and Trade
education 31–33; fall of Bakufu 35–36; (GATT) 135
historical overview 13, 21–23; industry 30–31; General Electric 70, 85
land ownership 181, 182; language 182–183; General Motors 89, 90
outcast class 184; politics in transition to Meiji geographical location 8–9
37–38; ports 35–36; relations with Korea globalization 8
183–184; transportation 28 Godai Tomoatsu 40
education: in Edo period 31–33; engineering gold 27, 76
52–53, 186 gold standard 75–76, 90–91, 104–105
electrical machinery 70 gorika 133–134
employment: informal rural 119–120; job- Goto Yonosuke 120–122
hopping 55–56, 67; non-regular 173–174; government: Edo-Meiji transition 37–38, 41–43;
structure 58; of women 56, 65 expenditure 75–76; Meiji period 38–39,
energy: efficiency 153; industries 85, 124, 134 41–43; by public deliberation 37
engineers: requirements for 65; training of Great Depression 104–105
52–53, 55, 67, 186 Great East Japan Earthquake 194

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Great Kanto Earthquake: bills 96–97; factory international reserves 138, 169
damage 189–190; impact on demand for cars international trade 35–36, 49–50, 51, 120
88–89 investment capital 140, 187–188
Ground, Maritime and Air Self-Defense Forces irrigation 24–25
(SDF) 125–126 Ishibashi Tanzan 105, 123
Growth Arrow 174–175 isolation policy 35, 111
Itagaki Taisuke 38
Hamaguchi Osachi 102–103, 104 Ito Hirobumi: preparations for constitution 43;
hans: military uprisings 181; system 22 Seiyukai 48, 107–108
Hara Akira 155 Iwakura Mission 39
Hara Yonosuke 116 Iwakura Tomomi 39
heavy and chemical industries 85–87, 140 Iwasaki Yataro 41
Heisei period (1988-present): Abenomics
174–175; ageing population 172–173; Japan: a brief history 11–18; external
asset bubble 162–167; earthquakes 172; impacts 5–6
financial crisis 167–170; fiscal activism Japan Development Bank 134
170–171; inequality 173–174; labor shortage Japan Kangyo Bank 77
172–173; Lost Decade (1990s) 166–167; Japan Railroad 69
monetary policy 167–170; small and medium Japan SME Management Consultants
enterprises (SMEs) 176–177 Association (J-SMECA) 143
Henry Dyer 52 Japan–China War (1894–95) 48, 73–74, 189
high growth period 131–132 Japan-China War (1937) 109–111
Hokkaido Takushoku Bank 77, 167 Japan–Russia War (1904–05) 44, 48, 73–74, 189
Honda 146–147 Japan–US Security Treaty 135
Honda Soichiro 147–148 jochu 56
hybrid technology 47, 56–58 Juran, J. M. 140
jusen 167
identity 5–6
ideological shift 135–136 kaizen 139–140
Ikeda Hayato 135 Kakuei Tanaka 146
illiquidity vs insolvency 97–98 Kamiyama Tsuneo 79–80
immigration 173 Kanegafuchi Spinning (Kanebo) 71
imperial family 180–181 Kaneko Naokichi 98–99
import substitution 39–40, 63–64, 85, 188 Kansai Railroad 69
imports, pre WWII 49–50, 51 Kataoka Naoharu 98
income 145, 150–151, 163, 173 Kawasaki Shipbuilding 69
“Income Doubling Plan” 135 keiretsu 125, 140
Industrial Bank of Japan 77 Keynes, John Maynard 105
industrial districts 65–67 Kido Takayoshi 38
industrial policy 141–144 kikan ginko 77, 95, 101
industrial schools 186 Kimura Kihachiro 123
industrialization: impact of wars 189; Japan’s Kobu Daigakko 52–53
unique situation 8–11; Meiji period kogi yoron 37
(1868-1912) 39–41, 46–47, 80–81; plans Koizumi Junichiro 102–103
for 38; pre-conditions for 22–23; proto- Komei, Emperor 35–36
industrialization 33–34 Komiya Ryutaro 157, 159, 159–160
industry, in Edo period 30–31 Konoe Fumimaro 112
inequality 145–146, 173–174 Korea: Japanese expansionism and 43–44,
inflation: Abenomics 175; in Edo period 27; 73–74; relations with, in Edo period 183–184
Meiji period 47, 189; oil shocks and 152; post Korean War 126, 132, 193–194
Korean War 132, 134; post Pacific War 120, Koto Kogyo Gakko 53
122–123 Kuroda Haruhiko 174–175
informal finance 77–78 Kuroda Kiyotaka 39
Inoue Junnosuke 104–105, 108–109, 110
insolvency 97–98 labor: market 55–56; rights 125; shortages
International Monetary Fund 135 144–145, 172–173

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land: expansion of 24–25; ownership 125, 181 Minsei Party 107–109, 110–111, 192–193
language 182–183 Mitsubishi 41, 70, 85
Liberal Democratic Party 146 Mitsubishi Shipbuilding 69
licensing 53, 55 Mitsubishi Trading Company 88, 89
light industry 156 Mitsui Miike Coal Mine 134–135
loans 122–123, 140, 143, 167 Mitsui Zaibatsu 41–42, 70
long-term business relations 139 modernization 13–14
Long-Term Credit Bank 167 monarchy, views of Okubo 42
Lost Decade (1990s) 166–167 monetary debasement 27
monetary expansion 152, 153
MacArthur, Douglas, General 118, 123–124, 126 monetary policy 167–170
machinery industry 65–67 monetary transmission mechanism 168
macroeconomic management, Showa period, money 26–27, 120, 165
Late (1945-1988) 136–138 monozukuri 139–140
macroeconomy: adjustments 137–138; Meiji Mori 88
period (1868-1912) 47–48; post WWI 82–83 Mori Nobuteru 88
Maegawa Keiji 6–8 Morigaki, Sunao 97–100
Maekawa Haruo 159
Maekawa Report 159 narikin 84, 98
management, conflict with shareholders 65 nationalization 127
management consultants 143 Natsume Soseki 44–45
Manchurian Incident 92, 109 Navigation Promotion Law 69
Matsukata Masayoshi 47, 76 New Regime Movement 112
McKinnon, Ronald I. 157 Nicchitsu 87–88
mechanization 62, 63–64 Nine Powers Treaty 91
Meiji, Emperor 43 Nippon Electric Company (NEC) 70
Meiji period (1868-1912): achievements Nissan 85, 87–89
80–81; banking 76–78; capital markets Nixon Shock 154
76–78; constitution 43–44, 186–187; cotton Noguchi Shitagau 87–88
textile industry 62–65, 188–189; electrical Noguchi Yukio 116, 155
machinery 70; exchange rate policy 75–76;
external funds 79–80; fiscal activism Oda Nobunaga 21–22
74–75; foreign bonds 188; government Odaka Konosuke 47, 56–57
38–39, 41–43; historical overview 13–14; Ohno Kenichi 157
hybrid technology 56–58; industrialization oil 124, 150–153
39–41, 46–47; inflation 189; international Okazaki Tetsuji 116
trade 49–50; investment capital 187–188; Oki Electric 70
Japan–China War (1894–95) 73–74; Japan– Okita Saburo 120–122, 127–129
Russia War (1904–05) 44, 48, 73–74, 189; Okubo Toshimichi 38, 39, 42
labor market 55–56; machinery industry Okuma Shigenobu 39
65–67; macroeconomy 47–48; politics in Okuno Masahiro 116
transition from Edo 37–38; railroad carriages Olympic Games 135
and locomotives 68–69; savings 78–79; “Organ Theory of the Emperor” 110
shipbuilding 69; silk industry 59–62; steel 68; Organization for Economic Co-operation and
Western technology 50–55 Development (OECD) 135
Meiroku Zasshi 58–59 Organization of Petroleum Exporting Countries
merchants 36, 62 (OPEC) 150–151
Mieno Yasushi 165 Osaka Spinning (Osaka Boseki Kaisha)
migration 92 64–65, 70
militarism 115, 124–125 Ota, Hiroko 155
military aggression 114–115 outcast class 184
military spending 48, 74, 111, 159, 189 “overloan” 140
military uprisings 109–110, 181
millionaires 41 Pacific War (1941–1945) 113–114, 193
Ministry of International Trade and Industry paper money 27
(MITI) 141–144 parliamentary government 38, 41–43

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peace 125 seisho 41

Perry, Matthew C. 35 Seiyukai: criticism of earthquake bills 98; fiscal
political parties: dismantled during wartime 112; activism 48, 74–75; militarism and 110–111,
militarism and 192–193; in prewar Japan 192–193; overview 107–109
107–109 shareholders conflict with management 65, 71
politics: postwar 146; reform of 80–81; terrorism Shiba Ryotaro 11
109–111; transition from Edo to Meiji 37–38 Shibaura Engineering Works (later Toshiba)
pollution 146 70, 85
population dynamics 33–34 Shibusawa Eiichi 41, 64–65, 70–71
ports 35–36 Shidehara Diplomacy 91–92
Postwar Management 74–75 Shidehara Kijuro 91, 104–105
postwar period: historical overview 14–18; see shindan and shindanshi 143
also Showa period, Late (1945-1988) shipbuilding 69, 134
poverty 173 shortages 152
power industries 85, 124, 134 Shoup, Carl C. 126
price controls 122 Showa period, Early (1926-45): Bank of Japan
price levels 27, 83, 105, 106, 134, 138 demands government guarantee 99–100; Bank
price stability 127 of Taiwan 98–100; banking crises 98, 100–102;
Priority Production System (1947–48) China, invasion of 109–111; depression
123–124, 128 (1930-32) 104–105; Fascism, rise of 105–107;
private dynamism 46, 139–141, 142 Hamaguchi Osachi 102–103; illiquidity vs
productivity improvements 133, 135, 156 insolvency 97–98; Japan-China War (1937)
proto-industrialization 33–34 109–111; Koizumi Junichiro 102–103; Minsei
public borrowing 79–80, 136 Party 107–109; political terrorism 109–111;
public spending 74–75, 111, 152–153, 171 Seiyukai 107–109; social instability 105–107;
public works 26–27 social psychology 114–115; Suzuki Shoten
98–99; war economy (1937-45) 111–114
quality control 140 Showa period, Late (1945-1988): Basic
quality issues 62 Problems Report 120–122; currency flotation
quality-cost-delivery (QCD) 139 154–155; Dodge Line stabilization (1949)
126–127; economic slowdown 150–151;
railroad carriages and locomotives 68–69 economic system reform 155–156; fiscal
rationalization 107, 132–134, 140, 153; see also consolidation/expansion 158–159; high
productivity improvements growth period 131–132; historical overview
recession 84–85, 126 14–18; Honda Soichiro 147–148; ideological
Recovery Financial Fund 122–123 shift 135–136; industrial policy 141–144;
Resource Mobilization Plan 111–112 inflation 119–120, 122–123; macroeconomic
rice cultivation 24–25 management 136–138; Ministry of
rice taxes 25–27 International Trade and Industry (MITI)
Rikken Seiyukai see Seiyukai 141–144; oil shocks 151–153; Priority
rural areas: need to revitalize 172–173; post-war Production System (1947–48) 123–124;
informal employment 119–120; poverty in private dynamism 139–141; rationalization
depression era 105–106; prosperity following 132–134; shortages 119–120; social
silk boom 61–62 transformation 144–146; United States
Russia 44, 48, 73–74, 189 124–126, 156–158; war damage 118–119;
world economy, reintegration into 135–136
Saigo Takamori 38 Siemens 70, 85
Saito Makoto 110 silk industry 59–62
Samurai, age of 11–13, 21–24 silver 27, 76
sankin kotai 28 small and medium-sized enterprises (SMEs)
savings 78–79 55–56, 65–67, 143–144, 167, 176–177
schools of practical engineering 53, 186 social instability 105–107
SDF (Ground, Maritime and Air Self-Defense Social Mass Party 111
Forces) 125–126 social psychology 114–115
Securities and Credit Bank 167 social transformation: economic system and 166;
Security Maintenance Law 191 following port openings 36; in high growth

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era 144–146; Japan’s unique situation 120; liberalization of 135–136; reduction of

8–11, 18–19 barriers 136; surplus 156, 157–158, 159
social unrest 74 translative adaptation 6–8, 56–57
socialist economy 179–180 transportation: in Edo period 28; of natural
Sony 134 resources 112–113; rice and 26;
Special Survey Committee of the Ministry of shipbuilding 69
Foreign Affairs 120–122 treaties: commercial 35–36, 43, 53;
stabilization 126–127, 128–129 friendship 35; Nine Powers Treaty 91; United
stagnation 166–168 States 135
state-owned enterprises (SOEs) 41, 65
steel industry 68, 85, 132, 134 Umesao Tadao 8–10
stock exchanges 78 United Kingdom 44
subsidies 69, 122 United Nations 135
success, conditions for Japan’s 8–11 United States: demands for treaties 35; Iwakura
Sumitomo Zaibatsu 41–42 Mission to 39; macroeconomic policy
Suzuki Shoten 98–99 154; in postwar Japan 118–119, 124–126;
Shidehara’s relationship with 91–92; trade
Taisei Yokusankai (Imperial Rule Assistance friction 156–158; trade with 49–50, 70;
Association) 112 treaties with 132
Taisho Democracy 92–93
Taisho period (1912–26): automobile production Vietnam 113
88–90; earthquake bill problem 96–97;
exchange rate volatility 90–91; heavy and war damage 118–119
chemical industries 85–87; kikan ginko 95; war economy (1937-45) 111–114
recession (post WWI) 84–85; Shidehara Washington Conference for Naval Disarmament
Diplomacy 91–92; Taisho Democracy 92–93; 91
World War I impact 82–83; zaibatsu 87–88 Watanabe Jotaro 110
Taiwan 43, 48 welfare 171
Takahashi Kamekichi 97–100 Western Electric 70
Takahashi Korekiyo 100, 102–103, Westernization 42–43, 44
108–109, 110 Westin House 70
Tanaka Hisashige 70 Westinghouse 85
Tanaka Kakuei 152–153 women, employment of 56, 65
Tanaka Keiichi 24 World Bank 135, 136
tariff protection 58–59, 68, 85–87, 135–136 world economy, reintegration 135–136
taxes 25–27, 171 World War I impact 82–83
tea production 61
technology: adapting to Japanese requirements Yamagata Aritomo 73–74
53; hybrid 56–58; indigenous 46–47; learning Yamaichi Securities 167
of skills 55–56; transfer of Western 50–55, 67 Yamanobe Takeo 64–65, 70–71
telephone network 70 Yawata Steel Works 68
Teranishi Juro 78–80 Yokohama merchants 36, 62
Tokugawa Ieyasu 21, 24, 181 Yoshida Shigeru 124
Tokyo University 52 Yoshikawa, Hiroshi 141
Tokyo Watanabe Bank 98 Yoshino Sakuzo 92–93
Tominaga Kenichi 18–19 yunyu boatsu (import substitution) 39–40,
Toyoda Kiichiro 89–90 63–64, 85, 188
Toyota 88–90, 134
Toyotomi Hideyoshi 21–22 zaibatsu: definition 41; new in 1920s-30s 87–88;
trade: deficits 156; friction with US 156–158, proposed breakup of 125
159–160; international 35–36, 49–50, 51, zero interest rate policy 168

207