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In the post-war period pre-1990, Japan’s economy roared ahead in what was then known as the Japanese economic miracle. Whether boom or bust, the Japanese economy consistently returned GDP growth higher than the OECD average. Entire forests were destroyed to print the books, articles and newspapers writing how Japanese collectivism was the way to the future. Much of this was racist rubbish, propagated by sociologists (the poor racist cousin to the noble cultural anthropologist), about how the Japanese clung to ‘feudal’ beliefs centred around honour and a sense of community. The worker felt feudal ties to his employer; the employer reciprocated by loyalty to the worker.

The same could be said of the Japanese banking system. The keiretsu system involved one main bank sat at the centre of a corporate group to which it was the primary lender. The bank held shares in most of these companies and provided a financial monitoring system and served as a way to bailout subsidiaries in danger of failing.

The same again could be said of other Japanese corporate groups. Massively diversified conglomerates spanned everything electronics, plumbing and manufacturing. This allowed cross-fertilisation of ideas, contributed by employees who would spend their lives working for that one company.

As any economically-literate person can tell you, this edifice came crumbling down in the 1990s when the asset bubble popped and everything came tumbling down. It is easy to now scoff at the idea that collectivism (which, as any good Republican can tell you is code for socialism) could ever have been the future for America and the developed world, but those ideas had real currency.

What’s interesting is that even modern analyses show that these structures were beneficial during the good times. Reduced agency costs, monitoring costs etc allowed firms to overcome information asymmetry – particularly when a firm is collapsing and the incentive to hide information is particularly acute. Of course, these same keiretsu structures were the cause of the ‘Lost Decade’ of economic growth from 1990 to at least 2003 (yes, that is two decades). So, in a perverse way, those people in the 1980s were right.

In a way, this is not surprising. Orthodox economic theory, originating with the Coase theory, says that a firm will choose to in-source a particular activity rather than outsourcing it to another firm if transaction costs are too high. This is simply another application of that principle in an unusual context. The keiretsu structure minimises transaction costs (monitoring costs, information asymmetry etc) during the good times but it increases transaction costs in bad times due to the perverse incentives it creates.

Those Japanese firms adopting the keiretsu model misjudged its economic effects, as firms often do. The capitalist model encourages firms to take such risks, knowing that if they fail they will be held accountable by the market. The error in Japan was that government intervention propped up these keiretsu firms during the boom years and also during the financial crisis rather than permitting them the discipline of the market from correcting their misjudgment.

So there. The free market beats collectivism once again.


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