Industrial Organization and Industrial Policy Policy 1 Industrial Organization and Industrial Policy This section looks at some unique features in Japanese industrial organization

Industrial Policy 1

Industrial Organization and Industrial Policy

This section looks at some unique features in Japanese industrial organization keiretsu the main bank systemWe also look at the government policies toward industries (industrial policy)

Industrial Policy 2

Keiretsu

Group of firms; Focus on two types1. Horizontal keiretsu (kigyō shūdan; 企業集団)

group of large firms in diverse industries2. Vertical keiretsu

Production keiretsu: group of contractors that supply parts to prime manufacturerDistribution keiretsu: group of distributors that operate under the name of a large manufacturerCapital keiretsu: grouping based around the flow of capital from a parent firm

Industrial Policy 3

Horizontal Keiretsu

There are six major ones (Flath, Tables 12.1 list presidents’ club members as of 2000)The table also shows important changes to the keiretsu membership (discussed later) More than one keiretsu groups share a financial

group

Industrial Policy 4

Traditional characteristics of horizontal keiretsu

Many firms share the same name (Sumitomo, Mitsui, Mitsubishi, etc.)

Presence of financial institutions Presence of general trading companies (sōgō shōsha; 総合商社)

Members in almost all industries Often only one company in an industry (“one-set

principle” A firm usually belongs to only one group (this is not

true anymore)

Industrial Policy 5

Weights of the Big Six (President’s Council Members)

Fiscal Year

Employ-ees

Assets Sales Gross Profit

1975 5.1% 15.8% 14.9% 8.3%1980 4.9% 15.3% 15.6% 12.1%1985 4.5% 14.2% 16.0% 17.2%1987 4.1% 13.0% 14.4% 11.9%1993 3.8% 11.9% 13.3% 11.0%1998 3.2% 11.3% 11.5% 9.9%

Industrial Policy 6

Two Types of Horizontal Keiretsu

Regrouping of prewar zaibatsu long history; Ex. Sumitomo: started in the late

16th Century as a copper crafting shop in KyotoBank-centered groups Bank financing was dominant source of funds

for the post-war Japanese firms Firms gathered around banks

Industrial Policy 7

Zaibatsu vs. Keiretsu

ZaibatsuFamily

Honsha (holding company)

member companies

Zaibatsu

Industrial Policy 8

Zaibatsu vs. Keiretsu

member companies

Keiretsu

Industrial Policy 9

Structure of Horizontal Keiretsu

Several types of ties between keiretsu firms1. President’s council (shachō-kai; 社長会)2. Borrowing from keiretsu financial institutions3. Cross shareholding4. Interfirm director exchanges5. Transaction of intermediate products6. Groupwide activities

Industrial Policy 10

President’s Council

Group of core companiesRegular meeting every month (Ex. Mitsubishi PC meets on 2nd Friday, Mitsui PC on 1st Thu, Sumitomo PC on 3rd Wed)Informal lunch meeting with no agendaRather opportunity to socializeNo direct control over its companiesUsually does not make any decisionsBut, can exchange information if they want


Borrowing from Keiretsu Financial Institutions

Bank financing was dominant in the post-war Japan (more on this in the section on the financial system)For a firm, a good relation with banks was indispensable for access to fundsImportant motivation to join (stay in) keiretsu


Borrowing from Keiretsu Financial Institutions

As % of total borrowingsFiscal Year 1986 1992 1998Mitsui 22.17 19.67 20.59Mitsubishi 22.37 20.22 19.37Sumitomo 27.29 19.89 20.43Fuyo 19.41 16.27 16.31Sanwa 19.22 17.76 18.58DKB 11.48 11.91 15.29


Cross Shareholding

Keiretsu firms hold shares of other keiretsu firmsThey can protect each other from hostile takeovers


Cross Shareholding

As % of total sharesFiscal Year 1986 1992 1998Mitsui 17.58 16.58 15.82Mitsubishi 27.44 26.33 25.97Sumitomo 24.67 24.65 20.81Fuyo 15.81 15.62 19.41Sanwa 16.70 16.72 15.11DKB 12.74 12.19 12.11


Interfirm Director Exchanges

Similar to “interlocking directorates” in the U.S.Some interesting differences An executive usually takes up full-time

position rather than part-time Flow of directors is often uni-directional


Transactions in Intermediate Products

Each keiretsu has at least one sōgō shōshaA keiretsu firm tends to buy from and/or sell to another keiretsu firm through sōgō shōsha


Transactions in Intermediate Products

Share of transactions conducted through sōgō shōsha (1983)

Sales PurchasesMitsubishi Heavy Industries 55% 27%Mitsubishi Metals 22% 38%Mitsubishi Aluminum 75% 100%Mitsui Petrochemicals 65% 50%Mitsui Metal & Mining 33% 31%Nikon 7% 11%Kirin Brewery 0.3% 23%


Group-wide Activities

Industrial projects 1957-58. Sumitomo, Mitsui, Mitsubishi all

came with their own atomic energy projects late 1960s. All started information service

and consulting companies early 1970s. All started companies for urban

development, petroleum development


The Main Bank System

Many Japanese firms have close ties with banks (through lending, shareholding, and director dispatch) Clearest for keiretsu firms, but firms that are not core keiretsu firms also have close ties to banksThe main bank system: network of close ties between firms and banksEach firm has its own main bank that is supposed to take care of the firmMore on this in the section on the financial systemWe will discuss the economic implications of horizontal keiretsu then


Production Keiretsu

Especially prominent in the auto industryMajor manufacturers usually maintain direct relations with about a hundred suppliers organized into exclusive cooperative associationsSome suppliers have cooperative relations with smaller second-tier subcontractors


Two Types of (First-tier) Suppliers in the Auto Industry

DA (Drawings Approved) suppliers has relatively unique stock of production knowledge supplies essential components (such as transmissions,

brake, engine parts, etc.) production based on the supplier’s own design as

approved by the prime manufacturerDS (Drawings Supplied) suppliers less specialized technological expertise supplies less crucial components (such as lamps or

plastic parts on the dashboard) produces according to the prime manufacturer’s design


Involvement of Suppliers in Model Development

Suppliers in production keiretsu, especially DA suppliers are involved in early stages of new model developmentTypically major model changes happen every four yearsDA suppliers start working with the prime manufacturer 2-3 years before the introduction of a new model


Benefits of production keiretsu

Close communication between suppliers and the manufacturer reduces development costsPrime manufacturer can provide long-term relationship to (relatively) small suppliers (a kind of insurance)Continued pressure from the prime manufacturer to cut the cost


Costs of production keiretsu

Limit to the cost reductionTechnological innovations are often kept only in keiretsu(From supplier’s point of view) risk of depending on only one assembler


Industrial Policy

Definition: Interventions by the government to change the current (market) allocation of resourcesIn microeconomics, such interventions are justified in the case of market failures A market equilibrium is efficient if

a. there is no increasing returns to scaleb. there is perfect competitionc. there are no externalitiesd. information is completee. there is a complete set of contingent commodities


Industrial Policy in the Post-War Japan

Main objective: to reduce imports from foreign countries and foster growth in the key industries (protection and promotion)

1. Provide infrastructure for all industries road system, industrial ports, water and

electricity supplies, etc.2. Change inter-industry resource allocation

(targeting industries) through subsidies and import restriction


Industrial Policy in the Post-War Japan

3. Authorize cartels cartels for “rationalization” cartels to avoid “excess competition” cartels for structurally depressed industries

4. Policies to protect small and medium enterprises


Which part of the government conducts the industrial policy?

Most often MITI (Ministry of International Trade and Industry); changed the name to METI (Ministry of Economy, Trade, and Industry) in January 2001Industrial policy also includes agricultural policy by Ministry of Agriculture, Forestry,

and Fishery financial regulation by Ministry of Finance regulation on communication industry by Ministry of

Post and Telecommunication


Stages of Japanese Industrial Policy

1. Late 1940s to 1950sIndustrial policy resembled central planning

Ex. Preferential Production Plan, 1946-48In the 1950s, rationalization plans became the center of the industrial policy

Targeted industries (steel, coal, shipbuilding, electric power, chemical fertilizer, etc.) received accelerated depreciation, tariff exemption for imported machines, preferential allocation of foreign exchanges, more funds from FILP, etc.



2. 1960sJapan needed to liberalize trade in order to be admitted to international institutions, such as GATT, IMF, and OECD.Objective of policy: strengthen the domestic industries in time for trade liberalization

Encouraged mergers to take advantage of the scale economyCoordinated investment to avoid over-capacity and “excess competition”



3. After 1970sGoal of industrial promotion became less importantObjectives of the industrial policy were gradually broadened to include: pollution control international cooperation (i.e. dealing with trade

conflicts) assistance to declining industries assistance to small and medium firms technological infrastructure for long-run growth support for “venture” business


Environmental policy in Japan

Environmental issues: “externality” is a key elementClassical example of a market failureGovernment intervention may be justifiedLet us look at simple economics of pollution and examined the Japanese government’s policy toward pollution control


Economic model of pollution

Example: a chemical factory and a fishermanProduction process for chemicals emits pollutants into the nearby river, which hurts the fisherman by reducing the number of fishWe model this by considering the following cost functionsCost for the chemical factory C(y, p) is decreasing in p (pollutants)Cost for the fisherman D(x, p) is increasing in pHow much pollution does the chemical factory produce?



If the chemical factory maximizes its profits (minimizes costs), it stops polluting when the marginal benefit of pollution is equal to the price it has to pay for producing pollutionIf there is no penalty for polluting, the optimal (for the firm) level of pollution is given by MC(y, p*) = 0If MD(x, p*) > 0, this not socially optimal, because the following transaction would make both better off: Fisherman pays Chemical factory a small amount of money with a promise by the factory to reduce pollution


Economic Model of Pollution

Amount of Pollution

Marginal cost reduction for the chemical firm

Marginal cost of pollution for the fisherman

Individually optimal pollution

Socially optimal pollution



1. Too much pollution in the equilibrium2. Socially optimal level of pollution is not zero3. If the government knows the socially optimal

level, the government intervention improves the welfare by limiting the amount of pollution

4. Alternatively, the government can tax pollution production or subsidize the reduction

5. The same result is achieved if the chemical factory has the (transferable) right to pollute (or if the fisherman has the right to clean water


Environmental policy of Japan

Turning point: four environmental cases1. Mercury poisoning in Minamata2. Mercury poisoning in Niigata3. Cadmium poisoning in Toyama4. Industrial pollution in YokkaichiIn the early 1970s, the corporations that were responsible for the pollution and the government lost the suits brought on by the victimsEstablished the responsibility for the business to control pollution and for the government to monitor



Government’s responses1. Industrial policy to achieve environmental

standards (for pollutants)Provided economic incentives for pollution abatement (subsidies and tax credits for installing abatement devices)

2. 1973 Act for Compensation of Pollution-Related Health Injuries

People who are judged to have pollution-related health problems are entitled to collect compensation from special funds financed by taxes on polluters



Environmental quality of Japan improvedFollowing figures show the changes in air quality since the 1970sIn this sense, the policy was successfulIt is not clear whether this was achieved at minimum cost (see Flath, Chapter 11 for more detailed discussion on this point)


Sulfur dioxide (SO2) concentration: FY1970-2004 (ppm (part per million))

0

0.01

0.02

0.03

0.04

1970 1975 1980 1985 1990 1995 2000

Fiscal year

Presenter

Presentation Notes

Source: http://www.env.go.jp/air/osen/jokyo_h16/rep04.pdf


Nitrogen dioxide (NO2) concentration: FY1970-2004 (ppm)

0

0.01

0.02

0.03

0.04

0.05

1970 1975 1980 1985 1990 1995 2000

Fiscal year

Presenter

Presentation Notes



Carbon monoxide (CO) concentration: FY1970-2004 (ppm)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1970 1975 1980 1985 1990 1995 2000

Fiscal year

Presenter

Presentation Notes



Suspended particulate matter: FY1974-2004 (mg/m3)

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

1974 1979 1984 1989 1994 1999 2004

Fiscal year

Presenter

Presentation Notes



Did the industrial policy benefit the Japanese economy?

We can identify both benefits and costsEmpirical assessment?


Benefits of Industrial Policy

“Infant industry argument”Protect a new industry today and allow it to become more productive than the foreign competitors in the future Cost: higher cost today (for consumers at

home) Benefit: lower cost tomorrow (for consumers

both at home and abroad)


Benefits of Industrial Policy

For which industries, does the benefit outweigh the cost?The benefits most likely for industries with: economies of scale in production predictable technological progress


Picking Winning Industries, Not Corporations

Problem of infant industry protection Protected corporation may not have an

incentive to increase the productivity Expect the government to continue protection if

the corporations fail to become competitiveDomestic competition between firms in the targeted industry can mitigate the problemImportant not to target (and protect) a corporation


Costs of Industrial Protection

Protection of “wrong” industries helping “losers” rather than “winners” sustaining sunset industries (for political

reasons)Too long protection Infant industry argument calls for temporary

protection, not permanent Perverse relation between the amount of

subsidies and industrial performance may exist


Empirical Assessment of Industrial Policy

Industrial policy successfully helped many infant industriesIndustrial policy also protected industries without growth prospects (e.g., coal, shipping, agriculture, etc.)Many researchers find industrial policy during the rapid economic growth period was overall successful



Beason and Weinstein (1996) Review of Economics and StatisticsFind industrial policy allocated more resources to low-growth industries (even in the rapid economic growth period)They also find industrial policy did not raise the productivity of supported industries



Costs of industrial policy clearly started to dominate the benefits after the high-growth period was overThere were not many “infant” industries anymorePrimary focus shifted from infant-industry promotion to declining-industry protectionIndustrial policy out-lived its usefulness

Documents

Industrial Organization and Industrial Policy Policy 1 Industrial Organization and Industrial Policy This section looks at some unique features in Japanese industrial organization