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Japanese economy: Survival of the
unfit
By C H Kwan
Gresham's Law:
Bad money drives out good money (or survival of the
unfit).
Darwin's
Law: Survival of the fittest (or
good money drives out bad money).
In a world where Gresham's Law
applies, the exceptional cannot make full use of his
capabilities since he receives the same rewards as the
mediocre. In contrast, where Darwin's Law rules, rewards
fall in line with ability - and competition drives
progress. History has demonstrated that a nation under
Darwin's Law prospers, but when Gresham's Law reigns,
the nation declines.
Egalitarianism and the suppression of
competition have formed the philosophical basis of
Japan's postwar economic system. While this system
functioned well during Japan's catch-up with the
developed nations, the maturation of the Japanese
economy and its integration with the global economy
revealed its weaknesses. Despite these revelations,
politicians, bureaucrats and business leaders have
fought to protect vested interests, providing fertile
ground for Gresham's Law to thrive.
One
example is the personnel system of Japanese companies,
which sets its basis upon lifetime employment and
seniority. Although attempts have been made to introduce
tailored-made employment contracts for professionals
based on performance, they have met strong resistance,
and little progress has been made. Meanwhile, Japanese
companies are losing their brightest talents (usually
after providing them with training) to their foreign
competitors, which offer more flexible remuneration
packages.
This is
particularly true for the financial sector, where
foreign institutions have expanded their share of the
Tokyo market. For those with neither motivation nor
ability, however, it is in their best interest to remain
in the socialist paradise of Japanese companies and ride
free at the system's expense. With this hollowing out of
talent in Japanese companies becoming an ever more
serious problem, the sustainability of the traditional
system is now at risk.
In an environment
dominated by Gresham's Law, price deviates from value.
For example, a person's wage won't reflect the value of
his performance. For the Japanese economy to be freed
from that curse, business leaders must not only be
competent at judging the value of labor and capital, but
they must also be able to quote prices accordingly. It
is only through closing the gap between value and price
that Gresham's Law is likely to give way to Darwin's
Law.
Other examples where prices deviate from
values abound. First, during the bubble period, ignorant
investors purchased paintings (including fakes),
property and anything they could lay their hands on at
exorbitant prices and subsequently suffered huge losses.
Second, financial institutions rely solely on land and
shares as collateral while extending loans without
developing their own credit-rating systems based on the
earning potentials of borrowers. As a result, venture
businesses with no such collateral to offer have
difficulty raising funds.
Finally, most Japanese
consumers wrongly believe "the pricier things are, the
better", and this translates into a propensity for
branded goods. They are responsive to the quality of
goods and services, yet insensitive to their prices. No
wonder Japanese tourists are charged higher prices
worldwide.
The invisible hand of the market is
the most effective way through which value and price can
be matched. For example, by comparing the actual profit
level with the market norm, one can obtain information
pertaining to the performance of individual companies,
as well as the abilities and efforts of managers. Yet,
myriad distortions plague Japan's market economy:
barriers to entry, opaque administrative guidance,
collusion and so on. It is not a coincidence that
business scandals occur in heavily regulated industries,
such as construction and finance, rather than in
manufacturing, a sector that sees competition.
Recently, the supervisory function of the main
banks has greatly weakened. There is an urgent need to
rebuild corporate governance based on market principles.
As part of that process, it is necessary to replace the
current system of promoting senior managers from within
an organization to recruiting talent from outside. Also,
objective market indicators should be used to evaluate
the performance of senior managers, and one way to
achieve that is to link their rewards to company share
prices by giving them stock options.
Despite the
lip service given to the importance of competition, the
egalitarian way of thinking remains deep-rooted. For
instance, concerns that the introduction of stock
options will cause income inequalities abound. Japan's
income distribution is probably the most equitable among
all nations in the world, and a widening of the income
gap would do the country more good than bad. There must
be a change of mindset from equality of outcome to
equality of opportunity, so that hard work is rewarded.
(Republished with permission from
Miyakodayori, the newsletter of Japan's Research Institute of Economy, Trade and
Industry
(RIETI).
C H Kwan is a Senior Fellow
at RIETI. The opinions expressed or implied in this
article are solely those of the author, and do not
necessarily represent the views of the Japanese Ministry
of Economy, Trade and Industry or RIETI.
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