Pursuing prosperity: Address to the Ukrainian Academy of Sciences

This is the abstract of a keynote address delivered I made at a conference organized by the Ukrainian Academy of Sciences in Kiev on November 13, 2008.

One of my most vivid childhood memories was watching Sputnik streak across the night sky in Ireland in 1957. I now know that Ukraine was not only the homeland of Sputnik’s creator Sergey Korolev but was the source of much of the most advanced work on the Soviet space program. Ukraine’s glorious record in aerospace suggests that it will be more than averagely successful in its industrial development plans for the twenty-first century.

If I have one message for Ukrainian economic policymakers it is this: don’t heed Western ideologues who argue that radical deregulation and privatization are the keys to prosperity. Although many other observers have been persuaded of this point in the light of the worldwide financial crisis that began two months ago, I have consistently been speaking out against laissez-faire ideology since the early 1990s. Before I moved to Japan in 1985 I had been a strong believer in laissez-faire but more than twenty years of observing both Japan and China, which are unquestionably two of the world’s most successful economies, has persuaded me otherwise. Neither Japan nor China has any respect for Western economic ideologues and it is clear that precisely for that reason they have consistently outdone Western nations in their economic performance.

For a start in both Japan and China, economic outcomes are much more heavily influenced by government intervention than is generally acknowledged in the English language media.

All talk about a lost decade in the 1990s notwithstanding, Japan is now clearly one of the world’s richest nations. Its wage levels are among the world’s highest, and it enjoys the longest life expectancy of any major nation — up nearly fifteen years since the late 1940s. Perhaps most important for present purposes, it has boosted its dollar-denominated current account surplus nearly four times since 1989, the last year of its 1980s boom.

Despite its high wages and the fact that South Korea and Taiwan have massively improved their competitiveness in the last two decades, Japan dominates world markets in virtually every industry it contests. It even runs a bilateral surplus with greater China. By contrast the United States and Britain — the two major nations that have gone furthest in embracing extreme free-market ideology — are running large and rapidly rising trade deficits. Without systematic support from surplus nations, both the U.S. dollar and the British pound would long since have fallen to a fraction of their present value against major East Asian currencies.

Japan’s economic system is not capitalism but rather a hybrid in which both market forces and government guidance are blended in pursuit of widely agreed policies. Private investors have little if any influence over how major Japanese corporations are managed. Although the banks are nominally private, they are tightly controlled by the Ministry of Finance, which is by far the most important agency of Japanese power.

The key discipline for corporate Japan is not the stock market but the lifetime employment system. A Japanese chief executive’s first responsibility is not to generate short-term profits but rather to ensure that employees recruited today will still have secure well-paid jobs thirty years from now. Any corporation that is forced through its own fault to lay off permanent workers is a self-evident disgrace and the top managers responsible can expect to be treated as pariahs.

China’s economic strategy is much like Japan’s except that China is much more frank in showing its contempt for Anglo-American ideology. Government leadership of the commanding heights of the economy is undisguised, and in particular state entities maintain dominant shareholdings not only in the banking system but in many key industrial corporations. It is true, of course, that Western corporations are heavily involved in the Chinese economy but they are not permitted a free run: their access to the local Chinese market is restricted and any access they get is generally a quid pro quo for transferring some of their most valuable manufacturing technologies to Chinese soil. Even then they are expected to export much if not most of their output, rather than sell it in China.

At the heart of both the Japanese and Chinese systems is a commonsense observation: if you give workers better tools and better know-how, they will produce more. Much of the peculiar structuring of these economies is geared to building up capital investment and know-how at a far faster rate than can be achieved under classic free-market conditions. A basic policy is to suppress consumption and thereby to boost the savings rate. The resulting huge flows of capital are then channelled via state controlled banks towards those corporations deemed most likely to make effective use of the money in boosting productivity.

How is consumption suppressed? The most obvious method is via tight controls on consumer credit. Less obviously the economy is regulated to make it physically difficult for consumers to consume (for instance, by severely limiting access to imported luxuries and by tightly restricting the supply of housing space). Sometimes the resulting savings arise in the hands of consumers. In many cases, however, they accrue to corporations in the form of super-high retained profits. Such profits are then used to build national muscle in targeted industries. A typical arrangement is that cartels keep consumer prices high, thereby allowing member firms to earn the necessary high returns to keep investing at a fast pace in the export side of their business. Cartels are generally given free rein provided only that they serve the national goal of boosting productivity. Although Western theorists argue that cartels make for slack management and general inefficiency, both China and even more so Japan have shown that such problems can be minimized, with the result that on balance East Asian-style cartels play a strongly positive role in growth.

One of the most noticeable aspects of economic policy in both China and Japan is the degree to which manufacturing is emphasized. This is not an accident. Manufacturing lends itself to a strategy of ever increasing capital intensity. Moreover valuable know-how acquired in manufacturing is generally easier to keep secret than know-how in service industries. Perhaps most important of all, manufactured goods generally need less adaptation for different cultures around the world and thus are much more widely exportable than services.

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