You are on page 1of 15

Constantinos Pagonis 2004

The relationship between democracy and economic growth has been the subject of rigorous debate within the development community. The so called East Asian tigers had authoritarian governments during their respective periods of high economic growth. Japan's post war economic miracle demonstrated that high growth rates were possible under democratic forms of governance. Although Japan was a democracy, the Japanese parliament or Diet was dominated by the Liberal Democratic Party (LDP) for the all but three years of the post war era. On the surface, the LDP's dominance in the Diet appears to invalidate Japan as a democratic state which succeeded in achieving high economic growth; however other forms of democratic pressure such as intraparty competition served as vehicles for accountability and representation.1 Therefore Japan is a relevant case study for policy makers who are trying to achieve rapid economic growth within a democratic context. This paper presents an analysis of the relationship between Japanese democratic governance and economic growth during the post war era. The findings of the paper suggest that there was an inverse or non existent relationship between democratic governance and economic growth. Rather it was the absence or deceleration of economic growth which served as the catalyst democratic reform. A statistical evaluation of democratic governance and economic growth was virtually impossible to undertake given the difficulty of isolating democracy as the causal variable in the degree of economic growth. Therefore a qualitative approach was utilized, emphasizing the impact of Japanese democracy on transaction costs, the degree of economic distortions it produced and its effect on the allocation of government expenditures. Further analysis of electoral and administrative reforms is included to demonstrate the prevailing inverse relationship between economic growth and democratic reform. Japanese Capitalism's Role in Facilitating LDP Dominance
1

Bradley Richardson, Japanese Democracy, (New Haven: Yale University Press, 1997) 243

Constantinos Pagonis 2004

In the Western model, democracy and capitalism are often portrayed as separate and distinct forces, with a democratically elected government seeking to regulate and mitigate the excesses of capitalism, without seriously impeding the market mechanism. The Japanese notion of the state's relationship with the market is fundamentally different than in the West. Japanese policy makers viewed the democratic state as a steward of the economy which should direct the market mechanism to achieve social goals.2 As Kyoko Sheridan states, "State control and capitalism brought together over the 120 years of industrialization to build a unique system of "government controlled capitalism."3 Japanese society's prior experience with government directed capitalism partially explains the electorates reluctance to vote out an LDP government which was exceptional in its ability to maintain an annual GDP growth rate of 6.37% between 1961 and 1989.4 Success as defined by the LDP government consisted of high economic growth with an increasing market share in global export markets and low unemployment.5 The LDP based its government's legitimacy on maintaining high economic growth.6 In addition to legitimizing the LDP's rule, high economic growth provided the LDP with the ability to buy the political support of opposition constituencies.7 Furthermore, because tax revenues were growing at such as high rate, Diet politicians could simultaneously placate their own constituencies and those of the opposition through government expenditures, without reaching levels of unsustainable debt.8 Thus the LDP was able to strengthen its support amongst its conservative constituency comprised of farmers, industrialists, and social conservatives through generous subsidies and
Yohsihara Kunio, Japanese Economic Development .(Oxford: Oxford University Press, 1994) 51 Kyoko Sheridan, Governing the Japanese Economy. (Cambridge: Polity Press, 1993) 209 4 Randall Morck and Bernard Yeung, "Japanese Economic Success and the Curious Characteristics of Japanese Stock Prices," NYU. Cited on 12/5/06. Available on the internet at: http://pages.stern.nyu.edu/~byeung/japanese.pdf 5 T.J. Pempel, Policy and Politics in Japan. (Philadelphia: Temple University Press, 1982) 54 6 J.E. Thomas, Modern Japan. (New York: Addison Wesley Longman Limited, 1996) 299 7 Pempel, 63 8 Ibid.
3 2

Constantinos Pagonis 2004

special tax treatment.9 Therefore it is possible to assert that economic growth hindered the formation of a more democratic system by providing the LDP with a tax base that allowed it to purchase political complacency. The Japanese Electoral System and Factional Competition High economic growth helped maintain LDP dominance from 1955 until 1993, however it was one among many factors which helped perpetuate the LDP's control over the Diet. The Japanese electoral system's multi-member district system (MMD) and the formation of coalitions with independents, allowed the LDP to remain in control of the Diet despite several elections in which it received less than 50% of the vote.10 Under the MMD system candidates compete to gain a small share of the electorate; the percentage necessary to win a Diet seat was often as low as 12-25%.11 Japan's MMD electoral system promoted factionalism because several LDP members would often compete for a district's Diet seats, especially in areas that were regarded as LDP strongholds.12 The absence of a legitimate opposition and the accountability mechanisms that a credible opposition normally provides were partially compensated for by the competition between various factions of the LDP. Japanese political campaigns required a large amount of cash funding in order to fund huge vote mobilizing efforts which relied upon patronage and forms of clientalism.13 Factionalism was encouraged under this system because junior politicians needed the support of a faction within the Diet to gain the necessary funding to run a successful campaign.14 Competition between candidates at the local level supported by LDP factions

Pempel, 35 Richardson, 14 11 Pempel, 39 12 Takayuki Sakamoto, "Explaining Electoral Reform," Sage Publications, Vol. 5, No.4 (1999) 419-438 13 Sakamoto, 422 14 Sakamoto, 429
10

Constantinos Pagonis 2004

provided the citizenry with a choice between candidates that in theory held a different set of policy preferences, despite their similar party affiliations. Factional competition within the LDP provided for some degree of democratic competition within the Japanese government. However the Diet's structure made the pursuit of political or economic reforms difficult. The diet is structured in a manner similar to the British Parliament wherein bureaucracies propose legislation which is then sponsored by the Prime Minister's cabinet.15 Eight-Four percent of the legislation passed between 1952 and 1989 originated within ministries that were controlled by the Prime Minister.16 The legislative agenda was therefore dictated by the faction that successfully controlled ministerial posts, especially the position of Prime Minister. Once the legislative agenda was established LDP factions would generally put aside their factional differences and support bills that were brought to the Diet floor.17 As a result nearly 60% of the bills passed by the Diet between 1952 and 1993 were passed without amendment.18 The division of the Diet into factions and the Japanese system of patronage may have reduced economic growth over time when viewed against a counterfactual. Constituent pressures forced politicians to allocate expenditures with little or no economic value, through what Americans would refer to as pork barrel spending. Further impetus for wasteful spending was provided by the LDP's rural supporters and business groups. The necessity of politically placating farmers required the highest farm subsidies in the world.19 Business groups' support of the LDP provided them with industry specific infrastructure that served as an implicit subsidy.20

15 16

Richardson, 245 Richardson, 129 17 Richardson, 130 18 Ibid. 19 Richardson, 217 20 Sheridan, 177

Constantinos Pagonis 2004

As a consequence of democratic pressures, billions of yen were expended overtime on projects which had little or no value in the promotion of economic growth. Although it is clear that subsidies and white elephant projects reduce the amount of capital that is available for other growth promoting expenditures, it is false to claim that these expenditures are unique to democratic governments. Korea had farm subsidies that were comparable to those in Japan and engaged in similarly misguided white elephant projects, despite authoritarian rule.21 Therefore the relationship between reductions in economic growth and democratic pressures from constituencies was indeterminate. The Effect of Japanese Governance on Transaction Costs and Economic Distortions In theory democratic governance ought to promote economic growth through a reduction in the transactions costs. Democratic governance reduces transaction costs by limiting the cost of attaining information and ensuring third party contract enforcement.22 The Japanese government was successful in significantly reducing transaction costs; however the ministries of the government which reduced these costs operated in a manner which was antithetical to democratic norms.23 Aside from a ministry's leader, the remainder of the bureaucracy was unelected and therefore only indirectly responsive to democratic pressures in the form of ministerial directives. Democracy further reduces transaction costs by providing predictability and stability in the "enforcement of property rights to goods".24 Predictability and stability were provided for in Japan through the special relationship between the network of interconnected industrial conglomerates called the Keiretsu and the

21

DuckWoo Nam and Kong Kyun Ro, "Population Research and Population Policy in Korea in the 1970's," Population and Development Review, Vol. 7, No. 4 (Dec., 1981), 651-699 22 Douglas C. North, Institutions, Institutional Change, and Economic Performance (Cambridge: Cambridge University Press, 1990) 27 23 Sylvia Chan, Liberalism, Democracy and Development (Cambridge: Cambridge University Press, 2002) 194 24 North, 28

Constantinos Pagonis 2004

government ministries.25 Government bureaucracies would help facilitate information exchanges between the Keiretsu and provide a benign policy environment in which they could operate.26 Thus unlike in the West wherein transaction costs were reduced from clearly denoted contract laws and active third party enforcement; Japanese transaction costs were reduced by tacit, government facilitated agreements between firms which would be considered both collusive and discriminatory in the West. The cost of contract enforcement was further reduced by cross shareholding arrangements.27 Additional assurances of transaction cost reduction were provided through the practice of "descending from heaven."28 Under this practice, government bureaucrats would leave their offices and "descend" into a high post within the private sector.29 These individuals' contacts within the government would assure the expedited processing of regulatory procedures and a greater access to privileged information. The special relationship between the government and Keiretsu was only possible because democratic norms were openly flouted. Meetings were held behind closed doors without minutes and boards were generally comprised entirely of company insiders.30 Furthermore, government ministries were secretive and reluctant to give public accounts of their information. Secrecy was promoted by ministerial competition which prevented the free exchange of information between ministries and even within different sections of the same ministry.31 T.J. Pempel's story of a bureaucrat who was sent to another section within his agency to obtain routine information and was sent away with the comment that if his section considered the date so important, it should

25 26

Chan, 194 Ibid. 27 Chan, 205 28 Peter F. Drucker, "In Defense of Japanese Bureaucracy," Foreign Affairs, Vol.77, Iss. 5, (Sep/Oct 1998) 68-80 29 Ibid. 30 Chan, 205 31 Pempel, 259

Constantinos Pagonis 2004

have collected it itself," was indicative of the Japanese bureaucracy's modus operandi.32 Despite reducing transaction costs for the Keiretsu, the competitive nature of the Japanese bureaucracy and the necessity of maintaining secrecy prevented the efficient dissemination horizontally to other bureaucracies and to the general public. Economic growth through asymmetric information access was therefore provided partially at the expense of transparency and democratic accountability. The absence of democratic oversight initially promoted economic growth, but only at the expense creating economic distortions which inhibited future growth. A major distortion created by the Keiretsu based economy was the allocation of banking credit on the basis of relationships rather than its ability to repay the loans.33 The effects of collusion became apparent during the late eighties and early nineties when the Japanese economy went into recession. During this time period, the extent of defaulted loans on Keiretsu affiliated bank's balance sheets became unmanageable and led to the downfall of several firms, thereby exacerbating the recession that was already underway.34 Thus in the long run, the absence of transparency and democratic accountability may have been a contributing factor in the diminution of growth by allowing for the formation of economic distortions, most notably in the banking sector. The Japanese government's emphasis on high growth and special relationship with the Keiretsu resulted in the neglect of consumer's interest. Promoting the interests of industry over consumers is a logical means for the promotion of economic growth during periods of capital formation. However in more advanced consumer economies, the absence of regulation will lead to distortions and rent seeking, which reduce potential GDP growth. Increases expenditures on

32 33

Ibid. Padraig Dixon, "Banking Sector: Roots of Recession in Japan," University of Dublin Student Economic Review, Available on the internet at : http://www.tcd.ie/Economics/SER/archive/1999/essay16.html 34 Ibid.

Constantinos Pagonis 2004

social welfare are likely to decrease GDP growth as funds are diverted from potential investment. Social welfare spending may also decrease unit labor costs by reducing the pension and health care costs firms' must normally pay themselves. The Japanese experience demonstrates the transition in regulatory policy making which should be undertaken as a country develops a large consumer base. The Japanese government's willingness to provide for business interest over the consumer majorities was most clearly demonstrated by the absence of monopoly restrictions. An antimonopoly law was not passed until 1977.35 Collusion was not banned until 1980, and only as a result of a Supreme Court decision.36 Consumer's interest were also neglected when it came to social spending. It was not until the Ministry of International Trade and Industry's (MITI) white paper titled "Vision for the 70's" that social spending became a significant budgetary item.37 The Japanese government's expenditures on social safety nets continue to be the lowest within the OECD.38 Reform Movements and their Relation to Economic Performance The structure of the Japanese electorate and the rate of economic growth largely undermined opposition efforts at reform. LDP politicians believed they could stay in power without initiating true reforms, as Asahi Seijibu states, "The LDP leadership expected neither electoral damage nor a loss of power because of its failure to reform."39 However the illusion of reform was given by several bills most notably the Election Reform Bill of 1961 and the Election System Reform Bill of 1982.40 Both pieces of legislation achieved little in the way of meaningful

35 36

Sheriden, 164 Ibid. 37 Sheriden, 163 38 Chen, 212 39 Sakamoto, 427 40 Richardson, 133

Constantinos Pagonis 2004

democratic reform; rather they attempted to placate opposition demands for reform by passing largely meaningless legislation.41 Similarly, the administrative reform process began with the First Commission on Administrative Reform in 1961, but did not produce results until the Morihiro administration in 1993.42 Although a relationship between Japanese democracy and economic growth is difficult to establish, democratic reforms and economic growth were historically inversely correlated. An inverse correlation can be established because the most significant democratic reforms of the Japanese electoral system occurred under the three years of opposition rule between 1993 and 1996, when GDP growth ranged from .2 to 1.9%.43 Furthermore the most far reaching administrative reforms were initiated in 1993 under the opposition and implemented under LDP rule in 1998 and 1999, when GDP growth plummeted to negative 1.8%.44 The LDP's removal from power in 1993 proved to be the prerequisite for reform. The first major catalyst for the electoral defeat of the LDP and its allies were a series of corruption scandals in 1988, called the Kyowa, Sagwa, and the Recruit scandals.45 A further impetus was the breakdown of the Japanese economic system, as Japanese growth slowed to a mere 1% in 1992.46 Although the LDP had faced scandals before, most notably the Lockheed Scandal of 1976, it had always maintained a degree of political legitimacy through its claim to providing

41 42

Richardson, 134 Toshiyuki Masujima, "Administrative Reform in Japan: Past Development and Future Trends," International Review of Administrative Sciences, Vol. 71, No. 2 (2005) 295-299 43 "World Economic Outlook Databases," International Monetary Fund, Available on the internet at: http://www.imf.org/external/pubs/ft/weo/2006/02/data/weorept.aspx?sy=1980&ey=2005&scsm=1&ssd=1&sort=cou ntry&ds=.&br=1&pr1.x=93&pr1.y=6&c=158&s=NGDP_RPCH&grp=0&a= 44 Ibid. 45 Sakamoto,422 46 International Monetary Fund, http://www.imf.org/external/pubs/ft/weo/2006/02/data/weorept.aspx?sy=1980&ey=2005&scsm=1&ssd=1&sort=cou ntry&ds=.&br=1&pr1.x=93&pr1.y=6&c=158&s=NGDP_RPCH&grp=0&a=

Constantinos Pagonis 2004

economic growth.47 As GDP plummeted, the LDP could no longer claim legitimacy on this basis. The LDP's likely failure in the upcoming elections of 1993 and internal political power struggles, resulted in the defection of 54 LDP members and the formation of two opposition parties collectively termed the Ozawa Group.48 The defection of the Ozawa Group and the LDP's subsequent defeat at the poles provided the political opposition with the ability to institute long awaited electoral and administrative reforms. The initiation of reforms under opposition rule and during periods of low or negative economic growth is a classic illustration of what Douglas North deems changes in the incentive structure. The absence of economic growth promoted the division of the LDP into factions as junior politicians and members of the Ozawa group came to view the opposition as a credible political force which could be co-opted.49 This division in turn made pursuing the status quo more costly for other Diet members and therefore changed the incentive structure at the margin to direct politicians toward reform. As Sakamoto states, "The LDP's split and the consequent change in political parties' incentive structures served as an immediate catalyst to reform enactment."50 The electoral reforms initiated in 1993 and enacted in 1994 fundamentally changed the Japanese electoral system.51 Prior to 1994 the Japanese House of Representatives was elected from multimember districts with between 2 and 6 representatives.52 Under the MMD system, candidates would compete for a small fraction of a district's overall vote. The new "combinational" single member districts (SMDs) were intended to reduce corruption by

47 48

Thomas, 301 Thomas, 305 49 Sakamato, 429 50 Sakamoto, 431 51 Sakamoto, 420 52 Pempel, 38

10

Constantinos Pagonis 2004

eliminating direct patronage to specific cohorts that promised political loyalty in exchange for "constituency services."53 Furthermore it was presumed that the districts would be more representative of the whole district rather than specific groups within the district. The 1994 electoral reforms created districts that were more representative of the population however they increased the LDP's dominance of electoral politics. In the 1996 elections, the LDP was swept to power and received the highest percentage of the new SMDs vote, with nearly 48% of the total seats in the Diet. 54 In subsequent elections, the LDP and its allies maintained their majority in the Diet. Thus although the SMD system was more representative, it did not result in the creation of a formidable opposition which could press for further economic and political reforms. Rather the experience of losing power and the necessity of appealing to broader constituencies under the SMD system, forced the LDP to rethink its previous economic policies. The LDP continued the economic reform efforts initiated under the opposition governments. Economic reforms were initiated in a largely failed attempt to increase GDP growth. These reforms included privatization, capital market liberalization, and changes in banking regulations to increase transparency.55 The reforms largely failed at catalyzing GDP growth because the measures were not radical enough to change the underlying economic distortions that had resulted from years of Keiretsu dominance. More radical reform measures were not taken because both the conservative elements of the electorate and leftist portions of the labor movement opposed greater promarket reforms. Therefore constituent pressures during the nineties forced politicians to introduce economic reform measures, but also limited the reforms to the point where they were insufficient to bring about the desired result of economic growth.
53 54

Sakamoto, 422 Sakamoto, 428 55 Dixon, Available on the internet at : http://www.tcd.ie/Economics/SER/archive/1999/essay16.html

11

Constantinos Pagonis 2004

Meaningful reform of the Japanese Ministries was similarly difficult to attain. The ministries were run without accountability and transparency mechanisms that are common place in Western bureaucracies. As Pempel states, "The Japanese government is relatively free from the autonomous commissions, bureaus and regulatory agencies that mark American bureaucracy."56 The reform of ministries was considered to be the "other wheel on the cart" for increasing democratic accountability.57 Furthermore, the ministry's impact on the economy meant that their reform would have far reaching and presumably positive effects on GDP growth. Therefore in theory, administrative reforms ought to have served as an example of democratic reform which increased economic growth. In practice it is difficult to isolate the effect of administrative reform relative to other confounding variables. Administrative reform was overseen by the independent Administrative Reform Commission (ARC).58 Ministerial accountability was improved through a disclosure law or joho kokai.59 Under the disclosure law, government deliberative councils or shingikai which determined ministerial actions, had to disclose the minutes of their meetings starting in September of 1995.60 The disclosure law immediately placed accountability on ministerial decisions which had previously been done in secret. Therefore the law was revolutionary in increasing the degree of public transparency and accountability to the electorate. Further accountability was created through privatization, the NPO Bill, and the reform of the powerful Ministry of Finance. In June of 1994 three public corporations were privatized, thereby necessitating the disclosure of their financial statements, which were previously off

56 57

Pemepl, 259 Koichi Nakano, "The Politics of Administrative Reform in Japan, 1993-1998: Toward a More Accountable Government?" Asian Survey, Vol. 38, No. 3 (March., 1998) 291-309 58 Nakano, 302 59 Nakano, 304 60 Nakano, 304

12

Constantinos Pagonis 2004

limits to the public.61 Japan has traditionally lacked civil society groups to serve as third party accountability mechanisms. The Non Profit Organizations (NPO) Bill was a failed attempt at creating the structure for the growth of civil society groups. The bill was killed by LDP insistence that nonprofit organizations only maintain tax exempt status if they lacked a political end.62 The Ministry of Finance (MOF) reforms were more successful at producing meaningful changes at the ministerial level. The supervisory and regulatory functions of the MOF were placed under a new Finance Supervision Agency.63 The separation of regulatory and central bank functions reduced collusion between the banking sector and MOF, by eliminating the MOF's ability to intentionally neglect its regulatory duties.64 Electoral and administrative reforms demonstrated the prevailing inverse relationship between democratic reform and economic growth in Japan. When economic growth lagged, democratic pressures rose for a more representative, accountable, transparent and efficient government. However the Japanese experience also exhibited the reverse; democratic pressures inhibited the initiation of far reaching economic reforms which could potentially increase growth. Recent economic growth suggest that the reforms have succeeded in increasing growth, however several factors that are exogenous to the reforms, most notably the steep rise in exports to China and the gradual elimination of deflationary pressures as well as negative real interest rates make the establishment of a direct causal link difficult. The Japanese Model's Value to Policy Makers The peculiarities of Japanese society and government would make the emulation of the Japanese experience difficult. Rather the Japanese experience serves as a case study for policies
61 62

Nakano, 300 Nakano, 305 63 Xiaoming Huang, The Political and Economic Transition in East Asia (Washington DC: Georgetown University Press, 2001) 117 64 Ibid.

13

Constantinos Pagonis 2004

that could potentially create economic growth and maintain democracy, if the institutional and societal frameworks are relatively comparable to those in Japan. East Asian states which are culturally and politically similar to Japan, and that are currently in their initial stages as democracies, can gain significant insight by learning from Japan's prior experience. However Japan had certain features which make emulation both in East Asia and other parts of the developing world difficult. Due to its defense treaty with the United States, Japan lacked significant defense spending and the accompanying pressures that militaries normally place on democratic governments. Similarly Japan has a unique tradition of successful state directed capitalism. Although many states in the developing world have pursued state directed capitalism, outside of East Asia they have almost always led to rent seeking and economic policies which undermine long run GDP growth. Japan's democracy was also unique in its ability to maintain democratic competition while one party dominated the legislature. Under similar conditions, other countries such as Kenya during the eighties, became authoritarian governments or rubber stamps for the party leader's agenda. The relationship between democratic governance and economic growth was largely indeterminate. Aspect of Japanese democracy may have contributed to economic growth, while others retarded it. However inverse relationship existed between democratic reform and economic growth. A reduction in economic growth created changes in the political incentive structure which forced politicians to enact reform. The Japanese electoral system and the party's claim to legitimacy based on economic growth helped maintain LDP dominance in the Diet despite scandals and a lack of reform. Transaction costs were reduced through collusive relationships between firms and the government, but at the expense of creating economic

14

Constantinos Pagonis 2004

distortions which undermined long run economic growth. Japan's unique history and culture make operationalization of the Japanese model difficult to achieve.

15