NCPA - National Center for Policy Analysis

The Hollowing Out Of Japan

February 27, 2001

The 1990s were not good years for Japan's economy. During the last decade, a stock market crash, a real estate meltdown, two recessions and a serious regional crisis hit Japan. It is widely believed that the cause is government-directed investment policies that encouraged a high level of investment at the expense of increases in productivity.

However, a recent study suggests that flaws in Japan's industrial organization are responsible.

The study argues that Japan's multinational corporations (MNC) have triggered the economic meltdown:

  • Japan has a highly intertwined series of medium-sized companies known as keiretsu.
  • These keiretsu form around a single large corporation, providing specific equipment to the large corporation.
  • If the large corporation moves production overseas, these keiretsu are left without buyers for their products.

Japanese MNCs have grown. Foreign investment by Japanese MNCs grew from 3 percent in 1980 to 12 percent in 1997. MNCs have moved much of their industrial production overseas. For example, 60 percent of Honda's assets are located outside of Japan. This has resulted in:

  • An increase in overseas Japanese production from 6 percent in 1992 to 13 percent in 1997.
  • An increase in overseas manufacturing employment from 7 percent in 1992 to 17 percent in 1996.

The keiretsu have been left struggling. Keiretsu have:

  • Lowered their gross profit margins from 2.5 to 3.5 percent in the 1980s to 1.6 percent in the 1990s.
  • Reduced the return on their capital from 5.5 percent to 3.2 percent in the same period.
  • Dropped by 10 percent in 1995 from their 1991 levels.

Small and medium-size firms employ four out of five workers in Japan. Due to the economic slowdown, the unemployment rate has doubled to five percent and for the first time exceeds that of the United States.

Source: "Japan's Hollowing Economy," Economic Intuition, Fall 2000; based on Keith Colwing and Philip R. Tomlinson, "The Japanese Crisis - A Case of Strategic Failure?" Economic Journal, June 2000.


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