ISSN O075-6407

KOBE& BUSnNrESSECONOMIC

REVIEW
46th

VOLUMEANNUAL,Gfliigi"le2z,

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
2001

KOBE ECONOMIC & BUSINESS REVIEW
Editor in Chief

Kazuo Shimomura

Co-Editors
Junichi Goto; Kenji Kojima; Takashi Kamihigashi

ISSN O075-6407

KOBE& BUSINESSECONOMIC
REVIEW
46th

ANNUAL VOLUME

tggvaIIe2e

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
2001

CONTENTS
Page

Economic Theory: Past and Future''''''''''''''''''''''''•''''''''''''''''''''''''''''•''''''''''''''''''Murray C. KEMP

1Long-Term Cooperation in Japanese Vertical Relationships''''''`''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''Kenji' KOJIMA

Experiences of Technological Partnership of Japan with Overseas:

The Case of Steel Industry'''''''''''•'''''•-''':•••'''•••'''•••-''•AkioHOSONO1NobuakiHAMAGUCHI 27

Analysis of Adoption of Forest Certification in Japan From Perspevtive ofOrganizational Terory••••••••••••••••••••••••••••••••--••••••••••••••-•••••••••••••••••••'•••'AkiraKAJIWARA 47

Sensitivity of Domestic Production to Import Competition:

Evaluation at Different Levels of Aggregation••••-••••-••••••••-••••••••••••••••••••••••••••••••••••••••••-••••••••••EiichiTOMIURA 73

Japan-Korea Free Trade Area and Stmctural Reforms••••••••••••••••••-•••••-••••••••••'•••'''•'''''`'''''Bonggil KIM1Kazuhiro IGAWA 91

5

KOBE ECONOnvC & BUSINESS REVIEM, 46(2001), 1-3

Economic Theory: Past and Future

Murray C. Kemp* University ofNew South VVales

For twenty years I have enjoyed a close and harmonious relationship with Kobe University and,in particular, with the Research Institute for Economics and Business Administration. It therefore
gives me great pleasure to receive from the University its highest award and to receive it in thepresence of many close friends, including several former students.

This is an occasion for reflection-on the path travelled and on the path to be takenmand thisevening I offer you some quite personal thoughts on the present state of economic theory. They
are, for the most part, grey thoughts but you will detect in them a strong undercurrent of hopefor the future.

During the last half-century, that is, during my own professional lifetime, economic theorists
have worked in an intellectual environment dominated by two bodies of thought. The first bodyof thought is based on the pioneering work of Leon Walras, Kenneth Arrow, Gerard Debreu andLionel McKenzie. The second has grown out of the work of Eli Heckscher, Bertil Ohlin, Abba
Lerner and Paul Samuelson. For brevity (but unhistorically, unfairly, and ungrammatically) I willrefer to these two bodies of thought as "Walrasian" and "Heckscher-Ohlin." Within thisenvironment, the work of theorists has for the most part been of the comparative static kind,with their normative calculations rooted in the Walrasian paradigm and their descriptive
calculations rooted in the Heckscher-Ohlin paradigm.

This neat division of labour is, at first sight, puzzling. For, after all, the Heckscher-Ohlin modelis merely a special case of the Walrasian. Why then do we persist with Heckscher-Ohlin? The
answer is painfu11y obvious: the Walrasian model yields no descriptive comparative statics; more
Corresponding Address:

Murray C. Kemp
Australian Graduate School ofManagement, University ofNew South WalesSYDNEY NSW 2052, Australia
Tel: 61-2-9931-9532

Fax: 61-2-9662-7621

Email: murrayk@agsm.edu.au* Australian Graduate School of Management, University of New South Wales, Sydney, Australia 2052.

2

KOBE ECOIVOMIC & BUSIIVESS REVIEM, 46(2001), 1-3

precisely, it yields no descriptive comparative statics that are easy to interpret and also profound,that is, answer questions that are interesting and non-trivial. To obtain descriptive results of thatkind we have taken on board the family of special Heckscher-Ohlin assumptions, and we havebeen rewarded with the Stolper-Samuelson, Rybczynski, Heckscher-Ohlin, Factor Price
Equalization and Hicks-Ikema propositions.

Most of those assumptions are well known; one easily remembers constant returns to scale, non-joint production and small numbers ofjust about everything. But there are other assumptions,assumptions that are rarely mentioned, even in formal expositions of Heckscher-Ohlin theory.
Here I think specially of zero costs of factor re-allocation, representative agents and theexistence of autarchic equilibria for all trading countries.

We have long known that each of the Heckscher-Ohlin propositions must be qualified if theassumptions of constant returns, non-jointness and small dimensions are relaxed. wnat we are
now beginning to understand is that those propositions crumble and entirely disappear if thehitherto hidden assumptions are relaxed.

Let me briefly explain, beginning with the assumption that all trading countries have autarchic

equilibria. Casual observation suggests that even wealthy trading nations may lack autarchic
equilibria. In particular, they may lack the climate and fertile land needed for subsistence foodproduction; one thinks of Holland, Belgium, Ireland, Singapore and even the United Kingdom
and Japan. Such countries were once able to survive in autarchy; indeed there may once havebeen no alternative to autarchy. Over the years, however, natural resources may have been
degraded and trade-based wealth may have induced a substantial increase in population, to thepoint where it cannot be supported in autarchy. If a country has no autarchic equilibrium, and if
there are just two traded goods, the offer curve of that country consists of two disjoint segments;
and this in turn suggests that, if there are just two countries, the offer curves of those countries

may fail to intersect. Thus the absence of an autarchic equilibrium, even for one country may

ensure the absence of a world trading equilibrium. Clearly the Heckscher-Ohlin depiction ofworld equilibrium in terms of an intersection of continuous offer curves must be revised.
Similarly the common belief that any distortion-free Walrasian economy must benefit from theopening of its frontiers, whatever the characteristics of other economies, must be reconsidered.

Let me now change tack and briefly consider another of the hidden Heckscher-Ohlin
assumptions, that the reallocation of factors is costless. If that assumption is dropped, so that afactor of production may earn different rewards in different industries, even in stationary
equilibrium, then, quite simply, all five Heckscher-Ohlin propositions should be abandoned.

KEMP: ECONOAtffC THEORY: PAST AND FUTURE

Finally, changing direction again, let us consider, even more briefly, the hidden Heckscher-Ohlin

assumption of the representative agent. We now know that if that assumption is seriously
relaxed, so that the Sonnenschein-Debreu-Mantel "anything goes" proposjtion comes into play,then even normative Heckscher-Ohlin results must be foregone.

That completes the act of demolition. Where do we go from here? Some of you will recall that,thirty years ago, Ivor Pearce suggested that we should abandon the Heckscher-Ohlin model. He

thought that any tailoring of theory to,achieve easily interpreted comparative statics is
indefensible. According to Pearce, the task of the theorist is to ask comparative static questions

on the basis of very general theory and then leave it to the econometrician to find approximate
answers. I could not agree with Pearce when he issued his manifesto; and I still cannot join him.

We cannot get along without restricted theoretical models. At the very least, they help us to
sharpen the questions asked of econometricians-including Ivor Pearce's own questions.

But we should not place our faith in a single body of theory. By all means, let us keep Heckscher-

Ohlin. It has much to teach us about the role of factor endowments in determining the shape of
the world equilibrium. But we need competing theories, each highlighting a particular subset ofprocesses and collectively providing a set of hypotheses from which econometricians canchoose. Perhaps some of them will do without the three hidden assumptions of Heckscher-Ohlin.
I hope so.

3KOBE ECONO?LUC & BUSIIVESS REVIEM, 46(2001), 5-26

LONG-TERM COOPERATION IN JAPANESEVERTICAL RELATIONSHIPS*KENJI KOJIMA KobeUniversity

Abstract
The primary purpose of the study is to identify significant features of Japanese vertical relationships andto provide economic rationale. Japanese vertical relationships, particularly automobile industry, areexamined in comparison with those in the U.S. Both buyers and suppliers can be identified to be mutuallydependent and have developed long-term cooperative relationships with relationship-specific investments.

They have developed facilitating practices to build and maintain trust between them. It could reducetransaction costs and eliminate inefficiencies in trading relationships with cooperation and reputation in longterm relationships.

JEL CIassi:fication: L14; L62

Keywords: Commitment; Cooperation; Japanese firms; Long-term relationships; Relationship-specificinvestment; Reputation; Vertical relationships

1 Introduction
Various systems have evolved in different countries to attain efficient trading relationships.

Particularly, there are significant differences in vertical relationships between Japan and theUnited States. It is commonly observed that U.S. automobile manufacturers are more venicallyCorresponding address: .
Kenji Kojima

Research Institute for Economics and Business Administration (RIEB), Kobe University

2-1 Rokkodai-cho, Nada-ku, Kobe, 657-8501, Japan
E-mail: kojima@rieb.kobe-u.ac.jp

Phone/Fax: +81-78-803-7018*Portions of this paper appear in Kenji Kojima, Commitments and Contests: A Game-theoretic Perspective on Japanese
Vertical Relationships (RIEB Kobe University, 2000). This paper was presented at the 75th Annual Conference ofWestern Economic Association International (July 2eOO). I am gratefu1 for participants at that conference for usefu1

comments and suggestions. Financial supports from The Japan Securities Scholarship Foundation and Ministry of
Education and Science in Japan are gratefu11y acknowledged.

KOBE ECONO?LtffC & BUSINESS REVIEM, 46(200I), 5-26

6integrated than their Japanese counterparts. Product development process in the U.S. is heavily
influenced by the traditional system in which suppliers produce parts under short-term, arm'slength contracts and have little role in design and engineering. In Japanese vertical relationships,

in contrast, suppliers are an integral part of the product development and manufacturing
processes: they are heavily involved, assume significant responsibility, and communicate
extensively and directly with product and process engineers. Japanese suppliers frequently play asignificant role in development. Japanese vertical relationships can be identified that both buyers

and suppliers have recognized the need to be interdependent and have responded by developing
mechanisms that build reputation for trustworthiness between them in the long run. Japanesefirms do not rely on legal contracts to protect their interests in trading relationships. Whatfactors determine the differences in institutional arrangements that govern vertical relationships

between Japan and the U.S.? Why are many trading relationships governed by flexible and longterm relationships in Japan?

In what circumstances should a firm procure its needs in the market and should it internalize
the market by integrating operations so as to be self-sufficient in its own capacities? Extensive
reliance on market procurement permits firms to exploit the efficiencies associated with specializa-tion in production and the exposure of independent assets owners to high-powered market
incentives. But it also exposes firms to the risks of self-interested opportunism. Upon realizationthat opportunistic behavior may occur, the governance structure and the terms and conditions of

any arrangement may be chosen to adjust contracts that pose more serious hazards with greater
safeguards.

Various institutional arrangements emerge to minimize the costs of making transactions. Thereexists a continuum of potential govemance structures for vertical relationships. Between vertical

integration and arm's length market transaction, we have a wide array of potential contracting

arrangements that mediate transactions through the market but involve the use of a variety of
specialized contractual provisions that arise as a consequence of efforts by firm to minimize thetotal cost of transaction over time. Governance of contractual relationships span a continuum
bounded at one end by the writing of explicit, detailed contracts, which may then be enforced bycourt in the event of breach by one of the parties. At the other end is reliance on implicit,

relational governance founded on enduring trust relationships and reinforced by largely nonlegalistic mechanisms stmctured to encourage voluntary compliance with informal agreements.
The central problem of govemance in trading relationships is to devise specialized systems of
incentives and safeguards that will promote the continuity of trading relationships that are
efficient in the absence of self-interested opportunism, but which might otherwise break underforces of unassisted market contracting.

If vertical integration is not economical because of diseconomies associated with internal

production, contractual arrangements to govern exchange between independent agents will
emerge to economize on these transaction costs. The structure of these market contracts will

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KOJIim: LONG-TERM COOPERATJON IN JAPANESE VERTICAL RELATIONSHIPS

reflect efforts to create incentives and restrictions that reflect anticipated performance problems

so that agent will perform as initially promised when different contingencies arise. Given
contractual incompleteness due to uncertainty and complexity, as durable relationship-specificinvestments become more important, the transaction costs associated with mediating vertical relationships using arm's length market increase. Relationship-specific investments generate a stream
ofpotentially appropriable quasi-rent equal to the difference between the anticipated value in theuse to which the investments were committed and the next best use. The presence of relationshipspecific investments creates incentives for one party to hold up the other ex post and can lead tocostly bargaining. When relationship-specific investments are important, governance structure
will emerge ex ante to reduce the incentives either party has to exploit them ex post.

Numerous researches focus on how trading partners protect themselves from the hazards
associated with exchange relationships. One can try to understand how trading partners choose,from the set of feasible institutional altematives, the arrangement that offers protection for their re-iationship-specific investment at minimizing costs. Relational governance systems can facilitate

the building and maintenance of stable, long-term trading relationships. These, in tum, foster
investment in relationship-specific assets, and enable firm operating within a relationship to
exploit transaction rent not generally available to arm's length transactions. What governancemechanisms will emerge as the parties negotiate a mutually acceptable trading arrangement inresponse to anticipated transaction costs and contractual execution difficulties? One should
understand the conditions under which close, long-term trading relationships in Japanese vertical

relationships can devise mechanisms to promote the continuity of trading relationships that are
efficient in the absence of self-interested opportunism. What mechanisms support the long-termcooperation in Japanese trading relationships? How can long-term relationships with fiexible
arrangements lead to efficient performance? It is important to understand the economic rationaleof vertical relationships in Japan.

This paper discusses various mechanisms to support long-term, cooperative nature of Japanesevertical relationships. The vertical relationships in Japan, particularly automobile industry, areexamined in comparison with those in the U.S. The primary purpose of the study is tocharacterize significant features of mechanisms to support long-temi cooperation in Japanesevertical relationships and to provide economic rationale in a transaction cost perspective.
In this paper, significant features of mechanisms in Japanese vertical relationships are character-ized. Mutual commitment with significant relationship-specific investments and cross-shareholdings, reputation for trustworthiness, and facilitating practices like extensive information

sharing and enduring personal ties can reduce transaction costs and eliminate inefficiencies
between buyers and suppliers.

This paper is organized as follows. The next section describes long-term relationships inJapanese vertical relationships. Section 3 discusses commitment of buyers and suppliers in
trading relationships. Section 4 discusses the role of reputation for tmstworthiness in Japanese

8

KOBE ECONOMIC & BUSINESS REVIEPV, 46(2001), 5-26

vertical relationships. Section 5 describes facilitating practices for long-term relationships inJapan. Finally, concluding remarks are presented.

2 Long-term Relationships
2.1 Long-term Relationships
One of the most salient and enduring characteristics of the Japanese firms is their tendency toengage in ciose, long-term business relationships with other firms. The Fair Trade Commission(FTC) surveyed the buyer-supplier relationships at 200 large non-financial firms, of which 94
firms responded in 1986 (Fair Trade Commission, 1987). In regard to intermediate goods as wellas capital goods, the overwhelming response was that they had long-term relationships overmore than five years with all or the majority of their suppliers. 630/o of respondents had the traderelationships with their 30 largest suppliers over more than ten years. The prevalence of those long-term relationships is explained in the FTC report as follows: a close, long-term relationship witha few suppliers affords substantial reductions in purchasing management costs as suppliers canbe increasingly relied on to perform product inspections and inventory control, to protect
technical secrets, and to settle transactions smoothly; in a long-term relationship, communication

becomes simpler and mutual understanding develops; this is seen as a major advantage inmaintaining existing purchasing relationships with trading off raising switching cost.i

In comparing Japanese vertical relationships in automobile industry, the duration of suppliers'

trading with the same automaker is significantly longer in Japan than in the U.S. Helper andSako (1995) shows that 87 percent of Japanese suppliers, compared with 68 percent of U.S.
firms, thought that their customer's commitment would last more than four years, the typicalduration of a model cycle. Liker, et al. (1996) also suggest closer, more long-term relationships

in Japan, though these differences are not as large as expected. Japanese suppliers are
considerably more dependent on their largest customer.

2.2 Cooperation in Long-term Relationships
In Japanese vertical relationships that are characterized to be long-term ones, common character1 Economic Planning Agency in Japan conducted the mail-survey on the trade practices in 1990 (Economic Planning
Agency, 1991). It shows that long-term relationships seem to both foreigners and the Japanese peculiar to Japan.
Moreover, it shows it works against newly entering foreign firms. Respondents are foreign businessmen in Japan and
the Japanese in that survey. 820/o of respondents among foreign businessmen agree that long-term relationships are
peculiar to Japan; 720/o ofJapanese respondents agree with that. 700/o of foreign respondents agree that long-term rela-tionships are working as an entry barrier. On the other hand, 350/o of the Japanese agree with that. That survey
supports the claim of foreign manufacturers trying to enter the Japanese market. It is claimed that they are unfairly
excluded because Japanese distributors purchase only from their accustomed manufacturers.

9
KOJIILL4: LONG-TERM COOPERATION IN JAPANESE VERTICAL RELATIONSHIPS

istics can contribute to controlling and coordinating the exchange relationships. One of them isheavy reliance on implicit, relational contracting founded on trust. Supply contracts are
established by a basic agreement which is short, written document that is little more than legal
ones stipulating that the supplier and buyer are entering into a trading relationship so as not to
restrict the flexibility considered necessary to modify the supply agreement over time. They canoperate on a basis of mutual respect for each other's autonomy, and will endeavor in goof faith

to maintain an atmosphere of mutual trust in their business dealings. The virtue of implicit
contracting as a mechanism for sustaining long-terrn trading relationships lies in its intrinsic
flexibility. Assuming a foundation of mutual trust and shared expectations, implicit contracting
among parties better enables firms to make fast, informal, and highly refined adjustments in theterms of trade to preserve the substance of trade agreements rather than merely the letter ofwritten contracts. What mechanisms can support flexible and long-term trading relationships inJapan? How does implicit, relational contracting enforce cooperative relationships?

Game theory can help us to explain what mechanism works to govern Japanese vertical relation-

ships. Repeated trading relationships can serve in place of formal contracts in developing
incentives for cooperative behavior in the long run. Game theory suggests that infinitely repeatedinteractions permit cooperation to occur if the players are sufficiently patient (Fudenberg andTirole, 1991). Repetition of a game allows the players to escape the prisoner's dilemma; eachplayer's pursuing immediate gain leads to an outcome that can be improved for all of them. The

vertical relationships can have the character of a prisoner's dilemma. One way of overcoming
this is to write contracts, with each party promising to refrain from the mutually damaging

activity and making himself subject to legal sanction if he breaks his promise. However,cooperative outcomes are enforced by the threat that any deviation will trigger switch to an

outcome of a prisoner's dilemma in a repeated game. In consequence, patient panies canimplicitly cooperate with any deviation triggering punishment. A contract is implicit in that theparties would not need to enter into binding contracts to enforce their cooperation. Instead, eachparty is deterred from breaking the agreement by credible fear of provoking a prisoner's
dilemma. If the equilibrium outcomes are suitably focal points among the parties, thencooperation might be sustainable without even communication.
In a continuing situation, people cooperate because it is in their interests to do so. The pointof the repeated game argument is that players cooperate now for fear of being cut off fromprofits in the future. Suppliers make efforts to produce products on behalf of the buyers. The

resulting consequences depend on an environment as well as on the suppliers' efforts. The
buyers cannot directly observe the suppliers' efforts. In this situation, the repetition of the game

would give the buyer an opportunity to observe the results of the suppliers' effort over a numberof periods, and use the idea like some statistical test to infer whether or not the supplier was

making appropriate level of efforts (Radner, 1985). The cooperative outcomes can be attained bya review that manufacturer periodically evaluates the cumulative performance of the distributors.

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KOBE ECONOA`fiC & BUSINESS REVIEM, 46(2001), 5-26

If a review results in a satisfactory evaluation, a new phase is begun in which the outcome isefficient to all of them; otherwise, the players enter a penalty phase in which the outcome is a

prisoner's dilemma. The equilibrium cooperative outcomes are self-enforcing, and thus do notneed to rely on any binding contracts or other precommitments.
Particular buyers in Japanese vertical relationships give suppliers ratings according to theirperforrnances and cooperation in both short-term and long-term trading periods. Suppliers that
perform well are given high ratings. Then, they are promoted to be higher status in which they
are provided with the various treatments being rewarded for target achievements and cooperationin prices, quality and delivery schedule (Economic Planning Agency, 1991). The buyers' policies

of maintaining long-term relationship with suppliers can be designed to encourage them inachieving good supplying performances and high cooperation.

Although repetition can induce the incentive for players to cooperate, a repeated game has
plethora of equilibria involving cooperation outcomes as well as non-cooperative ones; eachplayer rationally pursues either long-term or short-term gains (Fudenberg and Maskin, 1986).
Hence, repetition offers no guarantee that it will occur. None of the players can be ensured thatcooperation occurs as an equilibrium outcome. The cooperation resulting from repeated relationships is not robust, so that it is necessary to have devices to support cooperative relations amongplayers. Long-term, cooperative outcomes in Japanese vertical relationships are secured bymutual trust founded upon commitments and facilitating practices. Commitments with mutual

dependence between buyers and suppliers, relationship-specific investments and crossshareholdings can be essential mechanisms for sustaining long-term, cooperative relationships.

Commitment implies an implicit or explicit pledge of cooperative continuity between trading
partners and a willingness to make sacrifices of short-term gains to realize longer-term ones. It

provides a foundation for the development of relational governance, which is considered
important mechanisms for regulating long-term relational exchanges and reducing opportunism.
Facilitating practices work to encourage partners to exchange and disseminate information and toestablish personal ties among themselves. Information sharing and enduring personal ties may
ensure every member of the trading relationship to establish and maintain trust among them.
These commitments and facilitating practices encourage members of the trading relationships tochoose cooperation as one of the focal point equilibria (Schelling, 1960).

3 Commitment
3.1 Mutual Dependence between buyers and suppliers
Significant involvement of suppliers in product development is one of the major commitments

in Japanese vertical relationships. Japanese supplier management suggests that panicularsuppliers are trusted enough to be expected to participate in the early stage of product

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KOJIMA: LONG-TERM COOPERATION IN JAPANESE VERTICAL RELATIONSHIPS

development in Japanese automobile industry. One of the major benefits of the Japanese supplierinvolvement in design is access to highly customized design with unique features for particularbuyers' needs. Japanese automobile suppliers develop more unique parts for their customers andmake greater investments in specialized assets than do U.S. suppliers (Dyer, 1996a). Japanesesuppliers typically have contracts with automakers both for a variety of components in a single

model and for similar components in different models. There are usually several companies
within the automaker's supplier group qualified to manufacture a component. The other qualified
suppliers may be currently producing similar components for other models. Within an automaker's
hierarchical structure of suppliers, there are two basic types - design approved (DA) and design

supplied (DS) (Asanuma, 1985). DA suppliers provide both design and production services tothe automaker's specifications, while DS suppliers produce a component from drawings provided

by the automaker. The DA suppliers are usually those with the close, long-term relationships
with the automaker. First-tier and the DA suppliers have a greater number and more profitable

contracts with the automaker. The automaker usually has less detailed knowledge of the DA
supplier's production costs, which give the supplier an advantage in price negotiation. There aremany thousands of suppliers in the automaker's supplier hierarchy and only a few hundred at thefirst-tier.

The typical production cycle for a car model generally begins with a lengthy design anddevelopment stage followed by a 4-year production stage. The automaker usually invites several

qualified firms in the supplier group to compete for a contract to design and produce acomponent for a new model cycle. A DA supplier will undertake the design and development aswell as tooling for production with no guarantee of reimbursement by the automaker. For DS
supplier, the automaker will guarantee reimbursement for specific investments such as tolling.

The automaker makes a firm commitment to use the supplier for the 4-years production life of
the model. A first-tier suppliers does not usually receive a separate payment for the investment

in tools, dies, molds, and jigs that are highiy customized and would need to be scrapped if theautomaker cut off orders to the supplier. The suppliers' specialized capital investments makethem highly dependent on the automakers, with the real possibility of a hold-up problem.
However, automakers are also significantly dependent on the suppliers. Most DA suppliers' partsare "black box," meaning that the automaker provides only very general specifications while thesupplier does all of the detailed functional specifications and blueprints. Consequently, suppliers

have significantly more knowledge about the design and manufacture of the part than does theautomaker. Because black-box parts are customized to a specific model, the automaker is highly
dependent on the supplier. If the supplier did not perform as desired, the automaker would havedifficulty simply switching trading to another suppliers, given the product's customized nature.

Some DA suppliers claim that they do not provide the automakers with all of the specificfunctional details when they submit their design drawings for approval, but intentionally ieave
out certain important details such as tolerances. Because the automaker does not know the part's

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KOBE ECO?VOMIC & BUSINESS REVIEM, 46(2001), 5-26

exact design specifications, it is difficult to change suppliers, resulting in the automaker's
dependence on the supplier.2

3.2 Commitment with Relationship-specific Investments
Under mutually dependent conditions, both automakers and suppliers make commitment with
substantial relationship-specific investments in Japanese vertical relationships. Consider a firmthat invests in specialized assets used to support a particular trading relationship. By virtue of
their specialization and definition to one or a few specific customers, these assets may be highly

efficient and yield lower production costs than alternative general-purpose assets. But their
specialized nature also means that they have much lower value in alternative use. This create thedanger that investing firm's counterpart in the trading relationship might attempt to improve theterms of trade it receives by threatening to defect from the trading relationship. Altematively,
there is the possibility that the counterpart will simply cease to remain in business for any ofseveral reasons, thus saddling the investing firm with underutilized or even idle assets.
According to transaction cost economics, it may be difficult to specify ex ante precisely how theassets will be employed in production even if relationship-specific investments are entirely
contractible. Once relationship-specific assets are sunk, the characteristics of the transaction andthe gain from trade will be determined by ex post bargaining between the buyer and the
supplier. Highly relationship-specific investment should be avoided by buying commodities in
the market and making customized products in-house where the hierarchy can be used to reducetransaction costs (Williamson, 1979).3

By contrast, Japanese automakers increasingly pushed responsibility for design and manufactur-

ing of more complex subsystems to a close-tied group of suppliers who are willing to makesignificant relationship-specific investments in developing customized parts for the buyers.
Moreover, Japanese automakers seem willing to allow suppliers with development capabilities to
2 Most automakers in Japan restrict suppliers to sale design specification to other companies (Fair Trade Commission

in Japan, 1993).
3 Monteverde and Teece (1982) examine the role of asset specificity in determining the structure of vertical relation-

ships. They focus on the choice between vertical integration and market procurement of automobile components by
Ford and General Motors. They use application-engineering effort as a measure of the degree of asset specificity.
They find that specific components will have a higher probability of being venically integrated. The empirical result
provides support for the view that variations in asset specificity affect the choice between vertical integration andmarket procurements as hypothesized. Masten, Meehan, and Snyder (1989) attempt to distinguish arnong type of
specific assets, comparing the relative importance of relationship-specific human and physical capital. They also
study automobile component production finding that engineering effort as a proxy for human asset specificity appears
to affect the integration decision more than physical or site specificity. Klein (1988) suggests that specific humancapital in the form of technical knowledge is a major determinant of General Motor's decision to buy out Fisher
Body. To sum up, asset specificity and uncertainty appear to have significant effects on the vertical relationships in

the U.S.

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KOJIA`L4: LO?VG-TERM COOPERATION IN JAPA?VESE VERTICAL neLATIONSHIPS

receive the long-term advantages of cooperation. In fact, relationship-specific investments
increase mutual dependence ifboth parties make them equally. Since these relationship-specificinvestments increase the exit costs for a party and reduce the potential for opportunistic
behavior, parties are likely to be comforted and thus may increase their commitment to eachother. This, in turn, creates incentives to cooperate, and the reduction in cost and improvements

in quality that are gained through the cooperation outweigh the risks of opportunistic behavior

from the parties involved. Japanese suppliers dedicated some of capital investments to theirprimary customer that these customized physical assets that could not be re-deployed if thecustomer terminates to purchase from them. It generally requires various types of investments incustomized assets by one or both firms in order to make the production and physical distribution
more efficient.

Dyer and Ouchi (1993) identify three types of customized investments employed in supplier
relationship: (1) site-specific investment; (2) physical investments; (3) human capital investments.`(1) Site-specific investments: Site specificity refers to the situation whereby successive
production stages that are immobile in nature are located in close proximity to one another toimprove coordination and economize on inventory and transportation costs. Plants are located sothat they are dedicated largely to a particular customer in order to improve coordination andeconomize on inventory and transportation costs. Venical relationships in Japan involves
building a supplier plant within fifteen miles of the customer plant to reduce transportation costs,

improve delivery, and generally improve coordination. It allows supplier engineers to work daily
at customer technical centers with customer engineers in designing new products.

(2) Physical investments: Manufacturing equipment such as tools, dies, molds, jigs,
machinery, information system and so on is customized. Physical specificity refers to relationshipspecific capita1 investments. Physical asset specialization allows for developing unique feature of

product and may improve quality by increasing product integrity.

(3) Human capital investments: Dedicated design to manufacturing requires engineers todevelop significant customer-specific knowledge. Human capital specificity refers to relationship-

specific know-how accumulated by trade partners through long-term trading relationship.

Mutual human-capital increases as trade partners develop experiences working together andaccumulates specialized information, language, and know-how that allow them to communicate
efficiently and effectively. It involves transferring the buyer's executives or employees to the

supplier to work on a temporary or permanent basis, and sending consultants to work with the
supplier to improve production methods, implement just-in-time delivery systems, or assist in

solving other problems. For example, Toyota and Nissan have large supplier-assistancemanagement consulting groups that work fu11 time with suppliers to help them improve their
4 Williamson (1983) identifies four different types of relationship-specific investments: Site specificity; physical asset

specificity; human capital specificity; dedicated assets, Asanuma (1989) identified that transaction-specificinvestments are prevalent in supplier relations in Japan, and developed the notion of "relation-specific skill."

14

KOBE ECONOMIC & BUSI?VESS REVIEM, 46(200I), 5-26

production techniques and solve the problems on quality, cost, and delivery. Providing assistanceto suppliers is a highly effective method for both helping and forcing suppliers to continuously

innovate and improve their technology.

Dyer (1996b) shows that the more relationship-specific investments are involved in theJapanese vertical relationships than the U.S. based on the survey consisting of two Japanese
automakers and all three U.S. automakers and a sample of their suppliers. Toyota and Nissan's
supplier indicated that approximately 21 percent of their capital equipment investments were not

re-deployable, compared with 20 percent for Ford suppliers, 14 percent for GM suppliers. On
virtually every asset specificity measure, Japanese automakers and their suppliers were more
specialized than their U.S. counterparts. The optimal level of relationship-specific assets will
depend on the costs of safeguarding specific investments. If the safeguard costs are particularlyhigh then the gains from specialization may be outweighed by the costs. In fact, kankei gaisha(affiliated suppliers) exhibit greater asset specificity than U.S. in-house division (Dyer, 1996a).

A firm may choose to seek efficiency advantages by creating assets, which are specialized inconjunction with the assets of a trading partner. These relationship-specific assets are thevehicles through which trading partners are able to generate relational quasi-rent. Although
investments in specific assets boost productivity, the incentive to make relationship-specificinvestments is tempered. The contingent value of a specific resource exposes its owner to agreater risk of opportunism than the owner of generalized resources. According to thetransaction cost economics perspective, if trading partners make relationship-specificinvestments, then they must safeguard against the hazards of opportunism. Source of advantage
is contingent on the costs associated with safeguarding those investments. Relationship-specificinvestments are more likely to result in high performance when trade partners have developed
safeguards which can control opportunism at relatively low cost and task activities are characterized by a highly degree of interdependence.
The efficient level of specificity between trade partners is likely to be contingent on the task

activities and degree of interdependence. Generally speaking, the greater the interdependence,
the more both parties will benefu from investments in specialized assets. Toyota's Just-•in-time(JIT) system is a good example of how customized investments can create value. Just-in-timesystem is designed to reduce complexity and costs by eliminating inventories and work inprocess and to ensure that there are no redundant buffer-stocks, distribution facilities, or quality

inspections. However, to implement JIT efficiently, Toyota and its suppliers had to makecustomized investments in information systems, plants, and flexible manufacturing systems thatcreated mutual dependency.

3.3 CommitmentwithCross-shareholding
Another mechanism to maintain long-term, cooperative trading relationships in Japan can be

I5
KOJIILtL4: L02VG-TERM COOPERATION IN JAPA?VESE VERTICAL RELATIONSHJPS

commitment with cross-shareholding. An exchange of equity between two trading parties
connects their economic interests, which help mitigate incentives to act opportunistically. The
more equity the trading partner owns in the firm, the less sense it makes to try to exploit othershareholders' interests. Reciprocal equity ownership between any two Japanese firms, so calledmochiai, is typically small - generally in the range of 1-30/o of outstanding shares. The recent

surveys suggests that average ratio of cross-shareholding over total outstanding share is about
230/o of public corporations (Fuji Research Institute Corporation, 1993). The firms in the six
major keiretsu hold 140/o to 380/o of the total shares in the group (Fair Trade Commission, 1994).
Such a bilateral exchange of shares, by itself, constitutes a safeguard against abuse of trading relationships.

Japanese automakers are much more likely to use share ownership to make a credible
commitment. Nissan and Toyota own an average of 23 percent of the shares of their suppliers in
the long-term relationships, whereas U.S. automakers do not own shares in their supplier (Dyer,
1996a). Firms need credible commitments if they are going to be willing to make relationshipspecific investments. Cross-shareholding in Japanese automobile trading relationships represents

commitments that firms have made to each other, and in many ways, it is an arrangement that is

to deter opportunism. Automakers and their suppliers own significant portions of shares eachother. This ownership stake builds trust and represents a commitment among trading partners
that need an incentive to make the relationship-specific investment they require. The incentive to
breach contracts with suppliers and buyers in the interest of transferring value to shareholders

are reduced when the other stakeholders are themselves among the firm's principal owners.
Many enduring supplying and distribution relationships throughout the Japanese industry exhibit

multiple-claim ownership. A benefit derived from this tendency to hold a blend of different
financial and other claims against a firm is an attenuation of friction that might normally arise

among various stakeholders that each owned a separate and distinct claim. The incentives tobreach contracts with suppliers and buyers in interests of transferring value to shareholders are
reduced when the injured trading partners are the firm's principal shareholders.

Commitment by trading partners is mutually reinforcing and increases over time. Each party's

perception of the other's commitments will reinforce individual commitments and therefore
future commitment intentions. Commitment is an essential ingredient for successfu1 long-term relationships. It can imply an implicit or explicit pledge of relational continuity between trading

partners who are willing to make short-term sacrifices to realize longer-term benefits. wnere
credible commitments are jointly pledged, their presence develops shared tmst, which in turnwork to maintain the relationship and constrain opportunistic inclination. It is the presence andfunction of trust that are vital to further commitment and longer-term exchange.

16

KOBE ECONOMIC & BUSINESS REVIErM, 46(2001), 5-26

4 Reputation
Reputation for trustworthiness is an expectation held by an agent that its trading partner would

behave in a mutually acceptable manner including an expectation that neither party will exploit
the other's vulnerabilities. This expectation calibrates the set of possible actions, thus reducing

the uncertainty surrounding the partner's actions. Japanese firms have recognized the need to beinterdependent and have responded by developing facilitating mechanisms to build mutual trust.
The Japanese do not rely on legal contracts heavily to protect their interests in trading relation-

ships. Sako (1992) and Smitka (1991) argue that developing mechanisms to build reputation fortrustworthiness between suppliers and buyers have been critical in attenuating the hazards ofopportunism in Japan.

Dyer (1996a) shows that Japanese supplier are more likely to trust Japanese automakers totreat them fairly and more willing to make dedicated investments base on oral agreements. Sakoand Helper (l998) define trust as goodwill trust, that is, suppliers can rely on their automakers

to help them in ways not required by their agreement with customers. Then, they find thatJapanese suppliers more tmsted by their customers than U.S. suppliers.5 Japanese suppliers tend
to entertain a higher level of trust and a lower level of opportunism than U.S. suppliers do. They
also suggest that helps and technical assistance of automakers are significant in enhancing trustin Japan but not by in the U.S. Major Japanese automakers help their supplier match competitors'

efforts if one of competitive suppliers offered a lower price for a product of same quality.
Furthermore, the automakers provide significant helps for suppliers to reduce costs if theirmaterial costs raised and develop technological capability.

Trust in trading relationships means that one's counterpart in an ongoing relationships can be

expected to pursue those actions that would be to one's benefit and to refrain from those thatwould be detrimental. This does not necessarily mean that one's counterpart will always act in

one's own benefit. Rather, it implies merely a sufficiently high likelihood of responsible
behavior over a range of normal circumstances to warrant cooperation on an informal basis.
Although none of the agreements were legally enforceable, they were not easily broken. The

reputation effects and commitments embody in these arrangements evidently work well andprovide strong safeguard for the panies involved; the short-term gains form opportunism arelargely offset by Iong-term losses from a damaged reputation in the particular industrial

communlty.
Since many of these contracts are implicit, the party must be trusted to deliver on the implicit

contracts even without enforcement by courts in Japanese vertical relationships. To the extent
5 Sako and Helper (1998) collected data by questionnaire survey during 1993 from 675 first-tier automobile component
suppliers in the U,S. and 472 first-tier suppliers in Japan, Respondents were asked to answer the questionnaire for

their most important customer regarding one product, which was typically of their company's output, and with they

were familiar.

17
KOJIA,L4: LONG-TERM COOPERATIO?V IN JAPANESE VERTICAL RELATIONSHIPS

that long-term contracts reduce costs, such trustworthiness is a valuable asset of the party. The

principal reason why long-term contracts between parties are needed is to promote relationshipspecific investments by parties. The necessary arrangement to ensure appropriate investment by
parties is a long-term relationship, which allows them to collect some of the rewards of doinghonestly. The expense of writing a complete contingent contract ensures that these long-term relationships are implicit in nature. The relationships are beneficial to both parties, as they split theex ante gains from trade.
Although both parties benefit ex ante' from implicit long-term contracts, it might pay one party

to renege ex post. For example, a buyer might gain from refusing to compensate a supplier forinvesting in the relationship-specific investment, afier investment is done. Breach of implicit

contracts can therefore raise one party's gains and the more so the greater is the burden of
fu1fi11ing past implicit contract. Conversely, the value of supplier's relationship-specific assets

suffers a loss. To take advantage of implicit contracts, potential sellers must tmst buyers.
Otherwise, sellers would expect breach whenever it raises the buyer's value and would neverenter into implicit contracts. To convince sellers that implicit contracts are good, buyers must be

trusted not to breach contracts even when it is value maximizing to do so. A solution to the
problem of how implicit contracts are maintained is reputation formation. Suppliers adhere to
implicit contract because their adherence enables them to develop a reputation for tmstworthiness, and thus to benefit from future implicit contracts. If violating an implicit contract today

would make the suppliers untrustworthy in the future, they will uphold the contract as long as
the option of entering into future contracts is valuable enough. Conversely, if it is not important
for the supplier to be trusted in the future, they will violate the implicit contract. The long-term

relationships provide incentives for trade partners to build reputation for trustworthiness thatyields favorable long-term gains. The commitments and facilitating practices to maintain group
goodwill and trust can reinforce the mechanism of reputation building by trading partners.6
Trade partners do not rely solely on reputation available from outside parties to judge the tmst-

worthiness of other partner in the Japanese vertical relationship. To ascertain whether otherpartner is trustworthy they rely additionally on their own experiences. A certain periods of timeand a number of personal contacts are required to update the reputation about other patmers.
During that period they operate in a testing process. Initially small and short-term trades are
given and further trade depends upon performances and trade behaviors. Once they are satisfied
6 In Japan, firrns may choose a trade partner within a circumscribed group in which reputation about the othercontracting party is readily available and in which public sanctions against opportunistic behavior exist. The Japanese

are inclined to introduction. Many Japanese will deal only with panies that can submit introductions from respected
third parties. The introduction verifies both that the party has acted in ways considered 'honorable' within the worldof 'reputable' firms and that it will be subject to the sanctions of the third party if it tries to act 'dishonorably' in the

future (Ramseyer, 1986), The trading groups, which are mentioned beforehand, work in a similar way. When
members ofa group share the trading information and holda common code of honorable behavior and subject to the
sanctions of others in the group, monitoring cost can be substantially mitigated.

18

KOBE ECOArOmaC & BUSIIVESS REVIEPV, 46(2001), 5-26

with the trade, on-going trade relationship is ensured. The combination of certain types of

behavior and personal contracts involving the exchange of inforrnation and giving mutual
assurances, and a considerable time for the consistency of one's behavior to be observed andtested can enhance and maintain a reputation for trustworthiness. Japanese firms have recognized

the need to be interdependent and have responded by developing bonding mechanisms that build
trust among them. The Japanese do not rely on legal contracts to protect their interests in trading

relationships.' Since the new entrants are required to spend time and effort to establish
reputation to set up new trade relationship, it may burden the newly entering firms as a tradebarrier. Once the trade relationship starts, the trading cost of each party reduces substantially due

to simplified procedures. But each party must make efforts to maintain trustworthy relationship(Economic Planning Agency 1986).
5 Facilitating Practices

5.1 Extensive lnformation Sharing
Although they may be substantial, the mechanisms to maintain long-term trading relationships
in Japan are not perfect. What practices facilitate maintaining stable, long-term relationships inJapanese venical relationships? One of the practices to helps Japanese firms forestall opportunis-tic problems in the long-term relationships is extensive information sharing. The quality of
information that trading partners have at their disposal is clearly different from that available tooutside parties. Trading partners can learn about each other through ongoing trading relationships and through various collaborative projects. Monitoring with the relationships takes place inseveral ways involving formal and informal information sharing mechanisms.

Japanese suppliers are trusted enough to be given model information relatively early in thedesign process and suppliers are expected to participate in the development, beginning at theconcept stage. In the process, Japanese suppliers wield significant influence over the process ofdefining customers' requirements so that the product designs exploit the suppliers' unique manufacturing capabilities. Liker et al. (1996) indicate that almost all of the subsystem supplier inJapan receive early vehicle concept information from their customers although they do notnecessarily have a great deal of influences over the setting of specifications for their subsystems.
7 Wilson (1980) conducts an intensive study of the New England fresh fish market. He finds that underlying thesmooth functioning of the market was a system of mutual dependence created by the particular trade arrangements
there; reputation effects provided an enforcement mechanism. Acheson(1985) studies the Maine lobster market andfind the lobster market to be characterized by long-term, informal relationships between fishermen and lobster-pound
operators. They typically crafted agreements designed to reduce the costs of information and the possibility ofopportun-

istic use of informational asymmetry, Reputation considerations and interdependencies arising from the sharing ofscarce resources reinforced the arrangements. Informal agreements and norms in eighteenth- and nineteenth-century
whaling have been studied by Ellickson (1989) and Gifford (1993).

19
KOJIA,L4.• LONG-TERM COOPELFMTJON IN IAPANESE VERTJCAL RELATIONSHIPSJapanese automakers provide early new model information to first-tier suppliers as the productconcept is forming and issue only the minimum critical product requirements. U.S. firms arethought to provide much more detailed specifications to their suppliers, allowing suppliers little

latitude on specifying the design. Japanese vertical relationships involve intense and frequent
communication during the product development cycle, particularly in the early stages when the
product is being defined. This includes the intense and regular sharing of technical information

to improve performance and reduce cost. Because these are long-term buyer-supplier relationships, the quality and efficiency of information exchange is significantly higher than it would bein new relationships. Thus mutual human-capital investment enhances information sharing andcommunication between buyers and suppliers.
There was considerably more frequent exchange of design inforrnation reported in the U.S.
compared to Japan at all tier levels and all stages of the development process. The frequency ofcommunication does not necessarily reflect the quality of communication. Japanese have a longand continuous history of working together with their suppliers on design that they cancommunicate quickly and easily between them. Direct communication and relationships
developed over a long period of time made detailed and explicjt written communications largely
unnecessary. The result of this emphasis on communication is greater efficiency, faster product-development cycles. Japanese vertical relationships in automobiles can be thought to involve
intense and frequent communication during the product development cycle, particularly in theearly stages when the product is being defined. This includes the intense and regular sharing oftechnical information to improve performance and reduce cost. When a supplier gets a noticethat the concept session for a specific vehicle model is being scheduled, there is no ambiguity

about what the supplier must bring to the session; approximately when the first, second, andthird prototypes will be due; and what the buyer's expectations at each of those milestone events

will be. One can find clear and consistent communication between suppliers and buyers in theJapanese relationships (Licker, et aL, 1996).

The suppliers' associations continue to serve a useful function in delivering benefits to boththe automaker and member suppliers (Sako, 1996). Contrary to the bilateral contracting view,suppliers value mutual learning from other suppliers just as much as learning from their buyers,

and that the majority of first-tier suppliers do consider suppliers' associations to be usefu1.
Although there is a considerable variation among those associations, as a common characteristic,

association membership is much broader than the boundary of keiretsu groupings, panicularly inrecent decades when independent suppliers that stand outside the keiretsu have been taking up
membership in multiple associations. Tokai Kyohokai, which is affiliated with Toyota, has threesectors grouped according to the type of parts that members produce. Each group meets once amonth, typically to visit a member supplier's factory, and to learn from the member's
presentation about problems and achievements at his company in the following month. The
automakers except Honda, which have an association, continue to retain much control over the20

KOBE ECONOILtflC & BUSI?VESS REVIEva, 46(2001), 5-26

activities of the association. Although less common today, many of the associations required theautomaker's recommendation as well as the approval of the association's administrative board to

become members. wnether leading or advisory, providing support for the suppliers' association
is expensive in managerial time, judging from the frequency of meetings. Weighed against thiscost are the frequently cited benefits of being able to communicate about production plans, andof soliciting good suggestions for cornmon problems, such as parts standardization and pollution
control. The most popular benefits of belonging to an association are better informational accessto the buyer. Next, learning from other members through exchange of technical information isconsidered the second most important benefit, and more important than the receipt of technicalassistance from the buyer. Many members apparently regard fellow member suppliers as a more
important source of technical knovv'-how than their buyer. The type of buyer information, which

is vaiued by members, appears to be about design and development for the next model, rather
than, for instance, about the certainty ofproduction scheduling.8

The extents to which suppliers share confidential information with buyers also provide signalsof good faith between buyers and suppliers. Sharing confidential information signals to buyersthat the suppliers' motives and intentions are benevolent. Since it appears that trading relation-

ships are indeed governed as much by implicit understandings and practices as by legal
obligations, the mutual trust in relationships is in turn strongly infiuenced by the level of
information sharing among partners. Trusting relationships involve intensive information sharing,even to the point of becoming involved in each other's business planning. Thus, information
sharing, while it does not appear to have a direct impact on the continuity of the relationship, iscritical to build the tmsting relationships that in turn create stability. Intensive two-way communi-

cation concerning plans, programs, expectations, goal settings, and performance evaluation is
critical for resolving disputes and coordinating actions.

5.2 Enduring Personal Ties
Long-terrn duration of implicit contracts founded upon commitment arrangements depends
critically on preserve continuity in the identity of specific employees interacting at the tradinginterface. The rotations and transfers result in the extensive network of enduing personal ties

among individual employees inside and outside the firrn. These are crucial to the efficacy of

implicit contracting, for the terms of such agreements are held more between individual
employee interacting at the trading interface than between the firms as legal entities. It is in thisindividual employee that mutual obligations are formed and bonds of trust are forged. It isindividual employees who ultimately adapt contracts to changed circumstances and, out of consid-

eration for their reputations, can act against any ill-advised tendencies towards opportunism

8 These evidences can be supported by the survey conducted by Fair Trade Commission in Japan (1993).

21
KOJI?L`L4; LONG-TERM COOPERATI07V IN JAPA?VESE VERTICAL RELATIONSHIPS

elsewhere in their organizations. Once established, the Japanese practice of long-term
employment serves to preserve these personal ties for many years. It also raises the cost to
individual managers of untrustworthy, opportunistic behavior.

The practice of long-terrn employment within one firm is important in developing trust amongindividuals both within the firm as well as across firms. There is real personal contact between

the purchasing managers of manufactures and the managers or owner of a supplier firm. Because
employees can develop long-term relationships with their counterparts at the supplier or buyer, it

is not surprising that the Japanese have developed significantly greater trust across firms.
Furthermore, management transfers develop effective communication that ongoing relationships
require. Various levels of managers or engineers may be temporarily transferred to related firms

to help solve specific problems or to work on joint projects. Such transfers provide extensive

networks of personal relationships between individual managers in related firms by enhancing
tmst between the firm's managers. Reinforcing monitoring and information sharing at various
levels of managers are ties at the level of the board of directors. Employee transfers are common
among trading partners in Japan, panicularly among bank and their client firms and large manufacturers and their suppliers.

The way that Japanese firms build trust is by requiring career paths in which employeestransfer from firm to firm. Employee transfers, both temporary and permanent, are common
among business partners, particularly between large manufacturers and their suppliers. In
addition to permanent and temporary employee exchanges, suppliers often send guest engineers

to work at their customer technical centers on an ongoing basis. Supplier and automakerengineers work jointly designing the components for a new car model. Not only do these careerpath help build trust between firms, but also transferred and guest employees are better able tounderstand how to enhance the efficiency of the development and production processes because
they know both buyer and supplier operations. Direct contact is much more important than otherforms of contact in developing ways for employees to know and trust each other. Both ofautomakers and suppliers encourage a considerable amount of face-to-face contact between

supplier salespeople and engineers and between automaker purchasing agents and supplierengineers. Japanese suppliers engage in more face-to-face contact and utilize more guest
engineers than do U.S. automaker parts divisions and assembly divisions (Dyer, 1996a).

wnen supplier salespeople and engineers have frequent contract with buyers for business orsocial purposes, trust can be engendered because buyers can observe the salesperson's behavior
across a variety of situations. Frequent interaction fosters trust by giving buyers information that

heips them predict the salesperson's future behavior with confidence. Information sharing
improves tmst by resolving disputes and misunderstandings and by aligning perceptions andexpectations among them. Much of communication is informal, which greatly enhances trust andcoordinated behavior. Communications play an important role in realizing the mutual benefits ina relationship. Buyers and suppliers can achieve coordination by sharing infomiation through22

KOBE ECO?VOMIC & BUSINESS REVIEM, 46(200I), 5-26

frequent and intensive two-way interchanges. Communication also fosters confidence in thecontinuity of the relationship and reduces opportunistic behavior.

6 Conclusions
Extensive reliance on market procurement permits firms to exploit the efficiencies associatedwith specialization in production and the exposure of independent assets owners to high-powered
market incentives. But it also exposes firms to the risks of self--interested opportunism. As a funda--

mentally self-interested party in its own right, and one often capable of undertaking actions or

exploiting information hidden from other party, one party cannot always be counted upon to act
in the best interests of the other. Recognizing this possibility, rational parties are induced todevelop appropriate incentives and safeguards to mitigate self-interested opportunism by otherpanies. The costs of designing and running these relationships, and value lost due to opportunistic behavior in the trading relationships by one party that ultimately cannot be eliminated, arethe transaction costs borne by one party.

The major characteristics of vertical relationships in Japan making differences from the U.S.
can be identified that both buyers and suppliers have recognized the need to be interdependentand have responded by developing mechanisms that secure cooperation between them in the
Iong run. Japanese firms do not rely on legal contracts to protect their interests in trading relation-

ships. Long-term relationships and commitments based fiexible legal contracts in Japanesevertical relationships reduce transaction cost and eliminate inefficiencies between buyers andsuppliers. Trust founded on facilitating mechanisms among trading partners allows them to adapt

terms of trade as needed in response to changing circumstances based on high degree of
implicit, long-term, relational contracts. Opportunistic behavior in such relationships can be

mitigated, and their longevity fostered, by the multiple claims ownership of parties doing
business with each other, and by extensive information sharing. The relational governance tofacilitate building and sustaining stable vertical trading relationships may lead to investment inrelationship-specific assets to bring appropriable rents. For most Japanese firms, the long-term
trading relationships with firms in which they invest constitute the chief value of their overall

dealings with those firms. Value comes from the transaction efficiencies generated by building
and maintaining long-term trading relationships, mutually beneficial trust between managers in
the trading firms can be nourished and cooperation be fostered. Contracting can take place on amuch less formal, more implicit basis, often an advantage when it becomes necessary to adjust
rapidly to a changing environment.

As uncertainty and complexity become more important in a vertical relationship, the expected
costs of writing, administering, and enforcing fu11 contingent contracts increases. A contract isincomplete in the sense that it does not specify unambiguously the obligations of each party inevery possible state of nature. Contractual incompleteness sets the stage for ex post performance

23
KOJI?SM: LONG-TERM COOPERATJON IN JAPANESE VERTICAL RELATIONSHIPS

problems. When contingencies arises that are not fu11y and unambiguously covered by formal
contractual provisions, one or both parties to the transaction may have incentives to take opportun-

istic behaviors that increase the costs or reduce gains that will be obtained by the other party.

The anticipation at the contract formation stage that the possibility of opportunistic behavior
when certain contingencies arise affects the structure of initial vertical relationships. The centrai

problem of governance in trading relationships is to devise specialized systems of incentives,
safeguards, and dispute-resolution processes that will promote the continuity of trading.

One of the most important practices supporting the preservation of long-term trading relationships in Japan is tendency of trading parties to engage extensively in highly informal, implicit
contracting. The virtue of implicit contracting as a mechanism for sustaining long-term trading re-lationships lies in its intrinsic flexibility. Assuming a foundation of mutual trust and sharedexpectations, implicit contracting among parties better enables Japanese firms to make informal
and highly refined adjustments in the terms of trade to preserve the spirit and substance ofa
trade agreement rather than merely the letter of a written contract. Where implicit contracting is
widely prevalent, the reference point in any discussion regarding a trading agreement tends to be
the ongoing business relationship itselfrather than the agreements per se.

The market may provide a natural deterrent to agents behaving opportunistically and eliminate
the need to rely on either vertical integration or complex contracts. There is a potential cost to
breaches of writing or implied contractual promises: the loss of future business from either thisbuyer or other buyers. In market where buyers and sellers frequently engage in similar types oftransactions, and where it is possible at low cost to distinguish behaviors, reputation constraints

will mitigate incentives of opportunistic behavior and allow agents to more comfortably use
market transaction, recognizing that the market provides penalties for inefficjent behavior.
Developing mechanisms to build reputation for trustworthiness between buyers and sellers canbe essential in attenuating self-interested opportunism in Japanese market.

The execution and adaptation of trading agreements are made primarily by reference to norms
and expectations built over long-term trading relationships in Japan. Thus, relational governancewithin partners is of a more continuous administrative nature and relies less extensively on legal

rules, third-party assistance to effect change, or litigation as a means of resolving disputes.
Employees in Japanese firms are those who understand the interests and priorities of the relationships, are alert to the network of implicit contracts binding the firm to the relationships, and canbe trusted to uphold these contracts over time through changing circumstances.

0ne can understand how Japanese firms have developed unique mechanisms of relational
contracting to facilitate long-term, cooperative relationships with fiexible agreements. It is

important to understand why and how flexible trading arrangements sustain in the market
transaction. Relational contracting in Japanese vertical relationships facilitates building andmaintaining of stable, long-term, and cooperative relationships. These, in turn, foster investment

in relationship-specific assets, and enable firm operating within the relationships to exploit

KOBE ECONOAtflC & BUSINESS REVJEPV, 46(2001), 5-26

24transaction rent not generally available to arm's length transactions.

wnat governance mechanisms will emerge as the parties negotiate a mutually acceptabletrading arrangement in response to anticipated transaction costs under a particular institutional

environment? Arrighetti, Bachmann, and Deakin (1997) suggest that trading arrangement can beaffected by the institutional framework for exchange, as constituted by the legal system and byless formal, social norms. The institutional framework may play an important role inunderpinning long-term, cooperative relationships. It is important to examine the effects of institu-

tional environment on governance mechanisms in trading relationships.

Under what conditions a particular vertical arrangement can lead to efficient performance?
What conditions under which close, long-term trading relationships among few firms can lead toefficient performance? Yet many interesting issues still remain unknown about trading relationships between buyers and suppliers.

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Radner, R. (1985), "Repeated Principal-Agent Games with Discounting," Econometrica, 53, 1173-1198.

Ramseyer, J. M. (1986), "Lawyers, Foreign Lawyers, and Lawyers Substimtes: The Market for Regulationin Japan," Harvard lnternational Law Jouixal, 27, 515-522. .
Sako, M. (1992), Prices, euality, and Trust, Cambridge University Press.

Sako, M. (1996), "Suppliers' Associations in the Japanese Automobile Industry: Collective Action forTechnology Diffusion;' Cambridge Journal ofEconomics, 20, 651-71.

Sako, M. and S. Helper (1998), "Determinants of Trust in Supplier Relations: Evidence from theAutomotive Industry in Japan and the United States," Joumal of Economic Behavior and0rganization, 34, 387-417.
Schelling, T. C. (1960), The Strategy of ConLflict, Harvard University Press.

Smitka, R. J. (1991), Competitive Ties: Subcontracting in the Japanese Automobile Industrv, Columbia
University Press.

Williamson, O. E. (1979), "Transaction-Cost Economics: The Governance of Contractual Relations,"
Journal ofLew and Economics, 22, 233-261.

Williamson, O. E. (1983), "Credible Commitments: Using Hostages to Support Exchange;' American
Economic Review, 73, 5l9-540.

26,REVIErv,46(200I),&
KOBEECONOMIC BUSINESS

5-26

Wilson, J. A. (1980), "Adaptation to Uncertainty and Small Numbers Exchange: The New England Fresh
Fish Markets," Bell Jounial ofEconomics, 4, 491-504.

KOBE ECONOMIC & BUSIIVESS REVIEPV, 46(2001). 27-46

EXPERIENCES OF TECHNOLOGICAL PARTNERSHIP
OF JAPAN VVITH OVERSEAS:

THE CASE OF STEEL INDUSTRYAKIO HOSONO KobeUniversity
NOBUAKI HAMAGUCHI Institute of Developing Economies, Japan External Trade Organization

Abstract
Three cases of Japanese experience of transfer of technotogy to newly industrialized countries in thesteel industry during the 1960s and 70s are analyzed comparatively. The most successfu1 case in the

Korean POSCO project is compared with the apparently failed case in Mexican SICARTSA project and asort of intermediate case in the Brazilian USIMINAS projects. Both factors of success and failure are
analyzed. Observations from this comparative analysis led us to conclude that the success of technology
transfer depends very much on the quality of the system of learning of a recipient. The system incorporates
efforts in education, finance strategy, coordination of the market, clear targeting of quality, and stimulus fortechnology absorption.

JEL CIassi:fication: D24, L61, O14, 033, 053, 054
Keywords: technological partnership, steel industry, technical cooperation"The great questions of the day will not be settled by speeches and majority decisions ''' but by blood andiron." (Otto von Bismarck, speech to the budget commission of the Prussian Lower House in 1862)

1. Intreduction
In the 19'h century, iron was considered as the most strategic material of the military power
Corresponding Address:

Akio Hosono
Research Institute for Economics and Business Administration (RIEB), Kobe University,

2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: hosono@rieb.kobe-u.ac.jp

PhonefFax: 81-78-803-7006
Nobuaki Hamaguchi
Institute of Developing Economies
Japan External Trade Organization

E-mail: hamaguti@uol.com.br28 KOBE ECONOAtfiC &BUSI?VESSVIEPV,RE' 46(2001), 27-46

and therefore it became a symbol of the power of a country. In the post-war modernization era,a steel turned to be one of the most important input for wide range of industries such asmachinery (especially automobile and ship-building industries), civil construction and infrastructure building.

Development economists like Hirschman (1958) and Rosenstein-Rodan (1943) emphasized theimportance of backward- and forward-linkages and the need of initial "big-push" to put the self-

reinforcing forces in place. In this interpretation, the better quality of steel products areavailable, the great the chance will be to achieve higher level of industrialization. Then, owing

to scale economy in steel production, the 1arger the demand, the lower the production cost
becomes and the greater the variety of steel production can be sustained. Because of the circularcausality between the scale economy and forward linkage effect toward the down stream
industries, development of a steel industry was envisaged by newly industrializing countries forthe past 50 years.

Steel production does not necessarily depend on availability of primary material such as ironore and coal because a steel mill can be constructed at a coastal location which is advantageousin unloading of imported material and shipping of finished products. Rather, it highly depends

on availability of capital. It also requires very complex and comprehensive combination oftechnologies. Experiences of late industrialization suggest that, because the technology is alreadyembodied in the capital goods, if a country can introduce highly efficient equipment it cancompete with industrialized countries. Hence, successfu1 establishment of a steel would requirethat the government play important role in mobilization of capital and acquisition of advanced
technologies.

The experience of Japan in rapid industrialization supported by spectacular development insteel industry called strong attention, especialiy from those countries envisaging industrial
development. Japanese steel industry frequently received requests from them for financial and tech-

nological cooperation and cumulated a wide range of experiences in this regard. In this paper,
we will trace some examples of success and failure from them and attempt to draw some lessons
how we could implement an intemational teclmological partnership more successfu11y.

The case in point here is when a late industrializing country attempts to ride onto thesuccessfu1 trajectory how the project executing capability would matter. Issues are mainly
concerned to capital and technology.

There are three main source of capital mobilization and three ways to acquire newtechnologies. Investment can be financed by domestic savings, foreign borrowings, and foreign
direct investments. Acquisition of technology is possible through technology transfer (whichcomes with foreign direct investment), licensing, and imports of capital goods. So, experiencesof late industrialization may vary depending on which strategy a country would choose.

Japan reactivated its economy in the post-wwII period by concentrating the use of limited

domestic savings and hard currency into steel, carbon mining, and electricity generation.

HOSONO A?VD HAAL4GUCHI: ExeERIENCES OF TECHNOLOGICAL PARTNERSHIP OF JAPAN MITH OVERSEA

Although borrowings from intemational financial institution contributed to some important infra-

structure buildings, Japan was a rare case of being capable of financing late industrialization

basically through domestic savings. Japan rejected foreign direct investment. It was an
expression of a nationalism putting emphasis on "teclmological independence" not allowing
foreign ownership of productive asset. Instead, the Japanese industrial policy prioritized, throughforeign exchange control, acquisition of technology through imports of capital goods andlicensing foreign technology. It also emphasized investment in education, especially inengineering in order to stimulate learning and developing application.i

Korea, as the case of steel industry in this paper clearly shows, followed the Japaneseexample. Although its dependence on foreign borrowing was much higher, Korea did not allow
foreign direct investment and concentrated to acquisition of technology through purchasing of
the most advanced machinery and quick leaming of highly educated human resource.2

On the other hand, Latin American countries, like Brazil and Mexico in our case study,
foreign direct investment had much heavier weight. As many study showed3, Latin American industrialization progressed by constituting a triangular alliance of the government, national
private, and foreign capital. Multinational firms bringing both capital and technology weregenerally welcomed, yet when it comes to activities related to natura! resource and basic
materials, nationalistic views were always invoked and only a minor share participation wasallowed. At that point limitation of capital mobilization capability of the government appeared asa bottleneck. When a nationalistic point of view was translated into high degree of import-

substimtion policy, imports of advanced capital goods became difficult and the ability ofdeveloping compatible domestic technology became questionable.
In what follows we explore three cases of Japanese experience of technology transfer to newly
industrialized countries during the 1960s and 70s. By doing so, we are able to demonstrate how
differences in strategy might result different performance. The next section will depict the firstcase of this kind in Brazil with the Usiminas Steel project. Then, in the following sections, wewill visit both the most successfu1 case in the Korean POSCO project and apparently failed casein Mexico-SICARTSA project.

2. The Case of USIMINAS, Brazil(1) Initial period of USIMINASWhen Mr. Juscelino Kubitschek became the president of Brazil in 1956, his administration
announced an ambitious Five Year National Development Plan. It included the constmction offour new steel mills with several blast furnace steel mills (Belgo-Mineira, Acesita, and CSN). At
1 See Kim and Dahlman (1992).
2 See, in particular, Evans (1979).
3 See, in particular, Evans (1979).

KOBE ECONOMIC & BUSINESS REVIEW, 46(2001), 27-46

30

that time steel production capacity of Brazil was around 1.28 million. The Brazilian government
requested cooperation of Japan. Although Japanese steel produÅëtion was still much smaller inscale than in the US and Europe at that time, it already showed remarkable catching up by
introducing the newest technology of the moment, which is the example that Brazil wanted tofollow. The negotiation gave birth to the USIMINAS project.
The USIMINAS project was the first case of the Japanese cooperation for steel production inoverseas. The Japanese business community welcomed the request because the iron ore rich
Brazil was seen as an ideal showcase to prove to the world that the technological capability of
the Japanese industry was already comparable to that of the industrialized countries. Therefore anational project team was called involving high-profile government officials, business leaders ofsteel industry, industrial equipment industry, and construction and engineering industry. Afterexchange of visits of several highly qualified business executives and govemment officials, theboth countries swiftly reached an agreement to jointly establish USIMINAS in 1957.`

Short-term benefit came from considerable volume of plant equipment demand related to
USIMINAS. The plant equipment exports to USIMINAS during the construction period (196065) represented about 100/o of the whole industrial machinery exports of Japan during the same

period. This demand was very significant for the Japanese industry which entered a downward
cycle in the mid-1957.
In the long-term, the project was expected to contribute to enhance economic relationship with
Brazil to secure access to primary materials. Brazil is special to Japan also because the Japanesecommunity there is the largest outside Japan.

USIMINAS was formally established in 1958. As a counterpart organization a special purpose

investment company Nippon USIMINAS had been already established in the previous year
which also carried out organizing provision of equipment and technical support to USIMINAS.

Nippon USIMINAS is a consortium of the government fund (corresponding to two thirds) andinvestment ofprivate companies consisting of steel companies and plant equipment companies.

The founding agreement of USIMINAS included the following contents:(a) Construction of an integrated steel mil;(b) Initial production capacity is 500 thousand tons;(c) Capital: 3.2 million cruzeiros where the Brazilians and the Japanese hold 600/o and 400/o,
respectively;(d) Executive management board consisting of five executive managers, including three
Brazilians and two Japanese. One Brazilian chaired the company as a president and theother two took responsibility for sales and finance. One of the Japanese held the position ofa general manager who controls accounting and budgeting. Another Japanese initially
4 The negotiation process is described in great detail in Nippon Usiminas (1969) and Usiminas Kaiso Roku Henshu
Group (1997). Several persons involved in the inital phase of the Usiminas wrote books. See Nakamura (1999) andKobayashi (1997).

HOSONO AND HAAMGUCHI; EYPERIENCES OF TECH?VOLOGICAL PARTNERSHIP OF JAPAIV MITH OVERSEAS 3

supervised the plant construction and then in the operation phase directed planing of
expansion, technological research, production planning and improvement of productivity.

(2) Financial problems
Plant construction was started in l959 and the first blast fumace was installed in 1962.
USIMINAS gradually became an integrated structure by finishing casting plant and steel platemaking plant in 1963. In 1965 construction of hot strip mill and cold mill was completed. It

took more than eight years since the master plan was defined untii to achieve the planned
production level of 500 thousand tons per year.

Construction of the production plant was delayed more than one and half years than theoriginal plan for various reasons. Firstly, the govemment provoked significant fiscal imbalanceby implementing the development program in addition to the construction of Brasilia. This
problem caused inflation which increased USIMINAS' plant construction cost substantially.
Inflation also raised financial cost of the loan from the national development bank, BNDE,

because BNDE charged the monetary correction to compensate the real value loss of theoutstanding loan. Secondly, because the plant was constructed in deep inland, investment wasneeded in construction of urban infrastructure for employees' living and transportation in
addition to the plant itselÅí Thirdly, serious political uncertainty surrounded the post-Kubitschek

period with several anti-cornmunism military intervention, which led to the military coup in
1964.

Faced by the lack of finance for construction, USIMINAS proposed to increase the capital to
18 billion cruzeiros in 1961. Intense negotiation was held during 1961-62 and the Japanese sideagreed to increase their investment up to 9.7 billion yen corresponding 400/o of the capital.
However, the Brazilian government was not able to finance the rest of capital increase because

by 1961 Brazil went into balance of payment crisis and had already requested debt payment

rescheduling to creditor countries. In order to save the nascent project Japan agreed toreschedule the repayment of the outstanding commercial lending and further extended Export-

Import Bank loans to BNDE to cover the finance of BNDE's capital increase to USIMINAS.
The financial problem persisted, however. In 1963 the Brazilian side requested further capitalincrease to cover the soared construction cost and financial cost due to the inflation. For theBrazilian side, financing through capital increase is by far more preferable to the borrowing
under the inflationary economy because the financial cost is much higher due to the monetary

correction. Although Nippon USIMINAS conceded additional five billion yen for constmction,
the Japanese side became reluctant to further investment contending that, by the original
agreement, infrastructure building in the plant area and operational cost including financial ones

for inflationary monetary correction are sole responsibility of the Brazilian govemment. Thus

USIMINAS relied on the BNDE lending and when the construction was concluded the loan

32

KOBE ECO?VOMIC & BUSIIVESS REVIEM, 46(2001), 27-46

outstanding was converted into capital stock. This measure created intense discontent of theJapanese investors because although the Japanese invested 650/o more than what was commited
originally, their equity share decreased from 400/o to 21.460/o. The Japanese consounium's sharedecreased further to 18.80/o until 1967 by more capitalization of BNDE loans.

(3) Technical transfer

Despite of the conflict surrounding the financial problem, the construction of the plant was

carried out in harmonious cooperation between Japan and Brazil. The technical assistance of

1,508 men-months of 137 engineers from 34 plant equipment makers was devoted for the
installation. Plant construction was carried out by a Japanese general constructor Kajima involv-

ing whose civil engineering service of 460 menlmonths of works of 1 1 engineers was devoted.
As the production partly started in 1961, Yahata Steel, Fuji Steel and NKK jointly dispatchednearly 500 persons to USIMINAS in five years until 1965. These persons were stationed 3-4
years serving as leaders of production lines and also provided the following technical assistance:' Suggestion to completion of the plant construction;' Elaboration of an operation manual;' Production planning;' Preparation of production materials;' Training of local staff.

The technical cooperation was granted basically free of charge of technical fee. The line
operation was transferred to Brazilians one year after each plant started operation. The process

was actually carried out overcoming huge obstacles. Since the plant was constructed in theisolated area, Japanese engineers who came all the way from the other side of the earth sufferedfrom large difference in living standard and climate. It was also difficult to gather local
engineers and operators with reasonable qualification in such area. Cultural gap and difficulty incommunication were tremendous. In those circumstances, the role played by the nikkey(Japanese immigrants and their descendents) employees in mediating communications andfacilitating assimilation of the Japanese staff should be highly credited. Especially, they played

vital role in translation of operation manual into Portuguese and interpretation in training
seminars. By 1967 all the responsibility of plant operation was transferred to Brazilians and theJapanese engineers left USIMINAS.
The changeover of operational responsibility occurred in the midst of steel market crisis andthe company was in the continuous financial difficulty. According to Dahlman and Fonseca(1987, p. 163), USIMINAS broke the "recipe" left by the Japanese into basic elements andcarefu11y studied what was behind them and how they futed together5. Each elements were
5 The same authors points out that USIMINAS passed from know-how stage to know-why stage (p. 171)

HOSONO AND HAAL4GUCHI; EXPERIENCES OF TECHNOLOGICAL PARTNERSHIP OF JAPAN PVITH OVERSEA

compared with those used elsewhere in the world to learn weakness of USIMINAS. Thisrequired creation of the departments of industrial engineering, metallurgy and plant inspection,

as well as an researchlinformation center. The whole process of acquisition of technology wasbeyond the simple learning. It was worked closely with the technical assistance of Nippon Steel.

The success of technology transfer showed immediate result. In mid-1970s, USIMINAS had
the highest productivity in sinterization, and comparable to average productivity of blast furnace(in terms of daily production volume and energy efficiengy in cokelfuel rate) of steel mills inJapan, which was the world leader at that period (Dahlman & Fonseca, 1997, Table 6.9).

Production showed steady growth attending strong domestic demand during the high growth
period of the Brazilian economy in the decade of 1970s, as shown by Figure 1. Production
capacity was expanded to 1.4 million tones in 1973, 2.4 million in 1976, 3.5 million in 1981.
Accordingly, USIMINAS' share in total Brazilian production increased progressively from 150/o
in 1967 to 190/o in 1973, and 250/o in 1976. Especially, USIMINAS had maintained high share inflat sheet products which contributed substantially development of shipbuilding and automobile

industry (Dahlman & Fonseca, 1997, Table 6.7). Technologically, USIMINAS was in a position
to provide teclmical assistance to downstream activities such as capital good industries and othersteel mills. Dahlman and Fonseca (1987) reports that USIMINAS was doing for the new steel
plant of ACOMINAS basically the same thing which the Japanese did for it when it was getting
started (p. 164).

Figure 1. USIMINAS: Evolution of the production (tones)
5,OOO,OOO
4,OOO,OOO
3,OOO,OOO
2,OOO,OOO
1,OOO,OOOoNajP NdvS NdvA Ndv9 elN Nge eAS eAl e19 NdyN Kcsib ebS NS e"9 sN egS NeS(Source) Usiminas Kaiso Roku Henshu Group, 1997

(4) Regime changes: Nationalization and desnationalization
Brazilian government established Siderbras in 1973 as the holding company of the stateowned steel companies. The majority equity share ofUSIMINAS (51.680/o) was transferred from

BNDE to Siderbras. With other state-owned steel mills such as COSIPA and CSN, USIMINAS
was put under the direct control of the government. The government's idea was to take responsibility of financing steel production and command industrialization by distributing basic materials at

low cost. However, such non-profit maximizing control of price and production and nomination

46(2001),
REVIEM,&
KOBEECONOMICBUSINESS

34

Figure 2. Net profit after tax (27-46

in million US dollars)

4oo
300
2oo
1oo

o
-1 oo

-2oo

Boo

b.
c" mNaN N ts.. nmN
emeeeeea!-a"a!- mm or a"m
T.
t- 1-or1-or
1- av.ort.ptv-

at "co n
p
co
ot
m
m
!.
T"
T'.

F
m
co
co
or
or
"
t--

or
co

a
'

'm
o
'

n
m
m
m
or
m
'
'

(Source) Usiminas Kaiso Roku Henshu Group, 1997

of politically appointed managers without any experience in the steel business gave devastating

effect on profitability of USIMINAS as shown by Figure 2. 0n the other hand, althoughavailability of financial resource expanded initially, the government's ability was restrained substantially as the budget deficit accumulated and inflation soared in the 1980s.

The decade of 1990s witnessed the government's strong determination on the privatization
program. USIMINAS was the first case to be brought to the market auction in 1991. At the eveof the privatization, the position of shareholding of Nippon USIMINAS had dropped to 4.990/o
from 18.580/o prevailed at the time when Siderbras was established because of the unilateralcapital increase by the Brazilian part. At the time of privatization, Nippon USIMINAS acquired

equities held by BNDES through swap of (non-voting) preferential share with ordinary voting
shares and with withdrawal of deposited dividend for the preferential share. As a consequence of

this operation, the share ofNippon USIMINAS increased to 13.840/o. USIMINAS was reborn asa private company and achieved one of most remarkable successes of privatization in Brazil. Its
profit improved constantly (see the Figure 2) while the productivity increases as shown by the
Figure 3.

Figure 3. Productivity: Man-hour per ton of production
8
7

6
5
4
3
2
1

o

1990 1991 1992 1993 1994 1995 1996 1997
(Source) USIMINAS Web page (http:11www.usiminas.com.br).

HOSONO AND HAI}L4GUCHL• ELU}ERIENCES OF TECHNOLOGICAL PART?VERSHIP 0F JAPAAi PViTH OVERSEAS 35

3. The case of POSCO, South Korea(1) Elements of the success of POSCO
Pohang Iron and Steel Co. Ltd., POSCO is considered not only the most important steel
company in Korea but also one of the most successfu1 cases of development of steel industry in
newly industrializing countries. This company has attained almost the lowest cost ofproductionof common ("large-scale production") steel in the world, challenging traditional exporters. It isfurthermore catching-up to them in the field of high-grade types of steel. The amount of
production of POSCO increased in more than eight times in ten years from 2 114 thousand tons
(M.T.) in 1976 to 9 530 thousand tons in 1986, when the company attained the status of one of
the top steel mills in the world.

TabJe 1. Stee) Production in Korea(thousand M.T.)
1976

l978

1980

1984

1985

1986

1240 3.511

4.959

8.558

13.03413.53914.555

1973
Production

Total

posco

458

2.114

2.923

6.228

9.195

9.284

9.530

36,9

60,2

58,8

72,8

70,5

68,6

65,5

2.431

3.466

6.517

5.636

9.744

10.45911.262

501

1.403

2.338

2.747

5.542

5.747

6.354

20,6

4,3

35,9

48,7

56,9

54,9

56,4

Total

917

1.564

1.871

3.875

6.013

5.788

6.369

posco

118

41

525

2.365

2.527

2.573

2.463

12,9

26,4

28,1

61,O

42,O

44,5

38,7

Share(O/o)

Domesticmarket
supply

Total

posco
Share(O/o)

ExportShare(O/o)(Source) Toda (1990).

Few people thought that this fast development of steel industry was possible in Korea when

POSCO started in 1968. For example, the World Bank's report on evaluation of Korean
economy concluded in the same year: "the construction of the steel plant should be postponed
and, in stead, labor or technology intensive machinery industries should be developed." Behind

this conclusion, there was the opinion that Korea's technological capability was not yet
sufficient for the proposed steel plant.

Furthermore, the United States Operations Mission (USOM) sent the official document to the
Korean Economic Development Institute indicating that instead of integrated steel mill with blast

36 KOBE ECO?VOM]rC &BUSINESS REVIEif, 46(2001), 27-46

furnaces, it was recommendable to construct only continuous hot strip mill with the system ofelectric fumace.

Unlike the case of Brazil which was naturally endowed with rich iron ore resource, thechallenge of Korea was much harder one of creating the comparative advantage overcoming
obstacles all unfavorable factors such as lack of natural resources and capital and proximity to

the most efficient competitor of the world, Japan. It was also a challenge of the conventional
wisdom saying that a state enterprise is inefficient.

According to Hiromoto Toda (1986) who studied in details the case of POSCO, there havebeen the following factors, which enabled the successfu1 development of this Korean steel

company:1) Very active support from the govemment, especially from the President, was crucial.
Through this support, POSCO was able to get external finance, favorable conditions oftechnological transfer, construction of related infrastn,icture, etc.

2) High rate of increase of demand of steel in the domestic market was one of the very
favorable factors for POSCO.
3) The reduction of construction costs of the steel plant by diminishing the period of

construction. The construction period was reduced by 14 months through 4 phases ofPohang steel mill and by 6 months in case of Kouyou steel mill.

4) The purchase contracts of every components of the steel plants was made very timely
and with the best conditions in terms of price and quality through the system of open

bidding. The purchase of POSCO could be considered the most favorable among manycases of constmction of integrated steel mills.

5) Efforts were made to develop the own capacity of engineering through the four phasesof construction of POSCO, reducing substantially the cost of engineering.

6) The period of transition from initial production step to fu11 production step was
shortened considerably, on average to only three months in stead of six months of othercountnes.
7) Stabilization of the supply of raw materials as coal was considered as the essential

element for successfu1 steel production. POSCO made investment in Tanoma Coal Co.
(United States) and participated in joint ventures of coal mining development (Mt.
Thorley and Greenhills, both in Australia).

8) It should be emphasized that the planning of construction of plants were made on thebasis of the very carefu1 estimation of supply and demand of steel made by its own
staff.

9) The availability of very high quality of labor and its very low level of tumover was oneof the most important factors of the success of POSCO.

It should be emphasized that above mentioned merits have much to do with the Koreannational system of innovation. According to Kim (1993), the general framework of the Korean

HOSONO AND HAAL4GUCHI: EXI?ERIENCES OF TECHNOLOGICAL PAR77VERSHIP OF JAPAN PvrTH OVERSEAS

technology policy can be characterized by the following elements:

1) Investment in basic education, which eradicated illiteracy and universalized middleschool level education in 30 years;
2) Hard working habits encouraged by "beat-Japan" spirit and tension with North Korea;

3) Promotion of technoiogy transfer through the procurement of turnkey plants. Foreign

direct investment and technology licensing were restricted to maintain Korea's
independence from foreign multinationals;4) Continued military relations with the U.S. also contributed to transfer of technology innumber of sectors;5) Korea's own military technology investment brought significant impact on precision ofmachinery and electronics industry;6) Strategic industrjal policy to promote jmport-substitution of key industries such as
textile, consumer electronics, automobile, steel, and shipbuilding;7) Instead of multinationals, large national business groups, Chaebols, were promoted. They
were responsible for import-substituting industrialization and leading exports.

8) Export promotion to eam foreign currency to enable acquisition of foreign technology
and import-substitution;9) Domestic science and technology infrastructure played little role.

Despite the negative perspectives shown by the World Bank and the United States, in theparticular political context of Korea at that time allowed all the necessary conditions for the

POSCO development including finance, investment in learning, market creation concerted with
big business groups (chaeboD and technology transfer. Thus, the risk of investment was rather
safely taken by the government. It should be noted that the Korean govemment was in favorable
position to negotiate the package of financing and technology transfer from Japan because it wasgiven as the reparations for hardships under the colonial rule. However, these conditions are notsufficient without Korea's extraordinary leaming capability which was so much praised by

Amsden (1989)6. In this regard, we can observe very aggressive and organized efforts ofacquiring technology in the early stage of the POSCO project.

(2) Japan-Korea Technological Partnership
Until 1973, Korea had no capacity of production of iron for steel production. Consequently,
scrap or crude iron was imported to produce steel by small electric furnaces. According to Uhi

Pak (1989), as there were no integrated steel mill in Korea at the beginning of 70s, thegovernment of the Republic of Korea had to depend on foreign technology as well as foreign
finance when it planned to construct a large size integrated steel plant.

6 See Amsden (1989), especially Chapter 12. The idea was fUrther developed by Amsden and Hikino (1994).

38

KOBE EC07VOMIC & BUSI?VESS REVIEM, 46(2001), 27-46

The government tried twice to start plans of construction of the steel plant, but failed torealize them due to several reasons. The first plan was envisaged by the contract between thegovernment of the Republic of Korea and KISA (Korea International Steel Associates,
established as an international consortium with participation of companies of the United States,

West Germany, Italy and United Kingdom. France participated later.).

KISA promised on October 1967 to get necessary capital abroad before the end of 1969 andto finalize the construction of the steel plant before the end of 1972. Nevertheless, as it was
mentioned, both the World Bank and the US Mission were against the plan of construction of an
integrated steel plant. In this context, Koppers, the leading company of KISA were not able toobtain the required capita1 of 100 million dollars. Furthermore, the complex organization of
KISA made difficult to make its timely decisions. Therefore, KISA was dissolved in 1969.
The government, after this failure, decided to get external finance for the construction of thesteel plant. In August 1969, Japanese Minister of Foreigri Affairs expressed that its government

would support the Korean government's new approach to the construction of the steel plant.

According to the signed agreement, Japanese govemment would extend a loan of 123 million
dollars for a turnkey contract of up-to-date equipment. As a part of that contract POSCO andJapan Group (JG) consisting of steel companies agreed on the contract regarding the technicalcooperation: (a) cooperation for the project of consulting on planning of the construction of theplant; (b) cooperation for the project of purchase of equipment and construction; (c) support andadvice for purchase and installation of equipment as well as related construction works; (d)plauning and implementation of construction and integrated system of control of construction;(e) support of initiation and operation of the plant.

Japanese technological cooperation have been gradually reduced from the construction of theoriginal plant to the fust expansion plan (1974-76), the second expansion plan (1976-8S) and thethird expansion plan (1979-). Based on the experience in the first phase which entailed over 1 19

thousand foreign engineer hours (D'Costa, 1999, p. 8), POSCO already acquired capabilities toundertake the following engineering tasks: preliminary engineering planning, preparation of
procurement specifications for auxiliary facilities (power transmission and distribution systems),

preparation of common specifications for general technology, review and evaluation of
manufacturers' specifications, preparation of civil engineering and building construction design,
preparation of testing and start-up plans. In the second expansion plan (1976-85) the responsibili-ties of POSCO became even greater, although JG reviewed all the engineering works of POSCO

and the master engineering plan continued to be the responsibility of JG. As the Korean
engineers and workers were able to absorb very successfully the technology, at the third

expansion plan phase (1979- ), JG's only function was to evaluate POSCO's own masterengineering plan (Amsden, 1989, pp.308-309), entailing only 491 foreign engineer hours(D'Costa, op.cit.). The declining reliance on engineering service of JG is indicated by reductionof the ratio of engineering service fee per ton of steel production from $6.13 in the first phase toHOSONO A?VD HAthGUCHJ: ExeERIENCES OF TECHNOLOGICAL PARTIVERSHJP OF JAPAIV PVJTH OPERSEAS

Table 2. Comparison of steel product quality and process technology

JapanOthers"

Korea

Productuali
Steelplateforautomobil(t.s.kglmm2)

80

Steelplateforship-building(t.s.kgtmm2)

50

12050

5040

Processtechnolo

Laborproductivity(Tlman)

866

Energyefficiency(1,OOOkcallt)

529

1102603,589680*Others: estimates of the steel plants in developing countries.

(Source) Park (1997).

Table 3. Selected indicators of technology and competitiveness (O/o)

1986

1989

1998

1994

1993

1992

Korea Japan Korea Japan Korea Japan Korea Japan Korea Japan Korea Japan
C.C.ratio

75,1

92,7

88,3

93,1

94,1

93,5

96,8

95,4

97,8

95,7

97,8

-

Yield(Steel)

89,7

92,6

91,7

92,6

92,6

92,8

-

-

94,6

93,1

95,2

.

17,9

,8,2

17,8

8,9

17,6

10,7

-

SpecialtySteel

.

18.0

6,5

18,7

6,5

C.C. ratio: Continuous Casting Ratio(Source) Park (1997)$O.1 1 in the third expansion phase (Amsden & Hikino, 1994, p. 134).
Particularly high attention was paid to shorten the plant construction period and start its

regular operation as soon as possible. For this purpose POSCO sent engineers to Japanesecompanies for training where they participated in the set up process of steel plants in Japan andobtained a wide range of experiences of construction and operation of steel mills. As a result of

this effort, the first blast furnace of POSCO was brought to normal operation in only fourmonths while it normally takes 12 months after the initiation of the plant construction. In laterstage the period for POSCO to get normal operation of LD converter was also so short. Such a

performance was really surprising because LD converter needs very well coordinatedcombination of chemical and mechanical systems. Thus, the period of construction of theintegrated steel plants in POSCO was shortened substantially from the original plant to thefourth expansion plan, in spite that the scales of plants were increased.

Thanks to the aggressiveness in technology acquisition, it did not take long time for POSCO

to become technologically self-dependent. POSCO started its own R&D efforts. First, it
implemented a lot of improvements and adaptation of absorbed technology at Quality Control

KOBE ECOArOMZC & BUSIIVESSVIEPV,RE' 46(2001), 27-46

40

Table 4. Period of construction of integrated steel plants

Constructionperiod

Capacityofproduction(100M.Tfy)

POSCO
Originalplant
Firstexpansion

38month

1030,

30

1570'

Secondexpansion
Thirdexpansion

2,920

29

2,920

24

Toronto(Italy)

2,600

FOS(France)

3,500

49
50

Bokaro(India)
Usiminas (Brazil)

100

1700,

74

1,400

(Source) Toda (1990).

Table 5. Comparison of steel industries of seleeted countries

Korea

posco

Productioncapacity

Costofconstruction(1OOOt)(US$lt)Blastfurnance

9,600

500

2,700

860

12,OOO

Taiwan CSC

Brazil1,500

213(3,250)(860)

Usiminas

3,500

762

CST

3,400

760

840

952

1,700

430

4,500

700

Egypt

AlexandnaNationalSteel

DR

India

SAIL

Blastfumance

Qatar

QatarSteelCo.(QASCO) DR(Source) Toda (1990).

Department and production sites. They began to develop new products and finally decided tocentralize R&D activities establishing the R&D Center in 1977.' POSCO then started to
7 POSCO invested in R&D 7.30/o of profit in 1977, increasing further to 12.50/o in 1983. POSCO also establishedPohang Institute of Technology (POSTECH) and Research Institute of Industrial Science and Technology in the
1980s to train technical graduates and act as a source of innovation for Korean industry as a whole.

(D'costa, 1999, p.14)

HOSONO A?VD HAmuGUCHI: EL-PERIENCES OF TECHNOLOGICAL PAR77VERSHIP OF JAPAN MITH OVERSEAS

organize its own steel related business complex, especially heavy machinery industry. By thisprocess the percentage of equipment produced locally, instead of imported components,
increased substantially from the initial plants to the third expansion plan: from 12.50/o, 15.50/o,

22.60/o to 350/o. Furthermore, POSCO already became an exporter of its own technology at theend of 1970s, such as training of personnel of Chinese Steel Corporation of Taiwan, insta11ing

computerized system for Krukutou Steel of Indonesia, and setting up a joint-venture with US
Steel in California.

4. The case of SICARTSA, Lazaro Cardenaz, Mexico(1) Elements of the failure of SICARTSA
The case of SICARTSA (Sidenirgica Lazaro Cardenas-Las Truchas, S.A.), located at the cityof Lazaro Cardenas, on the Pacific coast of Mexico could be considered as a very contrastingcase of POSCO.
We must admit that the most of positive factors of POSCO was lacking in the case of thesecond phase of SICARTSA.
The original plan proposed by the President Echeverria of Mexico was to construct a steel
plant almost as large as the Pohang Steel Mill of Korea through its four phases of construction.

He plarmed to construct a steel plant of 1,300,OOO tons before 1976, and its capacity of
production was to be expanded to 10,OOO,OOO tons before 1994.

One of the most important shortcomings of SICARTSA is the fact that it had only one blast
furnace. It made impossible for the plant to maintain the continuous production of steel because

the plant had to be stopped when the blast furnace had to be repaired periodically. SICARTSA
has the rare combination of blast furnace system and Direct Reduction system.

Secondly, demand of steel product in Mexico decreased drastically because of debt crisis of

1982 and subsequent lost decade of 80s. This unfortunate process of Mexican economy madeextremely difficult the accomplishment of original plan of production and expansion of the plant.

The coefficient of actual production to the capacity of SICARTSA II was only 24.5 per centeven excluding the effects of two months strike of this plant in 1989.

Thirdly, period of construction was terribly prolonged. This caused the substantial increase ofcost of construction. On the one hand, the Mexican government (SEPAFIN) urged SICARTSA,NKS and PMT to purchase local components and equipment because of the constraints of intema-tional balance of payments. These products had not only problems of quality, but also ofdelivery period. This produced delay in the construction period. Furtherrnore, the government
ordered suspension of constmction of plants, due to fiscal constraints. For example nine monthsof suspension from July 1983 in the case of PMT and one year and six months from June 1985
in the case of plant of continuous forging of SICARTSA II.

42

KOBE ECONOMIC & BUSIIVESS REVIEM, 46(2001), 27-46

Fourth, lack of coordination among steel projects located at Lazaro Cardenas affected

negatively their performance. For example, PMT was not able to use steel products of
SICARTSA II for its production of large-scale steel pipe, because of prolonged delay of theconstruction of SICARTSA's mill planed to produce intermediate steel products for PMT. PMT
had to buy this type product from AHMSA, which is located at more than 1000 kilometers from

Lazaro Cardenas. More over the quality of the products of AHMSA was not satisfactory for
PMT's production of large-scale steel pipe.

Fifth, SICARTSA II faced unexpected troubles and problems that seriously affected its
perforrnance. The delay in the construction of the plant of electric generation (one of the mostimportant infrastructure for steel production) caused constraints in supply of electricity for theelectrjc furnace of SICARTSA II. This problem of scarcity of electricity reduced the coefficientof actual production of steel to the capacity of the plant.

Sixth, iron scrap, one of the most important input for the electric furnace, provided by local

companies, contained very high level of impurities. This obviously increased the cost of
production.

Seventh, in certain cases, technology and know-how are not well shared with co-workers andaccumulated in the steel plant, according to observations of some specialist, although it isnecessary to qualify more precisely this aspect.

(2) Japan-Mexico Technological PartnershipJapanese steel companies' cooperation for SICARTS II, NKS and PMT located in theindustrial port of Lazaro Cardenas was considered as one of the most outstanding large scalecooperation of Japanese steel industries for the modernization of steel industry of a foreigncountry, according to Tetsuo Nakaoka. (1991)
This cooperation constituted a part of the comprehensive Japan- Mexico economic cooperation
programa in the period of President Lopez Portillo. This program included other projects likecooperation for the construction of the industrial ports and imports of Mexican oil to Japan.

In contrast to the case of Korea, Mexico had already a considerable capacity of production ofiron and steel in 70s. The state owned company AHMSA (Altos hornos de Mexico S.A.) started
its production as early as 1943.

In 1981, AHMSA produced one third of steel produced in Mexico. But the plant was too old
and obsolete and efficiency was very low (O.86 tlm31d of crude iron production and 1OOOkglt ofcokes coefficient) Even the fifth blast fumace, the newest one had much lower level of
efficiency of operation compared with other countries like Korea and Brazil towards the end of70s.

On the other hand, HYLSA, Hojalatas y Laminas S.A., a private company innovated thetechnology of Direct Reduction and were producing 1 771 OOO tons of steel with this process inHOSONO A?VD HAA`e4GUCHI: El\PERIENCES OF TECHNOLOGICAL PARTNERSHIP OF JAPA?V PVITH OVERSEAS 43

Table 6. Steel production in Mexico
1981

1986

Productioncapacity

AHMSA 2,424

Public
2,869

3,950

691

254

(Closed1986)

SICARTSA 804

1,192

1,300

1,582

1,700

FMSA
Private

HYLSA

TAMSA

1,771

395

232

465

Minimills

1,099

1,046

1,633

Total

7,554

7,175

9,048

AHMA: Altos Hornos de Mexico S.A., FMSA: Fundidora Monterrey S.A., SICARTSA: Sidenirgica Lazaro

Cardenas Las Truchas S.A., HYLSA: HYLSA S.A., TAMSA: Tubos de Acero de Mexico S.A.
(Source) Nakaoka (1991)

After the visit of President Lopez Portillo to Japan, a mission of KEIDANREN (Thefederation of Japanese economic organizations) was sent to Mexico in 1979 and agreed to carryout the cooperation projects for Mexico's industrial development, especially of steel industry.

Another mission headed by Mr. Harada, Vice President of New Nippon Steel was sent to
Mexico to study on the possibilities of Japanese cooperation for Mexican steel industry and to
get information regarding regional development of the country.

5. Some Lessons and closing remarks
The three experiences of international technological partnerships of the Japanese steel
industries depicted above have shown us some common characteristics. First, they were all
initiated by the government-government based dialogues and not from private initiatives. They

were recognized as national projects and accompanied by the official loans provided by theJapanese government to the recipient governments. The implementation of projects were carriedout by the state-owned enterprises in the recipient countries and cooperation was provided by thegroup of Japanese steel companies. The main interest of the Japanese side was not directly

related to the steel industry perse, but it had more to do with diplomatic concern andenhancement of general economic interests such as export of plant and engineering services andin the case of Mexico especially related to access to Mexican petroleum in the middle of theSecond Oil Crisis.

Having these elements as background, observation of the three experiences clearly tells us

44

KOBE ECOArOMIC & BUSINESS REVIEM, 46(2001), 27-46

how important was the consistency and continuity of the support of the recipient government. In

the most successfu1 case of POSCO, the Korean government showed vigorous leadership, being
headed by the President, maintained the marketing perspectives high by aiming at the exports
and linkages to domestic industries within relatively stable macroeconomic environment. The
governnient had clearly in mind that Korea should be able to get self-sustained technologicallyas soon as possible and therefore aggressively absorbed technological capability of the Japanesecompanies. Korean government was clearly aimed at international competition of the steel
products and related products such as ships and automobiles, which increased awareness ofquality.

On the contrary, the Mexican SICARTSA case tells us that fragility of the government
support was the fundamenta1 cause of the failure. It included inability of financing until thecompletion of the project, imposition of the use of the local machinery instead of introducing thestate-of-art equipment, failure of power supply by delaying the construction of gas pipeline tothe steel mill and lack of coordination with the downstream industries which obscured prospectsof the market.

The case of Brazilian USIMINAS was a sort of middle-way. As Koreans did and unlikely the
Mexican did, the Brazilian government had introduced the newest technology at the moment andthe USIMINAS local staff was quick enough to absorb technological transfer in five years. It

continuously expanded production and also upgraded technology relying on technologicalcooperation from Japan and at the same time expanding local engineering capability. On theother hand, likewise the Mexican case, while the government attracted foreign investment, it
insisted in majority control although it was not able to perform corresponding role of financer.

This inhibited sound growth of the company. The Brazilian government was in a way more
flexible to utilize BNDE financing (although it was actually financed by the Japanese official
fund) to muddle through the financial problem. Yet, it also had limitation. Finally, as the resultof privatization in the 1990s, USIMINAS is now entering a new phase of modemization anddevelopment.
These observations led us to conclude that the success of technology transfers depend verymuch on the quality of the system of learning of a recipient. The system incorporates efforts in
education, finance strategy, coordination of the market, clear targeting of quality, and stimulus
for technology absorption.
Finally, it is worth recalling that the recent international business alliances of the Japanese

steel industry have stemmed from different motives. For example, Nippon Steel and Usinor
announced comprehensive alliance in the European market. In the similar vein, Kawasaki Steeland NKK are virtually merged and together signed an alliance with Thyssen. These are
motivated by intensified global competition aiming at cost reduction through asset consolidation
at a global scale and synergy effect.

The alliance between NKK and Argentine steel group Techint in the field of seamless steel

HOSONO AND HA?LMGUCHI: El\T}ERIENCES OF TECHNOLOGICAL PAR77VERSHIP OF JAPAN WITH OVERSEAS

pipe also should be understood in this context. NKK and Techint have complementary
relationship where the latter has the largest share in the world about a standard type of seamlesssteel pipe while the latter has stronger technological capability to produce more sophisticatedtypes of product but increasingly lost price competitiveness in the standardized products. The

alliance enables the both company to attend the customers' needs. The NKK-Techint example
suggests new type of business alliance between Latin America and Japan.

References
Amsden, Alice H., Asia's next Gianat: South Korea and Late Industrialization, New York, Oxford
University Press, 1989.

Amsden, Alice H. and Takashi Hikino, "Project Execution capability, Organizational Know-how andConglomerate Corporate Growth in Late Industrialization," Industry and Corporate Change 3(1), pp.

111-147, 1994.
Dahlman, Carl and Fernando V. Fonseca, "From technological dependence to technological development:
the case of the USIMINAS steel plant in Brazil," in Jorge Katz (ed.) Technology Generation in Latin

American Manufacturing Industries, London, Macmillan Press, 1987.
Dahlman, CarI and Claudio Frischtak, t`National System Supponing Technical Advance in Industry: The
Brazilian Experience," in Richard Nelson (ed.) National Innovation System: A Comparative Analysis,

New York, Oxford University Press, 1993.
D'Costa, Anthony P., "Overcoming Structural Barriers Steel Industries in Brazil, India and Korea," EPM

Review of Industiy and Management February 27-March 5, 1999. (http:11www.epw.org.in134091rm 1 .htm)
Evans, Peter, Dependent Development: The Alliance ofMultinational, State, and Local Capital in Brazil,
Princeton, Princeton University Press, 1979.

Hirschman, Albert, The Strategy ofEconomic Development, New Heaven, CT, Yale University Press, 1958.

Hosono, Akio and Neantro Saavedra, Development Strategies in East Asia and Latin America, London

McMillan, 1998.
Kim, Linsu, "National sytem of industrial innovation; dynamics of capability building in Korea," inRichard Nelson (ed.) National Innovation System: A Comparative Analysis, New York, Oxford
University Press, 1993.
Kobayashi, Hideo, Shin Usiminas Monogatari, Tokyo, Nippon Usiminas, 1997.
Nakamura, Naoto, Koro Monogatari, Agne Gijutsu Center, 1999.
Nakaoka, Tetsuro, "Nihon Tekl(ogyo no Tai-Mexico Gijyutsu Kyouryoku to Sonogo (1)," Keizaigaku Zasshi,
Osaka Metropolitan University, vol. 92, No. 1, pp. 69-91, May 1991.

Nakaoka, Tetsuro, "Nihon Tekkogyo no Tai-Mexico Gijyutsu Kyouryoku to Sonogo (2)," Keizaigaku Zasshi,
Osaka Metropolitan University, vol. 92, No. 2, pp. 82-111, July 1991.

Nippon Usiminas, IVippon Usiminas 10 Nen Shi, Tokyo, 1969.

46

46(2001),
BUSI?VESSREVIEM,
KOBE ECONOMIC
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Okazaki, Tetsuji, Nihon no Kogyoka to Tekko Sangyo, Tokyo Daigaku Shuppankai, 1993.
Pak, U Hi, Kankoku no Gi 'yutsu Hatten, Bunshindo, 1989.

Park, Eul Yong, Role of Government, Technological Capabiiity and Development of Steel Jndustry,
Hangdong University, 1997.
Rosenstein-Rodan, "Problems of Industrialization of Eastern and Southeastern Europe," Economic Journal

53, pp. 202-211, 1943.
Toda, Hiromoto, Gendai Sekai Tekkougyou-ron, Bunshindo, 1986.

Usiminas Kaiso Roku Henshu Group, Usiminas Kaiso Roku, 1997.

KOBE ECONOA,flC & BUSINESS REVIEM, 46(2001), 47-72

ANALYSIS OF ADOPTION OF FOREST CERTIFICATION IN JAPANFROM PERSPECTIVE OF ORGANIZATIONAL THEORYAKIRA KAJIWARA KobeUniversity

Abstract
This paper investigates the adoption of wood products certification for the promotion of sustainable
forest management in Japan and the USA. Bolman and Deal's four frames for analysis of organizations areused as the basis for the investigation. The analysis shows that the cultural differences between the twocountries revealed through the perspectives of social structure, political environment, human resource relation-

ships, and control of symbols to influence public opinion and decision making lend support for North's
observation that social instruments adopted by a society where they did not originate will not have thesame results in the adoptive society.

JEL CIassi:fication: L73, P51, ZIO
Keywords: forest certification, organizational theory

BACKGROUND
In the last several years the world-wide attention to conserving forest health in places where

the timber base has been threatened by over cutting has become an international issue promoted

by many NGOs. The concept of sustainability of forest resources on forest lands has become a
topic of international concern along with many other environmental conservation movements. International agreement about how sustainability should be achieved has not been established andthere is much debate between NGOs, academics, governments, and industry on this topic.
However, there seems to be agreement that sustainability means management of forest lands sothat the forests remain viable and healthy while producing wood products for consumption.

Corresponding address:

Akira Kajiwara
Research Institute for Economics and Business Administration (RIEB), Kobe University

2-1 Rokkodai-cho, Nada-ku, Kobe, 657-8501, Japan
E-mail: kajiwara@rieb.kobe-u.ac.jp

Phone!Fax: 81-78-803-7039

48 KOBE ECONOIvarC & BUSIIVESS RE'VIEM, 46(2001), 47-72

Japan has been a player in the world concern over the protection of the environment and theJapanese govemment is conscious of Japan's international image as a protector of theenvironment. NGOs in Japan along with forest academics have brought the issues ofsustainability of forest lands to the Japanese timber sector from their association with theircolleagues in other countries and because of Japan's role in the removal of timber from forests

in developing countries. These issues concerning sustainability of forest lands have foundsomething of a misfit when introduced to the Japanese domestic timber industry because Japan's
forests are currently not being harvested at or near possible production levels.

The forest industry in Japan has suffered many changes since the Japanese govemment instituted

the process of deregulation of timber trade. The opening of the Japanese market to foreign
timber virtually reduced the domestic production of timber to a fraction of what it had been.

This deregulation coupled with changes in monetary policies and governmental reductions in
support fer the timber growers have created a very economically depressed forest sector inJapan. The cost of cutting is higher than the price of imported timber. In this situation, theNGOs and university academics have looked hopefu11y to the western ideas of sustainability as
possible ways to reinvigorate the Japanese domestic timber production industry making it morecompetitive with world market trade. However, it is being discovered that actual implementationof sustainability as they are being discussed in other countries are finding a misfit in the
depressed forest sector of Japan because Japan's forests are being sustained through non-harvest

rather than active management. Furthermore, Japans forests were managed with sustainability for

generations due to the relatively small land base proportional to forest production need.
However, the Japanese practices of sustainability do not necessarily fit the western models
which are developing out of the western demands for timber on western land bases.

In Europe, the Americas, and many Asian countries, the recognition of the increasing demandson the forest land base as the source of timber supply, recreation, and environmental quality has

produced conflicts between the forest industry and NGOs representing public interests. Many
NGOs have attempted to find solutions which would protect the world's forest land bases forposterity and for uses other than only timber supply. The western institution of certification has

gained popularity as a viable way to influence the timber industry to implement sustainable
forest management practices on forest lands. This social tool has met with varied success indifferent locations but has continued in spite of serious criticism to gain support world wide.
NGOs and academics in Japan have taken notice and have introduced the concept of forest cenifi-

cation to Japan. One of the major players has been World Wildlife Fund Japan (wwF) whichhas promoted the Forest Stewardship Certification (FSC) plan in Japan.

Certification of forest lands means that a non-governmental third party evaluator investigates the

IC4JlrvARA: A?VALYSIS OF ADOPTIO?V OF FOneST CERTIFICATION IIV JAPAN FROM PEmsPECTIVE OF ORGA?VIMTIONAL THEORY 49

management practices of a timber company based on a set of standards and practices anddetermines if that company is managing its lands responsibly as a sustainable forest land base. If

the company meets the requirements, the company is granted certification and can use the logoof the certifying organization on its products. If all of the forest industry players in the chain ofcustody leading from timber production to wood product on the market are certified ascompliant with practices which promote sustainable forest management, the final product canreach the consumer as a certified product. The consumer can then choose to support companies
who practice sustainable forest management by purchasing their products instead of products ofcompanies who do not. As mentioned before this attempt at voluntary compliance withsustainable forest management has met with varying degrees of success in the countries where it
originated.

If we combine the introduction of the western concepts concerning the implementation ofsustainability which do not necessarily fit the Japanese traditional ideas of sustainability with theimplementation of the western social tool of certification, we have a simation which is open to

speculation as to how it will proceed. Sustainable forest practices from the west are notnecessarily applicable in Japan's forest sector and the western concept of certification as a social

tool which is meaningfu1 to the public is not familiar to the Japanese population. North says thatthe same set of regulations imposed on societies with different institutional arrangements willlead to very different outcomes (North 1990, p.101). His proposition cpmes from theobservation that fundamental changes happen at the margins of society where the issues require

more immediate attention. Margins are the locations in social and organizational structures

which are close to the actual implementation of policy and creation of product. This isapplicable to the phenomena under analysis in this paper because introduction of certification in
Japan is happening at the margins rather than at the top of organizations. It is not coming fromgovernmental decree nor from top executive levels of businesses. It is following the bottom-up
rather than top-down model of social change.

Due to the relative difference in the bargaining power of actors at the margins of different
societies and the differences in their historical development as well as incomplete feedback on
the results, these margin changes have the potential to cause very different results from one
society to the other. Since forest certification mainly focuses on promoting the western conceptof sustainability, and since Japanese social and organizational stmctures are largely different

from Western ones, North's observations suggest that an analysis and comparison of theintroduction of certification as method of promoting sustainable forest practices in the west

where these concepts originated and in Japan where they are new and have no cultural
foundation, can provide us with insights into the possible outcomes which can be expected by
the forest sector in Japan. Analyzing the adoption of certification in the USA as a representative

50

KOBE ECONOMIC & BUSI?VESS REVIEW, 46(2001), 47-72

western country and comparing it to the adoption in process in Japan can provide us with usefu1
information to guide the Japanese actors in their undertakings. Comparison between the process
in the USA and Japan will provide insights into the social attitudes, business relationships, andcultural biases of people and organizations which will influence the future of Japan's forest
sector as it searches for ways to improve it's current situation.

In order to investigate this social phenomena in Japan,Ihave chosen to use the frameworks for or-

ganizational analysis which were developed by Bolman and Deal (Bolman and Deal 1991). Theydeveloped their four frames by organizing the work of theorists of organizational behavior into

structural, human resources, political, and symbolic frames. Each of these frames provides adifferent perspective for looking at organizational bchavior. Theorists from each of these arcas

propose that an organization's problems can be identified and most efficiently solved byapproaching those problems from the premises their perspective emphasizes. Bolman and Deal's
use of all four frames is helpfu1 because in using all four, the analyst is forced to see thephenomena in ways which might not be considered under only one approach. In the following
paper I will use the major premises of all four of Bolman and Deal's frames to investigate theintroduction of wood products certification into Japan.

THE STRUCTURAL FRAME
The structural frame was developed primarily from research in the field of sociology. It is basedon the assumption that organizations exist first and foremost to accomplish established goals andthat well organized and clearly established technology is the key to accomplishing those goals. It

describes a reliance on the rational approach to organizational behavior and stresses thesignificance of formal roles and relationships, postulating that problems can be minimized andquality and perforrnance can be improved if the right formal arrangements are implemented.
Therefore, from the structural perspective, finding the right arrangement or pattern of roles and relationships is essential to achieving goals.

In order to rationally organize structure to implement technology for goal achievement, work
must be divided and then systems put in place to effectively coordinate operations. Choosing thebest stmctural arrangement depends on a rational and comprehensive appraisal of existing
conditions including size of an organization, nature of its core technology, how it fits into its
environment, what its goals and strategies are, use of information technology, and characteristics
of its people.

From the structuralists point of view, achievement of goals depends largely on reducing
ambiguity by effective communication of factual information and reducing uncertainty by

UJIMARA: AIVALYSIS OF ADOPTION OF FOREST CERTIFICATION IN JAPA,V FROM PERSPECTIZE OF ORGANIZ4TIO?VAL THEORY 51

buffering itself from the turbuience of its environment. This view emphasizes the importance of un-derstanding the environment by mapping external relationships in order to protect internal
operations. It is essential that all concerned at any level of an organization must agree on thenature of tasks to be accomplished and what the standards for completion of each task will be.

Therefore, from this point of view creation of the most suitabie organizational structure,development of appropriate technology, and thorough understanding of environmental context
are crucially important to decision making and the success of an organization.

If we look at what is known about organization for sustainability in Japan from the perspectiveof the structural frame, we can first say that goals of certification are not necessarily clearly
established. Certification is newly adopted from Western countries. Consensus about the goals offorest certification in Japan, which seems to be evident now, probably exists only because certifi-

cation has not yet been extensively applied and tested. There has not yet been time for it toclash with the society or cause conflict between the actors. Actors who apparently would be
adversaries in the USA seem to be very cooperative about certification in this initial stage inJapan. However, it is already evident that the goals of the Western system are not compatible

with application of sustainability as it is practiced in Japan, and that may be why only twoforests in Japan are now certified.

Japan has maintained sustainably her forestry for a long time by implementing regionallydeveloped ideas and techniques in forest management. There are several very strong nationwide

timber product brands such as Kiso, Yoshino, and Kitayama, which have been mainly createdbased on regional reputation through their long history dating from before the Meiji restoration.

These brands have functioned in a Japanese sense as a kind of certification which have shown,
but not certified in the Western sense of certification, that timber products from these companies
are from sustainably well managed forests in those regions.

The evidence produced by these companies indicates that the concept of sustainability is not at

all new to Japan. However, certification is a new and odd practice in Japan and not yet
understood or trusted by the general population nor leaders in business and government. If certifi-

cation standards were adjusted to refiect the sustainable management practices developed overhundreds of years in those regions, forest certification could be presented as a parallel to thereputations of these kinds of brands.

This might provide an inroad for people to begin to recognize and accept certification in
Japanese society. In the current situation goals diverge because traditional Japanese sustainability

and westem certification standards are not compatible. When we consider this lack of clarity
about goals, we see why certification is actualizing slowly in Japan and why actors are hesitantto commit to certification even though they all seem to be collaborating cooperatively topromote its adoption.

52

VIEM,
KOBE ECONOnvC & BUSI?VESS
RE'46(2001), 47-72

In the USA the primary goal of certification is clearly sustainability. The problem is the fact that

there are critical differences between the actors as to what sustainability means. Some actors
such as timber companies may consider sustainability as primarily sustainable timber production
while some NGOs consider it to be primarily a tool to protect and re-establish bio-diversity. Cer-tification is an established and understood practice in the USA and implementing it for forest
products is not looked at as an odd practice. The issue in the USA is the divergence of goals
between the actors due primarily to their different definitions of sustainability for certification
not in the implementation of certification for sustainability as a tool to achieve it.

From the structural frame we should next look at technology. Since Japan has no experience inforest certification and in certification processes in general, there is very little forest certification

technology. There are no dominate certification schemas which have local origin; there are only

the imported ones of FSC and International Standard Organization (ISO). As new imports, thetechnology they bring is not understood and only appreciated as a western phenomena that byadoption could strengthen Japan's voice in the international community. Since Japan participatedin the Montreal Process and is working to create some guidelines for sustainable forest
management, this effort might result in a more developed technology for certification in the near

future. Also, as mentioned above under goals, Japan has a very long history in forestry and has

accumulated her own philosophies and techniques in forest management. Some timber
communities which have kept their high reputation through maintaining Japanese style traditional

forestry management are being studied by forestry researchers attempting to codify and maketheir traditions usefu1 as criteria and indicators for forest certification. This well developed but

undocumented technology might help to create very strong techniques which can be used for

certification in the future. At that point Japan may have to petition for acceptance ofregionalized standards at the international level.
i

In the USA there are very strong technologies for forest certification. There are well establishedcertifying bodies with highly developed certification schemes of guidelines, principles, andcriteria. These have been developed in the USA with the experience and knowledge of USA
forestry academics, land managers, and industry professionals. ISO, FSC, and American Forest

and Paper Association (AFPA) schemes have detailed tested systems and auditors who aretrained to use them. The technology as well as the concept is familiar to most of the actors in
the forestry community.

The third aspect of the structural frame to consider is the establishment of formal roles and relation-

ships. In Japan there are no formal roles and relationships currently existing in the arena offorest certification with one exception. This exception is further evidence of the uniqueness ofJapan regarding certification. In most of the rest of the world the original parent body of FSC,IC4JIMARA: ANALYSiS OF ADOPTIO?V OF FOREST CERTIFICATION JN JAPAN FROM PERSPECTJVE OF ORGANIthTIONAL THEORY 53

wwF, has hidden its formal relationship with FSC since due to initial criticism it was decided
that FSC needed to appear neutral instead of associated with an environmental group. In Japanthe relationship between wwF and FSC is not hidden and is in fact the only functioning formal
relationship operating to establish forest certification. wwF is promoting FSC certification andhas offered more than 20 workshops in two years all over Japan. wwF is playing the major rolein coordinating efforts to bring forest certification to Japan. Other than this, all the actors so far

involved have been loosely connected through informal meetings and correspondences. No
specific outstanding patterns and arrangements such as formal alliances can be observed so far.
It is also interesting to note that no public antagonism can be observed either.

Japan is a very centralization-of-power country. Every governmental organization and agency is

generally tightly connected between central govemment and local as well as among central
government. However, since the Japanese Fore'st 4gency has Iost its legitimacy due to its misman-agement and huge debts, the tightly uniformly controlled formal system does not function interms of forest policy including implementation of forest certification. If the Forest Agency andthe Ministry of Agriculture were more powerfu1 and vigorous, the Forest Agency would take thelead more actively in the whole process of forest certification. This would be a normal andaccepted role of a government agency in Japanese society for implementation of a program thatwould regulate forest products. Traditionally, government is trusted and not looked at with asmuch suspicion in Japan as it is in the USA.

In the USA we can observe more vivid formal patterns of roles and relationships among actors
who are involved in forest certification. There are several alliances which consist of supportive

actors to specific schemes. In the alliances, very strong formal roles and relationships can beobserved. However, with internal and external turbulence, these alliances are vulnerable to rather
rapid realignment.

Since the structural frame emphasizes that the arrangement and management of internal systems
are critical to success, an organization must develop ways to protect these internal systems fromchanges in the outside environment. Structuralists refer to this kind of protection as bufferingfrom turbulence in the environment. For certification, buffering agents are activities associatedwith but not the direct influence of governmental regulations and activities of ENGOs. These
activities help protect the certification process keeping it from becoming irrelevant to current
issues.

In Japan, forest certification is a "baby" in society which is very fragile due to its recent

introduction. It is very vulnerable to outside turbulence and there exist at present no wellorganized and implemented regulations and laws related to eco-protection which wou!d buffer

54 KOBE ECOArOvaC &BUSINESS REVIEW, 46(2001), 47-72

certification and insure its survival. There is also very little well organized and supported
activity of ENGOs in Japan. These kinds of organizations are looked at with suspicion in Japan.
This is changing slowly, however, at this time, their activities are not widely enough supported
nor respected enough to act as buffers for certification.

Typical buffers such as coding, forecasting, and growth are not developed since technology is
not developed for coding and forecasting, and the general lack of acceptance of the concept ofcertification and lack of commitment to certification eliminate growth as a possible buffer. If

certification moves forward from its current conceptual only stage to actual implementation,
turbulence encountered could cause the whole initiative to fall apart. However, in Japan, if aconcept and scheme such as certification is formally adopted and established in society by theauthority of a strong arm of government, that policy could become very stable very quickly. The
Japanese government is now trying to create more and stronger pro-environment acts. If it does,
then buffers to turbulence wiJl also develop quickly.

In the USA there are strong pro-environment regulations compared to Japan which act as buffers
protecting certification. There are also strong ENGOs such as Friends of the Earth which act asbuffers for certification by gathering data which supports certification by predicting such things
as losses of resources if there is no intervention. Coding is evident and growth in certification

implementation, even though it is slower than many desire, is increasing. Buffers against
turbulence are in place and functioning in the USA from the stmcturalist point of view which
will help protect certification as it is tested and tried and promoted.

The next important feature to consider from the structural frame is the establishment ofagreement on task and standards to evaluate task accomplishment. In Japan no agreement exists

on the nature of the task much less on specific tasks to be performed, and standards are notestablished for evaluating task performance. There is much work to be done to codify Japan's
traditional sustainability practices. This must precede establishing standards and practices forJapan. Otherwise, adoption of western practices and standards would be unrealistic and merely
serve to appease the international community in support ofJapan's need to be seen as intemationally cooperative.

In the USA forest certification has evolved rather quickly by comparison to Japan into an arenaof specialized actors aligned with particular schemes each with their own task and highly
developed and critically appraised standards for evaluation. There is much turbulence in thisenvironment but the buffers discussed above are functioning and the actors are negotiating andfinding new and creative ways to agree without completely threatening the existence of certifica-tion in the USA. Standards are being reviewed and criticized. For example, discussion isdeveloping around the issue that some standards prevent certain owners from considering

K41IorAjLfl: A?VALYSIS OF ADOPTIO?V OF FOREST CERTIFICATION 1iV IAPAtV FROM PERSPECTIZE OF ORGAAIIzaTIO?VAL THEORY 55

certification even if their practices are certifiable due to the high cost for extensive documenta-tion which can include dependence on others in a chain of custody. The problems are being
addressed and creative ways such as cooperatives which bring together individual land owners to
be able to pay for certification jointly have successfu11y been formed. Tasks and standards might

not be universally agreed upon in the USA, but they exist and they are functioning and theactors are working on perfecting them and making them accessible and relevant to wider participation.

From the structuralist perspective, cenificatjon in Japan is very fragile at this time. Goals are notclearly defined, there are very few functioning formal roles and relationships, technology has notbeen developed which is workable in Japan, buffers are not in place to protect certification fromturbulence in the environment, and tasks and standards have not been developed. However, theunique thing about this in Japan due to Japanese organizational pattems is that this could allchange relatively quickly depending on what government does in relationship to sanctioning certi-

fication. The centralized government of Japan has influence over regulations but also has thecooperation of most of the Japanese people most of the time. From the structuralist view, thecritical factor in the success of a certification initiative in Japan will be whether or not theJapanese government is able to set up the necessary formal structures, establish formal roles andrelationships, and encourage the rapid and realistic development of certification technology forthe implementation of clearly defined goals.

All the actors are still ad hoc collaborating to install the concept of forest certification. They
have not been differentiated so much in the arena of forest certification. I anticipate that this col-laboration might end very soon and some kinds of agreements and formal frameworks might beestab}ishedAn analysis of certification in the USA from the structuralist view would conclude that certifica-tion is proceeding well due to highly developed technology, establishment of formal roles andrelationships, and the establishment of clear tasks and standards. North's conditions for adaptive

efficiency seem to be working and society is investing in skills and knowledge that indirectly
contribute to cenifications success (North 1990, p. 81). The structuralist would probably point to
the lack ofconsensus on a clear working definition ofsustainability as the major threat to the effectiveness of certification in the USA since this undermines the clear goal of certification which isintended to be sustainable management practices in place on the land. The structuralist mightalso warn that turbulence in the environment caused by this lack of agreement on definition
could escalate to the point where the buffers would not be strong enough to continue to protect
certification as an initiative. I feel certain the structuralist would advise all of the actors to attend

to the modification of standards making certification applicable and accessible to as many

56

KOBE ECOAJOMZC & BUSINESS REVIEM, 46(2001), 47-72

owners as possible. This would have the effect of producing one of the most effective avenues
to protecting certification, buffering through growth.

The Human Resource Frame
The human resource frame has a very different approach to analysis of organizational behavior

than the stmctural frame. The human resource frame was developed primarily from research in
the field of social psychology and studies phenomena in organizations such as bias, prejudice,hurnan needs and desires, feelings, and motivation. It focuses on the interdependence between

people and organizations and is based on the assumptions that organizations exist to serve
human needs, that organizations and people need each other, and that if the fit between an

organization and its people is poor, both will suffer. Instead of formal roles and norms
established by authority as in the structural frame, human resource theorists emphasize theimportance of informal rotes and norms and a democratic approach to decision making as mostcritical to the functioning of an organization.

Maslow's categories of human needs tphysiological, safety, sense of belonging, esteem, and self-

actualization) are basic to much of the work definitive to this perspective (Bolman and Deal
1991, pp. 124-125). Maslow's model states that as lower needs such as physiological needs are

met people need to satisfy higher level needs such as self-actualization. The human resource
theorist believes that organizations should be arranged to provide opportunities for Maslow's
higher level needs satisfaction. McGregor postuiates that conditions in organizations should bearranged so that personal goals of individuals in organizations witl be met while achieving thegoals of the organization (Bolman and Deal 1991, pp. 125-126). Argyris suggests that thesekinds of situations can evolve if organizations change from treating people like children totreating them like adults through systems such as participative management (Bolman and Deal
1991, pp. 127-128). In his model, organizations should facilitate interactions which emphasize

coinmon goals and mutual influence, open communication, public testing of assumptions andbeliefs, and combine advocacy with inquiry. He goes further to say that individual's behavior iscontrolled by personal "theories of action" which are Iike two categories of cognitive maps, one

which is what we say we do and the other is what we really do.

For the human resource theorist, conflicts should be resolved by seeking to agree on tasks andprocesses, searching for interests in common, establishing tests of opposing views, doubting ones
own infallibility, and treating differences as the responsibility of the group. Ouchi incorporated

many of the human resource precepts in his development of Theory Z (Bolman and Deal 1991,
pp. 172-174). His theory is a blend of Japanese and Arnerican approaches to organizational

management. The main premise is that humanizing working conditions improves productivity

IC4JIPVARA: AIVALYSIS OF ADOPTION OF FOneST CERTIFICATION IIV JAPAN FROM PERSPECTIVE OF ORGANIUTIONAL THEORY 57

and profit as it raises self-esteem. This frame focuses on the fact that humans are complex andthey bring that complexity with them to participation in organizations. Organizations must deal

with all aspects of human complexity if they wish to function well, and from this frame wesense a moral imperative that puts the human above task. The development of the organization
should serve the development of its people and vice versa.

An analysis of organization for sustainability in Japan from the perspective of the humanresource frame leads us to look at the interdependence between people and organizations as it
relates to the adoption of certification in Japan. It helps us identify what can be considered as

unusual and unpredicted behaviors that are manifesting in the relationships between the people
involved in promoting certification in Japan. Since forest certification is a very new topic in
Japan, and since organizations have not established their normative and formal ideas and goals
on certification, individual people are the main actors and their informal actions are carrying thetotal responsibility for this initiative. In my personal interactions with timber company representa-

tives, university professors, Forestry Agency personnel, ENGO representatives, and land owners
who are giving their attention to certification, I have observed that these people are cooperatingwith each other regardless of their organizational backgrounds.

In this very introductory stage, people are generally acting from their own personal views andattitudes rather than as representatives speaking for the interests of their respective organizations.

They are functioning autonomously about issues, independent of the organizations they belong
to, but they seem to be using their positions in their organizations as tools to promote their own
rationalized behaviors and opinions regarding forest certification. Looking at these individuals,

we also see a pattern in their relationships to their organizations consistent with North's
observations that in the margins away from centralized decision making is where alternativeideas and approaches are most often explored (North 1990, p. 81). It seems from my observationthat the actors in certification are not the typical mainstream people in their organizations. The
mainstream people seem to be paying attention to other things with the attitude that forest certification is not very important. Since the actors paying attention to certification have little pressure

from their organizations and therefore much individual freedom, it appears that they aredeveloping similar goals and have found much common ground to stand on together eventhough they represent organizations with potentially divergent interests. This is very unusual in
Japanese society.

It will be interesting to watch the developments as the initiative for forest certification matures.

If it does develop more importance and wins the more serious attention of more typicalmainstream representatives in organizations, will the common goals being established now

survive, or will the goals of the organizations create conflict which will destroy the

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KOBE ECONOMIC & BUSINESS REVIEM, 46(2001), 47-72

establishment of the current cooperation which has been based on informal relations and norms
rather than formal ones? I anticipate that the positive informal relationships will dissolve withthe establishment of formal roles and relationships between representatives of organizations andwithin organizations.

In the USA forest certification has been established in forestry society for long enough thatformal roles and relationships have been established. Since the issues of certification andsustainability are fundamentally associated with people's values, people have tended to gravitate

to organizations whose values are compatible with theirs. However, there have also been trends
to establish informal relationships across organizations encouraged by the creation of task forces
and conferences where representatives from diverse interests meet to discuss issues informally aswell as work on tasks together in workshops designed to promote understanding and good will.
These kinds of conferences have brought together very diverse interests and had a very positiveeffect on opening dialog about issues surrounding sustainability as well as certification. The

Olympic Natural Resource Center (ONRC) near Forks, Washington is a good example of aformal organization whose purpose includes providing forums for the exchange of ideas throughconferences created to enhance both formal and informal communication and encourage formal
and informal relationship building.

Human resource theorists would find very little happening so far in Japan concerning support fordevelopment of new skills, encouragement of involvement in issues, and provision ofpsychologi-

cal support for those effected by current situations related to forest certification andsustainability. In fact they would probably find problems that are not being attended to from ahuman resource perspective. Many timber communities are suffering because of imported low
cost timber products. They can not harvest their timber profitably for market value and in thelast few years the Forest Agency has eliminated subsidies to land owners for maintaining timberlands. Many of these communities are being hard hit by these conditions, and there have been so
far very few attempts to assist the people affected with retraining programs or psychologicalsupport.

The citizens of these communities have very weak recourses for involvement in decision making

and lobbying for support. The character of these people will probably prevent them fromorganizing to protest or try to influence using rallies or marches to gain attention for theirsituation. Due to lack of traditional involvement in matters such as infiuencing policy making,the people in these communities will probably not participate in the certification initiative andwill probably be unaware of the potential influence it could have on their lives. A humanresource theorist familiar with Japan would probably recommend that a govemment agency more

influential than the now powerless Forest Agency should take responsibility for human

K4JIWARA: ANALYSIS OF ADOPTIO?V OF FOREST CERTIFICATION IN JAPAN FROM PERSPECTIVE OF ORGANIZ4TIONAL THEORY 59

development in the forest communities ofJapan.

If a human resource theorist looks at the actors promoting the adoption of forest certification in
Japan, he or she would find that due to the informal nature of their relationships, these actors arecollaborating with each other across disciplines and professional interests in very productive

ways exchanging their information and sharing their resources, e.g. forest professors withindustry, industry with ENGOs, and Forest Agency personnel with professors. They aresupporting each other psychologically and emotionally almost like the behavior often associatedwith minority political movements. There are also a few training sessions now being offered by
WWF covering forest certification.

In the USA a human resource specialist would note that things have changed significantly overthe last 10 years in forest communities. The problems have not been solved but they have been

identified and have gained attention. Programs have been put in place in many communities
which have begun to offer retraining programs for displaced timber industry people. Also, public

meetings in which timber people have been involved have allowed them to participate in thechanges that the timber industry is dealing with. Psychological support has not been common in
a formal sense but informally timber communities have supported each other emotionally and psychologically through meetings and activities to gain attention for the displacements they haveexperienced.

With regards to actors directly involved with certification, there are many formal and informal

training programs offered for those wishing to become auditors or certifiers, for timber
employees to become trained in new more sustainably sensitive timber harvesting practices, forlandowners to become knowledgeable about certification issues, for exploring cooperation
between buyers groups, industry, land owners, and retailers, and for creating cooperatives oflandowners as groups for multiple unit joint certification. Though not pervasive in the timber

community these kinds of training are becoming well known and achieving success.

Regarding conflict resolution and open communication in the area of certification, in Japan there

is no noticeable conflict and a lot of open communication. As the situation is described above
there have not yet been any conflicts to resolve. The actors who are promoting certification areapparently getting along very cooperatively establishing common goals from their common
opinions and interests. Their communication is very open and informal. Things seem to be very

positive from these human resource perspectives even though not much actual certification ishappening yet.

In the USA certification and sustainability have been associated with the intense conflict

60

KOBE ECO?VOMIC & BUSI?VESS REVIEva, 46(2001), 47-72

between the environmental movement and the timber industry. Conflict escalated in somelocations to destruction of property and violence against people. In the last ten years much has

been done from a human resource perspective to promote conflict resolution. In the opinion ofmany it came too late and too little, but it did come and has improved cooperation between
divergent elements. At one time it was almost impossible for different sides to be physically inthe same location. Today, it is not uncommon for a representative of industry and representativefrom an ENGO to be collaboratively working on a project or task force together. The conflicts
and the seriousness of the problems related to changes in the forest community have changed thefield of forestry. The need for conflict resolution and better communication and understanding
across organizations and between actors has shown that forestry is now a social science as well
as a natural science.

The human resource theorist would probably conclude that most of the promoters of certificationin Japan are non-mainstream representatives of their organizations and that they are enjoying
more personal freedom in their relationships than is normal in Japan. If this kind of open commu-

nication seeking common goals and interests can be maintained as certification proceeds toward
wider implementation, certification for sustainable forestry has the potential to be very effectivein Japan because it will attend to the interdependence between people and organizations.

In the USA, improvements have been made in relationships between people and organizations,but the human resource theorist would probably advise that much more needs to be done withactivities related to panicipatory management and the seeking of common interests. They would

recommend more interfacing of larger industrial owners and small owners with third party
certifiers such as FSC to search for ways to make certification more accessible and affordable aswell as relevant.

The Political Frame
The political frame was developed primarily from research in the field of political science. It isbased in the attitude that organizations and the people in them are primarily concemed withcompetition for power and scarce resources. The major assumptions of this frame are that organizations are coalitions of interests, that there are pervasive differences in values, preferences,beliefs, information, and perceptions of reality among these coalitions, that most decisions
concern the allocation of scarce resources available to coalitions and organizations, that conflictwithin and between coalitions are the natural result of these conditions making power the mostimportant resource, and that goals and decisions are made through political processes between
coalitions. Theorists of this approach focus on skills such as bargaining, negotiation, coercion,and compromise as needed for success in the political processes operating between and innviMARA: A?VALYSIS OF ADOPTIOIV OF FOREST CERTIFICATION IAJ JAPAN FROM PERSPECTJVE OF ORGANIZ4TIONAL THEORY 61

orgamzatlons.
In this frame authority is seen as only one of several forms of power. Expertise or possession of
information, control of rewards, ability to coerce, alliance through networks, control of agendas,

control of meaning and symbols, and personal power of individuals such as charisma, politicalskills and verbal ability are all equally important. Conflict is not seen as a problem, rather it isan opportunity for new ideas and stimulating innovations. Taking advantage of conflict opportuni-

ties relies on ones skills in political processes. From this perspective politics can not be
eliminated from organizations, instead it is important to learn how to be effective in recognizing,understanding, and managing political processes in all organizational endeavors.

The theorist of this frame acknowledges that there are two faces of power. The first face
exploits and seeks petsonal dominance. The second face creates vision and establishes collective
goals. The second is consistent with what Burns terms as positive politics. Positive politics seekstmth, mutual actualization, definition of values, productive debate, moral reasoning, and higher

levels of principled judgement (Bolman and Deal 1991, p.221). Lax and Sebenius add topositive politics their principles of moral judgement: rules must apply the same to all concerned,
specific actions should follow moral conduct applicable to all situations, and all actions should
show concem for the legitimate interests of others (Bolman and Deal 1991, p. 221). It is evident
then that positive politics should have moral dialogue and moral frameworks.

Descriptively rather than prescriptively as with positive politics, advocates of this frame
acknowledge that the basic process within and between organizations is the pursuit of selfinterest in imposing one organization's agenda on the system. These agenda are often clothed ina variety of disguises to conceal real purposes. Therefore, it is understood that politics cormpt

decision making and that what seems like an excellent and perhaps even benevolent initiative by
one group may be viewed very differently by another.

From this frame organizations and their environments are seen as complex relationships which

can only be successfu11y dealt with through political action. Shifts of influence in theenvironment are constant and the only way to effectively deal with them is through politics. The

ever present question is how much power can any one organization mobilize to influence such
entities as govemments, unions, large corporations, and consumers at any one time and in any
one situation. The main limitations of this frame are that it underestimates the potential for
rational and collaborative process.

If we look at what is known about organization for sustainability in Japan from the perspectiveof the political frame, it is evident that politics has not yet become an obviously observable

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KOBE ECO?VOvaC & BUSINESS REVIEM, 46(2001), 47-72

activity in the adoption of certification in Japan. As described in the previous two frame
discussions, the initiative is young in Japan and so far competition and a struggle for power has

not evolved within or across the loosely formed coalitions. The two certification schemes (FSCand ISO) introduced to Japan developed outside Japan from the interests of two divergent
coalitions, ENGOs and industry. These coalitions exist with much less divergence in Japan thanin the USA; therefore, in Japan these two schemes don't necessarily cause conflict. Since thetwo schemes have very different concepts and approaches, competition between the two schemes
may not occur in Japan at all. The two schemes may in fact be used together with no conflict.
This would in fact be consistent with the Japanese societal comfort with syncretism or the easeof accepting more than one scheme which in some other cultures are viewed as contradiction.

If certification moves to implementation, and if it creates markets increasing profit, much moreinterest will evolve and power struggles could develop within and across organizations. For
example representatives from Sanvva Bank, one of the largest banks in Japan, is participating inworkshops and conferences to investigate the potential value of auditors, accreditors, and mostimportantly consultants for certification. If certification becomes firmly established, this bankmight easily take the most prominent power position in certification because of its establishedranking in society. Since Japan is very much a hierarchical and ranking-based society, this kindof struggle is normally settled by exogenous factors of social ranking such as this. It will beinteresting to see if this traditional political pattern of social ranking will be followed as thisnew and very western concept is adopted in Japan. Its initial introduction has already broken
traditional patterns, but as it gains prominence, it will be more and more noticed by those whohave established political power in organizations related to forest certification.

Japan is experiencing drastic changes in society with the alternation of generations and social
paradigm shifts. There still remains old-fashioned, closed, traditional, collectivism-oriented ideas
on politics which have occupied these fifty years. In these traditional ideas ofpolitics, conflict isalways considered something evil. However, because actors' attitudes are also new andconstmctive, there is a very open atmosphere to any conflict: confiict and settling conflict bydiscussing openly seems to be very welcomed in this area. This is very unusual in Japan.

The reason the highly participatory actors in forest certification are positive, innovative andconstructive is because the issue, forest certification, is too new and irmovative for "old-fashioned"

actors to participate in. There is a self-selection factor operating which has produced a group ofactors who are not in the mainstream of normal Japanese methods of political activity in all the or-

ganizations involved from banks to universities. Active actors have created arenas to meet eachother and exchange their information about forest certification in many ways such as informal

workshops, informal business meetings, and informal academic conferences. Even less-activekL4JIPVARA: ANALYSIS OF ADOPTION OF FOREST CERTIFICArlON IN JAPAN FROM PERSPECTIVE OF ORGAIVIZ4TIONAL THEORY 63

actors such as Forest Agency representatives and major large-scale timber companies havejoined these opportunities and given their feed back and their opinions to promote forest certification. There are no formal arenas for actors to negotiate.

As certification moves toward wider implementation, there could be a large struggle between tra-ditionalist and the non-mainstream proponents of certification adoption within and acrossorganizations. Struggles across organizations are not usually canied on in an open forum.
Courting favor of and infiuencing those holding, the most powerfu1 ranks is the most rewarded
political skill. There is evidence of change in this kind of political activity in Japan today.
There are examples of activities which show these kinds of struggles currently in spontaneousand open activities such as the attempted hostile take over of Shoei Electric Company which if
successfu1 would have pushed aside the traditional keiretsu allocation of political power. It

would have been another force ushering in a less defined and predictable arena of politicalactivities. This more public less networked kind of open to all activity is new in Japan. It did

not succeed but the simple fact that it was even tried indicates changes in the traditional
methods of political behavior.

In Japan, traditionally, the struggle for power is not often carried on in the public forum. Thiskind of public struggle is viewed as inefficient and demeaning. The issues that cause politicalstruggle are confined to those responsible for decision making in the specific arena and there isusually no appeal to the public for support by any of the sides in the struggle. As mentioned

much of this struggle takes place in very low profiie since ranking systems are methodicallyfollowed. Courting the favor of those in higher positions is, therefore, one of the main politicalskills rewarded in Japanese society. Open political struggles with attempt to mobilize public
support is not expected in Japan, and there is very little context for this kind of political activity.

Japanese people would look at any attempts to proceed in this fashion as odd and be reluctant to
partlclpate.

The old-type ideas are being challenged by new, less collectivist, less Japanese-traditional styled
ideas. Especially in newly emerging areas such as "sustainability" and certification, the old-stylepolitical activity may loose dominance. Currently, the more open style is being enjoyed by thepromoters of certification, but as certification moves into implementation, it will be interesting tosee if there is truly a paradigm shift in their favor. I expect this will be a slow process, and that
we will see much influence from the old-style politics still operating as cenification moves to im-

plementation.

In the USA there is a long history of open political activity related to use of natural resources

dating back to the first movements to preserve natural areas from development as national parks

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KOBE ECONOILUC & BUSINESS REVIEM, 46(2001), 47-72

and wilderness areas. Since that time there has been an almost continuous political struggle
between those who want to preserve areas of natural resources and those who wish to develop
and use them. At times these conflicts have become very polarized and the conflict has escalated
into very volatile situations. All of the political skills mentioned by political theorists have been

employed and developed from compromise to coercion. In- this long history some of the mostwell known ENGOs developed their power bases and their abilities to influence goveming
bodies and mobilize public support. They have refined their tactics over time and have become

adept at lobbying the USA congress and world bodies such as the UN and WTO. They haveextensive fund raising systems and have created many successfu1 techniques for mobilizing
public support.

One of the most recent examples of this kind of activity related to sustainability and one that has

been influential on certification is the well known spotted owl controversy. ENGOs used thethreat of habitat destruction for the spotted owl in the logging of old growth forests to mobilize
public support for the closure of many old growth forests to logging. With the threat of forests

being closed, factions in the timber industry reacted through political activity of their own

lobbying for open access and mobilizing public support to gain sympathy for their economicplight. All the political processes identified in the political frame were used in this controversy,

and as this frame predicts a lot of new information about forest ecology, timber communities,

and ways to effectively deal with controversies such as this have developed out of the open
confiict.

In the USA public open political struggles have a long history. This type of behavior is
expected, and, therefore, with the issues of sustainable forest management and certification offorest lands, no one is surprised to find politics operating in a public forum. Due to the longexperience with public political activity as a society, Americans expect this kind of activity andexpect to have the opportunity to participate in it if they choose. There is respect for those who
participate and an underlying faith that this process has the potential to produce positive results.
This kind of attitude and experience does not exist in Japan.

So the difference in Japan and the USA is dramatic. In Japan certification has not become ahigh profile political issue, but in the USA it has long been political and appears to have afuture of more political activity. In Japan the political stmggle will probably be quietly carriedon by experts and executives within and across participating organizations. Much of the behavior

will be dictated by the ranking system prevalent in Japanese society unless a paradigm shift tomore open activity takes place soon. Therefore, we can expect very different political activity inthe struggle for power in Japan compared to the USA in the arena of forest sustainability andcertification.

swIWARA: AIVALYSIS OF ADOPTION OF FOneST CERTIFICATION IN JAPAN FROM PERSPECTiVE OF ORGA?VIenTIONAL THEORY 65

Political frame theorists focus attention on competition for resources as critical to successfu1
achievement of an organization's goals. In the arena oforganization for sustainability and certifica-tion, some of the resources for which there could be competition can be identified as support by

the scientific community, forest management information, economic control of timber products,
and participation of landowners. In Japan currently there is no observable competition for theseresources. They are being shared by the experts and executives across and within organizations
in conferences and inforrnal communications. Banking executives and university professors aremeeting and discussing how the ecology and management information available from thescientific community can be used by auditors and consultants. ENGO representatives are talking

with industry leaders about how both of the certification schemes introduced to Japan can bemost efficiently used. I have observed no competition for resources. The resources mentioned
above are openly being shared at this point in the adoption of certification in Japan.

Economic control of timber products could become competitive if forest certification moves toextensive implementation. Currently, there are abundant forest resources which are untapped due
to lack of economic incentive to harvest. If certification produces a new market share situationin Japan which creates market incentive for harvesting Japan's overstocked forests, thencompetition for these resources could develop. Also, If some timber mills, wholesalers, andretailers become certified as chain-of-custody, and if they import relatively cheap certified

timber and wood products from outside of Japan, there might occur some serious conflicts

between imported cenified products and domestic certified products even within the same
scheme. These changes and the changing formal and informal business structures of Japan
happening at the same time create an unpredictable future for how competition for control oftimber products will evolve in Japan in the next few years.

In the USA we have a very different picture. Competition for all of the resources we canidentify using the political frame is intense. Public support viewed as a resource is evident in thecompetition between ENGOs and timber industry interests as discussed in the previous section
on power struggles. Competition for support of the scientific community is observable in therequests for and funding of research by all related factions and has escalated divisions in the
structures and relationships of the forest science community, ecology and production. Support

for various schemes of standards, criteria, and indicators which is compatible with special
interests is sought after from the academic community. Information is manipulated and debatedregarding all aspects of sustainability and application of certification issues ranging from how

many acres are really necessary to support one mating pair of spotted owls to the landscapemanagement needs for bio-diversity and wildlife habitat. Control of information used to forecast

supply and demand of timber products is competitive and its application is heavily debated. The

participation of timber land owners is also competitively sought after from large industrial

66

KOBE ECONOILtfiC & BUSI?VESS REVIEW, 46(2001), 47-72

owners to the small family timber land owners. In the USA we see a very complex competition
for resources in all areas.

If we then view the competition for timber products as the underlying stimuli for the politicalframe resources identified above, the picture becomes even more complex. In the USA thecompetition for the resources on public lands has been, and indications are that it will continue

to be, intense. Since the USA congress, the president, and the agencies who are responsible forthese lands can all make decisions about the use of these resources, there is much competition
for their sympathy and their support. Furthermore, competition for private timber resources andthe competition, from imported products also influence attitudes about, development of, andapplication of standards related to certification practices. Regarding competition between certifica-tion agencies, since forest certification schemes have been grouped based on their goals,
processes, and techniques, competition from the technical standpoint may de-escalate. For

example, FSC is more geared to the small-scale non-industry timber producer, and ISO and
AFPA have been developed for the large-scale industry timber producers. Therefore, we may see
more specialization of certifiers. We must also recognize that for each scheme to survive, it will

be important for each to obtain as many as possible. In general, we can expect that in the USA,

competition for resources identified using the political frame will continue to be a major
influence on how sustainability of forest resources and certification as a tool to achieve thoseends develops.

Due to the less open public forum in Japan for political activity, we can expect that the struggle

for power and competition for resources will be carried out with less obvious observable
political activity. However, due to the fact that cenification is a western concept unfamiliar to
Japanese society, that its current promoters can be categorized as non-traditional Japanese represen-tatives of their organizations, and that it is being introduced to Japan in a time when there areother attempts to force a paradigm shift in Japanese organizational behavior from reliance on the

ranking system and cross-organizational tightly controlled arrangements such as keiretsu, wemay see certification adoption in Japan happen in a way that will be unique for Japan and in theworld.

In the USA, from the perspective of the political frame we can expect more of the same intense
political behavior in struggles for power as well as competition for resources. It has, as predictedby the premises of this frame, brought about positive effects since there is a long history ofhandling conflict of interests in the open public arena by mobilizing support to impose ones
agenda on the system.

IC4JIMAR,4: ANALYSIS OF ADOPTION OF FOneST CERTIFICATION I?V JAPAIV FROM PERSPECTIVE OF ORGANIZ4TJONAL THEORY 67

The Symbolic Frame
The symbolic frame was developed primarily from research in the fields of social and cultural
anthropology. It is distinct from the other three frames in that it abandons rationality and views
organizations through the lenses of tribe, theater, or carnival. It seeks to explain organizational

behavior as primarily characterized by images and drama and analyzes it for metaphor, symbol,
stories, ritual, myth, and script. Theorists of this frame base their ideas on the assumptions thatwhat happens is less important that what it means, that schema determines meaning, thatprocesses and events are ambiguous and uncertain, and that humans create symbols to resolve
confusion, increase predictability, and provide direction.

Activity described by this frame is more evident when unclear goals and technology are characteristic of a situation. In uncertainty, symbols serve to provide meaning, clarity, and predictability.

Myths and stories as symbols, when well established, legitimize, promote solidarity andcohesion, and provide narrative which anchors the present in the past. They function as morality

tales that tell us what is valuable and give us heroes to immolate. They convey to us what isright and consequently tell us when things shou!d change. However, on the negative side they
can blind us to new information and misdirect our attention.

Ritual and ceremony as symbols bring order and predictability to organizational life. Theysocialize members of an organization, stabilize the system, reduce anxiety and ambiguity, andtell the outside world who an organization is and what it stands for. Many behaviors in organizations are not readily recognizable as rituals such as performance appraisals, training programs,

certifications, and surveys. Often the information provided by these behaviors is not used, but
the activity itself establishes legitimacy. March and Olsen state that decisions often decidenothing and suggest that the process is ritual which legitimizes the organizations behavior(Bolman and Deal 1991, p.273). Their garbage can theory is compatible with the symbolic
frame since they state that decision making is more a function of the mix of people and ideas
and timing than a rational appraisal of relevant information. Meyer and Scott state that structures

are often decoupled from activities (Bolman and Deal 1991, p.273). The symbolic theorist
would add that it is symbolism that maintains function. When rituals become out of touch withreal needs they become useless and resented.

wnen organizational behavior is viewed as theater, it is evident that getting the drama and thescript right is particularly important in sectors where product is ambiguous and hard to measure.
Viewed as theater as opposed to instrumental activity, we see that it is important to conform to
the appearance that society expects and trusts. Sometimes a modern look is also required to gain
legitimacy by symbolically representing that the organization is state of the art and is responding

68

VIEM,
KOBE ECONOILCC & BUSINESS
RE' 46(2001), 47-72

with current innovation in the public's interest. In this view, it is the theater of motion andprocess that establishes legitimacy, not rationality. Planning as a symbol for legitimacy has thefunctions of replacing measurements, tests commitment of planers, creates benefits from theinteractions of the planners incidental to the plan, and advertises an organization's strength.
Power is ambiguous and can function only when people agree that it exists

Viewing organizations as tribes with cultures of their own, we can interpret behaviors as
expressions of that culture serving to promote its survival such as rites of passage which allow

new comers to enter only after having passed the tests which mold one to the minimum
expectations of the group.

If we look at what is known about organization for sustainability in Japan from the perspectiveof the symbolic frame, we see that without clearly defined goals, with weak technologies, andmuch ambiguity due to lack of experience with the concept of cenification, symbolism may beplaying a very important role in the adoption of certification in Japan. Analysis from this frame

can offer an explanation of why wwF is playing the major role so far in promoting certificationand enjoying support from diverse factions in the process. WWF is known in Japan as a wellrespected international organization. The symbol of the panda is widely seen in Japan and has

captured the sympathy of many Japanese who are beginning to develop interest in pro-ecology
and green movements. It is a little faddish now to support this kind of organization, and since it

has an international reputation, it speaks to the Japanese rising interest in being considered
individual as well as organizational participants in the international community.

Currently, since the promoters have no specific rational goals and technologies, all they reallyhave to work with are their passions and anxieties. This makes their situation ripe for analysis

under the frame of symbolism. The pro-ecology and green movements in Japan have targetedtimber companies asking them to consider how they can compromise in order to survive due tothe international changing values in the arena of forest production. Subsidy cutting due tofinancial restructuring of Forest Agency budgetary systems has urged timber industry, especiallysmall-scale timber companies and local timber communities to consider how they can manage
their business without public financial support. One university with a prominent forestry
department which strongly supports implementation of forest certification is located in one of thetimber communities suffering from the subsidy elimination. This forestry department is hopingthat certification can save this community by increasing market share creating markets for theirtimber and premiums in market pricing. They have very little rational evidence that certification

will work for this community, but the symbolism of their efforts could be helping to maintaintheir legitimacy as a forestry department created to serve the timber interests in this region.
Their efforts are also helping to hold the community together, not with jobs and active plans but

K4Jl}VARA: ANALYSIS OF ADOPTION OF FOREST CERTiFICATION IN JAPAN FROM PERSPECTIVE OF ORGANiMTIONAL
69 THEORY

with hope generated from the symbolism of their efforts.

University professors and students attempting to codify the traditional Japanese practices ofsustainable forest management by regions are functioning symbolically to anchor the present
situation of ambiguity and uncertainty in the more secure vision timber people have of the past.

This gives everyone the hope that the future will include them. However, if we analyze thecodification, we must ask if it is really rational in application or if it is more of a myth with its
origin in a time that is too different from today and, therefore, will not succeed upon implementa-

tion. The main value of the codification may be the cultural anthropological documentation of apast era and its symbolic function for the present.

Further analysis from this frame could suggest that perhaps the ritual use of this codification
may be exactly what is needed for solidarity and legitimacy. As criteria and indicators, maybe

their foundation in the past offers more legitimacy than ones created to be more rationallyapplicable to the present situation. Perhaps symbolism that provides legitimacy and solidarity ismore needed that rationality to bring the timber communities out of their economic crises. If thesymbols and myths are skillfu11y presented by convincing theater, the market might shift in theirfavor and the world be convinced that these regional standards are internationally acceptable.
From the perspective of this frame, Japan would accomplish its desire to be a significant voicein the international community by affecting the international community's views on the use ofregional standards.

It seems like science fiction or advertising schemes which would be devised to market
something that has no real substantial value. According to the symbolic frame, rationality

maintains existence and finds application only as it can be symbolized and dramatized.
Therefore, in the above scenario, if we are looking for effectiveness, the use of the traditionalsustainable practices might have more benefit to the community in the long run as well as theshort run, than modern western sustainability practices which may be more rationally based incurrent technologies.

In the USA analysis from the symbolic frame could run to a detailed description of every
behavior relevant to certification and sustainability. One of the most revealing examples would

be a look at the standards and practices of FSC. The detailed documentation required tocomplete certification, the third party certification presented as unbiased, and the chain ofcustody requirements are all rationally thought out attempts to establish legitimacy. Investigations into the actual rational functioning of these implementation strategies have created criticism

which indicates that these strategies may not be functioning as rationally as intended. If not,perhaps their function has an element of establishment of legitimacy symbolically. Here we see

70

KOBE EC07VOMIC & BUSIIVESS REViEM, 46(2001), 47-72

how symbol, myth, and ritual can bring about solidarity but also how it causes division. The

symbol of Weyerhauser may inspire certain factions in the sustainability and certification
controversy, but it has and will continue to alienate other factions. The CEO of Weyerhauser has
said, "sustainability does not need to be defined the same for everyone (Jenkins and Smith 1999,
p. 286)." Can diversity in the definition of sustainability be accepted as workable by the majorityof the coalitions in the arena of forest management? Analysis from the perspectives of the otherthree frames would more than likely predict that acceptance of diverse definitions ofsustainability would not be able to be accomplished. The symbolic frame theorist, however,would say that if it is mythologized and symbolized, and if rituals are created to legitimize it, it

might have a chance of success. In fact, it might be the most rational of all the alternatives but
unacceptable to many factions unless it is dramatized in a vv'ay that gives it legitimacy.

Another critical factor from the symbolic frame directly related to the acceptance of certificationby the general public in the USA is that the label provided by FSC for certified products is
unknown by the general public. The symbol is there, but the theater has not been provided toactivate the symbol. Rituals and promotion of myth to make the symbol function are needed if
the consumer is expected to preference certified products. The symbolic frame theorist would
say that rational appeal is not enough. Certification needs the stamp of approval of admiredpersons and association with high moral values as well as quality incentives such as market
share and premiums.

CONCLUSION
Compared to the USA where formal roles and relationships have been established, technology
has been developed for forest land certification, and tasks and standards have been codified, thestructuralists would say that Japan is not prepared for the adoption of timber land certification

for the purpose of promoting sustainable forest management based on the western concept ofsustainability. However, this could change very quickly in Japan if government follows its usualrole of controlling social policy initiatives. Cooperation between diverse interests could bemaintained as cenification proceeds, whereas, in the USA, we can expect continued conflict andhard won cooperation.

Analysis from the human resource frame shows us that Japan has done little in the way offormally addressing the needs of the people in communities which depend on domestic timber
production and that those people have not and probably will not mobilize to demand attention totheir problems. However, it is also observable that those who are highly participatory in the
introduction of certification are trying to address these problems and are cooperating without
conflict. They are, thereby, forming a good base for productive alliances across their diverse

IL4Jl}I{ARA: A?VALYSIS OF ADOPTION OF FOREST CERTIFICATION I?V JAPAN FROM PERSPECTIZE OF ORGANIZ4TIONAL THEORY 71

interests. In the USA, the opposite has evolved. Local communities have demanded and received
attention from government and industry to help with their declining local economies. However,this assistance has come out of intense public conflict. Even though roles and relationships aredefined in the USA, this does not mean that there is cooperation. In fact, the future of certifica-tion and sustainable forestry will continue to be influenced by the divergent interests of theactors as they protect their own interests. Each step will be hard won due to the lack of an
overall foundation of interdependency in the roles and relationships between people and organizations in the forest sector.

The control of power in the competition for limited resources is the central premise of thepolitical frame. The political environment in Japan indicates that we can expect any struggle totake place behind the scenes and that government may be accepted as mediator and standard
setter and that this will be accepted by the players. In the USA, we expect continued distrust of

govemment as the arbitrator and continued political conflict in the open forum of politicaldebate. Lobbyists hired by industry and by NGOs will continue to try to influence government
policy makers. The media will be used by all special interests to promote their views. These
activities make outcomes somewhat dependent on the availability of financial support for eachspecial interest. In this public forum debate in the USA, public policy can be heavily influenced
by special interests with large funding bases.

Analysis of the situation from the frame of symbolism shows us that in both countries how certification is dramatized could have significant influence on its acceptance and the outcomes of that

acceptance. We can expect a more cohesive and well orchestrated dramatization in Japan due tothe structural and political environment of more behind the scenes collaboration and the long

history of cooperation between divergent interests in the keiretsu system. In the USA we can
expect the drama to be more public with more open conflict and less well orchestrated. Bothwill find their symbols and myths which will support the outcomes but these wi!1 evolve in very
different ways due to the structural and political differences in these two societies.

In conclusion, government in both countries will play significant roles in the realization of certifi-

cation and sustainability. However, in Japan we can predict that the government will act withmore control and more effectively direct the outcomes of certification. From the analysis using

the Bolman and Deal frames there is support for North's observations that outcomes will bedifferent when social instruments are adopted into a culture where they did not originate.

If certification of wood products finds success in Japan, analysis using the four Bolman and
Deal frames predicts that it will take place in very different ways than it is evolving in the USA.

If the players in the adoption of certification in Japan are not fu11y aware of the differences46(2001),& BUSINESS REVIEPV,KOBEECO?VOMZC

72

47-72

between Japan and the USA brought to light in the comparison of the social structures, politicalenvironments, human resource relationships, and control of symbols to influence public opinion,
they may be harboring unrealistic expectations of what certification can accomplish in Japan.

References
Bolman, L. G. and T. E. Deal (1991). Reframing organizations: artistry, choice, and leadership. San
Francisco, Jossey-Bass.
Jenkins, M. B. and E. T. Smith (1999). The business ofsustainable forestTy: strategies for an industry intransition. Washington DC, Island Press.
North, D. C. (1990). Institutions, institutional change, and economic performance. Cambridgc, Cambridgc
University Press.

KOBE ECO?VOMIC & BUSINESS REVIEPV, 46(2001), 73-90

SENSITIVITY OF DOMESTIC PRODUCTION TO IMPORTCOMPETITION:EVALUATION AT DIFFERENT LEVELS OF AGGR[EGATION'

EIICHI TOMIURA KobeUniversity

Abstract
This paper examines the impact of import competition on domestic production by exploiting the newly
constructed longitudinal firm-level monthly data of Japanese products. The firm-level estimates arecompared with those based on data at different levels of aggregation (2-digit industry and 7-digit product).

The results show that the aggregation effect, both through product coverage and through inter-firmheterogeneity, affects the estimates. The sensitivity of production varies substantially from firm to firmeven within the same industry. By linking this intra-industry variability with domestic price differentials,
this paper finds that highly sensitive to import competition is production of relatively low-priced products.

JEL CIassiJfication: C81, D24, F14, Ll1, L64.
Kaywords: import competition, longitudinal firrn-level data, aggregation, vertical differentiation

Corresponding address:
Eiichi Tomiura
Research Institute for Economics and Business Administration (RIEB), Kobe University

2-1 Rokkodai-cho, Nada-ku, Kobe, 657-8501, Japan
E-mail: tomiura@rieb.kobe-u.ac.jp

PhonelFax: 81-78-803-7008*This paper partly depends on the access to the government's micro data, which was allowed under No, 99 by the
Public Management Agency in 1996. This paper is also benefit from the Research Group on Statistical Analysis of
Production and Industry (1998), which is the output report from joint work with MITI Statistics Department. The
financial support by the Grant-in-Aid for Scientific Research Nos, IOI132 and 13630056 by the Ministry of Educationand Science is acknowledged, I appreciate valuable comments from seminar participants at Hitotsubashi University,
Kobe University, Shinshu University, and Japanese Economic Association, especially Takatoshi Ito, Kyoji Fukao,

Fumio Funaoka, Seiichi Katayama, Ryuzo Miyao, Sadao Nagaoka, Hiroyuki Odagiri, and Ryuhei Wakasugi. An
earlier version of this paper was circulated in the discussion paper form, as Tomiura and Uchida (1998), written in
Japanese. As this paper was substantially revised while I stayed at Massachusetts Institute of Technology as Visiting

Scholar, I acknowledge various supports by MIT and financial support by the Japan's Ministry of Education andScience. All remaining errors are mine.

74 KOBE ECON02LCC&BUSINESS REVIErv, 46(2001), 73-90

1. Introduction

It is widely believed that the import penetration intensifies competition and affects domestic

manufacturers. Although some industry groups emphasize the negative side of importcompetition, their claim is yet to be under square scrutiny. The quantification of impact ofimports on domestic industries is strongly required.

Among the issues which researchers face in estimating the impact of import competition on
domestic industries, this paper focuses on the aggregation effect.i The motivation to investigate
this issue is two-fold. First, as production and trade of differentiated products are more prevalent

in industrialized countries, more serious attention must be paid to the heterogeneity among firms

within the same industry 'ivhen w'c evaluate the sensitivity of domestic production to importcompetition. Since domestic productions of products with distinctly different quality tend torespond differently to the same import price changes, we must carefu11y control for inter-firmheterogeneity even if firms are classified into the same industry. Second, since many of theprevious estimates of the impact of import competition on domestic industries rely on aggregate

data, high sensitivity of some firms might have been obscured by aggregation with otherrelatively insensitive firms. This suggests that estimates previously obtained from industry-level
data might critically differ from firm-level estimates.

To investigate the aggregation effect, the estimates at the broadly defined 2-digit industry-level, at the finely defined 7-digit product-level, and at the individual firm-level will becompared, by exploiting the longitudinal firrn-level data newly constructed from the original
confidential government data files of the Current Sun?ey ofProduction (Seisan Doutai Tokei, inJapanese). The aggregation effect will be examined both in terms of the product category
definition and of the inter-firm heterogeneity. Depending on the definition of the product, we

may incorporate not only substitutes but also complements for imported products, thus obtaindownward-•biased estimates of production sensitivity. This possibility is beyond mere curiosity
because trade statistics in many countries classify intermediate components and parts and final
products into the same category if we depend on aggregate data. The comparison of results fromindustry-level and from product-level will reveal this side of aggregation effect, while the firm-level estimates will make clear inter-firm, or intra-industry heterogeneity obscured byaggregatlon.

The rest of the paper is structured as follows; Section 2 briefly surveys the previous related

research. Section 3 formalizes theoretical models and introduces its empirical counterpart.

Section 4 describes the data of which the detailed explanations are provided in Appendix.
Section 5 reports the estimation results. Section 6 concludes.

1 Another critical issue in estimation is the simultaneity of variables. This issue will be discussed again in the later
sections of this paper.

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TOMIURA: SENSITIVITY OF DOneSTIC PRODUCTION TO IMPORT COneETITION

2. Related literature

The impact of import competition on domestic industries has been intensively investigatedespecially in the U.S. Among many variables which could be affected by foreign trade, the main

focus of studies in the U.S. has been on labor, particularly on unemployment in the 1980s andon wage inequality in recent years (Branson and Love (1988) and Feenstra (2000), for example).

For the impact on employment volume, researchers have recently begun to distinguish net
changes from gross job creationldestruction by exploiting plant-level micro data.2

Related with estimation methodology, Grossman (1986) pointed out a critical issue; theemployment sensitivity estimated by OLS regressions on the import quantity variable, which isoften casually considered as a measure of import competition intensity, should be biased because

employment and import volume are simuhaneously determined. An alternative strategy proposed
was using the import price as an explanatory variable since the import price is assumed given in
the standard trade models.3

Previous studies have also examined the impact of import competition on many variables,such as mark-ups (Levinsohn (1993)), productivity (Harrison (1994)) and R&D spending(Bertschek (1995)). Many of these studies excavate micro-data sets, including those ofdeveloping countries during a period of drastic trade liberalization, to control for various plantspecific factors.

3. Model3-1. Conceptual framework
Before discussing the econometric models, let me start with the following standard system of

demand and supply for a domestic product to overview the basic ideas behind empirical
specifications;q-D(p, pM, y) (1)q - S(p, w),where q, p, pM, y and w denote production quantity, price of the domestic product, importprice, domestic income and factor price, respectively. The domestic product is assumed to be an
2 Levinsohn (1999) examines the impact of foreign trade on grossjob flows using plant-level data in Chile during theperiod of drastic trade liberalization.

3 We cannot deny the possible simultaneity even if we use the import price because the traditional assumption of"small county" may not be a realistic desicription of economies with large domestic markets, such as Japan and the

U.S. In those economies, import prices are likely to be influenced by their own domestic demand and no longer
given. The endogeneity problem will be discussed again in the next section.

KOBE ECONOMIC & BUSINESS REVIEM, 46(200I), 73-90

76

imperfect substitute for the imported product, which has an exogenous price and whose supply is
assumed to be perfectly elastic. All the price variables, including import price, are expressed interms of home currency. As Grossman (1986) pointed out, we need a "reduced-form" tocircumvent the simultaneity problem in estimating the domestic impact of imports. For thequantity, (1) reduces to,

q=a+BpM+ry+6w (2)if we assume linearity. We expectB>O,r>O, and6<O, from the standard setup of
downward-sloping demand curve and upward-sloping supply curve.` The specification of (2) isbasically the same as previous works of Grossman (1986) and Revenga (1992), as it includes theimport price, not the import quantity, as a right-hand side variable for a measure of importcompetition. The estimate ofB from (2) can be interpreted as the sensitivity of domestic
production to import competition. If variables are in the logarithm form, it represents the importprice elasticity of domestic production.

The main purpose of this paper is to examine how aggregation affects the estimates for thissensitivity of domestic production. Before discussing econometric models and estimation results,
the clarification of concepts will be usefu1. The aggregation brings about a bias in the coefficientestimate mainly through the following three routes: heterogeneity among fimis, definition of
product coverage, and endogeneity of variables.

First, firrns even in the same industry are inevitably heterogeneous in many respects. Thisimplies that estimates based on aggregate industry-level data often non-negligibly differ fromestimates based on micro firm-level data.

Second, subset of domestic products aggregated may be complements rather than substitutes

for the imported product. The foreign trade statistics in many countries actually classify
intermediate components and parts in the same category with the final products. This second
problem is especially serious when the definition of the industry is broad, such as 2-digit industry-level. On the other hand, if we restrict our focus on firms producing only the final products
based on 7-digit product-based data, we can be more confident in examining the first effect ofaggregation without the contamination of this second route.

Finally, the right-hand side variables are more likely to be endogenous in the regression
explaining the aggregate output compared with individual firm's output. The use of firm-level
data will not only reveal rich information of intra-industry variability but also alleviate thepossible endogeneity of explanatory variables in the regression, since we can naturally assume
that variables including the import price are regarded as exogenous for individual firms.5

We suspect that previous estimates based on industry-level data might be affected partly by
4 Although we have thus far assurned the perfect competition to derive (2) from (1), the specification (2) as the"reduced-forrn" is robust for a wide range of other typical modes of firm behaviors.

5 To resolve the simultaneity problem, Grossman (1986) and Revenga (1992) assign instrumental variables to import

pnce.

77
TOMIURA; SENSITIVITY OF DOneSTIC PRODUCTI07V TO IMPORT COMPETITIO?V

these aggregation problems. Therefore, this paper chooses a different strategy: exploiting newly
constmcted longitudinal data of individual firms belonging to the same 7-digit product category.

3-2. Econometric specifications

The empirical counterpart for the equation (2) estimated in this paper takes the following loglinear form',

ln qi,-t == a,, +Bi ln pit +ri ln gt+6i ln wit+uiit (3)where u is the error term with standard properties. Besides the time subscript t, the subscript j
denotes the firm supplying the producti (t=1, 2, ..., T;j=1, 2, ..., J). Due to the limit of data

availability, inter-firm cost heterogeneity has been assumed away in the empirical
implementation.6
While the specification (3) estimated with firm-level longitudinal data is served as the baseline

case in this paper, several other specifications using various data will also be estimated forcomparison as follows. First, the production sensitivity is estimated with the aggregate timeseries data of the particular product. For the product i,

ln Qit=ai+Bi lnp,M•t+ri ln yt+6i ln wit+uit (4),where the dependent variable Q is ithe total output of the product aggregated over all firms
producing the same product (Q, := jZ= , qj,). The comparison of this aggregate estimate with theformer micro estimate will enable us to examine how the aggregation effect, especially throughfirm heterogeneity, affects the import sensitivity of domestic production. Since both (3) and (4)are based on the same finely defined 7-digit product category, the aggregation through productcoverage is not supposed to appear in this comparison.
Second, the following will be estimated with industry-level data;ln Qht=ah+B ln phMt+r ln y,+6 1n zvh,+ Uh, (5),where Q is the output of industries defined broadly at the 2-digit level. The industries arenumbered by h (h==1, 2, ''', H). The industries are supposed to cover the whole tradable
industries. The comparison of (5) with (4) will reveal the aggregation effect through the productcoverage because both intermediate components and final products should be classified in thesame industry if we depend on 2-digit data.
Although they differ in data and in specifications, all of the above three cases assume that thesensitivity of production to import competition is the same across all firms in (3) and (4), or
across all industries in (5). Consequently, this paper next examines the effect of this pooling

6 The regression of a micro variable on aggregate variables results in biased estimates for standard errors, although thecoefficient estimates themselves are not biased. In this sense, most of the results reported in this paper should beinterpreted with some cautious margins.

KOBE ECONOM]rC & BUSINESS REVIErv, 46(2001), 73-90

78

constraint. We will be able to study the plausibility of assuming monolithic structure in theindustry, or of assuming the representative firm model by sequentially relaxing the poolingconstraint as follows. While keeping longitudinal structure of the data set, this paper allows
variability across firms in only one coefficient which attracts our attention; i.e. the import priceelasticity, by the following formulation:J

ln q,)t=aij+,\,B,JDUMi lnP,M,+r, ln y,+6, ln w,,+u,,, (6),where DUMj denotes the dummy which takes the vaiue of one for firmj only and zerootherwise. Similarly, for the industry-level counterpart derived in (5), we can estimate the industryspecific production sensitivity as follows;H
ln Qht=ah+]Z] BhDUMh lnPhM,+rln yt+61n wh,+ Uht (7)h==1Further, to allow variable coefficients for all explanatory variables, we will estimate the samemodel for individual firm by splitting the longitudinal data set into separate time-series data setsof individual firms.

In q,,, =B,, ln p,M, +r,, ln yt+6,j ln zv,,+ :li] a,ik Z,,k+u,jt (8)As is obvious, however, nobody can fu11y control for various individual effects, which issignified as Z in (8). Since firm--specific effects are not supposed to change monthly, however,
we can bypass this problem by taking time-difference as follows:7

dln qijt =Bi,•dlnP:•t+rijdIn yt+6i,•dln wit+viit (9)The error term is denoted by v. We will compare these various estimates for the sensitivity ofdomestic production in Section 5, after describing the data we use for estimation.

As explained above, our estimation will result in various estimates for the sensitivity ofdomestic production to import price changes (B) with different degrees of pooling restrictions
and with different data as follows:a) Based on longitudinal broadly defined (2-digit) industry-level data, with B constrained
equal for all industries (5).

b) Based on longitudinal broadly defined (2-digit) industry-level data, with B allowed to varyacross industries (7).
c) Based on time-series aggregate (7-digit) product-level data for a particular product (4).
d) Based on longitudinal firm-level data, with B constrained equal for all firms (3).

e) Based on longitudinal firm-level data, with B allowed to vary across firms (6).
D Based on time-series data ofindividual firms, with all coefficients to vary across firms (9).

7 Since firms in the same industry tend to face same shocks, the disturbance terrns are often correlated. Although thisprompts us to estimate (9) by SUR (Seemingly Unrelated Regression), SUR in this case degenerates to OLS since all
the explanatory variables are identical for all firrns.

79
TOMZURA: SENSITIVITY OF DOMESTIC PRODUCTION TO IMT)ORT COMI?ETITIO?VThe comparison of estimates from a) or b) with c) will reveal the aggregation effect throughproductiindustry coverage, while that of c) with d), e), and D will show the aggregation effectthrough firm heterogeneity or simultaneity.

4. Description of data

This paper exploits the micro data from Current Survey ofProduction (Seisan-Doutai Tokei, inJapanese). Among many statistics, this survey collects data on production quantity and price fora wide range of finely classified products on monthly basis in Japan.8 By defining the product at

the disaggregated seven-digit level, we can exclude intermediate components, which tend to becomplements rather than substitute for final products, from our analysis. Since individual plantlevel data before that month are generally no Ionger maintained even in the original data files of

the govemment, our sample period starts from January 1988. Due to the data availability at thetime of this research, the sample ends at December 1995. The aggregate data used for estimating(4) is not drawn from publicly available statistics, but constmcted by summing over all firms inour sample.9
Although plantiestablishment-level data are available in the original government data files, thispaper concentrates on firm-level data from the following two reasons. First, the strategic decisions

such as response to imports are likely to be made at the corporate level, not at the individual
plantiestablishment levels. Second, compared with that at the firm level, the production at theplant level tends to be volatile and unstable. Third, since openings and shutdowns, which arediscontinuous with sunk costs, are relatively frequent at the plantiestablishment level, the linear
regression framework is not a suitable tool. Therefore, this paper aggregates production quantitiesof all establishments which belong to the same firm and compiles them into the longitudinalform. Firms which experienced entry or exit are excluded from the sample due to the above
mentioned problem. As a result, the sample is a balanced-panel form.

To estimate the impact of imports, we need foreign trade data. The classification system oftrade data, however, does not coincide with that of domestic production data. There exists noofficial data concordance table between these two statistics for the Japanese case.iO Consequently,

8 Exactly speaking, the Survey collects data on quantity and value of production, not directly the price level. As aresult, this paper defines the "price" as the unit-value. Although the unit-value index is inevitably affected bycompositional shifts, this problem is less serious at the individual plantiestablishment level comp'ared with theindustry level because product composition is unlikely to change monthly within individual plant. Even if this bias
exists, our interpretation of the results is not qualitatively affected.

9 The legal restriction prevents us from revealing any inforrnation which could result in identifying any individual
plant. Hence, the data set used for our study cannot be revealed, although some summary statistics will be available

upon request.
10 Feenstra (1996) is a very infotmative source for the concordance connecting data in different statistics in the U.S.

case.

80

KOBE ECOArOvaC & BUSINESS REVIEM, 46(2001), 73-90

this paper exploits the concordance table annexed to the Input-Output Table, which links trade

data with manufacturing census data at the seven to nine digit levels. The procedure of dataconcordance and concordance tables are shown in Tomiura and Uchida (1998).ii
Other data employed in the regression include the total industrial production index for y, as
national income statistics are not available on monthly basis, and the input price index for w.i2
All data on prices, including import prices, are defiated by the aggregate wholesale price index.i3

On the other hand, the 2-digit industry-level data are derived from Annual Survey of
Manufacturers (Kogyo Tokei, in Japanese). The sample period is from 1988 to 1995 to facilitatecomparison with the results from micro data.i4

5. Empirical results

5-1. Estimates based on industry-level data

First, the result from broadly defined 2-digit industries is reported in Table 1.

As the F value in Table 1 suggests, the restriction constraining the constant term equal for allindustries is rejected. The responses to imports must vary across industries, as daily experiencesindicate. Based on the result from the Hausman test, the random-effect model is chosen in thiscase. The import-price elasticity of domestic production is estimated to be around O.18. Thisestimate means that the Japanese industry reduces production by less than two percent even if
the import price falls by ten percent According to Revenga (1992), the import price elasticity of

employment in 38 U.S. industries pooled for the period of 1977-87 is around O.24 to O.39.
Although direct comparison should be viewed with caution, production in Japan during 1988-95

11 The import price is defined as the unit-value, The interpretation of the results is not qualitatively affected even if

import price changes are driven by product compositional changes. I also tried WPI-based import price index tocheck robustness in some cases, but although classification mismatches limit the cases, no direct contradictoryevidence was found.
12 The input price indices are those at the industry-level. To check robustness, I also tried the wage index of eachindustry, but the results are basically the same.

13 Monthly dummies are introduced to adjust seasonality. The other variable included in the regression is the export
price. Due to the limit of data availability, we cannot exclude the production for export sales from total production.

Hence, the production quantity as the dependent variable in the regressions must be affected by the export price. Aslong as the assumption of perfect competition in foreign markets is plausible, the export price index must suffTiciently
control for foreign market conditions relevant to domestic firms. Other factors, such as foreign rivals' costs, however,
may affect domestic production decisions if oligopoly is prevalent in the industry. Studies including these factors willbe left to future research. The export price index, derived from trade statistics, is expressed in terms of yen.

14 Since the quantity data are not available in Annual Survey of Manufacturers, I define it by the shipment value
deflated by WPI of respective industry. For the factor price w, we use the "expenditure on materials" divided by theoutput `quantity' derived both from Annual Survay of Manufacturers, as it closely corresponds to the averagevariable cost. The price indices are drawn from WPI.

TO?LflURA: SENSITIVITY OF DOMESTIC PRODUCTION TO IMPORTCOMPETITION 81

Table 1 Estimates based on 2-digit Industry-level Data

B

POOL

PANEL(RE)ALLINDUSTRIES

1.78867

O.176552

COMBINED(2.1O167)[O.095437]

STATISTICS

R2-o.o35183

F==1408.1

x2=3.3021
Note: The regression is based on the two-digit level industry datafrom Annual Survey ofManufacturers. The dependent variable is thelogarithm of industry production. PANEL reports result from therandom-effect model. The figures in parentheses are t-value in thepooled regression and the standard error in the random-effect model
for panel data. Estimates of other coefficients are not shown.,F isthe test statistics for the constraint on the constant term a equal for

all industries. x2 is the test statistics for the Hausman test on theorthogonality of a and the error term.

is less responsive to imports than U.S. employment during 1977-87. This small estimate ofproduction elasticity, however, does not necessarily imply small impacts on employment because
import could reduce demand for labor further by substitution between labor and capital. Since
import penetration into relatively capital-rich countries, such as Japan, decreases demand to
relatively labor-intensive products or labor-intensive production processes. Therefore, we must
be carefu1 in interpreting the result in employment context.

Next, let me turn to the case where import price elasticity is allowed to vary depending on theindustry. The result is demonstrated in Table 2. In the classification introduced above, Table 2
corresponds to the model (7)lthe case b), while Table 1 corresponds to the model (5)lthe case a).
The Hausman test statistics show that the fixed-effect model is preferred. The important thing tonote here is the vast diversity of responses to imports across industries. Although the sensitivity

to import price changes has been estimated to be small in the case of all industries combined,
there exist industries seriously sensitive to imports. The high elasticity of the textile industry isquite reasonable if we consider the high import penetration in that industry.i5 On the other hand,the electric machinery industry is the only industry with the coeffTicient estimate significantly

negative. The reasons for this wrong sign in the case of electric machinery might be due to theindustrial composition or to the endogeneity of import price. By the former, I mean the broad

15 Grossman (1986) also reports high import elasticity of labor, 1.03-1.07, for the U.S. steel industry for which import
restriction actions had been discussed. Although it has the second largest estimate in Table 2, it is rather difficult tointerpret the case of "general machinery" since this industry is a composite of various different machines.

82

KOBEEco?voMlrc & BUSINESS REVIEM, 46(2001), 73-90

Table 2

Industry-specific Estimates based on 2-digit Industry•-level DataA
TextilesPaper

ChemicalsPetroleum&coal

Pottery&Clay

Steel

Non-ferrousmetals

Generalmachinery

ElectricmachineryTransportmachinery

Precisionmachinery

STATISTICSPOOLPANEL(FE)O.168361

1.67864(1.55555)[O.347244]

O.106924

O.170034(O.958782)[O.126606]

O.304501-O.123481(2.94051)[O.198382]

O.106107-O.141883(O.956087)[O.163621]

O.136224

O.050973(1.24788)[O.108364]

O.253179

O.532246(2.31971)[O.129152]

O.087823-O.075824(O.781983)[O.128836]

O.391160

O.940658(3.52900)[O.269292]

O.529635-O.433341(4.76930)[O.123251]

O.490568

O.500188(4.29667)[O.205962]-O.024013

O.584778(O.214350)[O.145534]

R2-o.gg2345

F-1408.1
x2=3.3o21

Note: The industry-specific dummies are interacted with the importprice. PANEL reports results from fixed-effect model. Other notes
to Table 1 also apply to this table.

definition of industry which may include many complements rather than substitutes, such asparts and components. The latter implies that Japan's demand for electric machinery may
influence the import price and this simultaneity biases the estimate. In any case, we must further
excavate the electric machinery case.

83
TOmaURA: SENSITIVITY OjF' DOneSTIC PRODUCTION TO IMPORT COMPETITION

Based on these industry-level estimates, this paper concentrates on the electric machinery in
the following section because its elasticity estimate has the significant wrong sign. To facilitate

discussions and interpretation of results, this paper picks up a couple of final consumer goods

which anybody can understand their product characteristics: color television and air
conditioner.i6 Needless to say, this paper does not intend to cover all product categories. I
neither mean to claim that the results from the following should be universally observed in allindustries. What this paper establishes is providing "examples" which we can relatively easilyinterpret and will be able to check with other data sources.

5-2. Estimates based on firm-level data

Table 3 compares the result from firm-level longitudinal data with that from aggregate data. The

rows titled as "AGR" correspond to regressions where the dependent variable is the total
production quantity aggregated over all firms producing the same 7-digit product (the model(4)lthe case c), while the rows titled as "PANEL" corresponds to regressions based on firm-levellongimdinal data with the fixed-effect model (the model (3)lthe case d).i'

Table 3 Estimates based on Firm-level Panel Data and on Aggregate Product Data

Product

TV
AirConditioner

A

t

R2

PANEL

O.863232

6.7623

O.8352AGR

O.190377

2.1393

O.8687

PANEL

O.271996

4.1086

O.7244AGR

O.116105

1.7082

O.8107

Estimation

Note: The dependent variable is the industry aggregated production quantity in

the AGR rows, the production quantity of individual firm in the PANEL rows.
The fixed-effect model is used in estimating panel data. A is the coefficient ofimport price with one lag in the AGR rows. Estimates of other coefficients areomitted from the table. "t" denotes t-value for A.

The figures in Table 3 demonstrate that elasticity estimates obtained from longitudinal data
are substantially larger than those from aggregate data in the case of television. This implies that
16 Although more disaggregated classifications are available in production data and in trade data, the limitation ofclassification matching between these statistics compels us to contend ourselves with this level of productaggregatlon.
17 To make comparison easier, "AGR" is the result from the aggregation of only firms which constitute the balancedpanel. The results from all the firms, however, are only negligibiy different. Hence, we can safely concentrate on thebalanced-panel firms. Since the Hausman test of misspecification supports it, "PANEL" is the result from the fixed-

effect model.

KOBE EC07VOMIC & BUSINESS REVIEPV, 46(2001), 73-90

84

the level of aggregation must seriously affect the assessment of impact of imports. Different

from the industry-level estimates reported in Table 2, the aggregation problem here isaggregating heterogeneous firms, rather than mixing intermediate components with final products
because the product is quite finely defined at the disaggregated 7-digit level. Hence, even if weconcentrate on substitutes, the aggregation bias in import response estimation is enormous insome products such as televisions probably due to inter-firm heterogeneity. On the other hand,the aggregation problem seems less serious in the case of air conditioner. The reasons for thisdifference, however, will be revealed only with sufficient knowledge of production technologies
andlor of industrial organization. I will leave it for future work.

Compared with the 2-digit industry level estimate of electric machinery in Table 2, both for
televisi-on and Åí.or air conditioner, th.e estim.ate for import. price elasti'city h.as now been fixed tohave the correct positive sign. Since inter-firm heterogeneity seems less prevalent, thesimultaneity andror contamination by intermediate components might be the main cause of thewrong estimate at the aggregate level especially in the air conditioner case.

Table 4 Summary Statistics of Firm-specific Estimates
ProductTV

MeanSt.Dev

pANELB O.979670

O.789577t

2.63082.1204

R2

O.8434------

Estimation!Stat.

INDB
AirConditioner

O.537213

O.373664

t

1.5134

O.6883R2

O.4307

O.2170pANELB O.271996

O.214630t

2.20451.7395R2

O.7374------

INDB

O.090338

O.098121t

O.7871

O.9406

R2

O.5994

O.1460Note: The dependent variable is the production quantity of individual firm.

"Mean" and "St. Dev" are calculated for firms which have estimates withcorrect slgns.
Next, Table 4 compares results in the case where import price elasticity is allowed to varyacross firms. The "IND" rows in this table report the results from independent regressions of

85
TOMIURA: SENSITIVITY OF DOMESTIC PRODUCTION TO IMPORT COMPETJTIOAi

individual firms in the time-series format, while the "PANEL" rows reports the results from
regressions based on panel data with firm dummies interacted with the import price variable. In
other words, all coefficients can be different across firms in "IND" cases (corresponding to themodel (9)lthe case D, while coefficients other than import price elasticity are constrained to beequal for all firms in "PANEL" cases (corresponding to the model (6)fthe case e). Due to theconfidentiality requirement imposed by the law, we are not allowed to show estimatedcoefficients for individual firms. Hence, reported in the table are the average value and standard

deviation for estimates of import price elasticity, t-value of the estimate, and the adjusted R
square of the regression. What is clearly shown from Table 4 is the limit of discussions basedon average values. Estimates with micro data have large standard deviation. We should notsatisfy with the representative firm model. Intra-industry variability, or variability across firms

within the industry must be examined.

5-3. Preduction sensitivity and relative price level

What this paper tries next is to interpret observed vast inter-firm diversity of responses toimports. Among many factors, the price level must be one of the most important factors in theinterpretation. In the extreme case of perfectly homogeneous products, the domestic pricedifferentials across firms must diminish as the result of intensified competition by importpenetration. On the other hand, in the cases such as the vertical product differentiation, eachproduct can have different price depending on its quality. For Japan's machinery industries, we

can safely assume that the competition with imports is more intense among firms who supply
lower-priced, lower-quality products compared with those who supply higher-priced, higherquality products, since import prices tend to be distinctively lower than prices of domestic
products. This suggests that previously observed vast diversity of production sensitivity amongfirms could reflect intra-industry price variability.

To test this conjecture, I split the whole sampie into two sub-groups: firms whose price levelis higher than industry average and firms whose price level is lower than industry average. Since
the relative price of each firm compared with the industry average is generally stable over timein this case, dividing firms based on the average price during the sample period poses no serious

problem.i8 Besides, the price levels of domestic products and import price level differ
substantially in our case. Those firms whose average price is lower than the industry averagecharge prices lower than higher-priced domestic products by forty to sixty percent. Thus, thisgrouping of domestic firms seems reasonable. Table 5 reports the result from the aggregated two
sub-groups. For both television and air conditioner, the production sensitivity of lower-priced
products is larger than that of higher-priced products.
18 We assume here that each firm produces prefixed one product variety. Although firms may produce simultaneously
many product varieties and may drastically reshuffle product-mix over time, the monthly stability of each firm's
average price implies that these cases are not likely in our sample.

46(2001),
REVIEM,&
KOBEECONOMICBUSINESS

86

Table 5

Estimates for Sub-•groups Aggregated by Price

B(t)

R2

Aboveaverage

O.182974(1.89479)

O.852104

Below

O.324800(1.97135)

O.677959

Aboveaverage

O.060608(O.959350)

O.853108

Below

O.175441(1.95849)

O.680882

Groupbypricelevel

Product

TV
AirConditioner

73-90

Note: The dependent variable is the production quantity aggregated over firm which belong to
the respective sub-groups. Figures in parentheses are t-value.

To check whether this result is a mere artifact of aggregation, I trace back to firm-level
estimates. Table 6 reports the average and variance of firm-level estimates in Table 4 for these

two sub-groups. While Table 5 reports the results from regressions based on aggregated sub-groups, Table 6 summarizes the individual firm-level regression results. Although somedifferences are observed in the absolute levels of estimates, the result that lower-priced products

are more sensitive to imports is robust irrespective of products examined (television or air
conditioner) and of estimation procedures employed.'9

Table 6 Firm-specific Estimates Summarized by Price

FirmsAboveFirmsBelow

B

AveragePrice

AveragePrice

PANEL

O.419342[O.428]

1.653531[O.715]

IND

O.269528[O.311]

O.562794[O.426]

TV

AirConditioner

'

PANEL

O.267674[O.136]

0283046[0279]

IND

O.042351[O.023]

O.129967[O.120]

Note: Weighted averages with weights equal to each firm's production
quantity. Figures in square brackets are standard deviation among firrns

belonging to each cell.
19 We should interpret this result with caution because the import price index employed in the regressions is defined at

the industry level. Since no more disaggregated data of imports which have same classifications as those in the
production data are available, we must contend ourselves with this import data. Although the homogeneous treatmentof the imports is theoretically inconsistent with the framework of differentiated competition, we anticipate no
significant vertical differentiation among irnports in this case because imports of television and air conditioner are

predominantly from Asian countries.

87
TOMIURA: SEIVSITIVITY OF DOMESTIC PRODUCTIO?V TO IMPORT COMPETITION

The results from firm-level data demonstrate that impact of import competition varies
significantly across firms depending on the position each firm occupies in the product space indifferentiated industries such as home electronics, even if all the firms face the same exchange
rate changes. Put it differently, the negative impact of import penetration on domestic production

concentrates on low-priced products, rather than dispersing evenly over all products in theindustry. Even if we notice negligible impact of imports at the aggregate levels such as thenational economy or the manufacturing industry as a whole, groups of manufactures who charge
low prices can be seriously damaged. On the other hand, the same result implies that a firm cansubstantially reduce competitive pressure from imports once the firm alters pricelquality level ofher own product. As was mentioned, however, the relative price level of each firm is stable overtime in the cases examined here. This may indicate that changing product quality entails nonnegligible adjustment costs for individual firms and thus means that firrns facing intense pressure

from import competition may feel difficult to alleviate the problem because they cannot easily
reshuffie their product composition. Anyway, we need more evidence to test this interpretation.
What is at least clarified from this study is that product differentiation cannot be neglectedeven within the product, defined narrow at the 7-digit level. Each product variety, or at least
each group of them, may constitute distinct sub-market within each product category.20 In sum,
we will not be completely free from the aggregation problem in differentiated products, even if
we excavate data probably into more finely disaggregated levels.

6. Concluding remarks
The purpose of this paper has been to quantify the impact of import competition on domestic
production by exploiting the newly available firm-level longitudinal data set. The remaining
issues, however, still exist as follows.

First, we need to further investigate the robustness of the results from only a couple ofproducts in Japan. Although this paper has conducted 2-digit industry-level estimation covering
all industries, the representation by television and air conditioner must still be regarded as

nothing more than examples. We need other cases to draw any general implications. wnat weneed before estimation, however, is the comprehensive data concordance between production
data and foreign trade data. On this front, we are still in the primitive first step.2'

Second, the impact of import competition should be assessed in terms not only of quantity but
also of price. The price data this paper employs is defined as the unit-value from Current Survey

20 See footnote 18 for the possibility of multi-product production and of the reshuffles of product-mix over time in thiscase.
21 In a different research project, I have constructed a data concordance connecting all the four-digit dornestic industries

in Annual Surveys of Manufacturers and the import statistics in Japan. The concorded data are available in Tomiura

and Uchida (2001).

KOBE ECO?VO?LflC & BUSINESS REVIEM, 46(2001), 73-90

88

of Production, while Annual Survey of Manufacturers contains no pricefquantity data. Although
the data availability will severely limit it, it will be worth seeking this line of research because

the market-discipline effect of import competition is more appropriately examined in the pricing
context.

Third, just as in the U.S., the employment will obviously be the next target of study. At leastin the past years which the sample in this paper covers, employment adjustment in Japan has

been inactive across firms and industries in any international standards. The Japan's

unemployment rate, however, has continued to rise over the recent years. Hence, theinvestigation of the impact of import competition on Japanese employment must deserve
attention.22

In spite of these remaining issues, the results from this paper will have deep policy

implications for many industrialized countries where import competition from low wage
countries has intensified. At the same time, this study has provided rich information which has
been unavailable from aggregate data.

References
Bertschek, I. (1995) "Product and process innovation as a response to increasing imports and foreign direct

investment," Journal oflndustrial Economics XLIII: 342-357.

Branson, W. and J. Love (1988) "U.S. manufacturing and the real exchange rate," in R. Marston ed.
Misalignment ofExchange Rates: Effects on Trade and Industry, University of Chicago Press, 241-

275.

'

Feenstra, R. (1996) "U.S. imports, 1972-1994: Data and concordances," NBER Working Paper 5515.
Feenstra, R. (2000) The Impact oflnternational Trade on Mages, University of Chicago Press.

Grossman, G. (1986) "Imports as a cause of injury: The case of the U.S. steel industry," Journal ofInternational Economics 20: 201-223.
Hanison, A. (1994) "Productivity, imperfect competition and trade reforrn: Theory and evidence," Journal

ofJnternational Economics 36: 53-73.
Levinsohn, J. (1993) "Testing the import-as-market-discipline hypothesis," Journal of International

Economics 35: 1-22.

Levinsohn, J. (1999) "Employment responses to intemational liberalization in Chile," Journal ofInternational Economics 47: 321-344.
Research Group on Statistical Analysis of Production and Industry (1998) A euantitative Analysis of

Impact of Import Penetration on Domestic Production (in Japanese), Research Institute of

22 Even if net employment loss in all industries combined is small, gross job destruction in import competing industries

might be substantial and some industries might create jobs during the yen appreciation period, See Tomiura and

Uchida (2001).

89
TOMIURA: SE?VSITIVITY OF DOMESTIC PRODUCTION TO IMPORT COMPETITION

International Trade and Industry.

Revenga, A. (1992) "Exporting jobs?: The impact ofimport competition on employment and wages in U.S.
manufacturing," euarterly Journal ofEconomics 107: 255-284.
Tomiura, E. and Y. Uchida (1998) "Impact of imports on domestic production: A quantitative study withlongitudinal firm-level data (in Japanese)," Discussion Paper #98-DOJ-90, MITI Research Institute.

Tomiura, E. and Y. Uchida (2001) "The impact of import competition on gross job creation anddestruction: A study based on Japanese import-industry data concordance," Discussion Paper #Ol-DOF36, Research Institute of Economy, Trade and Industry.

Appendix: Description of data
1. Micro data ofproduction
The Statistics Law in Japan limits the access to the original confidential data files of thegovernment. Upon the individual permission by the govemment agency in advance, however,anyone can make access to the data files as long as the research program satisfies necessary
conditions. This paper depends on the data access allowed under the No. 99 and posted underNo. 84 by the Public Management Agency in 1996 and also partly on the published report by
the Research Group on Statistical Analysis of Production and Industry in 1998. Due to the legal

restriction, original micro data sets used for this paper are not available from the author,
although some aggregated statistics will be provided upon request. The sample period is fromJanuary 1988 to December 1995. The series employed is seasonally unadjusted original series.
The official classification codes, numbers and product names for the products examined in thispaper are as following; "Air conditioners" (in "Reftigerating Machines" (2180)) is defined as thesum of 7-digit products from 2180116 to 2180123. "Color TV sets" (in "Television receivers" in"Home Electronics" (2340)) is defined as 2340101 plus 2340102.
Several notes are as follows;First, the sample includes only the firms which have production data. All the firrns including

those with shipment data are excluded as long as they have no corresponding data of production.

Second, as Current Survey of Production is not a census statistics, the sample does notcoincide with the whole sample of the corresponding industry. Although it is the only census,
Census ofManufacturers conduct censuses only twice in every five years. Since we restrict ourattention to the firms which constitute the balanced-panel data and since larger firms tend to
dominate in industries such as Japanese electric machinery which we studied here, however, thesampling problem does not seem to be serious in this case.

Finally, the major classification change has taken place only once during the sample period.
For the air conditioner, in 1993 and after, production data on "in-house unit" become available
separately from "outside unit," as more and more air conditioners in Japan has one outside unit
connected with multiple in-house units. To keep consistency with the data for the earlier period,

90

KOBE ECONOA{ffC & BUSINESS REVIEM, 46(200I), 73-90

we count the production quantity in terms of "outside unit," while we measure production
pricelvalue by the total series including in-house units.

2. Data concordance between import statistics and production statistics
The data concordance between foreign trade data and production data should have been found in"Exports and Imports of Machinery," the Appendix to Current Survey of Production. The
coverage of this Appendix is severely limited, however. No official concordance tables areavailable. Therefore, this paper exploits "Code Table between Input-Output Table and Trade
Statistics" attached to the input-output table. This code table links input-output table at the seven-digit level with foreign trade data at the nine-digit HS level. Among publicly available tables forJapanese data, this is the most informative and reliable one. This paper employs the code tablein 1990 issue of Input-Output Table. In the case of air conditioner, since the import data from1988 to 1989 include air conditioners for automobiles, which are classified in Transport
Machines in production statistics, we match trade and production data only after 1990. See
Tomiura and Uchida (1998) for more detailed description of the data concordance.

KOBE ECONOMIC & BUSINESS REVIEM, 46(2001), 91-100

Japan-Korea Free Trade Area and Structural Reforms

Bonggil KIM KobeUniversity

Kazuhiro IGAWA KobeUniversity

Abstract
This paper analyzes `formation of Japan - Korea free trade area' focusing on an economic stmcturalreform and a mutual strategic complement aspect.
Japan and Korea have similar systems in economic organizations, political decision-makings, and social
cultures. Those systems were effective for catching-up stages of economic developments, but have become
inefficient, sometimes have become fetters, after catch-up stages. Japan-Korea Free Trade Area formation
could be one of strong impacts for structural refomis in both countries for more efficient systems in adeveloped and competitive global economy. The similarities between Japan and Korea will become strong
points or advantage in forming the FTA. Joint strategies against EU and US, and more importantly against
China, will be beneficial for both Japan and Korea. Japan, Korea and China jointly could be a core of thirdpole in Asia, with US pole and EU pole. J-K FTA forrnation will be one of bases for this.

JEL CIassit}cation: F02, F14, F15
Keywords: Free Trade Area, Structure Reform, Global Competitiveness, Safety net

1. Introduction

There exist strong movements for forming FTA (Free Trade Area) in the world. This might
Corresponding Address:

Bonggil Kim
Research Institute for Economics and Business AdministratiQn (RIEB), Kobe University,

2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: bgkim@rieb.kobe-u.ac.jp

PhonefFax: 81-78-803-7005
Kazuhiro Igawa
Research Instimte for Economics and Business Administration (RIEB), Kobe University,
2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: igawa@rieb.kobe-u.ac.jp

PhonelFax: 81-78-803-7001
1 This paper was presented in the seminar at KIEP, July 20,2001, We would like to express thanks for many valuablecomments there, especially Dr. Kim, Yang-hee.

92 KOBE ECOArOMTC&BUSINESS REVIEM, 46(2001), 91-100

reflect a historical change from Cold War era to Market Principle era, or from national policy
oriented to economic efficiency oriented, or from role of national govemment activities to roleof private sectors activities. Developed countries were concerned with national interests but are

now more concerned with global markets or activities. Although an optimum market size formost of firms is not global, it is not within one national boundary. Seeking for an optimum sizeof market, strategic FTA formation is an important issue. For developing countries, which wereinterested in protecting their domestic markets or were taking nationalistic development
dictatorship, it becomes important now to open their markets and invite foreign direct
investments. To open or liberalize its domestic market accompanies large costs. A larger market
can invite FDI more easily. To share the costs and to make larger markets, a strategic formationof FTA is important for developing countries. Those are additional factors for traditional
arguments for FTA formation of trade creations and trade diversions.

Good results of forming EU and NAFTA have strong impact for forming regional FTA inmany areas. However, there always exist conflicts or frictions between forming free global
market and forrning protective regional markets. Former globalism is beneficial for firms whose

competitiveness depend on scale economies. A global standard or an international standard fortransaction rules is one of factors to unify markets and extend size of markets. A large
developed country, like USA, easily has those firms with high technologies and interested inusing its domestic rules as global rules. Latt,er regionalism is beneficial for firms, which related

to traditional or local products. Historically formed transaction rules, which reflect regional
cultures, are developed for those traditional or local markets. Small developing countries havethese markets and are interested in protecting markets and local rules. Each country has bothtypes of firms, and struggles between globalism and regionalism exist also within one country.

In the East and South-East Asia, there ware many diversified countries or areas of economic
development stages, cultures and political systems. However, economic development sequencesof flying geese pattern, staning from Japan, next to NIEs, then ASEAN, and to China, and new

ASEAN members, have changed the area into more uniform. This brings about deeper economic
integration of the area.

The early stage of ASEAN was a political group in the era of Cold War, but ASEAN
gradually increased cooperation as an economic group, which was still a defensive assembly ofsmall countries. In spite of Asian currency crisis, ASEAN now is more offensive in a sense thatit increases members and puts into practice AFTA and is planning to extend FTA relation to

China. China has absorbed foreign direct investments from EU and US and also from Asianneighboring countries. Cheep and efficient labor, combined with advanced foreign technologies

gives a comparative advantage for labor-intensive manufacturing industries in China. Its
potentially big domestic market is also an incentive factor of FDI into China. China and Taiwan

become members of WTO and how to organize a structure of international division of labor
between China is an urgent issue all over the world, especially for Asian neighboring countries.

93
KllM AND IGAorA: JAPAN-KOREA FREE TRADE AREA AND STRUCTURAL REFORMS

Japan and Korea have similar development and growth experiences of government policy led
and of manufacturing export led. Household sector's savings is large and big manufacturingfirms' investments are financed through banking systems. A government distributes funds for
producers, and benefits for consumers are not considered much. When investments of firms are
not large, export andlor government expenditure should absorbed savings-investment gaps. After
explosion of the recent Japanese bubble, investment and export and also government expenditure

have shrunk and Japanese economy is in lower equilibrium level of GDP. After Asian currency
crisis, a zaibatsu system has dismantled and Korean firms have become good buy for foreigners

and a small domestic market has become more disadvantageous for Korean firms in an interna-

tional competition. Both Japan and Korea are seeking means of pulling back from a brink ofdisaster. Japan-Korea FTA is one of means.

2. Economic structures of Japan and Korea
Environments of manufacturing firms' activities have changed both for Japan and Korea.
Profitable industrial sectors have changed from heavy-thick-long-big products sector to light-thin-short-small products sector, and this has made more efficient to use an outsourcing system thanan integrated-production system. It becomes more important to find profitable investment opportii-

nities than making large-scale investments in equipments. Managers of firms must change theirorganizations to have economic efficiencies by selecting profitable projects and investments. A

R&D activity is one of key elements for future profits. A govemment cannot lead its economy
for further developed stages and a big keiretsu-system is not efficient any more. A competitionin free and large markets is one way to form an efficient economic organization. A FTA'
formation might
help for this. 'Both in Japan and in Korea, indirect financial systems through banking systems, contributed
to government policies for economic development or growth. Regulations for banking activities
were used for selectively financing to basic or key industries, mostly to big firms. Big firms had
invested excessively to increase its market share, competing with other big firms. This produced
the results of over-borrowing and over-capacity by firms. In situations of low profit rate in newinvestments, their debts become heavy burdens for firms. A direct finance system through stock

market is another way to finance new investments in markets. Developing a stock market
necessitates a breakdown ofcrony capitalism, which exists in Japanese and Korean markets. Japan-

Korea FTA might have big waves to go away from the crony capitalism.

The government led banking system assisted low profit over-lending by banks (overborrowing by firms). Banks had selected firms, which were supported by the government, in

Iending and thus could not effectively affect firms to select investments projects. The
government also invested in social capitals or public goods for economic development, andsocial benefits were high in high growth rate eras in Japan and Korea. However bureaucratic

94

KOBE ECO?VOMIC & BUSINESS REVIEM, 46(2001), 91-100

decision-makings and political struggles of pressure groups reduced efficiency of government
investments and brought to misallocation of economic resources. Now it becomes better to use

market mechanisms and to privatize public or government organizations. Japan-Korea FTA,
again, might give good chances to push governments or pressure groups to accept principles ofmarket mechanisms.
A more fundamental focus might be in a mechanism of over-savings (relative to investments)
in Japan and Korea. Over-savings are sustained by current accounts surplus andlor government
budget deficits. Japan and Korea have weak constitutions of over-savings, and export promotion

policies or public investments were important government policies for increasing effective

demand. Success of an export promotion brought hike in exchange rates and this, in tum,brought DFI out-fiows. Foreign subsidiaries and foreign local firms, which got technology
transfers, have become competitors in third markets and even for investors' domestic markets.
With large decrease in trade surplus, government expenditure (investment) should be increased

to keep a GDP level. It was easy for a government to find socially beneficial investment
projects, when a social overhead capital was small. However, with accumulation of social
overhead capitals, with bureaucratic decision-makings and with pressure groups' politicalactivities, effectiveness of government's new investments was easily reduced. Government
deficits and misallocation of resources become burdens both for the government and taxpayers.

The over-savings constitution should be changed through increase of private investments andconsumptions. Deregulations might give chances to new businesses, and venture capitals offinancial supporting system might give chances of germination. Consumption will be increased
when firms' profits are distributed to share holders rather than kept for reserve funds. To
increase a consumption rate, pension systems should work effectively to give belief as safety
insurances for old ages. It is a role government to make a system with confidence.

Structural reforms of finance and manufacturing industries, and more importantly of
bureaucratic and regulatory government systems, are necessary at this starting point of 21st

century both for Japan and Korea. A coalition between a government and large firms cannot
lead to competitive and efficient economic systems in global world. A liberalization of international transactions and a deregulation of home markets will accelerate reforrns, but realization of

the liberalization and deregulation may difficult without outside (foreign) pressures. Althoughboth govemments are not very active for forming Japan-Korea FTA, this is a necessary first stepfor global liberalization and deregulation.

3. Roles of Japan-Korea FTA
There are some reasons to form Japan-Korea FTA (J-K FTA). Firstly, costs of structuralreform with global liberalization and deregulation by oneself will be mitigated by joint reformwith FTA. A lager domestic market by FTA will be advantageous for global competitiveness in

95
KIM AND IGAMA: JAPAN-KOREA FREE TRADE AREA AND STRUCTURAL REFORMS

the industries of increasing returns to scale. Secondly, domestic resisting or reluctant groups forreforms will be persuaded more easily with pressure of FTA and thus domestic inefficiencies

will be reduced with joint action for FTA. Thirdly, related to these two reasons and more

importantly, J-K FTA works as one of strategic power against USA and EU, and especiallyagainst China.
Structural reforms of financial sectors and manufacturing sectors in a global market will selectfew competitively surviving firrns (banks and companies). The size of firms in Japan and Korea

will be larger with J-K FTA than the case without J-K FTA. Without J-K FTA, a size of eachdomestic market is not large enough relative to EU and NAFTA, and to China markets, and thus
surviving firms in Japan and Korea may not have enough competitiveness in a global market.
With J-K FTA, the joint domestic market is relatively larger and mutual investments, firms'

cooperation or M&A, and competitive economic environment will produce more competitive
firms in a global market. From this point of view of J-K FTA, investment liberalization,
deregulation of M&A, and competitive cooperation of firms will bring more benefits than mere
trade liberalizations or tariff reductions have.

Both Japan and Korea have less-modernized industries and sectors, like agricultural sector or

marine products and more generally small and medium size enterprises of local traditional
sectors. Gradual liberalizations to global market, starting from FTA, will be a better procedure,

than big shocks of globalization, for forming efficient and competitive firms in those sectors.
Domestic political interest groups are very strong and traditional regulations for protection makeit difficult to promote structural reforms in these sectors. It is possible and necessary to havecompetitive firms and enterprises in those sectors, and the possibility will be larger with larger

joint domestic markets of Japan and Korea. J-K FTA is one way to persuade political interest
groups in a big wave of a global liberalization.

It may be hard for firms based in Japan and in Korea to compete with large multinational
enterprise based in US and in EU. However firms based in a joint Japan and Korea market will
be more competitive and J-K FTA is important as a strategy for geuing a strategic competitive-

ness. Joint strategies of Japanese and Korean firms against EU and US firrns will be more
effective than separated strategies are. Exporting to US and EU markets, Japanese firm andKorean firm are competing each other, and cooperative strategy between those firrns produces
more profitable chances. For import protections by EU and US, export coalitions of Japan and

Korea make it easy to change protective policies or structures. Japan and Korea now worry

about increasing import from China and coalition of Japan and Korea will have power fornegotiation of import protections. A more important strategy might be in negotiation for DFI to

China. Competitions of DFI into China between Japanese firms and Korean firrns reduce
benefits for both firms and give advantageous positions to China. The benefits will be increased

with Japan and Korea cooperative negotiation against China. J-K FTA will be beneficial both forJapan and Korea, but governments were reluctant because of uncertainty of future benefits and96

KOBE ECONOMIC & BUSI?VESS REptIEM, 46(2001), 91-100

certain short ran adjustment costs of FTA, especially when their economic situations were notgood. Past historical relation between Japan and Korea also impede the formation of FTA. FTA
is rather confused with economic and political unification. However in a stagnating economic
situations and effective policies are difficult to find, J-K FTA has become realistic issue ofpolitical negotiations between Japan and Korea.

4. Characteristics ofJapan-Korea FTA
A special characteristic of J-K FTA will come from similarities of economic behavior,economic institution and economic performance in the two countries. Geographical location, sizeand climate are like and thus naturally both countries have similar potentials in forming
economic structures. Historical relations also contributed the similarity. Before World War 2"d,Japan had unified Korea and had put Japanese system into Korea. After the war, Japan firstsucceeded in catching up developed countries and Korea followed the same way of Japan bytaking similar development strategies. As already mentioned, over-savings relative to investment,

export-led grow economy and govemment led economy are important characteristics of the twocountries. We are now in the position to reform these characteristics to vitalize their economies,
and thus both governments can write similar policy prescriptions. Safety nets for reducing risks
for future are necessary to increase a private consumption, and deregulations of domestic market

for DFI inflows and of other activities are necessary to increase private investments. However,
government procedures for safety nets and for deregulations are difficult to take by one country
alone, with competitive neighbors of similar economic structures. It might become easier to takesuch procedures with FTA formation.

Similarity of economic structures appears in dominance of export oriented manufacturingindustry both in Japan and Korea. The manufacturing industries make use of scale economies
and an imperfect competition prevails in the market. When each domestic market was growing
and catch-up was a policy target of development, domestic firms were protected as infantindustries or strategic industries for future. Protective government policies and financial supportsof banking system produced convoy Keiretsu system to share profits. Competition was about
increasing market share but the share was rather kept constant through stable share of big
Keiretsu banks' funds. When market growth rates become low and the catch-up stage has been
passed, the convoy system becomes difficult to sustain and a monopoly or an oligopoly becomesa inefficient form of organization in the manufacturing industry. A competition for efficiency
facilitates restructuring of organizations. A division and re-integration of firms is one dimensionof reforms. A division of manufacturing processes and re-integration of processes is anotherdimension of reforms.
Re-organization for differentiated products is one way for sharing a limited market size andmonopolistic competition might be one form of a market in a manufacturing industry. In this

KIM AND IGAWA: JAPAN-KOREA FREE TRADE AREA AND STRUCTURAL97REFORMS

case, a size of domestic market is one of important factors for global competitiveness. Eachmarket size of Japan and Korea is not large enough for global competition but the market size

becomes fairly large with J-K FTA. Restructuring within Japanese market or Korean market
itself may not accompany large costs but will not provide enough competitiveness for a global

market. Restmcturing with J-K FTA might accompany large costs for restructuring but will
provide more competitiveness.

Competition between Japanese firms and Korean firms within J-K FTA becomes severe andintense but this situation will provide competitiveness to them in third or global market. A
cooperative division of labor between Japan and Korea for strategically increasing competitiveness is one of important incentives for FTA. If both Japan and Korea are interested in taking
parts of intemational division of labor in high-tech manufacturing industry, cooperative strategy
against US and EU, and also against China, will make it possible to specialize in the industry.
Similarities of organizational forms in firms, or of economic transaction forms, or of contract
forms, exist in Asian countries, relative to forms in western (Europe or American) countries, andthe similarities between Japan and Korea are stronger with historical and locational reasons. On

the job and educational trainings are provided within firms, decisions are made in both bottom-

up and top-down ways, and team-work andfor interchange of personnel within a firm works,

with a long-term contracts system of employment. Similar relations could be found among
Keiretsu firms. Information is exchanged for making decisions of firms, and technologies areexchanged for improving quality of intermediary inputs. Cooperation in finance and personal

Table 1. DFI Outflows (as O/o of total FDI outflows)

Korea

Japan

toJapan

toChina

toKorea

toChina

1992

2.3

11.6

O.7

3.1

1993

05

20.9

O.7

4.7

1994

2.5

27.5

1.0

6.3

1995

3.4

26.8

O.9

8.7

1996

1.9

19.7

O.9

5.2

1997

1.9

19.2

O.8

3.7

1998

O.6

16.2

O.7

2.6

1999

1.9

i2.1

1.5

1.1

2000.1-7

1.4

6.3

-

-

Source : UNCTAD, World Investment Report

KOBE ECONOMIC & BUSINESS REVIEM, 46(2001), 91-100

98

Table 2. DFI inflows (as O/o of total FDI infiows)

Japan

Korea

Chian

fromKorea fromChina

fromJapan fromChina

fromJapan fromKorea

1992

O.3

O.1

21.6

O.3

16.6

O.6

1993

O.02

O.5

21.5

02

12.6

1.0

1994

1.6

O.2

34.2

O.2

6.1

2.1

1995

25

O.3

24.8

O.5

8.3

2.8

1996

1.0

O.1

12.1

O.1

8.8

3.3

1997

1.2

O.1

7.6

O.1

9.6

4.7

1998

O.1

O.02

8.1

O.1

7.5

4.0

1999

OA

O.Ol

7.8

O.1

6.3

3.6

9.7

O.8

-

-

2000.1-6.

-

Source : UNCTAD, World Investment Reportaffairs within Keiretsu firms make it easy to use longer term's organizational transactions insteadof arms length market transactions.
Unification or integration of the three (government, firm and household) is relatively stronger
in Japan and Korea, and this has both merit and demerit for economic efficiencies and competitive-

ness. Merit will be large when Japan and Korea take cooperative strategies, with J-K FTA,

against EU, US, and China. Without FTA, firms dominated by EU andlor US will control
Japanese or Korean firms through M&A or DFI in Japan or Korea. In this situation, it will bedifficult for Japanese and Korean firms to specialize into high-tech industries, where both Japanand Korea are interested in. China is a socialist country and firm's strategies are influenced byits government policies, and separate negotiations of Japanese or Korean firms with Chinese
firms will be favorable for Chinese firms. As already mentioned above, a strategic cooperation

among firms of Japan and Korea is beneficial both for Japan and Korea, and this will be
intensified by the formation of J-K FTA.

5. Asian safety nets and Japan-Korea FTA
Asian currency crisis exhibited an importance of forming safety nets in Asia by Asian
countries. Supports or assistances by EU and US, or by IMF and World Bank, were not prompt
and not fu11y enough for helping Asian countries, compared with the case of Mexico currency
crisis. Japan, which depends on US market, itself is not large enough to take role of leadership

KIM AND IGAMA; JAPAN-KOREA FREE TRADE AREA A?VD STRUCTURAL99
REFORMSin Asia. Korean economy also depends on US market but after the attack of currency
speculation, it becomes aware of importance of Asian safety nets by Asian countries. China,
taking for membership of WTO, has a political power and its potential economic power is large,

and thus China might gain the hegemony in Asia. Japan, Korea and China alone cannot make
Asian safety nets, but it will be possible to construct the core net with cooperation of the three
countries. With three countries, it will be possible to have a position comparable to EU and US,
in market size and in political power. Japan and China are rather competing each other to take aleadership in Asia and thus roles of Korea are important to mediate between the two countries.

Staning with J-K FTA is one of the possible approaches of forming Japan-Korea-China
cooperatlon.

China is increasing its economic and political power in the world, and will have decisive
effects, in future, to international system of division of labor, because of its enormous potential

capacities. A relation to China is very important both for Japan and Korea and will become
more important in future. Potential market size is so big, cheap and good labors are unlimited

and foreign capitals and advanced technologies are flowing into China. Firms in China will
dominate labor-intensive manufacturing industry. And thus Japan and Korea should find out
comparative advantage in high-tech industry and cooperative strategy of the two countries isimportant. Big EU and US firms get ahead of Japanese and Korean firrns in China market.
Competition between Japan and Korea firms in China market is not profitable and coQperative
strategy against China, EU and US firms, will be beneficial for both firms. The cooperation will

be tighter with J-K FTA. Competition for DFI in China market will reduce profit share ofcompetitors and will increase share of the host country as mentioned above. Competing
separately with big firms of EU or US will produce a situation that the big firrns occupy mostprofitable position and will drive Japanese and Korean firms to find position in less profitableareas.

After Asian currency crisis, EU and US have extended political and economic powers to Asiaand a view of three poles world, of EU, US and East Asia, might be revised to a view of twopoles world, of EU and US, or US hegemony of one pole. A realized situation will depend on
costs and benefits of accumulation or integration of economic activities, and information, telecom-

munication, and transportation technologies are important deterrninants for this. However Asia

has many countries of different cultures, especially different from European or American
cultures, and there is another large potential area of South Asia, and thus it might be necessary
to form one pole in Asia. J-K FTA is a first step to form East Asian pole, including China.

100

REVIEM, 46(2001), 91-100
KOBE ECONOAtflC & BUSINESS

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J. De Melo & A. Panagaria eds., New dimensions in regional integration, Cambridge University Press,
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World Bank, World Development Indicators l997, The World Bank, 1997.
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Supplier Relations in Japan: An International Perspective•-''-''''"'-'''''''''-'''''•••••••••''•'"-'•-'`'"'''''••••••••'Kenji Kojima

Alternative Component Sourcing Strategies within the Manufacturer-Supplier Network:
Benefits of Quasi-Market Strategy in the Japanese Automobile Industry '''''''''''''''''''''''''''''''''Kentaro ?Vobeoka

Value networks, Industry Standards, and Firm Performance in the World-Wide Mobile
communication Industries ''''''''''''''''-''''''''''''''-''''''''''''''''•-'-''''''''''''''''''`''''''''''-••''''-''-'Jeffrey L, Funk

The Effects of Transport Infrastructure and Urban Development Investment in
London's Docklands with Particular Reference to Leisure and Tourism 1970-1997 ''''''''''''''''''T. S. Menlyn JonesPublished on February 2002

byResearch Institute for Economics & Business

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