Aug 7, 2009

Why Japan Is So Slow

Today I talked with a correspondent of The Economist about the problems of Japan. He asked me why Japan is so slow to change in such self-evident problems as flexible labor market, active capital market, and globalization. It's very difficult because these problems are not self-evident for Japanese politicians and businessmen.

The core of the difficulty is the labor market. So-called lifetime employment and seniority wage is losing substance, but still persist. And temporary workers account for 1/3 of all the workforce, which the OECD calls "dual labor market". This is a collusion of managers and labor unions to protect their jobs by excluding young workers from the labor market. Since it's practically impossible to fire "normal workers", companies change workers to temps.

The OECD recommended Japanese government to make labor market flexible by "reducing the worker protection". But the government is going to eliminate short-term temps. The Democratic Party of Japan proposed a bill to ban the temp workers in manufacturing industries. It will only make temps unemployed, but it's politically incorrect to make firing workers easier.

The problem of capital market is related to that of labor market. Typical Japanese worker is employed for life and his salary increases by age. So his productivity is higher than his salary in the younger age, and lower in the older days. In other words, he "saves" his salary to the company in the younger age and "draw the deposit" when he is old. If he quits the company at the age of 40, he would lose 100 million yen ($ 1 million) in the lifetime salary. So it isn't a good decision to start up a company if you can't earn more than 100 million.

And the fundamental problem is the industrial structure: Japanese manufacturers were super-efficient in the integrated products such as cars and VTR that need complicated coordination. But the Information Revolution made products "modular" and standardized. The parts of PC are made in various countries and distributed globally, so Japanese advantage of coordination disappeared in the IT industries.

But why aren't they good at coordinating global division of labor, while they are so good at coordinating keiretsu relations with many companies? It's because the keiretsu coordination is based on implicit contracts between suppliers and makers. There are few problems of moral hazard due to asymmetric information, because they know each other closely. Global partnership is a strategic relation based on explicit contracts. Japanese managers aren't good at strategic decisions to profit from contracts, because they are promoted by consensus and cooperation.

All these problems stem from the long-term relation between managers and workers, suppliers and makers, which was efficient when Japan was growing steadily and the future was always better and brighter. In terms of game theory, such long-term relation is efficient when the players of a repeated game are patient and the rent from the relation is large.

Now the game is over: when the future is not so bright, the payoff of "defection" would be greater than that of "cooperation". The long-term relation became inefficient and fragile. It also changed politics: the Liberal Democratic Party has redistributed the rent of growth, but the source of the rent dried up. So voters want change, but they don't know what to change. And the DPJ doesn't know either. We can't expect too much from them. Real change would occur when the LDP is divided after it loses the election, and the "third party" emerges.

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