From Star to Dog …and Back? Changing Western Perspectives on Japan’s Business
System
D. Eleanor Westney, MIT Sloan School of Management
Presented at Workshop for “The End of Japan?” organized by the Centre for Innovation
Research, Hitotsubashi University
Japanese version published in Medo in Japan wa owaru no ka? (Tokyo:Toyo Keizai
Shimbunsha, 2010)
Few analysts of Japan’s economy and business system were surprised by the
collapse of the “Bubble Economy” in 1990-91. No one, however, expected the depth and
duration of the economic doldrums that followed. As Japan’s economy slid downhill, so
did the attention paid to Japan in the rest of the world: after 1990, interest in Japan’s
business system gradually eroded among students, businesspeople, and academic
researchers in North America and Europe. By the late 1990s, the decade-long flood of
publications trying to explain Japan’s economic success to Westerners had turned into a
trickle of books and articles trying to explain its failure.
The government’s economic policies were the focus of much of the criticism.
However, Japan’s business system, so widely regarded in the 1980s as a model for 21st
century capitalism, also came under attack. Ironically, once the extent of Japan’s
economic difficulties became apparent by the mid-1990s, the aspects of the Japanese
business system that were most admired in the late 1980s and early 1990s quickly came
to be identified as barriers to much-needed corporate restructuring. Most of Japan’s
Western critics, especially those in the business press, strongly recommended that Japan
abandon many features of its distinctive business system and adopt more market-driven,
American-style organization and strategies.
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This rapid re-labeling of “Key Success Factors” as “Key Failure Factors”
produced remarkably little reflection among Western analysts of Japan. Few asked
whether something went wrong not only with Japan’s business system but also with our
analyses of Japan’s earlier success. In his chapter in this volume, Michael Cusumano
indicates two reasons for this. One is a long-standing recognition among many Western
analysts of Japan that its business system had vulnerabilities as well as strengths, and that
those vulnerabilities would become more significant should a major economic downturn
occur.1 A second reason is a widespread belief that changes in Japan’s business
environment altered the conditions for success. In other words, the patterns that once
contributed to competitive advantage no longer worked effectively. Whatever the
validity of this belief, it carried the comfortable implication that no serious
reconsideration of the analyses of the 1980s was necessary.
Nevertheless, the speed of the shift in the evaluation of the patterns of Japan’s
business system should elicit some reflection. After all, how can the Western business
and academic communities today be so sure that their current critiques of the Japanese
business system are any better founded or more enduring than their certainty in the 1980s
that Japanese firms constituted a serious challenge to Western business models and a
model for the next century? Moreover, Japan may have been the first major advanced
society to experience a sudden shift in the apparent effectiveness of its business system,
but it is unlikely to be the last. Is there nothing to be learned about how to analyze
business systems from the sudden shifts in the Japanese case from “key success factors”
to “key failure factors”? This chapter takes a closer look at the dramatic change in
Western (primarily Anglo-Saxon) evaluations of the Japanese business system between
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the 1980s and the post-Bubble years, the rationales for the shift, and the potential
weaknesses in our approach to analyzing business systems that such analysis suggests.
Elements of the Japanese Business System: From Key Success Factors to Key
Failure Factors
During the past decade, both Japanese and Western writers have generated long
lists of flaws in Japan’s business system. The employment system, rewards and
incentives, governance, the vertical keiretsu structure of the firm, firm-level strategy,
close business-government cooperation – all of these have been identified by a range of
critics as features of Japan’s business system that had to change if Japan was to emerge
from its economic doldrums. However, in the 1980s and even the early 1990s, precisely
those features were widely credited with the spectacular rise of Japanese competitiveness.
Table 1 about here
This rapid shift in the evaluation of so many of the elements of Japan’s business system
(summarized in Table 1) should raise questions: Why were they seen as key success
factors in the 1980s, and what caused so many commentators to move them from a list of
Key Success Factors to a list of Key Failure Factors? And what, if anything, does this
sudden re-classification reveal about the analysis and evaluation of business systems?
Employment and Incentive Systems
The employment system and the incentive systems in Japan’s large companies
were the first features of its business system to be identified as distinctive (compared to
the United States especially). Since their first portrayal in English by James Abegglen in
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1958, they have also been the most-studied. The key aspects of the employment system
were “permanent employment” and the reliance on internal labour markets. The mostobserved aspects of the incentive system have been (1) seniority-based promotions and
pay, and (2) an egalitarian distribution of rewards through a tight compression of pay
levels from the top to the bottom of the company and company-wide bonuses tied to
corporate performance (which were calculated on a single standard rate whatever the rank
of the recipient).
In the 1980s, most analyses argued that these systems were important causal
factors in Japanese industrial success. The employment model encouraged high levels of
investment within the firm in employee training and fostered employee willingness to
engage in productivity and quality improvements. The commitment to provide jobs for
employees was also seen to foster a strategic drive to develop new, related businesses.
More detailed analyses also recognized that considerable flexibility was provided in both
the employment and reward systems by the dispatch of employees to subsidiary and
related companies within the vertical group, where reward levels were lower than in the
parent company.
The incentive system had more critics, but in the 1980s it was widely credited
with reinforcing the “enterprise as community” model, which meant in part cooperative
labour-management relations, and the willingness of employees at all levels to share the
costs of adjustment in downturns. In several Western accounts, the egalitarian
distribution of rewards was seen as one of the key success factors in the success of the
quality movement in Japanese firms. Economists also pointed out that although firms
probably overpaid senior employees relative to their productivity, they were able to
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underpay younger workers. Firms thereby were able to maintain an economically
sustainable demographic structure, especially as long as the workforce continued to be
relatively young and Japanese firms were able to maintain a comparatively early
retirement age of 55.
Economists in particular tend to view productivity as determined by “human
capital” – individual skills and knowledge – which is not closely linked to seniority and,
in a rapidly changing technological environment, might even be negatively related to it.
In a corporate world in which personal networks are of critical importance in getting
things done, however, seniority may be more strongly related to productivity than most
economists realize. The effectiveness of the reward system based on seniority in Japan
has been its link to “social capital”: that is, to the breadth and effectiveness of an
individual’s social networks both inside the company and with key outside constituencies
such as customers, suppliers, and subsidiaries.
However, the persistence of Japan’s economic doldrums in the 1990s changed the
evaluation of both the employment and incentive systems. Few analyses revisited past
assessments of their virtues; instead, most adopted the position taken by an editorial in
the prestigious business journal The Economist (with the unambiguous title, “Remade in
Japan: Permanent employment may have to go if Japan’s recession is not to stay”): “For
all its past virtues, lifetime employment is now a hindrance.”2 Such critics asserted that
Japanese firms should abandon the permanent employment model, because, in the
protracted downturn in revenues, they needed to be able to shed employees to cut costs
and to take full advantage of the productivity potential of the Information Technology
revolution of the 1990s. Logically, it is possible that Japanese firms could have coped
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with the recession in the domestic market not by a radical re-design of the employment
system but with a gradual readjustment of their demographic structure (which, in
retrospect, seems to have been what they actually did). Western critics insisted, however,
that the employment system was inherently flawed because firms also needed to be able
to hire in outside experienced workers to provide the new skills required by technological
change and the demands of global competition (particularly in financial services).
Similar objections to the incentive system were also widespread. Although Porter
and Takeuchi focused in their 1999 critique, “Fixing what ails Japan”, on the flaws in
firm-level strategy, they also asserted that at least some of the shortcomings in strategy
were the fault of the incentive system:
“Companies must move from an excessively egalitarian, seniority-driven model to
one where doing things differently is rewarded in compensation, advancement,
and opportunities for entrepreneurship.” (Porter and Takeuchi 1999: 81)
For Porter and Takeuchi, the fundamental flaw in the Japanese incentive system was that
it did not link individual performance to business profitability. The belief that
“profitability is the only reliable measure of sound strategy” (p. 80) is a fundamental
assumption not only for Porter and Takeuchi but for most of the Western writing in the
1990s on the Japanese business system.
Another issue concerning the reward system was less often articulated but
strongly influenced many critics. In any system, salaried executives are much more
likely to resist a takeover or merger than executives who have significant very lucrative
shareholdings in their firm, shares that yield very large windfalls for the top executives
when the firm is acquired. The reward system, like the employment system, constituted a
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barrier to the wider resort to M&A in Japan. At the root of such critiques of the Japanese
incentive and employment systems, therefore, were their effects on firm-level strategies.
Strategy
Throughout the 1980s, Japanese firms were widely seen as changing the rules of
the game in business strategy. Their focus on long-term strategic goals – growth, market
share, the development of new businesses – rather than on near-term profitability alarmed
American executives. Americans expressed fears that their firms were at a competitive
disadvantage because performance pressures from the U.S. stock market meant that they
could not match the long-term strategic commitments of their Japanese competitors.
Other admired elements of Japanese strategy were more easily emulated. One was the
active monitoring and matching of the strategic and tactical behaviour of competing
firms. In the mid-1980s, Japanese competition was the major factor in the rapid growth
of competitor analysis in the United States, both in consulting firms and in internal
corporate staff. This growth was sparked partly by the need to know more about specific
Japanese competitors. It was also stimulated by the belief that Japanese firms did a better
job of tracking and understanding competitors, and that this could provide a strategic
competitive advantage for the firm that did it rapidly and effectively.
Another aspect of Japanese strategy that was widely envied and emulated was the
focus on operational excellence, exemplified by Japanese leadership in quality in
manufacturing. It took several years, as Robert Cole pointed out, for American firms to
recognize the competitive advantage this gave Japanese firms in cost and efficiency, and
even more time to develop their own quality systems (Cole, 1999). By the late 1980s,
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however, most U.S. manufacturing executives acknowledged that the Japanese
superiority in operations was a core competitive strength.
The Japanese use of strategic alliances was another aspect of the business system
that challenged the strategic paradigms of Western firms. Japanese firms had built
capabilities in building and using strategic alliances both in their home market and
abroad, whereas Western firms seemed to prefer either mergers and acquisitions or equity
joint ventures (preferably with majority ownership). Alliances were seen to give
Japanese firms more flexibility and to allow a wider range of opportunities for learning
from other firms than the strong Western preference for internalization and ownership.
By the late 1980s, one of the most famous cases of Japanese use of strategic alliances (the
case of JVC, in which the company used alliances to dominate the manufacture of VCRs)
had become a staple teaching case in core strategy courses in most U.S. business schools.
Another widely admired element of Japanese business strategy was the reliance
on organic growth to expand the scope of the firm. One of the most influential Harvard
Business Review articles on strategy, Prahalad and Hamel’s “The Core Competence of
the Corporation”, written in 1990, argued that Japanese firms exemplified the ability to
develop new businesses internally by combining and building on different competences
located in different parts of the firm:
“The problem in many Western companies is not that their senior executives are
any less capable than those in Japan nor that Japanese companies possess greater
technical competences. Instead, it is their adherence to a concept of the
corporation that unnecessarily limits the ability of individual businesses to fully
exploit the deep reservoir of technological competences that many American and
European companies possess.” (1990: p. 81)
The dysfunctional Western concept of the corporation which Prahalad and Hamel
castigated was the “SBU concept”, in which the corporation is a portfolio of autonomous
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businesses, controlled by corporate management through the allocation of capital based
on the unit’s current and potential contribution to profitability. Of the 12 positive
examples of the alternative “core competence” concept of the corporation that Prahalad
and Hamel provided, 9 were Japanese companies. The sting of such dominance was
offset only slightly by the inclusion of 1 company each from the U.S., the U.K., and
Europe. In spite of this pronounced Japan flavour, the article is widely used even today
in business school strategy courses.
By the mid-1990s, however, strategy was increasingly seen as a critical weakness
of Japanese firms. Stagnation in the domestic economy shifted the focus of much of the
analysis to the apparent inability of Japanese firms to reduce costs to offset declining
revenues. The focus on long-term goals (growth, market share, and new business) at the
expense of current profitability seemed much less admirable when profits declined into
losses and there were few observable achievements in any of the long-term goals. Rapid
followership was once again criticized, as it had been in the 1960s, as leading to
excessive competition that quickly eroded profitability for all firms in the market. And as
American, European, Korean, and Taiwanese firms narrowed the quality gap with their
Japanese competitors, the Japanese focus on operational excellence was seen to yield
decreasing returns, as Porter and his colleagues pointed out. Moreover, the resurgence in
the U.S. and Europe of M&A as a strategy for re-structuring industries domestically,
expanding global reach, and extending the technological capabilities of the firm made the
lack of Japanese experience with and aptitude for M&A seem to be a major handicap.
In short, the elements of strategy that were viewed as Japanese strengths in the
1980s were increasingly seen as serious weaknesses in the 1990s. The justification for
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this reversal was that the competitive environment had so changed that Japanese
strategies were no longer effective at producing competitive advantage. According to
these critics, increased competition and slow growth demanded strategies that delivered
better short-term financial performance, especially speedier reduction of costs, and less
reluctance to acquire or be acquired.
Governance System
The adoption of new strategies in the 1990s, however, was increasingly seen as
constrained by Japan’s corporate governance system, which had been viewed in the
1980s with envy by American managers and with admiration by many critics of
American shareholder capitalism. Although the view that the interests of shareholders
should be the primary driver of the activities of the firm has grown in strength in the U.S.
since the 1970s, it has not been without its critics. Advocates of the principal alternative,
the stakeholder model, saw the Japanese firm’s prioritization of the interests of
employees over those of shareholders as proof that stakeholder capitalism was just as
effective in creating economic value as the shareholder model – and could perhaps be
even more effective.
The Japanese firm’s orientation to employees as key stakeholders was
underpinned by an internal board of directors made up of past and present executives,
rather than the U.S. model of an external board of outsiders appointed by the CEO to
safeguard, at least in theory, the interests of shareholders. By the late 1980s, economists,
perhaps driven by a functionalist logic that dictated that any enterprise system with such
impressive performance had to have an effective governance system, asserted that the
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main bank filled the role of external watchdog on the firm’s investment decisions. Little
of this writing was grounded in empirical research: the most-cited case to validate the
“bank as monitor” model was the mid-1970s intervention in Mazda by the Sumitomo
Bank, one of the few detailed case studies of bank-initiated turnaround (Rohlen, 1983).
However, the corporate excesses of the Bubble economy, in which firms engaged
in highly risky financial operations and over-invested in production capacity, cast a cloud
on the corporate governance system. The company insider board meant that there were
few strong external controls on decision-making in Japanese firms. In addition, by the
late 1990s, a revisionist literature on the role of the main bank in the 1980s demonstrated
that the dual role of banks – as shareholder and as lender – tended to distort their
watchdog functions: banks were too eager to lend money to their corporate clients, both
to expand their own business and to defend their role as lead bank (e.g. Scher 1997). In
the absence of a vigilant main bank monitoring role, the Japanese governance system, in
this critique, lacked sufficient constraints on the decisions of top managers. In the late
1990s, the business press (in Japan as well as in the Anglo-Saxon West) was urging
Japanese firms to turn to an American-style corporate governance system, with smaller
Boards composed of outside directors.
The rationale for the smaller Board was primarily that the collective decisionmaking processes of a large board that included several former senior executives made it
difficult for the CEO to impose radical changes, changes that would inevitably be taken
as implicit criticisms of previous management. As The Economist put it in its 1999
survey of business in Japan,
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“The best hope for Japanese companies is to change the way they are run…In big
companies, decisions generally percolate up from the middle or even the bottom
rather than being handed down from the top.” (pp. 9-10)
The article called for Japanese firms to re-structure their boards and compensation
systems (through stock options) to increase leadership from the top. Ironically, even as
these critiques were being written, American companies were being assailed in the
business press for being too top-down, for being too lavish with stock options, and for
having boards that were hand-picked by the CEO. After the turn of the century, the calls
for corporate governance reform in Japan along American lines were somewhat muted by
the obvious failures of U.S. corporate governance in the corporate scandals of the early
twentieth century – although financial analysts and foreign shareholders continue to push
for greater leadership from the top in Japanese companies.
The Vertical Keiretsu Structure
The vertical keiretsu structure was yet another aspect of the Japanese business
system that went from the Key Success Factors list to the dustbin of Key Failure Factors
in a very short time period. In the 1980s, it had taken U.S. businessmen and researchers
some time to comprehend the difference between the corporate structure of the Japanese
manufacturing firm and that of the U.S. industrial corporation. With Japan’s vertical
keiretsu structure, the parent or core firm concentrated on a focused set of high-valueadding activities, and relied on a dense network of affiliated firms and subcontractors for
the performance of lower-value-added activities and activities regarded as less crucial for
competitive advantage. This model, as expounded by the business press as well as by
business researchers, was praised for its enhanced ability to control costs and to improve
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quality (e.g. Dyer and Ouchi 1993) and its strategic focus (Hamel and Prahalad 1990).
Strong human networks provided the basic glue of the vertical keiretsu, a system that
facilitated coordination and speeded up joint development projects (Nishiguchi 1994), but
which proved difficult for American firms to emulate (Dyer 1996a).
By the 1990s, the term “keiretsu” was increasingly accepted in the U.S. business
literature. For example, the lead article in a 1990 Harvard Business Review was entitled
“Computers and the Coming of the U.S. Keiretsu” (Ferguson 1990).3 Increasingly,
however, American writers employed the term “extended enterprise” to describe the
general model inspired by the vertical keiretsu.
By the late 1990s, however, Japan’s vertical own keiretsu model was increasingly
criticized for being less flexible than the extended enterprise that had developed in the
U.S. in response to the Japanese challenge. The stronger relationship-specific ties that
bound Japanese firms to their network of suppliers, once portrayed as a source of
competitive advantage because they were so hard for non-Japanese firms to emulate,
were seen as generating rigidities that kept firms from switching to lower-cost and more
capable alternatives. The vertical keiretsu was also assailed as a “non-tariff barrier”
making it difficult for foreign firms to penetrate Japanese industrial markets, despite their
ability to offer lower prices. Moreover, instead of improving transparency, the vertical
keiretsu was increasingly seen to be a vehicle to conceal poor performance: Japanese
parent firms were accused of exploiting their networks to hide costs and artificially
improve their own financial performance (rather as Enron and other firms used offbalance sheet partnerships in the U.S.). Finally, financial critics increasingly objected to
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the “unproductive” tying-up of investment capital in parent company shareholding in
their wide array of subsidiary companies.
Business-Government Relations
Business-government relations have been the most controversial aspect of Japan’s
business system for over three decades. Scholars and pundits have agreed that the
networks linking Japan’s large business firms and the state bureaucracy have been
numerous and multi-faceted, and have provided dense information flows between state
regulators and policy-makers and Japan’s business leaders. Where they have quarreled,
sometimes acrimoniously, has been over how important those linkages have been to the
performance of Japan’s firms and which side – business or government – played the
dominant role.
One rare point of agreement across the 1980s and 1990s was that Japan’s
business-government relations had to change: the dense informal connections had to be
replaced by formalized procedures and “transparent” interactions. The rationale for
demanding change, however, shifted dramatically across the two decades. In the 1980s,
the relationship was widely seen as giving Japanese firms an unfair competitive
advantage, because the dense human networks were extraordinarily difficult for foreign
firms entering Japan to penetrate and because the state saw itself as the protector of
Japan’s business system. In the 1990s, however, the reason for demanding change was
that the relationship was a serious competitive handicap for Japanese firms, encouraging
banks and firms to allocate resources unproductively and holding back corporate restructuring. In other words, in the 1980s, demands for change were driven by a belief
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that Japan’s firms had an unfair advantage because of the relationship; in the 1990s, they
were driven by the belief that the recovery of Japan’s economy and business firms was
being hurt by the relationship.
Summary
Analyses of the Japanese business system did not significantly re-direct their
attention from the features that were the targets of such admiration in the 1980s to other,
less positive features that had been neglected in earlier analyses. The same features were
the focus of attention in the 1980s and the 1990s. A striking and rapid change occurred,
however, in how these features were evaluated. The analyses of the 1990s portrayed the
structural elements of the business system not as contributing to success but as factors in
the failure of the economy during the “lost decade” of the 1990s and features that needed
to change if Japan were to recover.
What kind of change was, however, often framed differently, depending on the
critic’s viewpoint and discipline. For economists, necessary change was clearly towards
greater reliance on markets, especially external and intra-firm labour markets and, most
importantly, markets for corporate control (i.e. the buying and selling of firms
themselves). More reliance on markets ensures, in the economic paradigm, more
efficient allocation of resources. Finance experts and business analysts certainly agreed,
but tended to put the emphasis on the need for change in the market for corporate control
(change that would open up enormously profitable opportunities for investment banks).
Business scholars, especially those in strategy, did not disagree with the economic
insistence on the need for markets, but their critiques had a different focus: Japan’s
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business system drove firms to adopt “wrong” strategies. The employment and incentive
systems and the vertical keiretsu networks favoured incremental strategies that enabled
the firm to maintain its commitments to employees and affiliated firms, even at the
expense of profitability and of winning distinctive competitive advantage. Although
political scientists paid less attention to business system changes than to public policy
reforms, they often framed the principal failing of the business system in terms of the
barriers to downsizing that its employment and keiretsu systems created, which in turn
led to the willingness of business leaders to support (or at least not to oppose)
government policies that slowed industry re-structuring.
The critics agreed, however, that the principal features of the Japanese business
system had become “failure factors” that had to change if the Japanese economy was to
recover. At best, according to the critics, they were barriers to much-needed restructuring. At worst, they were direct causes of the economic problems, because they
led to the inefficient allocation of resources first during the bubble years and then during
the “lost decade”. Many Western critics (and some Japanese) re-labeled the entire
Japanese business system as a legacy of the past – once successful but never again.
Reflections on the Analyses of the Business System in the 1980s
Looking back on what was written about the Japanese business system in the
1980s from the perspective of today, we can identify some problems in the analyses that
were not apparent at the time, including selection bias, idealization, the tight coupling of
business system patterns and macro-economic performance, and an emphasis on the
international dynamics of change as opposed to the domestic.
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The analytical weakness that has been most frequently acknowledged in the
Japanese business studies community is “selection bias”: that is, the focus on
manufacturing and the relative lack of attention to the financial services, construction,
and other service industries that proved to be the Achilles heel of Japan’s business system
in the 1990s. The abstract model of the Japanese business system constructed in the
1980s was built on foundations laid by a small number of early studies of Japanese
factories. Most notable of these were James Abegglen’s The Japanese Factory in 1958
and Ronald Dore’s British Factory Japanese Factory in 1973 (which to this day remains
unequalled in its careful and detailed comparative analysis and the impact of its theorybuilding), but a number of other empirical studies of factories and factory-workers in the
1960s were also important building blocks of the 1980s models (e.g. Cole 1971, 1979;
Marsh and Mannari 1971, 1972; Whitehill and Takezawa 1968).
The focus on manufacturing in these early studies was understandable. The
modernization paradigm, which dominated social scientific studies of Japan until well
into the 1970s, saw industrialization as the engine of economic growth and the factory as
the epitome of modern organization. The early focus on the factory rather than the firm
as a whole fed the 1980s focus on production (augmented in the late 1980s by research on
product development), at the expense of the firm’s support functions such as
administration, finance, sales, and so on, which proved to be much less efficient. It also
meant that there was little early attention to service industries or to non-factory-centred
industries such as chemicals and pharmaceuticals. This focus on manufacturing meant
that when popular attention turned to Japan in the 1980s, the natural tendency to
concentrate on the most successful firms and industries had relatively little detailed social
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science research on the other sectors of the economy to provide the base for an alternative
and more balanced view.
The Japanese business literature of the 1980s also provided the grounds for a later
backlash by idealizing Japanese patterns. The greatest expansion in publishing on
Japanese business was not due to a sudden expansion in the number of Japan experts in
the American universities and business press, but because of growing interest in Japan on
the part of experts in various subfields of business. Many of them saw in Japan a way to
justify changes that the authors had long urged on managers in their home countries.
Titles such as “Japan – where operations really are strategic,” written by an operations
research professor (Wheelright 1981), and The New Competition: What Theory Z didn’t
Tell You about Marketing, written by three marketing experts (Kotler et al, 1985), are just
a couple of examples of the many works that held up Japan as a model of how things
should be done. In some cases, Japan was genuinely a model and a source of inspiration;
in others, the discussion of actual Japanese practices was rather sketchy and highly
idealized. In both cases, however, the Japanese patterns presented were the “best-inclass” stories, and the presentations often focused on how things were supposed to work
rather than on how they actually worked – or on what difficulties or problems arose as a
result. Even many Japan experts, responded to the widespread demand for explanations
of Japan’s competitive success by emphasizing the best of Japan’s practices, rather than
by insisting on a nuanced appreciation of the strengths and weaknesses of the system.
This idealization led to a lack of attention to the weaknesses of the Japanese system, or to
cases in which the ideal patterns were not actually observed. It also opened the door even
in the 1980s for a “de-bunking” literature that presented the gap between the ideal and the
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actual (a gap characteristic of any social structure) as an indictment of the entire system
(e.g. Kamata 1983).
Finally, a major problem with the 1980s research, and one which is still with us
even today, is the tight coupling between the business system and macro-economic
performance.4 Certainly for many of those writing about Japan’s business system during
that decade, pointing to the nation’s economic success as the rationale for paying
attention to its business model was a common method of justifying their research. The
insistence on the link between Japan’s business system and its economic and competitive
performance was more than simply a ritual of legitimation, however. Japan’s patterns not
only differed substantially from those in the U.S. and other major western systems; they
also violated some of the most deeply embedded assumptions about how business should
be organized. Lester Thurow put this very clearly in his 1992 book Head to Head
(written while Japan was still seen as a major contender to dominate the global economy
in the early twenty-first century):
“Facts are very difficult to deal with when they conflict with both theory and
previous experience…Only if facts are very painful and very persistent (i.e. they
produce a crisis) will humans deal with fundamental inconsistencies in their
worldviews. Japanese firms create just such a series of painful and persistent
facts. Practices such as age-based seniority wages that don’t take individual merit
into account should make Japanese business firms inefficient, yet when facing
American or European competitors they always seem to win…The
communitarian Japanese firms’ modes of play are quite different from those of the
Anglo-Saxons, and their success is going to put enormous economic pressure on
the rest of the industrial world to change.” (1992: 113-114)
As Thurow indicates, it was the perceived collective success of the Japanese way of
organizing business and the persistent strength of Japan’s economic performance that
validated Japan as a model for other countries and forced Western businessmen to take
seriously not only individual firms but also the entire business system. That meant that
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when Japan’s economic performance fell precipitously in the 1990s, its macro-economic
failure undercut the legitimacy of its business system in the eyes of the many Western
business writers, executives, and academics who had never fully accepted what Thurow
calls Japan’s “communitarian” model. Many business academics and journalists were
delighted that the sustained problems of Japan’s economy “proved” that the Japanese
system could never really have worked in the long term.
Invoking Japan’s economic success to validate its business model was not the
only reason for the tight causal connections drawn between the business system and the
performance of the macro-economy. As far back as John Stuart Mill, theory-building in
the social sciences has relied on the comparative method, one important element of which
is the “method of differences”. This involves comparing similar units of analysis (e.g.
individuals, or enterprises, or countries) which have different performances or outcomes,
and then identifying the points of differences across those units to discover what causes
the differences in outcomes. In the 1980s, the key differences between the Japanese and
U.S. business systems quickly came to be identified not only as causal factors in the
superior performance of specific industries such as autos and electronics but also of the
entire economy. When outcomes in the 1990s were reversed – that is, when the macroeconomic performance of the U.S. out-stripped that of Japan – the differences in the
system had not altered; only the outcomes had changed. It was therefore a relatively easy
step simply to change the causal mapping from “differences as a cause of success” to
“differences as a cause of failure”. The lack of more detailed and thoughtful examination
of the complex relationships between macros-economic performance and the specific
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features of the business system represents a missed opportunity to learn from the
Japanese experience.
Finally, it is clear, in retrospect, that one of the weaknesses of the analyses in the
1980s was too narrow a framing of the issues of change in Japan’s business system. This
may seem to be a strange comment, given that so much of the writing during that decade
looked back across decades to understand how the business system had evolved to reach
its present patterns. Researchers debated the relative influence of the Meiji period of
initial industrialization, the prewar industrial and commercial systems, the wartime era of
centralized controls, the immediate post-war re-building and the Occupation labour and
trust-busting policies, and the high-growth era from the mid-1950s to the first Oil Shock
in 1973. The underlying assumption of most of this work, however, was that the business
system of the 1980s was mature and deeply embedded.
When it came to considering how the system might change in the 1980s, the
potential impact of domestic developments received very little attention. The
convergence debate framed and dominated the analyses: would the differences between
Japan’s business system and the presumably dominant Anglo-Saxon model persist, or
would the two systems converge over time? Those who believed that the systems would
grow more similar focused on the probable dynamics of convergence. One possible
source of convergence was mutual learning, so that both the Japanese and the AngloSaxon systems would change, each incorporating the strongest features of the other.
More often, proponents of convergence argued that the growing internationalization of
Japanese firms would force the abandonment of key elements of the Japanese system.
They argued that putting more of the firm’s activities outside Japan would expose
21
managers to alternative ways of operating and would also force the contraction of
employment at home (thereby putting acute stress on the employment system). The
other face of internationalization (“globalization” was the preferred term of the 1990s,
not the 1980s) was the increasing penetration of the Japanese domestic market, both by
Western firms bringing their own systems into Japan and by Western investors putting
pressure on the Japanese firms in which they invested to deliver “shareholder value” in
ways that eroded the distinctive features of the business system. In this debate, the
proponents of divergence focused less on the dynamics of change in the Japanese system
than on continuity and resistance to change, asserting that the Japanese system was
deeply institutionalized and embedded in the supporting institutions of the educational,
political, and cultural systems.
Given this perspective, it was not surprising that the analyses of the 1980s paid far
more attention to the pressures on the system from the international environment than to
the impact of the domestic economic environment of the 1980s: the sudden change from
the recessions of the early 1980s to the rapid expansion of domestic demand (naijukakudai) in the late 1980s. Most researchers, both from the convergence and divergence
perspectives, seemed to take the domestic market expansion as validating and reinforcing
the established business system. They therefore tended to under-estimate the impact of
these changes on the activities and organization of Japanese companies. In retrospect,
however, we recognize that the sudden change from serious resource and market
constraints in the early and mid-1980s to the seemingly unlimited supply of financial
resources and market growth in the late 1980s had a more significant effect than the much
more copiously studied internationalization of Japanese companies. Core elements of the
22
Japanese business system were affected. Ironically, just when Prahalad and Hamel (1990)
were holding up Japanese firms as exemplars of internally-driven strategies based on core
competences developed incrementally over time, most Japanese firms were at the peak of
bubble-facilitated unrelated diversification, especially into various financial services and
investments known collectively in Japan as “zaitech”.
This focus on the global rather than the local dynamics of change ignored the fact
that Japan went through more dramatic domestic economic changes between 1980 and the
early 1990s than any other major industrial economy, and drew attention away from the
important domestic changes affecting the business system.
Changing Assumptions of the 1990s
The 1990s were well underway before the world recognized the extent of Japan’s
economic problems. As late as 1994, publishers were still optimistically turning out books
with such admiring titles as The Japanese Firm: Sources of Competitive Success (Aoki and
Dore 1994) and Japanese Business Success: The Evolution of a Strategy (Yuzawa 1994).
Until the Asian financial crisis of 1997, most of the criticism and advice in the Western
business literature focused on the failings of the government’s economic policies. From
1997 on, however, the scope and severity of criticism of the business system stepped up
considerably.
The Asian financial crisis had two significant effects on the reputation of Japanese
business. First, it undercut the recovery strategy of many Japanese manufacturing
companies, who had responded to the recession in their home market by expanding their
activities in Southeast Asia. Like American firms, the Japanese companies built
23
manufacturing networks in Southeast Asia to take advantage of the region’s low cost base.
However, in contrast to their U.S. counterparts, who used the region primarily as a
production platform to serve Western markets, the Japanese oriented much more of their
investment to the rapidly growing local and regional markets. Large Japanese construction
firms had also turned to the growing infrastructure projects in the region, winning contracts
by offering financing and by assuming a considerable part of the risk involved. The banks,
which had not had much success in expanding in North America and Europe, had, like their
manufacturing counterparts, turned to Southeast Asia as a growth prospect, and had
invested quite heavily in local and regional businesses and infrastructure projects, as well
as in financing the expansion investments of their Japanese client firms.
Until 1997, many analysts warned Americans that the Japanese had a superior
strategy: Americans companies would be left behind as the Japanese consolidated their
presence in this dynamic region (e.g. Hatch and Yamamura 1996). However, the collapse
of Southeast Asian markets and currencies therefore hit Japanese companies much more
severely than it did most U.S. firms – and also inflicted serious losses on Japanese banks.
Just as the Japanese domestic economy was showing signs of recovery in 1997, the Asian
financial crisis dealt a heavy blow to its business firms and its banks.5
A second effect of the Asian financial crisis was to undercut the assumption that
there were many potentially successful variants of capitalism in addition to the marketoriented, shareholder-centred variant characteristic of the Anglo-Saxon economies. Even
though the luster had vanished from the Japanese model, other Asian systems had provided
most of these alternative models, and the perceived discrediting of the “relational
capitalism” systems in the rest of Asia reinforced the loss of legitimacy of the Japanese
24
system. One unanticipated byproduct of the Asian financial crisis, therefore, was that it
reinforced the view that Japan was trapped in an outdated model of the business system
whose time had passed.
At the same time, the American firms that had invested in Southeast Asian
production platforms found that the devaluation of local currencies relative to the dollar
dramatically reduced their production costs and therefore increased their profits. This
coincided with the acceleration of spending in the U.S. on Information Technology both by
consumers and by firms. Moreover, the growing American success in developing new
industries in biotechnology, new media, software, and financial services and the wave of
mergers and acquisitions at home and abroad fuelled a stock market expansion that drew in
investment from all over the world. Just as the Japanese economic success of the 1980s
had validated its business system, so the impressive growth of the U.S. economy, at a time
when virtually every other major economy was faltering, meant that the late twentieth
century American business system stood alone as the model for twenty-first century
capitalism. In the late 1990s, this ideal was a system characterized by aggressive
entrepreneurship, CEO-centric corporate governance, flexible employment, widely
disparate incentive and reward systems within the firm, and a strong orientation to profit
and shareholder value. The collapse of America’s own Bubble, the Internet Bubble,
tarnished somewhat the entrepreneurial elements of the model. However, the rapid
recovery of the U.S. economy both from the Internet bubble and from the terrorist attacks
of 9/11 seemed further evidence that the American business system was robust and the
superior model for the new century. The tight coupling of macro-economic success and
business system superiority, however dubious in terms of social science theory, remained
25
as deeply entrenched in the business press and the popular imagination as it had been in the
1980s.
The U.S. system was identified as a new form of capitalism: shareholder or
financial capitalism, in contrast with the earlier form of managerial/industrial capitalism
developed before World War II and consolidated during and after the war. The 1950s,
when Japan was building its postwar business system, was the high point of the U.S.
managerial capitalism described by Berle and Means in their 1930s classic on the
separation of ownership and control in the modern American corporation. According to
Berle and Means, and later writers like John Kenneth Galbraith, America’s large
industrial corporations were run by salaried professional managers who were more
interested in the growth and longevity of their firm than in generating profits for their
increasingly numerous and dispersed shareholders, who lacked the cohesion needed to
have a significant impact on the firm.
IBM, AT&T, and GE in the 1950s epitomized American managerial capitalism,
and they were the models for Japanese engineers and managers visiting and studying in
the United States in the 1950s and 1960s. The resulting similarities between the large
American corporation of the 1950s and the large Japanese corporation of the 1980s are
too often overlooked. As late as the early 1990s, however, the difference at least one of
the American icons and the Japanese was still alive and well. In his recent book on the
turnaround at IBM, Lou Gerstner describes the personnel system he found at IBM in
1993, when he arrived as CEO:
“ Annual increases were typically given to all employees except those rated
unsatisfactory.
 There was very little variance in the size of the annual increase between a topranked and a lower-ranked employee.
26
 Increase sizes were in a small band around that year’s average. For example, if
there was a 5 percent increase in budget, actual increases fell between 4 and 6
percent.
 All employee skill groups (such as software engineers, hardware engineers,
salesmen, and finance professionals) were paid the same within a salary grade
level, regardless of the fact that some skills were in higher demand than others.”
(Gerstner 2002: 93-4)
The similarities with the Japanese employment and incentive systems are obvious
and striking. By 1993, however, Gerstner saw IBM’s patterns as relics of an earlier stage
of corporate development, and moved as quickly as he could to “re-structure” the
company, certain that even within IBM itself, employees would recognize that the old
patterns were no longer sustainable in the new era of re-engineering, down-sizing, and
“pay for performance”.
That IBM still exhibited at least some of the key features of managerial capitalism
as late as the beginning of the 1990s indicates that even some of America’s leading
companies were slow to embrace the business system features associated with
shareholder/financial capitalism. As the term “shareholder/financial capitalism” implies,
one of its key features is a focus on the firm’s financial performance and on share price as
the key measure of performance, rather than older measure such as total sales, market
share, or even profitability. Within the firm, it involves extensive efforts to bring market
principles inside the firm: for example, in transfer pricing, internal labour markets, and
requirements for internal support functions (“cost centres”) such as Human Resource
Development and IT to compete with external contractors for “contracts” from the
company’s operating units (“profit centres”). Executives receive much of their reward
packages from stock options, ostensibly to align their interests more closely with those of
shareholders.
27
In the business system as a whole, one of the features of financial capitalism is the
growing dominance of service firms, especially financial services, in the economy, and
the growing importance of finance-related activities for industrial corporations (GE and
GM, for example, two of the largest U.S. industrial firms, have recently relied on their
financial services businesses for most of the profits). Financial capitalism also at least in
its American incarnation, involves an increasingly active “market for corporate control”,
with the buying and selling of firms becoming an increasingly important feature of the
business system (and an increasingly important element of the activities and profits of
financial services firms). Interestingly enough, in America one of the consequences of
the concept of financial capitalism as a more advanced stage of the development of
market-based capitalism has been that it comfortingly identifies as wrongheaded and oldfashioned the anxieties so prevalent in the U.S. in the late 1980s about the loss of
manufacturing jobs, the “hollowing-out” of U.S. companies, and the disappearance of
many of America’s leading industrial companies.
In the late 1990s, therefore, the convergence assumptions that business systems in
different countries would move over time towards greater similarity grew in strength not
only because of the virtually unmatched performance of the U.S. economy but also
because of growing acceptance, at least in the U.S., that shareholder/financial capitalism
was the inevitable next stage of economic evolution. Because the United States was the
exemplar of financial capitalism, this meant that other economic and business systems
would increasingly come to resemble it. Those who regarded financial capitalism as a
superior form of economic organization based their support largely on its greater reliance
on market principles in the organization and reorganization of the firm. Belief in markets
28
as the most efficient and effective way to allocate resources of all kinds was increasingly
widespread in the late 20th century (a faith that its advocates saw as science and its critics
as theology). Others identified a more political driver: the interests of aging populations
in the OECD countries. The rising dependency ratio increased budget pressures on
governments and has produced pressures for individuals to save more in order to enjoy a
living standard above subsistence when they retire. These pressures have been
exacerbated by the increasing reliance of employers on part-time and contract workers
who are not eligible for company pensions, and, at least in the United States, in the retreat
from standard company pensions in favour of individual retirement savings accounts.
This has produced a growing demand for substantial returns on investments by private
citizens, pension funds, and governments. Even critics of shareholder capitalism
reluctantly agreed that the forces for convergence toward the new model were strong.
However, they attributed much of the pressure not to its intrinsic superiority but to the
increasing global dominance of U.S. financial institutions and the normative influence of
U.S. universities (particularly Economics departments and business schools), consulting
firms, and U.S. and U.K. based business publications.
In this context, Japan’s economic problems were increasingly attributed to its
reluctance (or its inability) to move to the new model of capitalism (see Dore 1997 for an
insightful summary and critique of this view). That many features of Japan’s business
system constrained the development of an active market for corporate control was
deemed particularly problematic. Many U.S. economists would agree with the analysis
of Glen Hubbard, a former Chair of the President’s Council of Economic Advisors. In his
29
Business Week commentary in 2005, he strongly advocated regulatory changes to
encourage M&A activity in Japan as “A Free-Market Cure for Japan’s Chronic Cold”:
“The M&A debate is really about making management face the discipline of
capital markets. Recall the U.S. experience in the late 1970 and early 1980s, in
which corporate raiders forced inefficient managers to maximize the value of
shares, leading to entrepreneurial wealth creation and greater productivity.”
(Hubbard 2005, p. 30)
Many business historians would hotly dispute this picture of the effects of the U.S.
corporate raiders of the 1970s and 1980s, but this “myth” – in the sense of a widely told
and accepted story – has become the orthodoxy in financial circles in the US. It provides
the justification for arguments like Hubbard’s that a more active market for corporate
control in Japan “jump-started” by foreign direct investment would have the same
galvanizing and liberating effect on the Japanese economy. Most executives in the
financial services industry, both in Japan and in the international investment banks,
would heartily agree. Japanese bankers in particular have an interest in developing a
growth business in Japanese M&A, both for the immediate revenues it would give them
and also to help them build expertise in handling the kinds of M&A deals that are
increasingly important in the revenues of more prosperous banks in the U.S. and the U.K.
In summary, in the 1980s acceptance of the model of managerial/industrial
capitalism exemplified by the Japanese system was still widespread, and provided the
foundation for the admiration of its key features. One can argue that the changing
evaluation of the system from the mid-1990s on was shaped as much by a change in the
dominant perspective of U.S. business academics and the business press (growing
articulation and acceptance of the financial capitalism model) as by the actual problems
of the Japanese business system.
30
Today’s Changing Perspectives
Today, both the ideological and the economic context are shifting once again.
The American model of shareholder financial capitalism may still be dominant, but it is
subject to growing scepticism. America’s business press has become increasingly critical
of the very high levels of executive compensation in U.S. corporations and of some of the
M&A activity, which often seems designed more to increase executives’ rewards than to
generate long-term value for shareholders. Academic researchers like Mary O’Sullivan
(O’Sullivan 2000) have drawn attention to the fact that, in contrast to Japan and Europe,
very large American corporations are rarely innovation leaders, suggesting that the shortterm profit orientation of the business system has serious drawbacks. The American
economy, moreover, is causing increasing unease about the sustainability of its
performance, given the very high levels of consumer debt and the fiscal imbalances at all
levels of government.
Growing skepticism about certain aspects of the U.S. model has not, however, led
to the identification of a new “exemplar” system. It has nevertheless opened the way for
recognizing the possibility that there may be successful variants of the next generation of
capitalism, even as there were multiple variants of managerial/industrial capitalism.
Japan may provide one of those alternative models. Interestingly enough, as the Japanese
economy is showing signs of recovery despite the absence of radical changes in the key
elements of the business system, a new interpretation of Japan’s business system seems to
be emerging, one that backs away from the wholesale indictment of the late 1990s. The
31
Economist survey of Japan in October 20056 stated this approach in startlingly clear
terms:
“A simple way to understand what happened to Japan in the 1980s and 1990s is
that a country with many strengths, especially a high average level of education,
formidable technology, and powerful social cohesion within companies, came to
lose its basic disciplines and incentives, particularly in the late 1980s, when it
experienced one of the biggest asset booms in world history. Flushed with
success and with seemingly costless capital, companies expanded and diversified
recklessly.”
Academic researchers as well as the Western business press have presented this reinterpretation as well. James Lincoln and Michael Gerlach in their 2004 book on the
keiretsu point out that:
“While Japan has stumbled badly, a case can be made that much of the cause lies
with the peculiar mix of conditions associated with the late 1980s bubble, a time
when Japanese business, caught up in a wave of ‘irrational exuberance’
…embraced what looked more like the style and values of American business
than those the world had come to associate with Japan….In this reasoning, the
bubble was utterly destructive of Japanese economic vitality because it was such a
radical departure from the fundamentals of the post-war business system.”
(Lincoln and Gerlach 2004; 4, 6)
This interpretation, like the critiques of the 1990s, still holds business firms at least partly
accountable for the recession of the 1990s, but no longer attributes the blame primarily to
the core features of the business system. Instead, it blames the abandonment of those
core features, especially the key elements of strategy: Lincoln and Gerlach estimate that
during the bubble between forty and sixty percent of the profits of Japan’s leading
industrial firms were derived from “zaitech” (2004: 4). It has taken over a decade for
firms in some of the most over-extended sectors (such as construction and retail) to
extricate themselves from the effects of the Bubble investments, but most have survived
and are beginning to prosper. The English-language literature on Japanese business has
been so focused on the need for radical transformations toward the American model that
32
the specific adaptations by which the recovery of Japanese firms has been accomplished
have not been studied adequately. More research is clearly needed, and some of the
chapters in this volume provide an excellent foundation for building an understanding of
the effects of the “Lost Decade” on Japanese firms, and their response.
Why is this important? It obviously has a crucial relevance for Japanese
companies, as they work to build on and adapt elements of the traditional business
system. Beyond Japan, however, other societies are likely to experience sudden changes
in their economic performance, with pressures on the legitimacy of the business system
similar to those experienced by Japan (indeed, the United States may well be the next
major example). Understanding how companies and institutional systems coped with the
sudden loss of legitimacy in the Japanese case will therefore prove useful to other
societies. Indeed coping with the loss of legitimacy may well become a major theme of
comparative business research in the coming decade.
Moreover, Japan may well be developing models of industry systems and firms
that exhibit new ways to balance the market principles so central to the U.S. model with
cooperative and relational approaches. Many societies find the extreme market focus of
the American model unappealing, and Japan could well provide the inspiration, if not the
model, for alternative approaches. It is worth remembering that Japan has been through
this before. In his analysis of Japan’s postwar economic development, the pioneering
Japan economist, William Lockwood, wrote in 1965 that:
“Amid all the conflicts of interest and principle, a new industrial order is taking
shape, not as one coherent blueprint but through a series of groping experiments.”
(Lockwood 1965: 510)
33
We may well be witnessing another era of gradual transformation that will produce the
next generation of Japanese capitalism. Whether it is the next generation of
managerial/industrial capitalism, or a new variant of shareholder/financial capitalism,
remains to be seen.
34
Table 1: What’s Wrong with this Picture?
JAPAN’S BUSINESS SYSTEM
Key Success Factors 1980s
Key Failure Factors 1990s
Employment system:
Employment system:
“Permanent employment”
“Permanent employment”
Reliance on internal labour market
Reliance on internal labour market
Incentive system
Incentive system
Seniority-based rewards and
Seniority-based rewards and
promotion
promotion
Egalitarian distribution of rewards
Egalitarian distribution of rewards
Strategy:
Strategy:
Focus on long-term goals over nearFocus on long-term goals over nearterm profitability
term profitability
Rapid followership
Rapid followership
Focus on operational excellence
Focus on operational excellence
Use of strategic alliances rather
Use of strategic alliances rather
than majority JVs or M&A
than majority JVs or M&A
Reliance on organic growth based
Reliance on organic growth based
on internal competences
on internal competences
Governance system
Governance system
Employees as key stakeholders
Employees as key stakeholders
Internal board of directors
Internal board of directors
Banks as external monitors and
Banks as external monitors and
shareholders
shareholders
Extended enterprise – vertical keiretsu
Extended enterprise – vertical keiretsu
Close business-government cooperation
Close business-government cooperation
35
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1
As early as 1965, for example, William Lockwood, a pioneer in the study of Japan’s economic system,
described Japan’s emerging industrial order and concluded that “short of a war or a serious depression no
radical change seems in prospect” (Lockwood 1965: 510).
2
The Economist Dec. 18, 1993, p. 18.
3
As late as 1996, HBR featured Jeff Dyer’s article “Chrysler creates an American Keiretsu”, indicating that
the term had not lost its legitimacy, though the Japanese model had lost much of its luster.
4
David Weinstein is one scholar who has questioned the strong causal linkage drawn between the two that
characterized so much of the writing on Japanese business in the 1980s (Weinstein 1999).
5
Much of the blame for the faltering of Japan’s 1997 recovery has focused on the Japanese government’s
increase in the consumption tax, but the Asian financial crisis was a much more serious blow to its
companies and banks.
6
The Economist Survey: “Japan: The Sun Also Rises.” October 6, 2005.
38