ISSN oo7S-6407

BUSINESS
3Oth

REPORT
ANNUAL<tt..;";2

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
1984

KOBE
ECONOMIC & BUSINESSREVIEW
30th

ANNUAL REPORT<`illlEII"ll.I,l;s:"

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY

1984

CONTENTS
Page
National Monetary Policy in an International
Capital Market ........................................................,JUrg NiEHANs 1

Craft Unions, Wages and Employment ..............................Murray C. KEMp 11

On the Applicability and Implementability of the (Finite)
Compensation Principle ..............,...........................Murray C. KEMp 17

Internationalization of Japanese Commercial Banking-The Recent Experience of City Banks..................Masahiro FuJITA, Kazuya MIzusHIMA and Ryoichi MIKiTANI 23

EMciency of the Least Squares Estimators in Linear Models

with Idempotent Covariance Matrix ofthe Error Terms ..,..........................,.................,...Hiroshi SADAMIcHi 55

Diversification of Large Japanese Manufacturing
Firms ...............................................................Hideki YosHiHARA 61

Indexing Policies and Macroeconomic Stability in Brazil:
Rational Expectation Model ...................................,...Shoji NisHmMA 73

A Simple General Equilibrium Model Involving
aMaximizingLabourUnion..,................................,KazuoSHiMoMuRA 87

NATIONAL MONETARY POLICY IN AN
INTERNATIONAL CAPITAL MARKET*
JUrg NIEHANS""

Introduction
In the interwar period, under the influence of international economic disintegrationand marxist theories of capitalism, there was a feeling that competition was pro-

gressively supplanted by monopoly. To protect competition, the United States
thought it necessary to activate her antitrust policies, and after the war these spreadto Europe.
Reality turned out to be different. Contrary to expectations, there was a generalincrease in competition, caused mainly by the progressive integration ofinternational

economic relations. The "new protectionism", which is talked about so much today,
emerged as a reaction to this trend. Like "old protectionism", it had little to do withthe general interest, but a lot with the political influence of the special interests

concerned. Free trade manifestos by ministers of trade sound hollow when eachclaims a "special case" for precisely those sectors which are politically influential
in his ovvn country. European agricultural policies, including those of Switzerland,
offer an impressive array of examples.

Naturally, this deyelopment is particularly obvious in commodity markets.
However, it has a counterpart in money and capital markets. The following discussion is about the progressive integration or internationalization of capitai markets

and its implications for national monetary policies.

1. The Integration of Capital Markets
The first part is about the international integration of capital markets and the ac-companying intensification of competition. The discussion will be limited to three
aspects which are of special relevance for national monetary policy.
1.1. Growing Perfection of Asset Arbitrage

The first aspect concerns the growing perfection of international asset arbitrage.

Whoever has a choice between an investment in D-Marks and an investment in" The foliowing article is adapted from a lecture originally given in German at the HWWA
Institute for Economic Research in Hamburg.

"* Professor, Faculty of Law and Economics, University of Bern, Switzerland. Visiting
Professor, the JSPS Fellowship for Research in Japan, 1982.

JURG NIEHANS

2

dollars will, other things equal, react to a decline in dollar interest rates by increasing

the share of D-Marks in his portfolio. This portfolio shift will mainly be checkedby two factors. One restraint may result from an increase in risk; this wili not be
further discussed here. The other restraint is transaction costs. Transaction costs
originate from the time, trouble, telephone expenses, computer time, etc. which eachtransaction requires. For security transactions they are most easily recognized in
brokers' fees, in exchange markets they are reflected in the margin between purchasing

and selling rates, and in the money market they appear in the margin between borrowing and lending rates.

Just as transportation costs impede international price equalization for commoditjes, so do transactjon costs on assets impede the equalization of yields, thus
isolating one asset from another.

Where they are high, the yields for various securities, currencies or countries

can differ widely even with the same risks; arbitrage is very imperfect. However,where the transaction costs are low the yields have to be virtually even; arbitrage isrelatively perfect.

During the last decades, technical progress in financial services, due largely tothe electronic revolution, has resulted in a fall in transaction costs and thereby inmore perfect arbitrage. As a consequence, interest differences tend to lead to promptand extensive portfolio shifts.

This is often described as an increase in the mobility of international capital
flows. The conclusion seems to be that even small differences in interest rates now

cause a country's capital accounts to oscMate rapidly between net inflows and net
outflows. Highly perfect arbitrage thus becomes identified with a high sensitivityof net capital movements. Now every beginner in economics learns that capital
imports are inevitably accompanied by an import surplus for goods and services.
From this it is concluded that the relative perfection of asset arbitrage increases thedanger of perpetual disturbances of trade flows.
This is a misunderstanding. As a matter of fact, asset arbitrage is quite different

from net capital flows in a balance of payments sense. Arbitrage takes place between

different securities-more generally: capital assets-regardless of the nationalityof the inyestor. Net capital movements, on the other hand, take place between theresidents of different countries, and the type of investment is of no consequence.
With pure arbitrage, each participant and each country preserve their net wealth,whereas the essence ofcapital movements lies precisely in a shift ofnet wealth between
participating countries. Consequently, the progressive perfection of arbitrage, taken
in itself, has no particular relationship with the volatility of aggregate capital andtrade flows.

The real problems of international asset arbitrage are at a different level. One

NATIONAL MONETARY POLICY IN AN INTERNATIONAL 3
CAPITAL MARKETof the most important concomitants of exchange rate flexibility is the so-called"overshooting" of exchange rates, which means that the rate of exchange first reacts

to shifts of monetary policy with apparently excessive oscillations. The essential
point is that the "nervous" reaction of exchange rates is not necessarily the resultof "irrational" or "pathalogical" speculation, but may be the result of rational
behavior under approximately perfect arbitrage.
This leads to one of the basic problems for present-day monetary policy. In thelong term the purchasing-power parity proposition is valid. It essentially says thatmonetary policy has the same influence on exchange rates as on commodity prices,
so that the real exchange rate is nothing to worry about. In the short term, however,frorn month to month, monetary policy has a much stronger influence on the exchange

rate than on commodity prices, thereby producing disturbances of the real exchange

rate. Gustav Cassel recognized 60 years ago that these disturbances can be very
serious. Experience since the collapse of Bretton Woods confirms this view. In somecases the primary effect of these disturbances is on foreign trade. However, this is

not necessarily so. In fact, it is quite possible for these disturbances to show
themselves primarily in domestic production and employment; at the same time there
may be talk about an "export miracle" in foreign trade. In view of the risk of serious

employment disturbances, the arbitrage-induced overshooting of exchange rates
poses the first problem for national monetary policy. It is one of the strongest forces

behind the "new protectionism".
1.2. Mobility of the Money Markets

A second aspect of the integration of capital markets concerns the international
mobility of money markets.
The classical theory of international trade shows how the location of industry

is determined by comparative costs. For commodities, comparative costs depend
primarily on a country's natural resources and factor endowments. One of theircharacteristics is their low mobility. As a consequence, a country's principal export

and import goods often remain the same for decades or even centuries.
In the field of finance, location tends to be less firmly rooted. Nevertheless,financial centers often maintained their importance for a long time. The notion thatthe money market in dollars is naturally located in New York or at any rate in the

United States, while Swiss francs have their market in ZUrich, Basel or Geneva,
survived into the postwar period. One of the most important financial developmentsof the last 25 years has been the progressive weakening of these locational ties,

accompanied by an increasing mobility of money markets.
The signal was given by the partial migration of the dollar market to London
and the emergence of the Euro-dollar market. The United States thus paid the pricefor the minimum reserve requirements and interest ceilings which she chose to impose

JURG NIEHANS

4

on her banks. In the meantime, the dollar market has spread all over the world andthe same has happened with other currencies, although to a lesser extent.

This development was decisively encouraged by the rapid improvement andcheapening of the international transmission of information. An additional impulse
comes today from the multinationalisation of individual banks. If a bank maintains
a worldwide network of oMces, with virtually instant transmission of information,
minute differences in profit margins may be enough to cause a movement of certain

banking activities from London to one of the Caribbean islands and from there
perhaps to Luxembourg, Within a few years, and indeed almost within months, newfinancial centers can emerge while others decline. Apparently trivial tax differences

can cause a market for gold or Eurobonds to move from one country to another.
Under these conditions, the main determinant for the international location offinancial services is legislation, especialiy banking legislation, fiscal laws and foreignexchange legislation. Whereas natural comparative advantages are the primary
determinants of location in the fields of production and industry, the primary factors

in financial markets are comparatiye advantages ofa political kind. As will be shown,

this has far-reaching consequences for monetary and banking policies, and here,
too, protectionism raises its head.
1.3. Competition for International Loans to Goveruments

The third aspect of capital market integration is the international banking competition for loans to foreign governments. One of the striking changes in the international asset structure is the relative decline in direct investments and the relative

increase in bank credits as a proportion of capital exports by highly developed
countries. Most conspicuous is the increase in bank credits to foreign goyernments.

This raises the problem of how credit risks should be evaluated in such cases.

Naturally, banks haye done extensive work on this problem; piles of papers havebeen written about so-called "country risks". The first reaction is to construct coef-

ficients and ratios similar to those which have proved usefu1 for private debtors,
like the interestlexport ratio or the proportion of foreign debt to exchange reseryes.
The debt crisis of recent months has reyealed these criteria to be deficient. It is now

clear that the banks, under the pressure of intensive competition for foreign loans,have widely misjudged their risks.

I am inclined to believe that there is, above all, one fundamental difference

between a private domestic credit and most of these foreign government loans,
whose significance the banks did not fu11y understand. I mean the fact that for thesegovernment loans there is neither collateral nor a bankruptcy court. If a mortgage

debtor cannot keep up with his payments, he loses his house. When a firm becomesinsolvent, the court transfers its assets to the creditors. In the case of foreign govern-

ment debtors, this pressure is usually lacking. Under these circumstances the debtor

NATIONAL MONETARY POLICY IN AN INTERNATIONAL 5
CAPITAL MARKET

has only one strictly economic motive for fu1fi11ing his obligations, namely the fearof receiving no further credits in future. So long as the debtor can hope to meet his
obligations from new loans and still have something left over, the obligations will
naturally be met. However, if debt grows too rapidly, sooner or later there is inevi-

tably a critical point at which interest and amortization payments begin to exceed

new borrowings. Cash payments should now reverse their direction, beginning tofiow from the debtor to the creditor. At this point, from the point of view of pureself-interest, it becomes clearly advantageous for the debtor to default.

Naturally, insolvency will rarely be explained in these terms. As a rule, thedebtor will have a thousand excuses for what he calls his "absolute inability to pay",

pleading unfavorable and unforeseeable circumstances like bad harvests, falling
export prices, rising import prices, recession, etc. However, one should not be overly

impressed by such pleadings, for every finance minister worth his salt can produce
a "financial crisis" within three months, the easiest way being the overyaluation of
the currency.

Under these conditions, the only protection for creditors is to expand theirloans so slowly that the critical point is never reached. This calls for lending to becarefu11y adjusted to the long-term economic growth of the debtor, which again
requires complete information about all loans and close co-operation among creditors.

Evidently, free competition does not automatically solve this problem-this isprecisely why coilateral and bankruptcy courts were created in national credit
markets.
In particular, there is a classic congestion problem. In road transportation,congestion problems arise because each driver, when selecting a route, takes into

account only his own loss of time, omitting the time losses he imposes on otherpeople. For loans, an analogous externality problem can arise, inasmuch as eachbank is oniy concerned with its own risk, leaving out of consideration the additionalrisk its own loans impose on the claims of creditors. As a consequence, the volume
of such loans tends to become excessive.

On the whole, bank loans to foreign governments, under the pressure of competition, have often exceeded the critical point. This raises a third problem for themonetary policy of creditor countries,

2. lmplications for National Monetary Policies
The first part of this article described three aspects of international capital market

integration. The second part will draw some implications for national monetary
policies.

6

JURG NIEHANS

2.1. The EMcacy of Monetary Policies

The first implication concerns the eMcacy of monetary policy. It is often argued
that the internationalization of the money market reduces the effectiveness of nationalmonetary policy. Will not monetary contraction lose its anti-inflationary effect if

any borrower can provide for all his needs by simply going into the Euromarket?
Will an easing of credit conditions not lose its stimulating power if the additional
money is just used to repay Eurocredits? From such questions it is oniy a short stepto the conclusion that either the internal market must be insulated from the externalmarket or the external market must somehow be brought under control too. Theinternationalization of monetary markets thus leads to national protection.
For a proper evaluation of this argument, it is convenient to distinguish between

two types of monetary policy. One type consists of measures in which the central
bank acts like other market participants, for example, by buying or selling domestic

securities or foreign exchange. Such measures may be called "market instruments".

The other group of "nonmarket instruments" consists of regulatory measures bywhich the central bank imposes restrictions on banks or individuals. Minimum
reserves and interest ceilings may serve as examples.

The effectiveness of nonmarket instruments is indeed undermined by the internationalization of money markets. In fact, interest ceilings have largely disappeared,

and the importance of minimum reserve requirements as an instrument of monetary
policy is declining. This is hardly to be regretted. Economists, including both Keynesians and monetarists, always tended to be critical of interest ceilings, and, in

retrospect, it seems hard to justify that in the early post-war period minimum
reserves were elevated to the rank of a "classical" instrument of monetary policy.

At the same time, market instruments lost nothing of their eMcacy through theinternationalization of money markets. If the Federal Reserve System buys treasury
bills on the open market, the market for dollar funds becomes more liquid, regardlessof whether it is located in New York or London. Consequently, the internationalization of the money market does not weaken the responsibility of each central bankfor the national money supply and the national price level. With flexible exchange

rates, each central bank is master of the long-term development of the national
price level, irrespective of the existence of Euromarkets.
2.2. Exchange Rate OvershootingThis does not mean that the internationalization of capital markets causes no prob-

lems to monetary policy at all. There are indeed such problems, particularly withrespect to the overshooting of exchange rates.

It was sometimes proposed to reduce overshooting by artificial restraints onarbitrage, similar to the American interest equalization tax of the 1960s. It is truethat some of these proposals came from bureaucrats with little economic under-

NATIONAL MONETARY POLICY IN AN INTERNATIONAL 7
CAPITAL MARKET

standing, but some were made by respected economists. In my view, this protectionist
approach is mistaken. In principle, the growing perfection of asset arbitrage improves

the eMciency of the economy in the same way as the lowering of transportation costsby the advent of railroads. To neutralize this eMciency gain through taxes would be

as counterproductive as the replacment of transportation costs by import tariffs,
Furthermore, in order to withstand the relentless pressure of profitable arbitrage,

the system of fiscal impediments would have to be so pervasive that in the end it
would become virtually equivalent to an adjustment in interest rates.

As an escape from overshooting exchange rates, others have recommended a
return to fixed exchange rates, and their number has recently been growing. It canbe shown that in an inhation-free world fixed exchange rates would indeed be thebest currency arrangement. In such a world, the Bretton Woods system would nothave collapsed in the first place and its junior successor, the European Monetary

System, would not just survive, but prosper. However, in an inflationary world asystem of fixed exchange rates can, at best, only drag itself from crisis to crisis. For

this reason, any attempt to create a new institutional framework for fixed exchange

rates would, so far, have been doomed to fail. However, once the United States canlook back on five inflation-free years with satisfactory employment, the return to

fixed exchange rates will probably be almost automatic. Fixed exchange rates are
not a question of international conferences but of national monetary policies.
It seems to me that, at the present time, the overshooting of exchange rates has

two main implications for monetary policy. First, it makes a steady course ofmonetary policy even more important. Sudden changes in the djrection of monetary
policy are the main cause of overshooting and the avoidance of such changes must
be regarded as the principal guideline for monetary policy, both with regard to thedomestic economy and from the point of view of international co-operation,

Second, national monetary policy must remain flexible enough to dampen
massive deviations of exchange rates from purchasing power parity, if necessary

through temporary deviations from long-term monetary targets. Success in thiseffort would make a notable, and perhaps decisive, contribution towards averting the"new protectionism". Precisely the maintenance of a steady long-term course may
thus, under certain conditions, call for considerable short-term flexibility in the

conduct of monetary policy. Fortunately, during recent years, central banks seemto have made significant progress in combining steadiness with flexibility.
2.3. Competitive Deregulation

A third implication of capital market integration concerns banking regulation. In

the early post-war years, banks found themselves subjected to highly restrictive
legislation which narrowed the range of their business activities, required excessive
and discriminatory reserves and limited competition in interest rates. In view of theJURG NIEHANS

8high and ever-increasing mobility of capital markets, such discriminatory measuresresult in an increasing tendency for the affected firms to move abroad. In such cases,

the authorities, like monopolists faced with outsiders, have a choice between two.
strategles.
One strategy is to persuade other governments to impose similar restrictions
and, if necessary, to enter into an international agreement. International co-operationof this type leads, in the end, to a regulators' cartel. In this spirit, the Federal Reserve

System, confronted with the movement of banking firms to the Euromarket, tried topersuade European central banks of the necessity of a co-ordinated regulation of
the Euromarket. Such endeavors are not particularly promising, because the moreinsiders are regulated the more lucrative becomes the position of outsiders, and thelatter will be in no hurry to kill the goose that lays the golden eggs.

The alternative strategy consists in relaxing the discriminatory restrictions.
This is the strategy the United States has actually followed in recent years with herradical revision of banking legislation. The partial return of the dollar market to theUnited States after the establishment of the International Banking Facilities highlights
the effect of such a policy.

Altogether, international competition for profitable financial markets mightlead to a gradual liberation of banking firms from the shackles of discriminatory
regulation. Financial people do not necessarily vote with their ballot or with theirfeet, but they do vote quite effectively with their check books. This can be generalized.

Time and again throughout history, it has been international migration which limited
the power of the state. Financial markets show that this is not just a question of the

migration of people, but also of capital and ,markets.
2.4. Protection agalnst Default Losses

The preceeding argument does not at all mean that regulatory measures in thefinancial sector are ineMcient and obsolete in all cases. In fact, in some cases they
appear to be not only necessary but in need of strengthening. In particular this seems
to be true for those measures which do not, in the final analysis, put a discriminatoryburden on the banks' customers but rather protect them against risks.
What I have in mind are the policy implications of default losses on loans toforeign governments. The starting point must be the observation that there is no
reason for such losses to be shifted from the banks to the taxpayer through theintermediary of the International Monetary Fund. It is sometimes argued that thedelinquent loans had been in the interest of the creditor countries, in as much as they

helped to finance their exports and thereby to reduce unemployment. This argument-a mixture of Keynesian reflections about the usefulness of unproductive pyramidbuilding, post-Marxian theories of imperialism and robust mercantilism-is not
valid, though. Imprudent foreign credits are not in the interest of the creditor country,

NATIONAL MONETARY POLICY IN AN INTERNATIONAL 9
CAPITAL MARKET

and its taxpayers are under no moral obligation to shoulder responsibility for them.
There is no particular reason, therefore, to deplore the fact that the International

Monetary Fund is now pushing against the limits of its lending capacity.
A second observation concerns the fact that relief should not be expected froma return to prosperity in the world economy nor from an American policy of cheapermoney. Prosperity in the world economy would not necessarily help because it has
little effect on the profitability ofinsolvency for many debtors. An American monetary
expansion would indeed help the debtors, but only at the cost of a return to inflation.

A negotiated reduction in foreign claims would still be preferable to the euthanasiaof the creditor through inflation.

In the light of these observations, a defensible strategy might include thefollowing points. First, the annual rate of debt expansion must be drastically reduced ;otherwise the problem will become more insoluble with each postponement. In
particular, the rate of increase of indebtendness must be reduced below the rate of
economic growth, so that in the course of time the real pressure of the debt declines,

gradually leading back to a steady state. Second, by co-operation between banks,
central banks and international institutions, it should be made possible to maintainan annual credit flow slightly higher than annual payments on interest and principal.

Third, the externality problem could be reduced, if not eliminated, by requiring
banks to publish fu11 information about their Ioans to foreign governments. Fourth,shareholders of incautious banks must be expected to bear losses. Fjfth, in vjew of

the absence of collateral and bankruptcy courts, we can hardly dispense with
diplomacy and general foreign policy to reinforce the payment morale of debtor
countries. Such a strategy of debt reduction "on a slow burner" actually seems toemerge. Whether it wjll be successfu1 is quite uncertain, but at least it does not appear
hopeless either.

Conclusion
It is customary today to refer to the condition of the international monetary systernas being "in crisis",Ido not share this pessimism, It is true that structures like theEuropean monetary system may collapse, though even these have shown themselves
to be more stable than pessimists have feared. In the main, however, whatever there
is to collapse has already collapsed eleven years ago. The present state of affairs is arubble-heap, and such heaps tend to be very stable. Certainly banks may get into
diMculties, but in cases of occasional disturbances in the international capital market

the national monetary policy of the individual countries should, I believe, be able
to preserve its effectiveness, thereby also making an essential contribution to thedefense against the "new protectionism".

10

JURGNIEHANSIt also seems to me that the outlook is more hopefu1 today than it has ever beenin the last ten years. Assuming sensible national policies, countries with highly
developed financial markets can hope, in the foreseeable future, to overcome long-term infiation and to find their way back to normal economic growth. In spite of
all controversy, and in part even because of it, policy-makers have learnt much inthe past twenty years, as shown by the examples ofthe United States, Japan, England,
Germany and Switzerland. To be sure, it is not diMcult to lapse back into the errors
ofthe sixties. But neither should it be very diMcult to make the coming years a periodof solid progress.

CRAFT UNIONS, WAGES AND EMPLOYMENT*
Murray C. KEMp**

1. Introduction
The relationship of the level of unemployment to the policies of labour unions stillis the subject of ljvely debate. Similarly, the jmpact on wages and employment of
capital accumulation, technical improvements and the level of the dole remains the

subject of wide differences of opinion, especially between academic and othereconomists. In the present paper I seek to model powerfu1 labour unions which set
the wage leve!s to which competitive employers must then adjust. Thus the analysis

focuses on the interaction of employment and labour supply. Indeed, to make thefocus as sharp as possible I proceed on the assumption that the aggregate demand
for goods always matches the aggregate supply.

0ne expects that unions will press for real wages incompatible with the fu11
employment of all types of labour. However in practice large unions must recognize
that, even if their members are not called upon to directly support the unemployed,
they must do so via the income tax, and this understanding serves to moderate theirdemands; moreover unions may provide direct support for their unemployed
members. Of course the working members of any given union share with the working

members of all other unions, and with non-union income earners, the burden of
supporting the unemployed. There is here an obvious externality, and the more
numerous the unions and the smaller the proportion of national income accruing
to labour the more severe the externality. Nevertheless it is possible that unionpressure on real wages is suMciently curbed by the prospect of higher taxes that
there exists a definite and non-trivial equilibrium of Nash type. Indeed it is possiblethat the equilibrium involves the fu11 employment of some or all types of labour.

My first purpose is to examine this possibility in detail. After establishing theexistence and uniqueness of a non-trivial equilibrium I provide a condition for it* The present paper was the basis of one of a series of lectures delivered at the Research Insti-

tute for Economics and Business Administration at Kobe University in late August, 1983. I am
gratefu] to the Masuda Foundatjon for making possible my visit to the Institute and to the meinber3of the Institute, especially the Director, Professor Masahiro Fujita, for their warm an4. generous

The paper is companion to Kemp et al. [1]. It owes much to the latter paper and to conversations with Daniel Leonard and Ngo Van Long.
*' Research Professor, School of Economics, University of New South Wales, Australia.
Visiting Professor, Rokkodai Foundation, Kobe University, 1983.

MURRAY C. KEMP

12

to be of the full-employment type. I then proceed to examine the responses of theequilibrium to changes in some of the parameters, notably the level at which the
unemployed are supported, the state of the industrial arts, the size of the work force

and the stock of accumulated capital.

The detailed analysis and statement of conclusions may be found in Section 2.
The third and final section contains some brief remarks concerning the scope of theconclusions.

2. dnalysis
There are n types of labour, each with its own craft union; and there are unspecified
additional factors like capital and land. All labour is unionized. There is an aggregate

production function which for simplicity and to ensure comparability with a companion analysis of seniority (Kemp et al. [1]), we take to be of the symmetrical Cobb-

Douglas typen(1) e== ptLf/n ... L:inKi-a==pt( 17 L:. in)Ki'cr O<a<1
i=1

where Lt is the level of employment of the ith type of labour, the constant K (for"capital") is a catch-all for factors of production other than labour, and pt is a positive

parameter variations in which indicate changes in the state of the arts. Initially,
pt == L

Employed labour ofthe kth type receives a gross or pre-tax wage wic, unemployedlabour of any type receives the dole W, and the owners of capital receive a rental r.
All factor returns are in terms of product.

Gven (1), the unit-cost function is(2) c= u-i(aln)-a (1 ---a)'(i-ct) ri-a w:!n ... w:ln

Under competitive conditions, unit cost = price =1; hence we obtain from (2) theequation to the (real) factor-rental frontier:(3) 1=pt-i(a/n)'cr (1-a)'-(i-a> ri'a wfln ... w:ln
Let ak be the demand for labour of the kth type, per unit of output; and let b be thedemand for capital, per unit of output. From duality theory,
ac!Owk == aic

OclOr =b
and, from (2) and (3),ac/Ow,--(aln) (c/wk) =(aln) (1/wk)

Oc!Or ==(1-a)(clr)==(1-a)(11r)

Hence
(4)

ak = (cr!n) (1 lwic)b ==(1-a)lr

CRAFT UNIONS,WAGESANDEMPLOYMENTIt is assumed that each union seeks to maximize the total real income of its

members and that, by means of intra-union welfare payments financed by uniondues, it distributes that income evenly over its members. Now the real income Yic of
the kth union is the sum of the net or after-tax earned income ofits employed members

and of the dole payments received by its unemployed members. The former is Licwic(1-t), where t is the uniform rate of tax on earned income; the latter is (Nic-Lic)W,

where Nk is the membership of the kth union. Hence(5) Y,=L,w,(1-t)+(N,-L,)W
The supply of labour of the kth type is

Ar,,.. EIVIn if Yic>(Nln)w

10 if Y, r<. (Nln)W
where N is a positive constant. Hence the total supply of labour is N if Yic>(N/n)W
for all k, and is zero if Y,$(Nln)W for all k. On the other hand, from the symmetry
ofthe model, in any equilibrium Y,= Yfor all k. Hence in any non-trivial equilibrium

Yk>(?Vfn)ul for all k. The Ievel of employment is then IV-XLt and dole payments

sum to (N-XLt)W. Assuming that the only functions of government are to raise
taxes and make dole payments, the rate of tax must be')t=(?v-xL,)w!e= [(Nle)-ia,]w-[(bN/K)-Eai]W(6) =- in(N!K) ((1-a)/r) [llw,a.i"]i/`'-a'-W(aln)i(11wi)where
r =- [pt(aln)d(1 -a)i-a]il(i-a)

In a Nash equilibrium it is impossible for any kth union to enhance its real
income by adjusting the gross real wage wic, given the remaining n-1 gross real
wages. Now the rate of change of Yk with respect to wic is, from (5),(7) oO .Y -- [w(1-t)-w] g{li +L,[1 -t- w, oO.t, ],kBut, from (3) and (4),L,=a,e== akK/b

rKwte"(IZ wJa/")va-a)(8) =" -iir a-1-a
whenceOL, a+n(1-a)

Ow,=- na.a) Wk-iLk1) Neither the dole nor intra-union unemployment benefits are taxed. This is an innocuous
assumption since, as we have noted, in any non-trivial equilibrium, take-home pay Yic1(N!n) exceeds
the dole.

13

MURRAY C. KEMP

14

a+n(1-a) cr rK(9) =:M n(1-a) -ii- 1-aW-(2'a)l('-a)
in symmetric equilibrium; and, from (5) and (6),(10) 1-t-wic-oO wt, =1-W iK w"i(i-a)(1ffcr+.li.)+aww-i(n;il1 )in equilibrium. Hence, substituting from (8)-(10) into (7),(lb Z.Y,k =-li--lr-K. w'v(i-a)[-ww'i- .(la-.)]which, in any equilibrium, must be non-positive.
For the existence of a non-trivial equilibrium it suMces that at full employment
the marginal product of each type of labour exceeds the dole, that is,- a9

W< OLk Li = .. =L. ==L= Nlnae-n L=' pt-II- (NnNr) -('-a)(12) =-w"
It will be assumed that this condition is satisfied.

Evaluating (11) at full employment, with w =w", we find thatoY,
aWic wi=.. ==wn=w'k
is non-positive if and only if(13) ,I'$ an(1-keT) W"

Given (12), there is full-employment equilibr um if and only if (13) also is satisfied;
and there is an interior equilibrium with unemployment if and only if (13) s violated,that js, jf and only if(14) crln<1-aso that the share in earned income of all non-labour factors combined exceeds theshare of each type of labour.

Thus even a union-ridden equilibrium may be blessed with fu11 employment.
Neyertheless we proceed on the assumption that (14) is satisfied, so that unemployment is inevitable. The equilibrium wage is defined then by the first-order condition

1-a(15) 'V= aln tu>W
which is obtained by equating (12) to zero;2' and the associated level of employment
is given by (8), with wi=w for ail i. Eq. (15) is quite remarkable; it tells us that if W
2) The second-order condition is automatically satisfied if the first-order condition is satisfied.

CRAFT UNIONS, WAGES AND EMPLOYMENT
is compatible with under-employment equilibrium (that is, if W> la-/na w") then the'
gross wage rate bears a relationshipof constant proportionality to the dole; moreoverthe constant of proportionality is the ratio of non-labour earned income to theearned income of the typical union and thus is independent of all parameters oflnterest.

Equipped with (8) and (15) we can examine the responses of the equilibrium levelof employment and the equilibrium wage rate to small changes in the parameterspt, K, Nand W. From (15),(16a)dw
du dw= dN =O(16b) dd .4 .. n(lia) .,m;.;;>oand, from (8) with wt=w,

dL L ar 1 L drv

du -r Opt-1-a w du•LOr(17a) ==
- iJ- opt >O(i7b) ,"

.L-.,,I. -e- ,d.W -odL =-11-a
Ldw(17c) dw
T dw <O
In view of the Cobb-Douglas form of the production function, a burst of capital
accumulation has exactly the same implications for wages and employment as doesa technical improvement. Thus without detailed analysis we can be sure that theaccumulation of capital raises the level of employment while leaving wages
unchanged.
Moreover, from the factor-rental frontier (3),ri-n=g(a/n)pt(1 -a)i'" w-"inequilibrium. Hencedr r ardw

du - pt(1-a) 1-a w dg
r

(18a)

"(1-a)
dr

a

>o

(l8b)

dN- 1-a U-

(18c)

dul ;

dr

'-'

15

a r dw

1-a- W' -ZZjlr=O

r dw-a w dw <o
3. Final Remarks

The short-run comparative-statical conclusions summarized jn (16) and (17) contain,

16

MURRAY C. KEMP

no real surprisesS'. Accordingly, we do not pause to decorate them with elaborate
commentary. Perhaps the chief virtue of the foregoing analysis is its demonstrationthat familiar results have a much broader field of application than their origins insingle-uniofi models would suggest`' .

In conclusion I venture two suggestions for further work. First, it is recalledthat the analysis of Section 2 is short-run in the sense of taking the stock of capital

as a datum. However, given time, the stock of capital can be expected to adjust tochanges in the other parameters, and this suggests that the direction of the adjustmentof employment and wages to changes in those parameters may depend on the timeallowed for adjustment. Comparative steady-state calculations could be made tocheck this conjecture. Second, it has been assumed throughout Section 2 that theeconomy is closed to foreign trade. It is not diMcult to adapt the analysis and con-clusions to fit a small open economy, facing invariant world prices. However acomplete analysis of the large-country variable-terms-of-trade case requires a carefu1

reformulation of each union's objectives and of the concept of a dole. Such ananalysis might not be easy ; but it would be well worth attempting.

References[1] Kemp, M.C., D. Leonard and N.V. Long, Labour Unions, Seniority and
Unemployment, University of New South Wales, 1983.

[2] Oswald, A.J., "Trade Unions, Wages and Unemployment: What Can Simple
Models Tell Us?" Oxford Economic Papers 34, 1982.

3) The finding that wages are independent of the state of the arts is a partial exception; butthat particular result is a theoretical artefact created by the unitary elasticity of substitution of the

Cobb-Douglas production function.
4) For an excellent example of one-union analysis, the reader is referred to Oswald [2].

ON THE APPLICABILITY AND IMPLEMENTABILITY
OF THE (FINITE) COMPENSATION PRINCIPLE*
Murray C. KEMp*Si

1. Introduction: the Compensation Principle
The so-called Compensation Principle has become one of the corner stones of modern

or post-Pigovian welfare economics. Aceording to that Principle, any Åëhange ineconomic policy is to be judged advantageous if those individuals who suffer as theresult of the change can be and in fact are compensated by those who benefit fromthe change and if, after compensation has been effected, all individuals are betteroff than before the change.

Until recently it has been taken for granted that in implementing the Com-pensation Principle goods andlor money are to be taken from those who havebenefitted from a change in policy and giyen to those who have suffered. What could

be more natural?

During the past decade or so, however, there has been a growing awarenessamong economists (in particular, among those who specialize in the theory of inter-national trade or in the theory of public finance) that the implementation of the
Principle is not always completely straight-forward. Thus there have been unearthedcases (indeed, whole classes of cases) in which the direct welfare effects of a transfer

between agents are dominated and reversed by the price-induced or indirect effects,
implying that the implementation of the Principie may require the transfer of goods

andlor money from the losers to the gainers. Moreover, but on another tack, it has
been suggested that changes in goyernment poJicy nearly al}vays involve loss of life

for which no finite amount is adequate compensation. Let us dwell for a momenton the first of these two possibilities.

The earliest and most important discoveries were made by MichihirQ Ohyama[5, 6] and David Gale [2]. At the time when Ohyama and Gale were writing, the sum
total of our knowledge concerning the welfare effects oftransfers was contained in* The present paper was the basis of one of a series of lectures delivered at the Research Insti-

tute for Economics and Business Administration at Kobe University in late August, 1983. I am
grateful to the Masuda Foundation for making passible my visit to the Institute and to the membersof the Institute, especially the Director, Professar Masahiro Fujita, for their warrn and generous
hospitality,'* Research Professor, School of Economics, University of New South Wales, Australia.
Visiting Professor, Rokkodai Foundation, Kobe University, 1983,

l8

MURRAY C. KEMP

the famous Mill-Samuelson proposition from the pure theory of international trade:

Under the assumptions of the standard Heckscher-Ohlin model of trade, a smalltransfer necessarily improverishes the donor and enriches the recipient. However
the standard model of trade is rather special-in particular, it allows no market

distortions and it recognized only two countries and two produced commodities,
both of them specialized private consumption goods; and it was the contribution of

Ohyama and Gale to show that, when those assumptions are relaxed, the conclusionof the Mill-Samuelson. proposition cannot be established. Thus as early as 1972
Ohyama [5, Proposition 19] demonstrated the possibility that, in the context ofstable tariff-ridden trade between two countries, a small transfer in kind may impoverish the recipient; and, shortly after (Ohyama [6]), he returned to the subject ingreater detail. Moreover he showed (in Ohyama [6]) that the recipient might beharmed by aid which is tied (by the donor or otherwise)i'. Thus Ohyama showedthat the Mill-Samuelson proposition fails if market distortions (broadly interpreted)are allowed. Gale, on the other hand, showed that if distortions are ruled out but if

three or more countries are allowed then the Mill-Samuelson proposition again
breaks down: the recipient may be impoverished by a transfer and/or the donor
enriched.

In Section 2 of the present paper I add marginally to the pathology of compensation by considering a class of examples which incorporate public consumption-

goods (and which therefore are quite different from those of Ohyama and Gale).
In the examples now considered, suMciently small finite transfers have no bearing
whatever on the welfare of either donor or recipient; that is, transfers are locally
impotent in effecting compensation2).

To this point we have focussed on possible ambiguities in the implementationof the Compensation Principle. The Principle itself remained unchallenged. However
the possibility of policy-induced death has been made by John Broome [1] the basisof a serious attack on the Principle itself. Broome's argument will be considered,and ultimately rejected, in Section 3.

1) Ohyama did not answer (or indeed ask) some questions now thought to be of interest: forexample, is it possible for a transfer to simultaneously impoverish the recipient and enrich thedonor? But he provided the raw materials from which answers to such questions can be easily
derived.
2) Even in the models of Ohyama and Gale it is possible that the indirect or price-induced effects

of a transfer may exactly cancel each other. However in their models such an outcome requires
a singular constellation of parameter values, a clifferent constellation for each vector of transfers.

ON THE APPLICABILITY AND IMPLEMENTABILITY 19

OF THE (FINITE) COMPENSATION PRINCIPLE
2. Conditions for the Local Impotence of Lumpsum'• Transfers to Effect a Redistribution of VVelfare3)
Suppose that N countries collectively produce and trade m private consumption
goods and t pure public consumption goods. Here it is understood that Nl2, m). O,t llr. 1 and m+t ll; 2; thus it is not required that either countries or commodities exceed

the traditional two in number. Suppose further that the governments of the trading
countries have only two functions; they impose corrective taxes to ensure that, fromthe national point of view, private consumption of public goods is optimal; and they

may engage in international lumpsum transfers. On the basis of these assumptions
we can establish the following proposition.

PROPOSITION: If in international equilibrium each country purchases as least
one public good then any pattern of suMciently small international transfers leaves

unchanged (a) world prices of both private and public goods, (b) the consumption
by each country of both private and public goods, and therefore (c) the welfare ofeach country.
That is, within limits the world equilibrium is independent of the international
distribution of income; a small international transfer is completely absorbed inoffsetting changes in the private consumption of public goods in those countries
which are parties to the transfer.

On refiection the proposition makes a strong appeal to common sense. Thus
suppose that an initial equilibrium is disturbed by the transfer of one dollar fromcountry 1 to country 2. If the donor cuts its expenditure on public goods by exactly
the amount transferred and if the recipient increases its expenditure on public goods

by the same amount then, in each country, the totai consumption of each good,
public and private, is unchanged and no country has an incentive to make further
adjustments to its expenditure.

Warr [7] proved a version of the proposition suited to a closed economy with
t== 1; but he claimed that the proposition is invalid fort>1, thus implying that it isa mere curiosum. Kemp and Kojima [4], on the other hand, examined the welfare
economics of international transfers under the polar specification that public goods
are provided only by governments and are public only within the borders of a single
country.

Proof' of theproposition. Let ci be the vector oth consumption of private goods incountry i; and let gi be the vector of purchases of public goods in country i, so that.5,"

gj is the vector ofconsumption of pub]ic goods in each country. Letp be the vector
3) The first part of this section has appeared, in preliminary form, in Kemp [3]. However inthat earlier version the generality of the central proposition was rather played down. In particular,
it was not noted that the proposition is valid whether or not the intra-national publicness of public

consumption goods is neutra!ized by suitabJe commodity taxation.

MURRAY C.
KEMP

20

of world prices of private goods, q the vector of world prices of public goods, andyi the income of country i. The task of (the typical individual in) country iis then tofind(P) max ui(c`, igj)
C,igt

s.t. pci+qgi ;$ yi (1)ctlO, gi lllO (2)where ui is taken to be an increasing and strictly quasi-concave function. By assumption, any solution to (P) is interior in gi; for simplicity only, suppose that it
is interior in ci also. The first-order conditions consist of (1) anduki ==Aipk k=:l, .. ,mu,`=Z`qt l= 1, .. ,twhenceJk`(ci, igj)iuk`luti=pklqt k=1, .. ,m (3a)Jlii(c`, .Xgd) =- uti/uti=gi/qt l= 1, .. ,t-1 (3b)
Recalling that i=1,., , N, we see that in (1) and (3) there are n+n(m+t-1)=n(m+t) equations in the same number of unknowns (nm cki's and nt gti's). If t=1
we can reasonably require (1) and (3) to be uniquely soluble. When t>1 we cannot
expect to solve for the git's, for to individual countries the source of supply of aparticular public good is a matter of indifference; however, even when t>1, we canreasonably require both the aggregate world supply of individual public goods andthe value of all public goods supplied by each particular country to be uniquelydetermined, and that is all we need. Let the unique solution be indicated by asterisks.

From (3a),e`"=H`(p, q, Xgj") iEEHi(p, q, g") (4)From (1),y=-. Xyj=p2] H'(p, q, g") + qg* (5)From (5) and (3b), the latter with solution values inserted,g"-D(p, q, y) (6)Thus g" depends on aggregate income only. From (4) and (6),ci*=Hi(p, q,D(p, q, y))!iiiEi(p, g, y) (7)hencec'• iiiXc'*=EE'(p, q, y) iff. E(p, q, y) (8)Thus ci" and therefore c" depend on aggregate income only. The conclusions of the
proposition follow immediately.
As already noted, the proposition does not rely on the assumption that country
i purchases the whole range of private consumption goods; in fact it is not requiredthat country i purchases any private consumption goods. Of much greater importance,
it is not required that the intra-national publicness of public consumption goods be

ON THE APPLICABILITY AND IMPLEMENTABILITY 21

OF THE (FINITE) COMPENSATION PRINCIPLE

offset by corrective taxes. That assumption merely simplifies the proof by allowing
one to treat each country as a single coherent maximizer.

We note also that the proposition is valid for any international equilibrium,
whether stable or unstable, whether or not some goods are inferior in consumption,

and whether or not there are more than two countries. Thus it contrasts sharply
with the recent literature on the welfare paradoxes of international transfers. (Aswe have recorded in Sec. 1, the key contributions are those of Ohyama [5, 6] andGale [2]. For further references see Kemp and Kojima [4].)What is indispensable is the assumed uniqueness of the world equilibrium.
Without that assumption there are many ways of choosing the post-transfer equilibrium, and associated with each choice is a different vector of equilibrium national
welfares.

3. The Valuation of Human LifeThe argument advanced by John Broome [1] goes roughly as follows.
(a) As the result of almost any change in government policy lives are lost and lives

are saved. Hence the application of the Compensation Principle requires that lives
be valued.
(b) For the loss of life there is no adequate finite compensation.
(c) But all economies are finite.

(d) Hence the Compensation Principle is almost worthless as a device for orderingsocial alternatives.

In this syllogism step (b) is the weak link. We are all mortal; whatever choices

the government makes, we will die. At worst, a change in policy merely advances
the date of death; at best, it merely delays death. It therefore is reasonable to postulatethat for each individual and for each advance of the date of death there exists adequate

finite compensation, proyided only that death is not immediate (there must be timeto enjoy the compensation). (Figure 1 illustrates.) It then follows that no practicablechange of policy can be ruled out on the ground that the required compensation is

infinite. (Of course, policies to be implemented very soon may entail very large

compensatory payments.)

Normally it will not be known whose death will be advanced by a proposedchange of policy, But that does not invalidate our defense of the (Finite) Com-pensation Principle; it simply means that compensation must be paid to eachindividual for whom the distribution of probabilities of dying is made less attractive.

Nor is the Principle invalidated by the fact that normally a change in policy
advances the date of death of individuals not yet born. Evidently the compensationof such individuals must await their birth. But that is neither here nor there' there'

22

MURRAY C. KEMP
Figure 1
Compensation
requiredTime until
death
is nothing in the statement of the Principle to suggest that compensation must be

paid when a policy is chosen, or at the moment of its implementation, or at anyother specific time.

In summary, Broome's paper fails as a critique of the Compensation Princi lebut usefu11y draws attention to those dithculties of implementation associated with
policydetermined mortality.

References[1]

Broome, J., "Trying to Value a Life," Journal ofPublic Economics 9, 1978.

[2]

Gale, D., "Exchange Equilibrium and Coalitions: An Example," Journal of[3]

Kemp, M.C., "A Note on the Theory of International Transfers," Economics

Mathematical Economics 1, 1974.
Letters, to appear, 1983.
[4]

Kemp, M.C. and S. Kojima, "The Welfare Economics of Foreign Aid," toappear in G.R. Fiewel, ed., Issues in Contemporary Microeconomics (Macmillan,[5]

New York, I984).
Ohyama, M., "Trade and Welfare in General Equilibrium," Keio Economic
Studies 9, 1972.

[6]

Ohyama, M. "Tariffs and the Transfer Problem," Keio Economic Studies 11,
1974.

f71

Warr, P.G., "The Private Provision of a Public Good is Independent of theDistribution of Income," Economic Letters, to appear, 1983.

INTERNATIONALIZATION OF JAPANESECOMMERCIAL BANKING-THE RECENT EXPERIENCE OF CITY BANKSMasahiro FuJITA, Kazuya MizusHiMA* and Ryoichi MiKiTANI**

1. Introductory Note
In recent years, Japanese position in the international economic-political society hasrisen rapidly. In addition, Japan is strongly requested to accomplish the international

responsibility. It came up to the surface, as a practical problem, in the form of themuch intenser financial friction between Japan and U.S.A. The diMcult negotiation

between both government authorities on this matter had been continued for a longtime. After all, Finance Minister Takeshita and Treasury Secretary Regan agreed

by the Yen-Dollar Committee (Report by the Working Group of Joint Japan-U.S.
Ad Hoc Group on Yen/Dollar Exchange Rate, Financial and Capital Market Issues)

was announced oMcially on May 29, 1984. The main problem imposed on Japan in
the report on Yen/Dollar is to implement financial liberalization and yen internationalization. Firstly, financial liberalization implies both liberalization ofJapanesefinancial institutions' business affairs beyond the fence on banks and financial intermediaries, and reciprocity of the Japanese financial institutions and the foreign banks
in Japan. In particular, it mainly aims at liberalization of interest rates and internationalization of the financial institutions. Secondly, yen internationalization meansthat Japan-yen complements the function as the international currency of U.S.
dollar, and bears the cost as an international currency, by the wide use ofa bill of

exchange denominated in yen at the time of export and import, and the need for yen
as a reserve currency held by many Asian countries.
We have carried out twice the academic fact-finding type of research on internationalization of banks since our project started in 1977. Speaking of the situationof Japanese economy, the growth rate of real GNP has recovered to zF5 O/. Ievel since

the latter half in 1983. Furthermore, current balance surplus in 1983 fiscal year is
24.3 billion dollar, trade balance surplus is 34 billion dollar, and overall balance

surplus is 2.41 billion dollar. On the other hand, long-term capital balance is 34* Professor of Insuranoe, Faculty of Business Administration, Kobe University.

** Professor of American Economy and Monetary Economics, Faculty of Economics, Kobe
Unlverslty.

24

MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI MIKITANI

billion dollar in deficit, and short-term capital balance is 1.3 billion dollar in deficit,

i.e. net capital outflow takes place. Along with recovery of the economy, the ratio ofsaving to GNP in Japan is still the highest among the advanced nations. Private
fixed investment is stagnant, because of increase of firms which can be self-financed,

and advance of technological innovation. Because the opportunity for domestic
investment decreases, excess-saving is naturally invested to U.S. and Euro-currency
markets through banks and other financial institutions. Especially, Japanese capitalbalance in 1983 fiscal year recored 34 billion dollar, reflecting large scale foreign in-vestment, on the basis of large surplus of current balance. Being indirect investment,

portfolio-investment amounted to 16.7 billion dollar, about half of foreign invest-

ment, Such a high weight on portfolio-investment is characteristic of Japan as acountry of capital outflow. Therefore, excessive competition of Japanese banks,
particularly, thirteen city banks shifted to the oversea financial markets just as it is,and further, trust banks and life insurance companies and so on employ a mass of
their funds abroad and make profits.

The average ratio of income from Japanese city banks' international businessaffairs to current profits was less than 10 O/. when we started the project. At that time,

the corresponding ratio of American banks was 40-50 Y., and the value of City Corp

was 60-70%. However, the average ratio of Japanese banks from 1982 to 1983
reached 38 O/., exceeded 15-20 O/., the target range of all banks at the time of our firstsurvey (Table 1, 2, 3, 4).

Moreover, considering the actual condition, the rapid improvement in Japanesebanks' operating power in oversea financial markets, shown by the remarkableincrease of the ratio of income from international sector to current profit represents

an unprecedented share-up. If high interest rate in the U.S. persists, high savingrate in Japan do not fall suddenly, and domestic private fixed investment do notincrease rapidly, we will expect the tendency mentioned above to continue for a while.
Besides, if financial liberalization and yen internationalization proceed steadily,
the revenue of Japanese financial institutions will more depend on the foreigh sides.

As we pointed out earlier about the character of Japanese capital movement,
portfolio-investment accounts for more than 500/.. On the other hand, portfolioinvestment to Japan by non-residents reached 12.5 billion dollar in 1983. Nowadays,`money game' dominates international capital movements. We would like to dare
to point out that this problem will be serious to the developments of the international
finance in the future.

We have carried out the fact-finding type of research about internationalizationof Japanese banks since it started in 1980. In 1983, we did the oversea academic

investigation in Australia, New Zealand, Singapore, and Hong Kong. And we arecompleting the results at present. The following is the paper which our working

INTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING 25
group members; Prof. Fujita, Prof. Mizushima, Prof. Mikitani, Associate Prof.
Ishigaki and Associate Prof. Niwa, and then Prof. Suzuki (New South Wales University), who jointed us on the spot, made the interim report at the seminar, with'

Table 1. The Thirteen City Banks, Closing the Books in March, 1983

(billion yen)xBank x.
Nx.-.-

Å~
Dai-Ichi Kangyo

Ordinary

Ordinary

Income from

Revenue

Income(B)

International

834
1,365

426
620

1,571

651

951
929
670
558
479
261
298
305
241
504

426
532
354
336

(A)

1

1,843

Fuji

:

1,778
1,618
1,624

Sumitomo
Mitsubishj

Sanwa
Mitsui

1,572
1,205

Tokai

1,087

Taiyo-Kobe

906
589
546
513
417

Daiwa

Kyowa
Saitama

Hokkaido Takushoku
Tokyo

l,493

1

Affairs (C)

231

139
152
96
l14
F

i

1,224

'

ayerage

CIAe/o

C!B

23.0
35.0
40.0
26.0
34.0
29.0
31.0
26.0
24.0
28,O
19.0
27.0
82.0

51.1

45.4
41.4
44.8
57.3
52.8
60.2
48.2
53.3
51.0
31.5
47.3
242.9

3.30

63.6

o/o

l

Table 2.

Net Profit from Related International Commercial Banking Business(billion yen, e/.)

Å~
'

x

Bank
Dai-Ichi1xTotal profit

1983

1982

fiscalfiscal

year

year

51.1

t

change .

year

1982

amount 1983
of

Details of 1983 fiscal

Share of related international profit (%)

changefiscalfiscalsecond amountof
halfchange

first

half

year

year

1.3

26.6

24.5

2.1

-2.6
-O.7
-O.8
-O.6
-O.2
1.5
O.4

29.0
30.7
21.4
26.5

25.9
34.7
21.5

3.1
-4.0

42,6

8.5

13.0

E 11.7

62.0

-7.1
8i,3

15.5
18.7
13.2

18.1

65.1

KangyoMitsui

54.9
65.4
42.9
53.6
36.6

Tokai

39.1

Taiyo-

l 25.3

23.1

Daiwa

5 15.8

Kyowa

14.6
12.3
12.9

13.9
15.2

9.6

1.9
-O.6
2.7

11.4

1.5

IO.5
9.3
12.1

134.8

122.4

12-4

80,8

Fuji

Sumitomo
Mitsubishi

Sanwa

Kobe
Saitama

Hokkaido
TakushokuTokyoaverage

42.6
53.2
35.4
33,6

?i42

17.i
17.3

glg

16.9
11.3

19.4
l4.0
17.7
17.5
15,4
10.9

12.1

l

19.1

Source: Annual Report of the Ministry of Finance, 1984.

18.5

18.1

21.4

17.7
12.4

12.9

12.6
11.5

-O.5

8.2

-1 .0

7.6

7.9

1.4
O.8

6.9

4.0

70.2

11.3

76.8
18.8

l

O.3

27.1

6.8

L
t

-O.1

-O.6
O.4
3.7

l O.5
O.6
O.6

7.6
7.0
5.5
6.0

1.3
O.9

64.6

5.6

x
Table 3. Change of Foreign Loan Outstanding
3-1. Change of short-term foreign Ioan outstanding
Xx-s.s!El!nd ot' year

1971

1972

1973

1974

1975

1976

1977

1978

1979

l980

1981

1982

1983

Denominated in

K
>
ca
>
:
-pa
o
-Åë
lt
ri

Foreign currency

15

47

oo

80

Yen

91

92

o

94

119

151

225

339

403

"8

2

3

1

4

14

18

21

l
Source: Anual Report of the Ministry of Finanoe, 1983.

->

x
>
N
c
K
>
K
-N
C
ee

x

}

3.2. Change of middle and long-term foreign loan outstanding

Å~--x!)td of year

x

1971

Denominated iX
nX

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

z

e
2

Foreign currency

g

25

73

Yen
:

86

87

82

89

181

285

324

404

523

586

g

2

5

10

17

88

189

210

233

299

398

N
g
as

Source: Anual Report of the Ministry of Finanoe, 1983.

:zTable 4-1. Ratios of Working Balance and Operating Return Denominated in Foreign Curreney (all banks)(unit: O/.)Å~ End of year

1975

xX.
-xx..

I

Items 'x'xl
Ratio of average
outstanding of working

balance denominatedin foreign currency to1975 1976

III1976 1977

III

1977 1978

III

1978 1979

III

1979 1980

III

1980 1981

III

1981 1982

III

zH
tn
pu

:

1
L

13.5

13.0

12.3

11.9

11.4

10.6

10.4

12.2

13.6

i6.5

17.4

19.5

22.0

24.0

29.5

14.2

13.9

12.9

12.1

11.6

12.2

13.0

18.3

21.9

28.1

252

29.9

38.5

40.6

45.6

average outstanding ofworking balance
Ratio of operating return
denominated in foreign
currency to operatlng
return
I: The first half period of a year

II: The second half period of a year
Source : The Ministry of Finance .

Table 4-2. Weight of International Business Affairs Sector (in the mid-1983 fiseal year)

Ratio of working balance ofinternational business affairs

sector to outstanding of working
balance (average outstanding)All banks
City banks, Foreign exchangebanks and Long-term Åëredit

Ratio of operating return ininternational business affairs
sector to operatlng return

Ratio of gross operating profit
in international business affairs
sector to gross operating profit

oversea branches

29.9

36.6

11.6

5.7

36.8

44.6

17.5

9.1

bank
Note: Gross operating profit= operating return-(operating cost-reserves transferred for possible loan losses-other expenses)
Source: The Ministry of Finance.

z
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x
z-

Q
e

28

MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI MIKITANI

Prof. E.S. Crawcour and ProÅí H. Arndt, held at Australian National University in

Canberra on October, 1983. We would like to express heartfeltly our appreciation

on Prof. Crawcour kindly consideration and friendship that we have discussed
fruitfu11y with many specialists in Australian academic circles and government
oMcials.
The subject of the paper vvhich we are going to give today is Internationalizationof Japanese Commercial Banking-the recent experience of city banks in Japan.
This is a summary of the results of our questionnair type of research work which we
conducted twice, one is 1977-78 and the other in 1981-82. In this project we all ofus here and two other professors participated.""* We have been working very closely

since the making of the questionnairs, through the work of compilation of the responses and to the discussion about the summary of the results and its interpretation.

Therefore this project is really a "joint product" of our cooperation, therefore thecompution of each member's contribution to this project is very diMcult to assess
as it is said so in economics. However, the actual writing of the summary has been

done by our working group, Prof. Fujita, Mikitani, Mizushima, especially Mr.
Miyata, Ishigaki, Niwa, and Izawa.

Internationalization of Japanese economy, development of interdependent
relationship between Japan and the rest of the world, and increasing importance ofJapan's status in the world economy in the past twenty years, obviously have had agreat effect upon the activities of various large banks, which have played a majorrole in the financial activities in Japan. For example, in the past 10 years, GNP

increased by 3.3 times while the amount of foreign exchange transactions of all
Japanese banks by 7.5 times, the foreign assets of banks by 12 times, and earning

profit from international banking by 8 times. At the end of 1970, there were 58

overseas branches and 7 overseas local banks, however at the end of 1981, they
increased to 151 overseas branches, 81 local banks and 196 representative oMces.

The international banking business of Japanese banks has been expanding not

only quantitatively, but also changing qualitatively. They have been multinationalizing quite rapidly.

In our survey we not only asked the bankers to respond to a questionnaire but

also we interviewed them. Ten of the twelve city banks and one special foreignexchange bank cooperated with us in this survey. They account for about 84 O/. of theforeign exchange asset balance and about 90 O/. of all overseas branches of Japanesebanks. Therefore it seems to be fairly reasonable to say that this survey would provide

us a considerably accurate picture of internationalization of Japanese banking.
Generally speaking, the internationalization of finance has three aspects. Firstly,*** The other working members are Professor Yusaku Futatsugi. Professor Nobuo Miyata andAssistant Hideki Izawa. They could not attend our Camberra seminar in last October.

29
INTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING

it involves the internationalization of domestic currency . . . that is, a domestic

currency becomes also an international vehicle currency and reserve currency.

Secondly, it involves the internationalization of banks and other financial
institutions-namely, they transact both domestic and foreign currencies with nonresidents and residents. Thirdly, it involves the internationalization of money andcapital markets-that is, both short-term and long-term funds move freely into andout of the markets across the borders of the countries, and interest rates are
determined by market forces.
Of course these three aspects are closely inter-related with each other. On one

hand the internationalization of a currency and of the money and capital markets
promotes the internationalization of banking business. Conversely, the developmentof international banking contributes to the promotion of internationalization of thecurrency and the money-capital markets. However, one of the feature of the inter-nationalization of Japanese banking is that it has developed without significant
corresponding developments in internationalization of yen and the financial market
in Japan.

2. The Purpose and Motives of Internationalization of Japanese Banking

Among the purposes and motives of internationalization of Japanese banking,earning of profit is, as a matter of fact, the most important, although the various
other shorter-term objectives are subsumed in this profit motive.

Our survey (Fig. 1) indicates that the long-term percentage target of the profit

from international banking which the city banks consider appropriate is between
11O/. and 30%. The upper-ranking group of city banks give a figure of 26-300/.,
the middle ranking group 21-25O/. and the lower ranking group 11-20 9/..

Besides profit earning, Japanese banks consider the following objectives asimportant; in order to enlarge the number of customers, the accumulation of techniques and `know-how' in international banking is very important. Other objectives
include collection of overseas information and the maintenance of banks' prestige
among the competing banks. It seems to be interesting that the upper ranking grouptends to emphasize enlargement of numbers of customers and accumulation ofknowledge, on the other hand some middle and lower groups tend to give more weight
to maintaining of their prestige.

Next, we would like to examine the motives and methods of internationalizationof Japanese banking in the past. There are two main courses in internationalizationof banking; one is; banks may internationalize itself in accordance with internatio-

nalization of their domestic business customers; the other is; banks may initiateinternationalization by themselves. According to our survey, more than half of the30

MASAHIRO FUJITA, KAZUYA MIZUSHIMARYOICHIMIKITANIAND
Figure 1. Actual and Target Profit Share

Legend(t)

ww Target

g Actual

(2)
(3)

(4)
(5)
(6)

(7)
(8)
(9)
(10)
(ll)

O 109o 11-159o 16-209o 21-259o 26-309o31-409o41-509o 519oThe upper group-(1), (7), (9), (10)The middle groupun (4), (6), (8), (1 1)

The lowergroup (2), (3), (5)banks think the former is more significant, three banks consider the latter is moresignificant, and the rest of them stated that their internationalization had proceededwith their business customers together. Therefore, it seems to us that internationali-

zation in Japanese banking has been primarily motived by, and proceeded together
with, the internationalization of their Japanese business customers. We can saythat liberalization of trade and capital transactions and an increase in overseas
activities of Japanese business companies haye resulted in an increase in demand forvarious foreign exchange dealings and finance of the banks.
However, this is not to say that self-initiated internationalization is an insignificant aspect of the internationalization of banking. For example, the specjalized

foreign exchange bank proceeded on its own initiative, competing with foreignbanks in various aspect of banking business well before the internationalizationof Japanese business companies. In the case of other banks, also, there are someexamples of this type of internationalization-for instance, some Japanese banks
have often helped customers in their internationalization, especially when a customer

is of small or medium-size without suMcient knowledge of overseas conditions.
In addition, in early 1970s, when the financial market conditions eased due toINTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING 31
excessive domestic liquidity and they thought that the demand for investment funds

was going to slacken for a long time to come, banks actively sought new field of
business in the international finance market. Similarly, the easing of regulation on

foreign exchange transactions since 1972 by Japanese monetary authorities helped
Japanese banks develop international business.

3. Estab]ishing Branches, OMces and Local Banks
In order to start international banking business in Japan, banks need to obtain an
authorization from the monetary authorities to deal in foreign exchange. And thenthey have to establish foreign exchange sections within domestic banks and open acorrespondence relation with foreign banks overseas. At the end of December 1981,

there were 125 authorized foreign exchange banks. However, the establishing ofoverseas branches, representative oMces and local banks is the main method ofinternational banking. The overseas operations of Japanese banks, especially fundraising and accomodation of funds, are conducted in foreign currency, usually U.S.
dollars, the establishing of overseas branches and aMliates is critically importantfor international banking.

Table 5 shows the geographical distribution of overseas branches, oMces, local

banks and Japanese staff. In terms of the geographical distribution of overseas
branches, North American has 31.50/., Europe 27.90/. and Asia 31.50/.-in total,
these three areas cover 90.9O/. of branches. 39.50/. of Japanese staff are located in

North America, 34.1O/. in Europe and 22.30/. in Asia. Representative oMces are
more scattered, with 19.7 O/. in America, 23.8 O/. in Asia, 18.40/. in Central and SouthAmerica, 15.60/. in Europe, 8.89/. in Oceania, 10.20/. in the middle and Near Eastand 3.4 O/. in Africa. The distribution in terms of staff is similar to the above. 40.3 O/.

of local banks are in Europe, 24.20/. in Asia, 27.40/. in North America, 8.1O/. inCentral and South America. The distribution of Japanese staff, however, is very
different-58.20/. in North America, 22.20/. in Europe and 11.50/. in Asia. This
indicates that local banks in North America are considerably larger than those inother countries.

In order to know the geographical distribution of overseas branches, oMces
and local banks we adopted the total number of Japanese employees as an aggregate

measure. Column (4) of Table 1 teils us that North America as 41.40/., Europe as
28.40/., Asia as 19.79/., Central and South America as 6.79/,, Oceania as 1.40/. andthe Middle and Near East as 1.1 O/.. The first three areas together account for about
900/., and can thus be considered important areas. Oceania is only 1.40/..

Fignre 2 shows the relationship of the geographical distribution of overseas
bases of banks (banking), trade, and direct inyestment overseas. In the case of North

ki

Table 5.

Geographical Distribution of Overseas Branches,

Representative OMces, Local Banks and Japanese Staff

K
>
>
:
H
T

ua

(2)

(1)
Branches
III
II
I
Branches Japanese Ernployees

Employees of Local

OMces(overseas

Banks

I
III
II
I
Represen- Japanese Employees Local
tativeEmployees of Local
Banks

Nationality

(4)
Total

(3)
Local

Representative
OfficesIIbases)
III

Japanese

Employees Total

Employees of Local

Nationality

Nationality

Japanese

Employees(A)

North America

31

5

39,5

24 9

19.7

16.7

12 6

27.4

58.2

77.4

41 4

(B)

Central and South America

7

2

3.3

7

8

18.4

19.8

t8

3

8.1

8.1

10 9

6 7

(C)

Europe

27 9

34.1

24 5

15.6

16.3

10 6

40.3

22.2

3.9

rs 4

(D)

Middle and Near East

o

9

O.6

o

2

10.2

10.8

12 3

o.o

o.o

o.o

1

(E)

Asia

31 5

22.3

42 6

Z3.8

24.3

34 6

M2

11.5

7.9

19 7

(F)

Oceania

o.o

le.1

o.o

e.o

1 4

3.4

2.1

o.o

o.o

o.o

1

(H)

Others

o.o

o.o

o.o

5 3
6 o
o o

o.o

Africa

o o
o o
o o

8.8

(G)

o o
o o
o 9

o.o

o.o

o.o

o o

Total

ioo o

1oo.O

1OOo

1OO.O

1oo.O

1oo o

1OO.O

1oo.O

1OO.O

ioo o

lll

1,215

6,t64

147

287

301

62

554

11,744

Number of Banks and Employees
The second survey (1981-82)

o.o

.

.

1

2
.

o
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33
INTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING

Figure 2. Geographical Distribution of Oyerseas Bases of Banks, Trade, andDirect Investment (the first survey 1977-78)
9o

1oo

90
80
70

60
50

OverseasBasescoDirectInvestmentOyerseas

.

30

20
10

Na

x ,.x.sl

Trade
b

-t

..A..

"'.o--.

.-.a.--

Nvi/'."N--......
.

North Central

America and SouthAmerica

Asia Middleand Europe

..-e
.=a

AfricaOceania

Near East

a. Southeast Asia
b. West Asia

America and Europe, the figure for banking is considerably higher than those fortrade and direct investment, while in the case of the Middle and Near East and otherareas, it is considerably lower. This may mean that even if internationalization ofJapanese banks began in response to internationalization of their customers, banks'internationalization has now taken some different direction from that of theircustomers. North America and Europe, in particular New York and London, arethe two major international financial markets in which almost all fund raising anda lot of loan accomodation are conducted. It is interesting to note that the geographical distribution of representative oMces, whose main function is collecting
information rather than conduction fund raising and loans accomodation, is similar
to figures for trade and direct investment overseas. It should be noted, however,that the present pattern of geographical distribution of banking bases reflects thedicisions of banks within the framework of regulations and guidelines issued byauthorities in Japan and overseas. It is quite likely that the present distribution may

change with the progress of internationalization. The first survey shows that all
Japanese banks want to establish new branches in the near future in North America,
half of the banks want to establish branchgs in Europe and Asia, and a few want toestablish branches in Central and South America, and the Middle and Near East,
It seems, therefore, that North America will continue to be the most important area,34 MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI MIKITANIwith Asia, the Middle and Near East, and Central and South America gaining inimportance, and Europe possibly becoming less important in this regard.

However, our second survey shows that in the near future 9 city banks wantto establish l9 branches in Asia and 10 banks in Australia (Sydney). Half of thebanks want to establish branches in Central and South America, Europe, North
America and the Middle and Near East. This would mean that for the present city
banks complete to establish new branches in the international financial center, andturn their eyes to Asia, Oceania and many principal cities in the world.

These conclusions are based only on predictions of the future distribution of
branches of Japanese banks which are already internationalized, or in the processof internationalizing. We do not take into account other banks, especially large

regional banks and mutual loan and savings banks, which may establich overseas
branches in the future. If they want to establish branches in the international financial

markets, particulariy in New York and London, the future disturbution of branches
of Japanese banks will not change as much as indicated earlier. Our survey suggeststhat recent years, Japanese city banks want to establish new representative oMces
in socialist countries (China and Soviet Union), but distribution of representativeoMces will not differ greatly from the present pattern. This would refiect the factthat the function of these oMces is not to conduct financial business themselves, but
to collect local information on the region in which they are established.

In the case of the establishing of local banks, Japanese banks must consider
the advantages and disadvantages ofestablishing a local bank as opposed to a branch.

Our research indicates that the main advantage of local banks as compared withoverseas branches is that they are able to conduct various financial dealings in ac-

cordance with local regulations and economic conditions, independent of oMcial
Japanese control. The main disadvantage is that local banks cannot benefit directlyfrom economies of scale and the credit power of the parent bank because, legally,

local banks must be independent of the parent bank. In fact, however, because ofcontrols imposed on financial activities by both Japanese and overseas authorities,

there is often no alternative but to establish a local bank. For example, Japanesebanks are not permitted to engage in securities business both domestically andoverseas, so it is necessary to establish local banks abroad to carry out this business.

Similarly, regulations prevent the establishing of new branches of foreign banks inAustralia, so foreign banks are compelled to establish non-bank financial companies(merchant banks, finance companies) instead.

4. The Operation of International Banking
There are several phases in the process of internationalizationof banking.

Table 6

Table 6.

Phases of Internationalization ef Ba"kingThe 3rd Phase (in a broader sense)

PhasesInternationalization

The lst Phase(National Banking)Export-I(nportof Customer Companies
International

Operations in Banking

The 2nd Phase(International Banking)

Active Direct Overseas
Investment

Mainly foreignexchange operations
connocted with

Overseas ioans andinvestments become

foreign trade.

aRd longer-run capital
traRsactions become

Capital transactions

F

The 3rd Phase

The 4th Phase({nternational ful1-service(World full-servicebanking)banking)

Muttinational

Corporation
Non banking fringe activities such as merchant-banking,leasing, consulting. and others are condu:ted.

important and medium-No retail banking

are mainly
short-term ones.

Important.

Methods ofCorrespondence

To strengthen own

By strengthening of own branches and oMces,

Internationalization

contracts withforeign bankoverseas-branches andcapital-participation, aMliation in business, establishingoMces

non-bank fringe business firms. the most profitable ways offund-raising and lending are sought on a global basis

Customers inInternational

Operations
Source: Mitsubishi Bank,

Mainlydomestic
customers
Chosa, September 1974.

.

Retail banking is done

N
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stu
ca

MainlyCustomers are ofdomestic

various nationalities

customers

pa

a
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N
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Table 7.

Altermation of Treatment by the Type of Transaction

Amounts (million dollar)

Type of

Alternation of Treatment

Transaction(1) Impact loans(foreign currencygDuringDuringRate of

1980

1981

lncrease1loans to residents)

Short term:

lndividual permission -Medium andlong term

11

2,174

11,072(1,071)(9,455)11

2,245(2,041)(Al,293)lt

3,753(2,314>4,792+280/.

(3,981)(+72%)

Liberalizationk

5.1 times
8.8 times

Al,550d(2) Foreign currency
deposits by residents

Limit 3 million yen g(3) Borrowings between firms

Short term

Ind ividual permission --> Prior notification

Medium andls}tIong term

'

3

(-)

573
(518)

71

207

2.9 times

(69)

(185)

(2.7 times)(domestic direct investments are examined)(4) Loans between firms

Short term andmedium and long term

Individual permission ----> Prior notification(with examination)(excluding direct investments)

Medium and long term

Individual permission -(direct investments)(restricted type of

19

824

(-)

(809)

Automatically permission ----i>(general'type of industry)domestic currency(6) Loans to foreign countries

11

Permission withPrior
the notification
payment of issue prjce ---M'> (wjth examinatjon)

Permission(

main Japanese banks

are generally per-mitted)-vt(ge.tr2,'fil;sadne.s.e,>

Sto notity 1

x
>
N
c
K
>
K
N-

C
ca
:
-K
>
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pu

11

industry)(5) Issue of foreign bonds in

K
>
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:
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r
C
:
H
v'
va

1,799
(2,081)

3,473(3,240)1.9 times(+58 0/.)

1,115

2,871

2.6 times

464

2.4 times

12,688

1.9 times

ln yen194

billion yen
in foreign

currency
6,704

K
o
a
rc
p--

K
-x
.
>
z
p.-

-.-

billion yen

(7) Issue of foreign bonds(private cooperate bond,

3,522

Permission - Prior notification(with examination)

govemment guarantoed
bond)

4,697

debenture

673

333

convertible

bond
2,413
government

3,901+33 ?/opuguaranteed

bond
436
Approval and permission - Prior notification(8) Domestic security investment(excluding T.B. conditionaltransaction of bonds)

iautomaticallyapproyedx tviadesignated x

464

10,318

9,294

4,988

3,523

5,330

5,771

2,912

6,048

A344

240

3,255

5,808

73

3,224

stock

k2,n.,g.s'ermittedinprin') L:2.I,lifri{g,C,O.M.P.lll,},YJ

bond(9) Foreign security investments(excluding T.B.)

Permission

----

>

tl

stock

(copermMPirsesloennSiinve>

Nprinciple 1(10) (Jonditional transaction of

Permission

bonds by non-residents(ggM':,?ghc?•:'yl

bond

-

tt

Xprinciple 1
Approval(1 1) Domestic direct investments(stocks and equities)(gSBOrl;l3e'G9?•I'Y>- prior notification(with examination)

328

389

+l90/e95+760/.

3,354+520/.

establishingbranches

Xprinciple 1(12) Foreign direct investments(g,q,u.ibSff,iOh".g.fie.Cf"tr/rSeh,,

54

Permission)(8eei•fikc8gd,Kype)

Notice(general item)

2,211

-

s}

N
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"t"

Source : T. Kato,

The Development of International Fiuancial Policy,

1983.

38

MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI iMIKITANI

shows the content of each• phase in terms of the internationalization of customer

companies, international banking operations, method of internationalization andthe customers in the international operation.

In the first phase, the initial step is an internationalization of customers
themselves. Here the customers are mainly engaged in import and export transactions
with foreign companies, therefore the most important aspects of international banking

are foreign exchange operations connected with foreign trade. Capital transactions
with customers are limited to finance trade that is mainly short-term finance. In

this phase, the main method of internationalization is to make correspondence
contracts with foreign banks. In the second phase, as the bank-customers' direct
investment to overseas increases, banks increase their loans to Japanese aMliatedcompanies relative to foreign exchange business. Medium and long-term capitaltransactions increase correspondingly. Banks aim to internationalize their businessby building up a network of overseas branches and representative oMces. In thethird phase, the multinationalization of big business develops, and foreign as wellas Japanese companies become bank customers. International business extends tonon-banking activities, such as merchant banking and leasing, through the strengthening of branches and oMces, capital participation, business aMliations and theestablishing of non-bank business firms. Banks seek the most profitable ways of fundraising and lending. In the fourth phase, retail banking is to be conducted on theworldwide basis and the content of international operations and the methods ofinternationalization make more advance and become more complex. An aspect of
the fourth phase which distinguishes it from the third phase is the declining importance of the exploitation of new businesses and methods for the banks, and moreconcentration on deepening and strengthening of the activities already commenced
in the third phase. This may be revealed in terms ofan increasing ratio ofinternationaltransactions to the total transactions of the banks (Table 7).

Now look at Figure 3. 0ur research shows that in 1977-78, four banks were in
the fourth phase, five in the third and two in the second-in other words, on average,banks have reached the third phase of internationalization. Our second survey showsthat in 1981-82 six banks were in the fourth phase, and five in the third. Comparing

these two surveys, the internationalization of Japanese banking has been steadily

advancing. Our survey also confirmed that the internationalization of Japanesebanking had progressed rather slowly prior to the 1970s, but rapidly in the first halfof the 1970s, before slowing down again in the late seventies.

What attracted the Japanese banks into international operations? Our survey
indicates that the major attractions for them are (i) diversification of banking operations and customers (ii) higher profits (iii) high potential for growth and (iv)
access to large, flexible and free international finance markets. These attractions of

OF JAPANESE COMMERCIAL
INTERNATIONALIZAiTIONBANKING
Figure 3. Development of International Banking;pa
Å~ .Å~.ixs'X4:x: Ns N
x

ÅÄ

(2)

i
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(3)

:
:

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(4)

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(1)

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--

50 60 70 80 90 (year)
international banking have been motivated by both short-term objectives and long-term objectives of the banks. It should be noted, however, that risks which areabsent in domestic banking, such as exchange risk, country risk and availability

risk, are present in international banking. Moreover, competition is much more
keen in the international market, which is a free market by nature. And there is nolender of Iast resort in the international sphere.

As mentioned previously, Japanese banks have branches in various countries
to carry out their international business. We will now examine the relative importanceof banking business at the New York, London and `others' branches (Table 8).

At the New York branch, the order of importance in 1977-78 was that tradefinance was the most important, and loans to Japanese aMliated companies were in
the second place and fund raising was the least important among them. The situation

changed greatly in 1981-82. Loans to non-Japanese companies are now the mostimportant, and loans to Japanese aMliated companies follow. Trade finance becomesthe least important. At London branch, on the other hand, fund raising was by far
the most important activity, and it is still in 1981-82 the most important business.

However, the second importance shifted from trade finance to loans to other com-panies. This seems to suggest that some Japanese banks have already developed
various kinds of international banking operations in the international financial

39

40

FUJITA, KAZUYA MIZUSHIMA AND
RYOICHI MIKITANIMASAHIRO
Table 8.

The Order of Business in each Branch

The second survey (1981-82)

The first survey (1977-78)

New York Branch

(1)

(2)

Trade Finance(1)

Loans to Japanese aMliated(2)

Loans to other companies(non-Japanese)
Loans to Japanese aMliatedcompanles
Trade Financecompames
London Branch(3)

Fund raising

(3)

(1)

(2)

Fund raising
Loans to other companies(3)

Fund raisng
Trade Finance
Loans to other companies(3)

Loans to Japanese athliated(1)

Trade Finance

(1)

(2)

Loans to Japanese aMliated

(2)

(1)

companles
Other Branchcompames(2)

companles(3)

Fund raisingt

Loans to Japanese aMIiated(3)1

Trade Finance
Loans to other companies

markets. At the other location of branches, the ranking of activities was approximately similar to that of the New York branch.
From the result of this survey we can draw a tentative conclusion that throughtheir net works of overseas branches the banks raise funds at London branches andmake use of the funds for trading finance, loans to both Japanese aMliated cpmpanies

and non-Japanese companies through New York and other branches.
Figure 4 and 5 show the geographical distribution of fund raising for overseas
operations. Almost all funds for overseas operations are raised by overseas branches,

and the funds supplied by head oMce are surprisingly little. Japanese banks raise
about 55 O/. of funds in Europe, 30 O/. in America, 15 O/. in other regions and in headoMce. This is consistent with the description of London branch activities given above.

Figure 6 shows the maturity structure of the raised funds. About 800/, of all

funds are short-term (within 12 months), 20% are long-term. Generally speaking,in the case of upper-rank banks, the figure of long-term is less than 100/,.

Now we turn to the use of funds for international business, we note that themain banking business related to the use of funds is dealing in foreign exchange,
trade finance, loans to non-residents and merchant banking. The first item, dealing

in foreign exchange, is growing steadily with the growth of the Japanese economy
and foreign trade, and because it remains a fundamental operation of internationalbanking business the stability and certainty of these dealings is very high. However,its relative importance has been decreasing due to the rapid increase in loans activities. The ratio of the trade bill in foreign assets of all banks was about 80 %. in
September 1970; this fell to about 35 O/, by September 1978. This is due to the growing

importance of loans to non-residents.

Figure 7 shows the distribution of loans among developed, developing andINTERNATIONALIZATION OF JAPANESE COMMERCIALBANKING

41

Figure 4. Sources of Funds for Overseas Operation

LegendEggeiS Overseas(D

N Head Office

(2)
(3)
(4)
<5)
(6)
(7)
(8)

(9)
<1O)

(1D

O 20 40 60 80

lO09o

Fig"re 5. Geographical Distribution of Fund Raising
Legend,tÅ} '' ",' " ./i' :'. ': kS,,

(1)

. I".':' ,/:"' .:'.

ttt.wa.t

/ .)

(3)

..

•l

<4)

M AMERICA[ ]EUROPE

tt.-t

'N

(2)
..

k."

E:k{ii oTHERS't .: tt '. ptt;,X' ')/zi'.t;tt"','Ftt -t/ tttt t.

,- .l

/ii'
' ..,.
't . JeS,:/l.
t' ts'imas.

I'x,.•.r',••,.",; i.. ;, ,t/.;'.)',;. ,t•./ .., t.;e'//•{' 'i/ '•'•,: 'E•• .t'+':" f' •;' "'/'k 'i• i'l '"ff'.ttS(5).. :'t. Il ' :';: 1.'-,"' -.x't'f,`':lle.i.,': .itE,V-ee.l

(6)

ttt

(7)

l•

. .•';.t[' s't'f+ ••• :'L" *,. • Åí•,. .+,. r,. ,t; .-,.,,..;i.. ', ,,,,ti.', "(8)." g..i..t.I(9)l•••"•"o)., ' ,'

(ll)

o

20

i'

, ,' ,: . ,l,'.:v.-.= C.i 'i's. :;,ss..1,./tlit/tt;t{,"s.x40ooma..!,,-/iige/",.

.,.".l

80

loo9o

42

RYOICHIMIKITANIMASAHIRO FUJITA,MIZUSHIMA AND
KAZUYA
Maturity Structure of Funds Raised

Figure 6.

LegendN(D

tt Stttltt

long-term
short-term

(2)

(3)

(4)

{s>

Cb)

(7)

(8)

(9)

(1O)

(l1)

20

o

40

oo

80

1ooc/eGeograpbical Distributien of Loans

Figure 7.

Legendbem.."',".I''xt(1)

ww Advanced

tt

[

I'

•:'

[I I] Dcveloping

tt

'tttt
'"l...t,.
't
''

(2)

'-'

(3)

<4)

tt

''

'
'

ttt

't t'

'''''

t''

"'

tt

''

mmttmmmTtttTTt -t
tttttttttttttttttt}t.s.,x'•"•={='gttt",'ti,nf;ilipsin,'.,eet.."Z,s•v.'S"'t,r,,,va"ff2tr•l,rk'•ptee•'iliZL'//j•ti".$•L.se,,t•:i?a9ag'ge:.tWezS"
'

'

tt

(5)

N socialist

tt/tttt.

"t

-

tt

l.K.v•}.,Åíi•v.,li•nit:ggngiktt'ei...itt/il3'tr,/ek.t•im.

tt

t- -

(6)

lffv,•l3va"ltx',"Eg.k:•gSiee.iK'="i}.'ptdi"tiEtitW'va,li,tt'tkt-"i"'`'i
'

'

(7)

rfTT.tt,•t'?.pt.`,"t."=,,k,}ln'/k',.ltLg're."'x've.."/li'."j-'za{',l'b•sut"'k.ee'Y,.lk.,i'as;:tll,te•wa.l.IE••.

tt tt

(8)

st'

-'''

y,'•l'ri•il••:ty,i•x,,i'i,Tl,•eetotSttdi,ile•itt•/i.lp,,tsii.'Lig'/S.'k•if,N.".ra•.'tt..e,E.i.tT.,ee,V"ta"'1.i;•.

si,illy:•t/'

'

...

(9)

(10)

af;•'-•me"..i's•ki.,re',t,•'•.'litsttes."aleq..."t;;';g/i.s.iig'tt'-ee.I'•.,,,,'le•.`•iE.•g,..`•thec:",Ssi,//",)fi.'il"fi.
'

'

'

ttt

l'lltg'g,!,.tfut;.<•5•ss.l/,,""th',Ci'.eeit"t.,'v'..,X'e.tstdit,%tmak.see•.le"'l'k'#')••

<11)

-pt'

/t/

o

20

40

oo

//t

'

'

80

1ooO/oINTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING 43
socialist countries. The developed countries' share is about 60 O/., that of developing
countries is 35 O/. and socialist countries 50/.. It should be noted that the combined

total of loans to developing and socialist countries amounts to 40 0/.. According toour research, four out of ten banks want to increase the volume and share of Ioans

to developing countries, and three want to increase the volume without changing
the share. It can be sajd, therefore, that Japanese banks generally have an aggressive

attitude towards extending loans to developing countries, despite the greater riskthat may often be associated with such loans. These risks comprise both individual
credit risk and country risk. It is interesting to note that banks which are alreadylending about 400/. of their loan funds to developing countries do not, according
to our research, wish to increase the share of developing countries more. This might
presumably reflect the rapid increase in the marginal risk of this sort.

Figure 8 shows that the share of loans to Japanese aMliated companies andto non-Japanese companies is about 30 0/. and 70 O/. respectively. This confirms thatthe internationalization of Japanese banks has already reached the third of fourthphase. Although almost all Japanese banks place considerable importance on existing

relations with Japanese customers when accommodating loans to Japanese aMliatedcompanies overseas, they do not always insist on the past and existing customer
relationship in Japan. This means that the Japanese banks are trying to acquire new

Figure 8. Share of Loans to Japanese AMIiated Companies
Legendww Japanese{D

X others

(2)

(3)

(4)

(5}

(6}

(7)

(8)

(9)

"o)
(11)

o

20

ap

oo

80

IO09{o44 MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI MIKITANI
customers through international finance activity.

Between our two surveys the share ofloans to non-Japanese companies increased
greatly. This is an evidence of further progress of the internationalization of theJapanese banks.
Figure 9 shows the maturity structure of loans. The percentages of short-termand long-term loans vary among the banks, reflecting the international lending policyof each bank. Roughly speaking, the share of short-term is 45 O/. and the long-term
is 55 O/.. Figure 9 indicates that the Japanese banks are conducting a kind of "maturity

transformation" by borrowing short and lending long. According to our survey,
Japanese banks accept this transformation as one of the functions of banks but they
are also worrying about it.

All banks are interested not only in trade finance and loans to non-residents
but also in other related business, such as merchant banking, securities business,leasing, credit cards and so on. Among these, securities business and merchantbanking are particularly important for them. Almost all banks express their strong
interest in securities business.

Recently the syndicate loans and project finance have been becoming very

Figure 9. Maturity Structure of Loans

Legend(1)/•.,,•-,,=,// short term

N long term
(2)

(3)

(4)

(s)

(6)

(7)

(8)

(9)

{10)

{11)

o

20

co

oo

80

1oo91eINTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING 45
important. Therefore the knowledge and know-how of merchang banking are
becoming very much in need.
5. The Performance of Internationalization
In this section, we examine the performance of internationalization in Japanesebanking.

In accordance with the progress of internationalization of Japanese banks,
profits from international activity are increasing steadily and contributing to totalbank profits greatly. In 1982 the total bank profits of 13 city banks increased by
21.0 O/,, meanwhile profits from international activity by 38.2 O/.. The profits from thecommission fee of international business did not change so much, but they had aremarkable increase in profits from loan and investment.
Table 9. Profits of International Secter in Japanese City Banks

imx
(1)

G
1

(2)

(3)
(4)
(5)
(6)
(7)

l

(9)
(1O)

122
107

101

133
117

15

13

11

9

(13)

Total

sion

111

109

14
12

12
10

203
174

35
28

31

212

23

20

185

20

219

l
f

83

22
24

(o/o)
76.8

F

68.1

transactlon(million dollar)

201,956
l82,675

2
2

12.6
10.8

39,457
29,161

5
5

17.5
16.1

106,494
95,684

17

3
3

10.9
10.6

50,11442,765

34
26

28
20

5
5

15.4
l3.4

99,551
74,950

53
3J

46

8
8

17.7
15.9

139,585
137,885

43
35

37

6

261

31

4

14.0
13.4

111,507
88,344

336
276

65
50

57
42

9

19.4
18.0

125,114106,286

191

301

305

342
365

62

"

43
39

32

55

7

18.1

7

15.5

157,688
122,7oo

35

8

31

8

11.7
12.0

120,877
106,886

1
1

11.3
8.8

28,56817,029

1
1

7.9
7.6

34,081
19,313

78
77

l8.2
15.9

1,242,147
1,044,675

11

10

85

8

122
98

7

7
9
6

2,907
2,403

530
384

452
346

Note: upper raw 1982, lower raw 1981
Source: Shukan Toyo Keizai

7

/

37

101

10

i

23

2
2

11,5

Amounts offoreign exchange

27,15520,997321(12)Commis-Share of international
sectlon

9.6

281
(1 1)

Loans andlnvestment

159
157

247
(8)

International section

Gross busjness
profit(billion yen)

{

L
j

I

i

46

MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI MIKITANI

Table 9 shows the profits from international section of Japanese city banks,
compiled by Toyo Keizai Shimposha. The proportion of profits from international
section to the total profits of the banks in 1981 and 1982 ranges from about 10O/. tol50/., excepting the Bank of Tokyo which is the special foreign exchange bank.
Comparing actual figures with the feasible targets for profits in our survey shownin Figure 1, the feasible target exceeds the actual figure by 5-10%. The gap between

the actual and the target value is higher for the upper ranking banks than for the

middle and lower ranking banks. 100/. as opposed 5O/.. This may suggest that theupper ranking banks are more willing to internationalize.

6. DiMculties and Limitation in the internationalizationof Japanese Banking
There are two types of limitations in the process of internationalization of banking-internal and external. Internal limitations are basically management problems
while external limitations arise from general economic conditions and various
regulations imposed on banks. According to our survey, the main internal limitations
as perceived by the banks are, in order ofimportance, the shortage of staff competentto carry out internationalization, the inability to collect adequate information andknow-how, the lack of an adequate system of operations for internationalized banking

business and cost of establishing foreign bases, such as branches, representativeoMces and local banks.
The shortage of competent staff is the greatest concern of bankers. As mentioned

earlier, as internationalization proceeds, the international banking operation
becomes more complicated, moving from mainly foreign exchange and trade financebusiness to loans to non-residents and to syndicated loans business. For example,

in any project involving the development of resources, finance is extremely important, and banks must play an important role. This extends from the funding of
the project through to playing a role in its formation, promotion and programing,
as well as supervising its progress. It is thus necessary for banks to have staff competent in the fields of economics, finance, tax, law, information collection, research andinvestigation, and business administration. Many banks feel that to obtain specialists
in these areas in a matter of urgency.

As is generally known, a system of `life time' employment prevails in Japan.
It is thus quite diMcult for banks to snatch off the competent staff from the `outside'.

An exception is some senior staff from monetary authorities. Consequently, it isunavoidable for most banks to train their own staff by sponsoring their study atoverseas universities, by training them in overseas banks or by providing inhousetraining. It takes considerable time and money, for a bank to secure a personel who

INTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING 47
has the high level of expertise in international banking. This is putting Japanesebanks at a disadyantage position in promoting rapid internationalization. However
it might possibly become their long-term advantage if the trained staff are to remainin the bank and contribute to its international activities over a span of years. The

bank can harvest the fruit of investment in human capitaL ,Secondly, information and know-how on international business are extremely
important in terms of the development of international banking operations and inassessing and avoiding the associated risks. The lack of such knowledge within
their operations is a concern to banks. As mentioned earlier, Japanese banks makeuse of foreign currency in their international operations. This gives rise to exchange

risk and availability risk, In addition, with the increase of non-Japanese firms(including foreign governments) as customers, the big rise in loans to developing
countries and the increase in long-term and large-scale loans for resource development, it has become increasingly necessary for banks to collect authentic informations

promptly and to analyse them rightly. It is therefore necessary for banks to collectcontemporaneous and comprehensive informations on the politics and economy of
the foreign countries as well as on the individual customers. To obtain suMcientand prompt information and to acquire "know-how" on international finance seems

to be one of the main present limitations to the future development of internationalization.

The third internal limitation perceived by banks was the lack in an adequate
system of operation for international banking business. Japanese banks intend to
overcome this problem by localization of the banking operation-that is, ensuringthat the operation conforms with the culture, national character, economic practices

and law of each country, and providing clearKut definitions and the assignmentof broad powers to the local staff in charge.
The fourth limitation is the costs of establishing overseas bases, such as overseas

branches, representative oMces and local banks. The Japanese banks tend to establish
their overseas bases in the same place where rival Japanese banks have their bases.

Therefore, Japanese banks, particularly lower ranking group, are compelled toestablish foreign bases, even if unprofitable, in order to maintain their prestige.

These behaviores are being re-examined by themselves recently.
There are also three external limitations on the internationalization of banking,according to our research namely, general world economic conditions which arereflected in the economic growth rate, price level, exchange rate, interest rate and soon of individual countries and the international market; the Japanese economic
situation, which is reflected in the position of the Japanese economy in the world

economy; and the regulations and administrative guidelines from Japanese andoverseas authorities on international banking operations.

48

FUJITA, KAZUYAMIZUSHIMA
MASAHIRO
ANDRYOICHIMIKITANIIn the 1970s when the internationalization of the Japanese banking wasincreasing rapidly, the world economic situation was not as good as it had been in
the 1960s. It was characterized by turbulence of the international monetary system,
the introduction of the floating exchange rate system, the oil crisis and skyrocketingoil prices, unrest in the financial system due to the bankruptcy of the Herstatt Bank,high interest rates and the co-existence of high inflation rates and increased unemploy-ment. The general economic situation had effects on both developed and developing
countries, especially the latter, with countries like Turkey, Peru, Brazil, Mexico and

Poland having diMculties with debt repayment. The prospeot for the 1980s is notparticularly optimistic, which may be disadvantageous for the internationalizationof finance activities, with economic depression making it more diMcult to measurecountry risk.

Japan was no exception in experiencing the diMculties of the world economy.
The oil crisis at the end of 1973 and the failure of economic management caused theJapanese economy to get into diMculties, negative economic growth and skyrocketing prices. However, the Japanese economy fared reasonably well in the
1970s, compared with other developed countries, with her ranking based on GNP,
trade and capital exports rising. As mentioned earlier, the internationalization ofJapanese banking was promoted by the internationalization ofthe Japanese economy.
However, it is not certain whether this pattern can continue in the 1980s. The growthof the Japanese economy in the midst ofthe stagnation of the world economy, which

formed the background for the internationalization of Japanese banking, dependedon overseas rather than domestic demand. For this reason, it is said that Japan's

pattern of economic growth and the so-called `closed market' have produced considerable friction between Japan and other developed countries. If the Japanese

economy must in future depend much more on the domestic market and less onoverseas markets, the incentive for internationalization of Japanese banking fromthe economy will weaken. However, it may be that the problem of friction overtrading issues will be settled through the increase of overseas investment, and thatthe incentive will continue to work. Even so, it will be necessary for Japanese banks
to find ways of diversifying their business with non-Japanese firms in order to develop
the internationalization,

Besides the economic conditions surrounding Japanese banks, financial conditions, especially the internationalization of the yen, are very important in con-sidering the internationalization of Japanese banking. One of the features of theinternationalization is that Japanese banks have promoted it through making use
of foreign currency, without any significant internationalization of the yen. Thispattern of internationalization places Japan at a disadvantage compared with
American banks, in that the latter can use its domestic currency as international

49
INTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING

currency, which is not possible for Japan. According our research, almost all bankers
think the internationalization of the yen, and thus the internationalization of themoney and capital market, is extremely important as it will enable them to enjoy
the same advantages (easiness, stability and eMciency in the use and raising of funds)

as the American banks. It should be noted, however, that some banks (for example
the specialized foreign exchange bank) have attained a similar level of international-

ization as American banks without the internationalization of the yen, demonstratingthat it cannot be regarded as a pre-requisite for the internationalization of Japanesebanking. In addition, it would be simplistic to discuss the internationalization of theyen solely in terms of the internationalization of Japanese banking, as the former

would have widespread effects on the balance of payments, monetary conditions
and the financial market, and the management of monetary policy in Japan. Viewed
in this light, it is possible to understand the' argument of some banks that the inter-nationalization of the yen is a different problem from the internationalization ofbanking. However, in general terms, it seems that, for the reasons mentioned above,
the former does promote the latter.
The third external limitation on internationalization is the various regulations

and guidelines imposed on Japanese banks. Almost all banks think that regulations
on foreign exchange operations, the establishing of overseas bases and other international banking operations constitute a significant limitation. In particular, manybanks are greatly concerned about the regulation of the establishing of overseas
bases, because this is the way they have pursued their internationalization.

According to our research, almost all banks (eleven banks) agree that thepresent licensing policy of the Japanese monetary authorities regarding the establish-

ing of new overseas branches (the so-called `one new branch every two years' Iicense)

should be liberalized. One bank regards the present policy as good, while anotherthinks it should be strengthened because of the undue competition between Japanesebanks, which was reflected in the Japan rate in the Euro-dollar market in 1974, andthe low-interest lending rates in the American market in the late 1970s. It is naturalthat some banks are concerned about the market disorder brought about by such
behaviour, and this illustrates one of the features of Japanese banks' behaviour-yokonarabi ishiki, worrying about comparison with other banks. However, even if
such undue competition does exist, it is by no means certain that the cost of competition exceeds the benefit, or that strengthening controls on establishing branches

would solve the problem. One of the important factors for the development of theinternational finance market is that it is a `free' market, regulated not by controls,

but by rational and prudent management on the part of the banks themselves.
The second aspect of regulation of internatiOnalization is the exchange control.

As mentioned previously, in December l979, the foreign exchange law was revised,

50

MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI MIKITANI

leading to `free foreign-exchange dealing in principle'. However, in case of emergency
such as international financial crisis, the regulation on the foreign exchange position

and the prohibition of paying interest on deposits of non-residents will be put into
force by the monetary authorities. In regard to the necessity of the regulation in caseof emergency, our survey indicates that all banks consider it necessary, if international

financial disorder and the great disturbance in the foreign exchange market should

occur. On the regulation of foreign exchange position of banks, almost all banks
except two consider it necessary to maintain the stability of financial market and thesoundness of banking. And on the prohibition of paying interest on deposits of nonresidents in case of international crisis, all banks consider it unnecessary or doubt
its effectiveness.

A further guidelines relates to securities. The present laws prohibit bankers
from dealings in securities, and this principle is also applied to overseas banking.

Japanese banks cannot do the securities business except through local finance companies, even if the monetary authorities in the foreign country are willing to permit
it. Due to this quideline, Japanese banks are in a disadvantageous position comparedwith foreign banks, which can issue both debentures and syndicate loans. The reason
for this guideline is the policy of separation between secutities dealing and banking.

The policy that the maintenance of domestic financial order has been taking precedence over the development of international banking is now one of the concerns
to bankers.

7. Some Conclusions
The main points of this paper can be summerized as follows.
1. The internationalization of Japanese banking has developed primarily due to thedeyelopment and internationalization of the Japanese economy itself (, although

there are some aspects in which the banks have taken the initiative towards
internationalization).
2. A feature of the internationalization of Japanese banking is that it has not beenaccompanied by internationalization of the yen or the money and capital market.
3. By establishing overseas branches, representative oMces and local banks, Japanesebanks raise funds in foreign currencies through the international market, especially

London branches, and lend funds to Japanese and non-Japanese firms overseas
through other branches, especially in New York.
4. The present phase of the internationalization of Japanese banking is the thirdor fourth phase (, in which banks enlarge the number of their customers to include

both Japanese and non-Japanese firms, and to diversify their business to include
merchant banking etc. By strengthening their branches and representative oMces,

51
INTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING

they seek to globalize their profits by improving and extending capital participation, business afuliations, fund-raising and so on). The ratio of international

business to total banking business for Japanese banks is considerably lower thanthat for major American and European banks (although the size of the international business carried out by Japanese and major European banks is similar).
5. Some limitations and problems facing the development of the internationalizationof Japanese banking exist, Firstly, it will be necessary to train competent staff
and establish an operational system to cope with increasingly diverse and complex
international business. Secondly, the economic circumstances which fostered thedevelopment of the internationalization of Japanese banking will change,
providing a bleaker environment with the prospect of problems such as friction
over trade issues and increasing protectionism. Thirdly, despite the liberalisingof previous controls on international banking which should stimulate the inter-nationalization of the yen, the Japanese money and capita1 market and, consequently, Japanese banking, problems may arise as banks have to practise selfregulation. Fourthly, despite liberalization, there are still some areas (such as the

securities business) in which the domestic finance system takes precedence overstandard international banking practice.

In summary, Japanese banks will face ihtense competition in internationalbanking business in an economic environment which is at once more harsh and more
liberalized. In order to survive in these conditions, Japanese banks will need to be
self-reliant, which depends on their ability to acquire competent staff and establish
an effective system of international operations.

8. Some Remarks on the Internationalizationof Japanese Life Insurance Industry
Now the Japanese life insurance industry takes a great interest in the Australianeconomy as the investment outlet of its funds. As you have already known, Japanese

economy has experienced rapid growth in two decades since sixties, and the life
insurance business developed in a much higher pace than was the case in the national

economy.
In these years, as the world economy stagnated and the trade friction intensified,

the Japanese economy has been in the recession, too. So individual consumption,
housing investment and plant and equipment investment levelled off substantially.
In spite of such an economic climate, new business of the life insurance industry

showed recently a fair increase mainly because of the premium reduction as wellas the intense sales efforts of individual companies.

The Business in force as of the end of fiscal year 1981 amounted to about $A3

52

MASAHIRO FUJITA, KAZUYA MIZUSHIMA AND RYOICHI MIKITANI

trillion, more than three times of the national income, which is at the top level inthe world, The total iife insurance assets exceeds now $A140 billion.

The Japanese Iife insurance 'industry did not handle the foreign investment at
all until a few years ago. This changes result from firstly the fact that because ofcontinuing stagnation of Japanese economy there are not given so many gainfu1
investment opportunities in the interior. Secondly there are circumstances that they
will be able to expect good performance as to yeild through the large difference in
the interest rates, even if they take account of the risks of foreign exchange rate
fluctuations.

Thirdly I would like to point out another reason for the increasing overseas
investment, that is, a precautionary measure against an eventfu1 earthquake disaster,which is feared to occur in the near future. It might be said a strategy from the view-

point of portfolio risk management.

Generally speaking, there are two types of Japanese life insurers' foreign
investment: securities holdings, most of which are of fixed interest and loans. The
former is used to be done jn term offoreign money, the latter usually in Japanese Yen.

While the total holding of foreign securities, esp., bonds was only 2% of totallife funds in 1979, it increased up to more than 60/. in 1982, or three-fold increase
as to ratio to the total funds. On the ,other hand, the overseas loans have remained
about 2O/,. It must be emphasized that only in a few years the total of the overseas

investment rose considerably from $A2.4 billion to over $A4.5 billion, that meansincrease from 4 O/. to 8.5 O/, of total life insurance funds.

When ratios of the Qverseas investment increment to the added funds in eachyear are to be shown, one can visualize more clearly the posture of Japanese life
insurers in this field. As far as their securities acquisition in concerned, the ratio roseby 13 O/. in two years, namely, from 4O/. in 1980 to 17% in 1982, while in the same

period the overseas loan showed the growth from 1.5 O/. to 4O/. of new funds. As aresult of this development the Japanese life jnsurers invest at the end of fiscal year

1982 as much as 20 0/. of newly increased funds to capital and financial markets inforeign countries.

As concerns Australia, most major life companies in Japan are used to appreciate it as one of the best investment outlet in the world. So Australia has thesecond ranking next to Canada.
The recent statistics shows that total investment outstanding to this country
as of the end of June 1983 has the proportion of 13.2% in the total overseas invest-

ment of Japanese life oMces, which amounts to $A15 billion. I would expect that
this situation would last further in the future yet.

53
INTERNATIONALIZATION OF JAPANESE COMMERCIAL BANKING

The members of our research group are. Professor M, Fujita, Kobe University, Professor K. Mizushima, Kobe University, Professor R. Mikitani,
Kobe University, Professor Y. Futatsugi, Kobe University, Professor
N. Miyata, Kagawa University, Associate Professor K, Ishigaki, Kobe
University, Associate Professor N. Niwa, Toyama University, Associate
Professor K. Shimomura, Kobe University and Assistant H. Izawa, Kobe
University. Moreover, these all members belong to Special Committe ofInternational Finance, Research Institute for Economics and Business
Administration, Kobe University which Professor Fujita serves as thechief of this committee. Especially, we do deeply appreciate for Mr.

Miyata, Mr. Ishigaki, Mr. Niwa and Mr. Izawa as our most importantworking group.
The following banks co-operated in our research. City banks; Dai-

ichi Kangyo, Daiwa, Fuji, Hokkaido-Takushoku, Kyowa, Mitsubishi,
Mitsui, Sanwa, Sumitomo, Taiyo-Kobe, Tokai and Tokyo. And Nihon
Saiken Shinyo, Japan Export Import Bank and some regional banks;

Hokuriku, Yokohama and some stock companies; Nomura, Nikko,
Yamaichi, Daiwa and many life insuraiice companies; Nihon Seimei,
Dai-ichi $eimei, Meiji Seimei. We would like to express our approciation
for their kindly cooperation.

Furthermore, we do appreciate the financial support by Grant in Aid
for Scientific Research, the Ministry of Education and Nihon-ShokenShogaku-Zaidan (Japan Securities Scholarship Foundation).

EFFICIENCY OF THE LEAST SQUARES ESTIMATORS IN

LINEAR MODELS WITH IDEMPOTENT COVARIANCE
MATRIX OF THE ERROR TERMS
Hiroshi SADAMICHII. Introduction
There are two well-known theorems on the best linear unbiased estimatgrs (BLUE)of linear models-Gauss-Markov theorem and Aitken theorem, which assume thatthe moment matrix of all the regressors and the covariance matrix of the error terms

are both nonsingular. However, discovery of pseudoinverse or generalized inverseof matrices made it possible for Gauss-Markov theorem to be generalized to thecase where neither the moment matrix nor the covariance matrix is assumed to benonsingular. [9]Under this more general set of assumptions it has been proven that the Aitken

estimators or the so-called generalized least squares estimators obtained from
replacing the inverse sign with the pseudoinverse sign (we shall call the pseudo
Aitken estimators hereafter) are no longer BLUE unless the covariance matrix is
nonsingular, and that they are not necessarily more eMcient than even the least. estlmators.
squaresIn this paper we will show that (1) the least squares estimators are more eMcientthan the pseudo Aitken estimators in the case of an idempotent covariance matrix
and that (2) the Basmann estimators may be interpreted to be the least squares andthe pseudo Aitken estimators in such models, which are also the best.

ll. The Pseudo Aitken Estimators
Consider a general linear model as follows:(1) y-XB+u

y is a vector of the dependent variable, X is a matrix of the independent

exogenous variables, and B is a vector of the parameters. u is a vector of the error

terms, which is assumed to have the mean vector and the covariance matrix given by(2) Eu==O(3) Euu'= V2=M
It is to be noted here that no assumptions are made on the rank of X and M.

HIROSHI SADAMICHI56

The pseudo Aitken estimators may be defined as(4) p -(x' w+x)+xt rv+y,where + indicates the pseudoinverse sign. For any matrix, say M, there exists sucha matrix N that satisfies the following four relations and N is called the pseudoinverseof M, denoted by M+. [1, 6](i) MNM-M(ii) NMN-N(iii) (MN)'-MN(iv) (NM)'-=NM
It is shown that N is uniquely determined. If M is nonsingular M' ==M-i. M' may

be written as (M' M)'M' or M'(MM')'.
The pseudo Aitken estimators thus defined are not BLUE in general. When W
is nonsingular, the pseudo Aitken estimators(5) P"=(XtPV-iX)+XtPV-iy
turn out to be BLUE. [1] But when PV is singular the pseudo Aitken estimators areneither BLUE nor are they necessarily more eMcient than the least squares estimators.

Now, let us impose two more assumptions:(6) PV is idempotent, and(7) X' WX is nonsingular, hence X'X is also nonsingular.
It will be shown under these assumptions that the least squares estimators are more

eMcient than the pseudo Aitken estimators.

Since Mis idempotent, M'== va. The pseudo Aitken estimators become(8) P=(X' M+X)+X' W+y == (X' MX)-iX' Wy.
The Ieast squares estimators are given by(9) P--(I'X)-'X'y.
In order to prove that the least squares estimators are more eMcient than the pseudo
Aitken estimators, it is suMcient to show that the difference between the covariancematrices of both estimators are non-negative definite.

(10) S=(X' MX)-i-(X'X)-i(Xt MX) (X,X)-i
It may be assumed here without loss of generality that X'X is an identity matrix.
If not, there exists a nonsingular matrix T such that T'X'XT=I and the estimatorsof B are BLUE if and only if those of T-'B in the transformed model given by(11) y=H(T"i3)+u,
where Hr==XTandH'H=L
The difference in (10) will be simplified to be(12) S=(X'WX')-i-(X'MX)=TD-iT-TDT'==T(D-i-D)T'.
Since X' vaX is symmetric there exists an orthogonal matrix Tsuch that I' rvX= TDT',
where D is the diagonal matrix whose diagonal eiements are the characteristic rootsof X'ifX. Furthermore, all the characteristic roots of X'WX are positive and notEFFICIENCY OF THE LEAST SQUARES ESTIMATORS IN LINEAR MODELS 57
WITH IDEMPOTENT COVARIANCE MATRIX OF THE ERROR TERMS
greater than unity. They are positive because X'MX is nonsingular and X'WX==(WX)' (MX), i.e.. positive definite. Let us define an idempotent matrix as (I- W).

Then X'(I-M)X is non-negative definite and its characteristic roots are all non-.
negatlve.

(13) X'(I- PV)X- T(I-D)T'In other words, 1-6t20, where 6i is any characteristic root of X'WX. Hence
126i. (D"i-D) in (13) is a diagonal matrix and any of its diagonal element is ex-pressed as 6t-i-6i, which is nonnegative because 1l}l6i>O. Thus, the difference
S in (13) in nonnegative definite, which completes the proof.

If PVis idempotent and nonsingular, then PV=Iand therefore the pseudo Aitken
estimators collapse into the classical least squares estimators. Even though the leastsquares estimators are more eMcient than the pseudo Aitken estimators if W is
idempotent and singular, they are not the best in general. It is to be noted that thebest linear.unbiased gstimator of B is given by the general Gauss-Markoy theorem as(14) P=- X"(I- V' V) 'y.
where V== V(I-XX') and V2 is an arbitrary covariance matrix of the error terms [7]EMciency of the least squares vs. the pseudo Aitken estimators in relation totheir underlying assumptions in the model may be summarized. in Table 1. Some
explanation is in order.

Case 1. The least squares estimators may be well defined as the unbiased estimators

given by(1 5) A-(X'X) 'X'J, =- X'y,
but when none Qf those assumptions are imposed upon X and M, the pseudo Aitken
estimators may not be unbiased.

Case 2. It is interesting to see that one single assumption of nonsingularity ofcovariance matrix may allow the pseudo Aitken estimators to be the best as well as
unbiased.
Table 1. EMciency of the Least Squares vs. the Pseudo Aitken Estimators
Which are assumed?(i)X'X

nonsingular

case

t

W X'WXnonsingular nonsingular

Which are more ethcient?(2>W

idempotent

estlmators estlmators

2

X
X

o

X
x

3

o

o

o

X

Å~

4

o

X

o

o

o

x

o

o

o

o

oo

oo

1

5

l

X

(1) O=assumed, X=-Tnot assumed

X
X

least squares pseudo Aitken

X
X

XX
oo
oo

(2) XX=::not applicable,

X=less eMcient
oo=the most eMcient,

O=more eficientHIROSHI SADAMICHI58

Case 3. If X and W are both nonsingular, then it is the case of the Aitken theorem.

Case 4. If in case 3 Wis not assumed to be nonsingular but to be idempotent, thenthe least squares estimators are not necessarily the best but more eMcient than thepseudo Aitken estimators.
Case 5. If in case 4 PV is also assumed to be nonsingular, then it comes back to thecase of the Gauss-Markov theorem. The least squares estimators are identical tothe pseudo Aitken estimators and are the best.

The Basmann estimators will present an interesting example of the intermediatecase between the cases 4 and 5, where the least squares estimators are identical tothe pseudo Aitken estimators and also the best although Wis not an identity matrix.

M. An interpretation of the Basmann Estimators
A structural equation in the simultaneous equation model may be written as(16) jv=-ZB+u,
where y is a vector of the dependent variable, Z is a matrix of the explanatory variables which include some other jointly dependent variables, and B
is a vector of the parameters. u is a vector of the error terms, and its mean vector

and covariance matrix are given by(17) Eu==O, Euu'=LLet Xbe a matrix of all the exogenous variables in the model and C=X(X'X)'-'X'.

Since Z includes some of the jointly dependent variables, it is correlated with u.

Now consider the following transformed equation premultiplied by C.

(18) Cv-CZB+Cu
In this transformed equation the explanatory variables CZ are not correlated withthe error terms Cu asymptotically. Let us rewrite Z as(19) Z=(Y.I,),
where Yi and Xi are matrices of the explanatory jointly dependent variables and of
the exogenous variables appearing in the equation. Then it is shown that(20) plim (X'I)-'X' Y= ni,
where ni is a matrix of the reduced-form parameters for Yt. Using this, we obtain(21) lim E(CZ)'Cu==lim E Z'X(X"'x)-'X'u-iim E I.Yi,ll[[IIIillllll y'u,== i(ko'i')liim Ex'u=o

The mean vector and the covariance matrix of the error terms are given as(22) ECu=O, E(Cu) (Cu)'=C

EFFICIENCY OF THE LEAST SQUARES ESTIMATORS IN LINEAR MODELS 59
WITH IDEMPOTENT COVARIANCE MATRIX OF THE ERROR TERMS
We will notice here that in the transformed equation the covariance matrix of theerror terms is idempotent and singular.
The Basmann estimators P' in (16) are given as follows. [2](23) P-(Z' CZ)-iZ' Cjv=(CZ)+ v= =(CZ)+ Cy.
It is clear from (15) that the Basmann estimators are identical to the least squares
estimators in the transformed equation (18).

The pseudo Aitken estimators in (18) may be expressed as(24) P-[(CZ)'C+(CZ)]+(CZ)'C+y-:(z'c'c+cZ)'Z'C'C'y=(Z'CZ)-iZ'Cy=-p.
It follows that the least squares and the pseudo Aitken estimators in (18) are not only
identical but also the same as the Basmann estimators. It will be also shown that they

are the best linear unbiased estimators in such a sense that they are unbiased in thelimit. To the extent that CZ is approximately independent of Cu in finite samples,the best linear unbiased estimators in (18) are given by the general Gauss-Markov

theorem as(25) P-(CZ)+(I-V+C)'Cy,
where V=C[I-(CZ)(CZ)']=C-(CZ)(CZ)'. Since V proves to be idempotent
V'=V. Substituting into (25) and using the definitional relations of pseudoinverse,

we obtain

A ==(CZ)+[I- {C-(CZ)(CZ)+} C]'Cy(26) P== (CZ)+ {I- C+(CZ)(CZ)+} Cy==(CZ)+{C-C+(CZ)(CZ)+C}y=(cz)+(cz) (cz)+ cy== (CZ)' Cy--B.
Thus, the Basemann estimators have turned out to be the best linear unbiased
estimators in (18) in the sense mentioned above.

References[1] Albert, A., Regression and the Moore-Penrose Pseudoinverse, Academic Press,

1972, New York.
[2] Basmann, R.,L., "A generalized classical method of linear estimation ofcoeMcients in a structural equation," Econometrica, 25 (1957), 77-83.
[3] Boullion, T. and Odell, P., Generalized Inverse Matrices, Wiley, 1971, New York.

[4] Kruskal, W., "When are the Gauss-Markov and least squares estimators
identical? A coordinate free approach," AMS, 39 (1968), 70-75.

60

HIROSHISADAMICHI[5] Mitra, S.K. and Rao,.C.R., ."Condjtions. for optimality and validity of simple
least squares theory," AMS, 40 (1968), 1617-1629.
[6] Rao, C.R. and Mitra, S.K., Generalized Inverse of Matrices and Its Applications,Wiley, 1971, New York.
[7] Watson, G.S., "Linear least squares regression," AMS, 38 (1967), 1679-1699.

[8] Zyskind, G., "On canonical forms, nonnegative covariance matrices and bestand simple least squares linear estimators in linear models," AMS, 28 (1967),

1092-1109.
[9] Zyskind, G. and Martin, F.B., "On best linear estimation and a general Gauss-

Markov theorem in linear models with arbitrary nonnegative covariancestructure," SiAM Journai on Appiied Mathematics, 17 (1969), 1190-1202.

DIVERSIFICATION OF LARGE JAPANESEMANUFACTURING FIRMS
Hideki YosHiHARA

1. Introduction
Purpose of the Paper

The purpose of this paper is to present some findings of our research" on diversification strategy of large Japanese manufacturing firms, and to attempt comparisonswith the case of American firms.
Research Design
The aim of our research is (1) to identify the actual state of diversification strategyof large Japanese manufacturing firms, and (2) to investigate the causes of diversification, the economic performance of diversification, and the relationship between
diversification strategy and organizational structure.

The sample is the largest 118 manufacturing firms in Japan. The period coveredby our research is from 1958 to 1973. This period roughly corresponds to the periodof high economic growth in postwar Japan.
Using Rumelt's (1974)2' method (slightly modified), each firm's strategy was
identified for 1958, 63, 68 and 73. We also computed the Herfindahl indices ofdiversification for each of these years. Each firm's organizational structure was identified

for 1963, 68 and 73. The data sources for strategy classification are the company

annual reports and the special survey conducted by Japan Economic Data Development Center. The data for organization classification are provided by Management
Research Institute, Japan Productivity Center and Kansai Productivity Center.

2. Findings of Japanese Diversification andComparison with American Diversification
Strategy Pattern

The composition of strategy types of Japanese and American firms is shown in Table
1. As for Japanese firms, an overall strategic trend is toward diversification as isrepresented by the decrease of S type (26.3 O/.->16.9 O/.) and the increase of RL typei) The other co-researchers are Hiroyuki Itami, Akimitsu Sakuma and Tadao Kagono. The
findings of our research are presented in more detail, in Yoshihara, Sakuma, Itami, and Kagono,
Diyersification Strategy ofJapanese Firms, Nippon-Keizai-Shinbunsha, 1981 (in Japanese).
2) R. P. Rumelt, Strategy, Structure and Economie PerJbrmance, 1974.

62 HIDEKI YOSHIHARA(15.8 O/,.25.40/.). But, it needs to be noticed that V type steadily increased in thisfifteen year period.

Let us compare with American firms. In the United States, the proportion ofdiversified firms increased 28.3 percent (49.9 O/.->78.2%) in twenty years and in 1969

far surpassed the proportion of non-diversified firms of S and V types. In Japan,
diversified firms increased only 3.9 percent (60.5O/.->64.40/.) in fifteen years. Thus,

compared with American firms, Japanese firms were much slower in their diversification moves, and far behind in the attained level of diversification. The differenceof tempo in diversification moves of Japanese and American firms is clearly represented in Figure 1, which graphicly presents the data of Table 1.

The direction of strategic moves of Japanese and American firms is shown in
Figure 1. Comparison between Japanese and American Diversification(A) Japanese Firms (B) American Firms
1oo9o

1oo9o

U

RL

RL

RC

RC

L

DL
DC

509fo

soqo

DC
v

v

s
09o

09o

'63 '68 73 l949
Notes : This figure is based on the data of Table 1.

'59

1958

'69

Table 1. Strategy Composition

Å~ Yearxx\t,r,a,tedy

1958

1963

1968

s

30 (26.3 e/.)29 (24. 6 0/.)23 (19.5O/.)v

IS (13.2)
17 (14.9)

18 (15.3)
t3 (t1.0)

22 (18.6)

7 ( 6.1)

7 ( 5.9)

17 (14.9)
18 (15.8)
10 ( 8.8)
114 (1oo.O)

23 (19.5)

DC
DL
RC
RL

U

Total

1973

U.S.A.

U.S.A.

U.S.A.

(1949)(I959)(1969)

20 (16.9 0/.)22 (18.6)
13 (11.0)

34.5O/.

16.20/.

I5.7
18.0

14.8

6.2O/.
15.6

16.0

7.1

8 ( 6.8)

1.8

6.4

6.5

17 (14.4)
30 (25.4)

18.8

29.1

10.9
100.0

21.6
23.6
19.4
1oo.O

# of firms(peroentage)

19 (16.1)

12 (tO.2)
10 ( 8.5)
17 (14.4)
26 (22.0)

9 ( 7.6)

8 ( 6.8)

8 ( 6.8)

7.9
3.4

118 (1oaO)

118 (joo.o)118 (1oo.o)

1oo.O

Notes: To compare with Japanese data, Rumelt's DLU is combined into DL. and
DV is shown as V.

6.5

DIVERSIFICATION OF LARGE JAPANESE MANUFAcrURING FIRMS 63
Table 2. Compared with American firms, the strategic moves of Japanese firms arecharacterized as (1) more active in venical move and concentration move, and (2)less active in diversification move. This feature of Japanese strategic moves is moreevident in the data of Table 3, in which the CL-classification is used. According tothis classification, among the strategic changes involving DC, DL, RC, and RL,

only the changes which involve changes in C and L (DC-->DL or RC.RL) are
identified as the diversification move. Thus, this classification is a more severe
standard in identifying diversification move. As it is shown in Table 3, in the ten

year period of 1958-68, the venical move and the concentration move of Japanesefirms amount to 13.2 percent, and surpass the diversification move (12.3%). On theother hand, in the case of American firms of the ten year period of 1959-69, thestrategic changes were mostly the diversification move, and the venical move andthe concentration move were only small percent (3.5IZ.1 and O.4%.).

To sum up, the diversification moves of Japanese firms were less active than
American firms. It is our reasoning that this relative inactiveness in diversification ofJapanese firms was a rational response to higher growth rate of Japanese economy.
Japanese firms were able to grow within their existing business fields. It is ourestimation that fu11-scale diversification moves of Japanese firms are now under way
Table 2. Directlon of Strategic Moves"s..

xperiod' -"'"'s.

U.S.A,

Japan
19S8-68

1963-73

1949-59

19S9-69

No move

64.1O/.

62.6e/.

2.1

Concentration move

8.8
9.6

712e/.
5.1

73.7%

Vertical moye

S.9

O.7

Diversification moye

17.5

17.8

'23.5

3.5
2.7
31.2

moves

X- x-

--x"-

Notes:
Vertica1 move: move to V
Conoentration move: move to a less diversified type
Diversification move: move to a more diversified type

Table 3. Directlon of Strategic Moves (dnlassification)

Å~! --..xt x.

moves

No MoveÅ~

Vertica1 Move
Conoentration ,Move
Diversification Move
Notes:
CL-classification:

C=DC+RC
L==DL+RL

U.S.A.

Japan

period1958-68

1963-73194S}--59

1959-69

74.5O/.

so.se/.

74,1O/.

65.8 e,i.

8.8
4.4

5.1
2.5
11.9

2.1

3.5
O.4
30.3

12.3

V, S, C, L, U

O.7
23.1

"

HIDEKI YOSHIHARA

as the growth rate of Japanese economy has substantially slowed down since theoil crisis in 1973.

Causes ef Diversifieation

In investigating causes of diversification of Japanese firms, the following eightvariables were examined in our analysis: (1) industry growth, (2) concentration ofindustry, (3) change of concentration of industry, (4) size of firms, (5) financial
resources of firms, (6) research and development expenses of firms, (7) advertisingexpenses of firms, (8) performance gap of firms.
Our quantitative analysis tells us that the diversification moves are significantly

related with the following three variables: (1) slowdown of growth ratg of industry,(2) negative profitability gap, and (3) high density of research and development
expenses. The first two variables represent the necessity of diversification, and thethird variable represents the resources for diversification.

Comparison with American firms is not possible since the causes of diversification are not treated in Rumelt's study.
Economic Performance of Divershication

Firstly, let us compare economic performance of Japanese and American diversification. As for profitability (ROC or ROE in Table 4), Japanese and American
firms share similarity. Profitability is high at DC and RC, and low at V and U. The

pattern is convex both for Japanese and American firms. But, growth performance(GSL or GER) significantly differs between Japanese and American firms. As for
American firms, growth performance is also good at DC and RC, and poor at V and

U. Thus, in the case of American firms DC and RC are best performers of bothprofitability and growth, and V and U are worst performers of these two measures.
As for Japanese firms, DC is not so good in growth performance. Low diversification

strategy types of V, S, and DC are relatively poor in growth performance, and highdiversification strategy types of RC, RL and U are relatively good in growth performance. Thus, in the case of Japanese firms, degree of diyersification seems to belinearly related with growth performance (This relationship is to be treated later inthis paper.) To Japanese firms the diversification strategy simply was a growthstrategy.

Next, let us control non-strategy variables and examine net effect of diversi-

fication strategy on economic performance. The result of regression analysis ispresented in Table 5. Profitability performance is high at DC and DL, and low at
V, RL, and U. The Pattern of strategy effect on profitability is convex. The convex

shape of profitability performance is identified in our different analyses using
Herfindahl diversification indices and metric strategy variables, and pair-wise com-

parison by ANOVA.

DIVERSIFICATIONJAPANESE
OF LARGE
FIRMS
MANUFACTURING
Table 4.

65

Comparison of Japanese and American Performances(Data in deviations from the overalt mean)

X Perform-

ROC

ROE

GSL

.GER

Japan U.S.A.

Japan U.S.A.

Japan U,S.A.

Japan U.S.A.

-2.24
O.57
4.28
-O.88
2.67
-1.14
-2.26

-2.28
O.29
2.l9
-1.83
1.45
-o.op
-1,12

-L79
1.08
1.50
1.49
1.77
-O.89
-1.67

-2.46
O.56
2.27
-2.36
1.47
-O.36
-2.26

-1.76
-O.99
-1.36
O.87
2.55
1.25
O.14

Overall mean

13.13

le,52

10.78

12.64

14.59

-2.91
9.01

Significancelevel of F-test

O.03

O.oo1

O.1

O.oo5

O.02

O.05

Å~.. •ance

Strategyil.))))>>....

v
S

DC
DL
RC
RL
U

Correlation

between two

O.92a

O.65c

-1.59
-1.84
O.47
-2.08
O.61
-O.95

11.56

-1.38
-3.91
O.36
-O.62
1.67
-1.57
-O.94
8.72

O.Ol

O.1

-O.25

-5.14
-O.Ol
-1.56
3.18
3.05
1.17

O.24

O.71b

Notes:

1. Performance: ROE and GSL are defined similarly for both Japan and USA.
Definitions of ROC and GER for U.S.A. are on an after-interest and after-tax basis,

Risk measures are not comparable and omitted.
2. Strategy: Sinoe there is no conglemereate in Japan, its category is omitted here
for USA. Sample firms are those which remains in each strategy category for theperiod, for both countries.
3. Period and Sample : 1963-73. , 1 12 firms (6 firms were excluded due to data problems)
4. Definition of performance variables;

ROC: Return on investment, (net income before interests and tax)/(Total
Capital-Non-interest-bearing current liabilities), 10 year average
ROE: Return on equity, (net inCome after tax)1(net worth), 10 year average
GSL: Growth of Sales, measured by a time-series -log-linear regression for

63-73
GER: Growth of Operating Eamings, measured similary as GSL

The pattern of growth performance is rather different, The good performers
are high diversification strategies of RL and U, and poor performers are low diversification strategies of V and S. Thus, growth perforMance seems to be linearly relatedwith the degree of diversification. This linear relationship is nearly identified in our
analysesS).

Our findings of strategy effect on economic performance may well be summarized
in Figure 2. Strategies of low diversification are worst both in profitability andgrowth. Strategies of medium diversification are better in profitability than strategies

of high diversification, and vice versa in growth performance, Thus, a kind of tradeoff relationship exists between profitability and growth.

Comparison with American firms is not possible since Rumelt does not examine
net effect of strategy on economic performance.
3) See pp. 149-152 of our Japanese book.

HIDEKI YOSHIHARA

66

Strategy and Structure

There were twenty S type companies in 1973 and.
percent of thesenlnetydiversified companies(Table 6). On the otheradopted functional structures
Table 5.

nonhand,Regressions with Strategy Dummy(t-values in parenthesis)

XPerformance
Variables Å~

ROC

ROE

GSL

GER

XG

-9.085
O.195-13.393
O.274b

-4.443O.56oa-12.631O.642a(1.38)(2.34)(4.99)(2.93)

Xg

1.308b

1.425a(3.36)

O.722c(1.77)(1.92)

O.227-O.053c

Constant(2.56)O.O19

Xc(O.98)

XR

XA
Ys
YDc

YDL
YRo

O.068

(O.14)

1.373aO.023(1.43)

O.813b

(1.51)

O.060

1.523c(1.79)

1.oo7(2.11)(O.16)(1.40)

O.499a-O.138-O.380O.030-5.516a(6.58)(2.88)

O.970

1.586

(O.83)(1.17)(O.74)(1.46)(o.oo)

3.549b

2.985b

(2.28)(2.30)

O.544
(o.")

(1.20)

1.e74-O.358(O.77)(O.13)

2.045

2.444c(1.17).

(1.68)

1,216(O.82)-O.033(O.03)

O.320(O.27)(2.71)

2.903-1.857(O.80)

YRn-O.044O.115

1.655c(O.03)

2.020(O.12)(1.79)(1.12)

Yu-O.113-O.1oo1.310(1.oo)(O.54)

R2

O.406

O.288

O.265

O.206

(O.07)(O.07)

Notes :

1. For performance yariables, see notes of Table 4.

2. Period and sample: 1963-73, 112 firms
3. Control Variables for environmental and other factors
XG: Industry growth, defined as the weighted average of the growth rates ofthe shipments of each 3-digit industry in which the firms has sales. Weights
are the firm's sales composition peroentages.
Xg: Size of the firm's sales (natural logarithm is taken) in 1968.
Xc: 3-firm concentration ratio of the fum's principal industry in 1968.
XR: Average ratio of research and development expenses over sales for l968-73.
(Data availability limited the period of calculation)
XA: Average ratio of advertizing expenses over sales fOr 1963-73.
Zt : Science industry dummy, 1 for a science industry firm, O for a non-science
industry firm.
Zc: Consumer industry dummy, 1 for a consumer industry firm.
4. Strategy Variables

Yi (i==S, DC, DL, RC, RL, U): Dummy variables for strategy type in 1973.
All Yi's are zero for V firms.

1.386

DIVERSIFICATION OF
JAPANESE
FIRMS
LARGE
MANUFACTURING
Figure 2.

Diversification Effeet on Profitability and Grewth

performanoe levelhighgrowthprofitability

lowmedium high degreeof

low

Table 6.

diversification

Relationship between Strategy and Organization

Å~9rsganization

Strategy X

Functional

Functional-withsubsidiaries

Divisionalsls (go.oo/.)o (o.o)2 (IO.O)v

8 (36.4)

5 (22.7)DCDL

6 (46.2)
3 (37.5)

9 (40.9)
3 (23.1)

RC
RL
U

Total
(# of firms)

1 (12.5),

2 (25.0)
3 (17.6)
3 (10.0)
1 (12.5)

4 (30.8)
3 (37.5)
7 (41.2)
22 (73.3)
6 (75.0)

48

21

49

7 (41.2)
5 (16.7)

Notes: Strategy and organization are as of 1973.

nearly three fourths of twenty-eight highly-diversified companies (RL and U) had
divisionalized structures. For the companies of medium degree of diversification andV type companies, organizational structures were rather evenly distributed among
three types of organization.

Next, let us examine the relationship between strategy and structure using the
Herfindahl indices of diversification. As it is shown in Table 7, the Herfindahl indices

are Iowest for the firms having functional structures, and highest for the companiesof divisionalized structures. And the indices of the companies having the structureof functional-withJsubsidiaries fall between these two cases.
The above examination tells us that degree of diversification runs parallel with

degree of adoption of divisionalized structures. Thus, it may well be said that67

HIDEKI YOSHIHARA

68Tab}e 7. Herfindah] Index of Diversification of OTganization Types

X----x.
Year
xx
Organization S-"L"''x-s-x-s------s.

1963

1968

1973

Functional

26.6

23.3

24.8

Functjonal-wjth-subsidiaries

38.7

41.5

Divisional

57.6

57.1

41.0
56.7

Overall mean

37.5

38.4

40.5

F-ratio16.856E

36.084a31.191aNotes:
1. Henindahl Index of Diversification (DI) is (1 -1/S} pei) Å~ 1oo, where Pi represents

i=1

the ith business of each firm identified by the throe-digit standard commodity
classification.
2. a: significant at 1O/, levelstructure followed strategy in Japanese firms, too.

Let us compare Japanese structures with American structures. While more than
three fourths of American firms had divisionalized structures in 1973, only one thirdof Japanese firms adopted divisionalized structures. In ten years from 1959 to 1969the proportion of American firms with divisionalized structures increased nearly
thirty percent (49.7O/.--e,77.00/.). On the other hand, the proportion increased only

thirteen. percent (28.8%--)41.5%) in the case of Japanese firms from 1963 to 1973.
Thus, the speed of adoption of divisionalized structures by Japanese firms was muchslower than American firms, and the attained proportion of this organizational
structure was much less in Japanese firms. And it is our reasoning that this slower

spread of divisionalized structures among Japanese firms was a rational responseto their strategic behavior. As it was already mentioned in this paper, diversification

moves of Japanese firms were less speedy than American firms.
Finally, let us investigate organization effect on economic performance. Is
fitness between strategy and structure related with better economic performance?
The result of regression analysis shown in Table 8 tells us that fitness between
strategy and structure is not necessarily related with better economic performance.

The regression coeMcients of the variables of OC (Over-Centralization) and OD(Over-Decentralization) are mixed with the positive and negative signs, and mostof their t values are below the significance level.

The result presented in Table 8, however, suggests an interesting fact. As forthe profitability performance (ROC and ROE), the variable OC has larger coeMcients

than the variable OD, and vice versa for the growth performance (GSL and GER).
It is our hypothesis that overcentralized organization has a positive effect on profit-

ability, and that over-decentralized organization is good to improve growth
performance.

DIVERSIFICATION OF
JAPANESE
FIRMS
LARGE
MANUFACTURING
Table 8.

69

Organization Fitness and Economic Performance-Regression Analysis-

XPerformance

A

B

xx
Å~..

Variables Å~

ROC

GSL

ROC

GSL

Constant-14.203-5.19'9

XG

O.252c1.569E

O.568aO.771c-5.340O.581aO.026-O.oo2
1.522a
1.243

O.022
O.051
-O.131
O.075

3.359b
1.381

1. 208

oc
OD

O.028
O.435
2.048c1.302

O.242
1.663c
1,332-O.188O.567-7.597
O.199
1.097b
O.028-O.044
1.449a1.130
3.355b
2.813
2.254
O.690
O.535
2.076
-1.057

R2

O.418

O,255

O.484

Xs
xc
XR

XA

Ys
Ypc
YDb
YRc
YRL
Yu

O.720

O.9"

O.715eO.028cO.Oll-O.op5
O.184
O.075
1.IOI
O.465
1.983b
1.587
1.728
O.292
O.353

Notes:
1. 0C: Over-CentralizationOD: Over-Decentralizatiqn
2. 0rganization fitness with strategy is identified in the two ways. ln Panel A, discrirni-

mant analysis is used, where dependent ,variables are orga. nization types and•independent variables are (1) DI, (2) Xs, (3) Xc, (4) XR, (5) XA and (6) Xd. ln Panel
B. an a priori judgement is used as follows.

Organjzation

F

Strategy

F+S

D

OD

OD
OD
OD

S

V

DC

oc

DL
RC
RL
U
oc:
OD:

•oc

oc
oc
oc

oc
oc
oc
oc

Over-Centralization
Over-Decentralization

3. Significance level

a:1%, b:5%, c:

10%We are not in a position to compare with American cases
effect on economic performance is not treated in Rumelt's study.
3. Conclasion
Overview of Findings

Basic findings of our research may be summarized in Figure 3.

since organization

HIDEKI YOSHIHARA

70

Figure 3.

Overview of Findings on Japanese Diversification

Competition

Industry Growth

el
t

o

l
l
l

Growth Potential
in Existing Industry

e

I
NI

e N5.

Gap inIt@

Growth Goai

i

s
tl

Growth Performanoe

o

e

t

7Å~
il
tt

Divisionalization

ll

e

e

diNNN ttt

e

e

R&D

Advertising
lt

Å~. e
SNX

e

e

I

e

t

s

N

Corporate
Resouroestt'

Diversification

'

'
'

eore
o
Gap ineProfitability

PerformanoeeeProfitability

Goal
Notes :

1[ ll : decision variables of managementl land ll il : variables directly treated in our analysis( ) : variables not directly treated in our anaiysis--------- : relationship directly or indirectly identified in our analysis. : hypothetical relationship not identified in our analysis

e, e : relationship is positive (+) or negative (-)

Three variables are identified as the causes of diversification. The first one isslowdown of growth of industry. This is indicated in Figure 3 by the line with arrowfrom `industry growth' via `growth potential in existing industry' via `gap in growth
goal' to `diversificationl. The second cause is the high density of R & D expenses.
This is indicated by the line with arrow from `R & D and advertising' via `corporate
resources' to `diversification'. The last cause of negative gap in profitability is shownin Figure 3 by the line with arrow from `gap in profitability goal' to `diversification'.

The findings of the strategy effect on economic performance and of the relationship between strategy and structure are represented in a similar manner in Figure 3.

71
DIVERSIFICATION OF LARGE JAPANESE MANUFAcrURING FIRMS

Thus, this figure represents an overall view of the findings of our research on thediversification of Japanese firms.
Zigzag Model of Strategic Behavior

As mentioned earlier, a kind of trade-off relationship exists between diversificationand economic performance (see Figure 2). High diversification strategy is optimum
for growth performance, but behind medium diversification strategy with respect toprofitability. On the other hand, the medium diversification strategy which is bestfor profitability sacrifices growth performance to some extent. This trade-off relation-

ship suggests an interesting hypothesis concerning strategic behavior. When thefirst priority is given to growth rather than to profitability, then firms would pursue

stretched-diversification (relative to their resources and environmental conditions).

On the other hand, in situations where profitability is given the first priority,
restrained-diversification would be pursued. Firms pursue either stretched-diversi-

fication or restrained-diversification depending upon the goal priority. And firms
might attain a long-term prosperity by carefu11y switching between these two modesof diversification. In short, a zigzag mode of diversification might be optimum inthe long run.

A similar argument may be applicable to organizational response to diversi-

fication strategy. As mentioned earlier, over-centralization surpasses overdecentralization for profitability, and vice versa for growth. It might be that firm'sorganizational response is also zigzag in the long run.

Thus, our findings suggest a zigazag model of strategic behavior.

INDEXING POLICIES AND MACROECONOMIC STABILITY
IN BRAZIL: RATIONAL EXPECTATION MODEL
Shoji NIsHIJIMA

1. introduction

Indexing policies have played an important role as a macroeconomic stabilization
policy in many countries and it is well-known, Brazil is the typical country wheresuch policies have been widely adapted in various areas since the 1960s. Even in
Brazil, however, there has been no common understandings as to their effectiveness on
stabilization. Particularly after the First Oil Crisis, Brazi1 has experienced substantial
instabilities of inflation and growth rates in spite of the existences of almost complete

indexing policies regarding to exchange rate, wage adjustment, interest rates, etc.
In order to understand the roles of indexing policies, this paper develops a stochastic

macro model that analyzes their effects on price and output varianee. The secend
purpose of the paper is the empirical study of the Brazilian economy, in which wetest the "random walk" hypothesis derived from the model.

The model treats three aoeommodating policy rules: the money supply rule,the exchange rate rule and the wage adjustment rule. "Accommodation" implies
that the authorities set nominal variables according to changes of prices. In the caseof fu11 accommodation, these variables are held constant in real term. An accommodating policy, in general, can eliminate relative-price changes and work todiminish variances in real side. However, when we consider explicitly the stickinessof wage adjustment which is caused by the lagged wage indexing rule andlor theimported intermediate goods which affect both the demand and supply side, we haveto correct the general story. From the experiences of the Brazilian economy, in which

there have been an explicit lagged wage indexing rule and serious impacts of oil
crises, we intend to reflect these two points in the model.

Taylor [6] has developed a macromodel of sticky wage adjustment in the senseof long-term overlapping contracts (not in the sense of lagged wage indexing rule),

where disturbances have effects on the stability of output and price. Dornbusch[4], [5] demonstrated, in the extended Taylor model, that the PPP exchange rate
rule affects the output-price stability trade-off through two channels. The PPP ruletends to maintain the real exchenge rate constant, therefore stabilizing demand. On

the other hand, devaluation of the exchange rate by the PPP rule affects costs andprices through the domestic currency costs of imported intermediate goods. When

74

SHOJI NISHIJIMA

there is a wage disturbance, its impact on prices will be enforced by this second
channel.
This paper presents an extension of these models, including three accommodating

policy rules of money supply, exchange rate and wage adjustment rate. These rules

are specified that the authorities execute them using their expected price andinflation rate for the present period, under a rational expectation formulation.
An another extension is the explicit introduction of the Lucas type supply function
and the wage indexing rule. In such a model setting, we investigate the role of theaccommodating policy rules to stabilize price and output, focusing on the effects ofstochastic variables on the variances ofprice and output. Finally we test the "random

walk" hypothesis of prices applied to the Brazilian economy. In the case of full

aocommodation, the model demonstrates that the deviations of prices from theirlong run trend follow a "random walk". Using inflation rates as a proxy, Brazilian
case was most significantly estimated.

2. The Model
The model is composed of two basic equations; the aggregate demand function andthe aggregate supply function. The former is derived from the standard IS-LM modeland the latter is based on the Lucas type supply function. The policy rules are
specified that, under the assumption of the rational expectation formulation of theauthorities, the money supply and exchange rate are adjusted according to expected
price levels and the wage adjustment rate is determined by expected rates of inflation.

In this setting, we analyze the policy rules as stabilization policy, mainly from thepoint of their impact on convergence speeds of the system and on variances of prioeand output.

We now begin with the demand side. The aggregate demand function is derived
from the equilibrium condition ofgoods and money markets through the equilibrium
interest rate, expressing the relation between the planned demand for goods and theprice level. The equilibrium conditions for the two markets are given respectiyely:
m/p --f (y, i)

y=h (y, i, elp, g),where, the notations are as fo11ows; m: nominal money stock, p: price level, y: real

output, i: nominal interest rate, e: nominal domestic currency price of exchange
rate, g: fiscal expenditure, and all variables are dated at period t, but without attached"t" , throughout the paper.
Assuming the usual sign of the partial differencials of these equations from thestandard IS-LM model, we obtain the following equation expressed in logs (fromnow on all variables are in logs):

75
INDEXING POLICIES AND MACROECONOMIC STABILITY IN BRAZIL:RATIONAL EXPECTATION MODELy-a(m-p)+b(e-p)+cg
a, b, c>O.
The aggregate demand depends on real money stock, real exchange rate and realfiscal expenditure. A rise in the real money stock reduces the interest rate and rises

the investment demand. A real depreciation of the currency causes shifts in demand
from forejgn goods to domestic goods so far as satisfies the Marshall-Lerner condition. Real fiscal expenditure is assumed to be determined exogenously, independentof the policy rules mentioned in this paper,

The authorities determine nominal money stock and nominal exchange rate ofperiod t according to the rules specified as:

m=ap", O-<-a$1
e=Bp", O-<-B$•1.
Where, p' denotes expected price level for period t formulated by the authorities

at the end of last period t-1. The coeMcient a and B measure the extent to whichthese rules are aoeommodating. Unit value (a==1, B=1) implies the case of ful1
accommodation, in which real money stock and real exchange rate are held constant,maintaining real demand stable. The case of B=1 implies the PPP rule. Substituting
these rules into the demand equation, turns out the equation:p==-(a+b)p+(aa+bB)p'+cg+e. (1)Where, s denotes random variable, assumed white noise: E(e)=O, E(ee,.k)==O,
E(e2)= o!2. In the context of the Brazilian economy, e represents unanticipateddisturbances deviated from the policy rules: stochastic changes in money supply
caused, for example, by unanticipated inflow and outflow of foreign reserves andirregular devaluations of exchange rate called "maxidesvalorizagao". Needless to say,could be included unanticipated changes of exports and fiscal expenditure.

Figure 1 might help us to understand the implications of equation (1). Let's
assume, for the convenience, that the difference between the expected price p* andFigure 1

a=B=1

p

a<I

fi<1

o

dj

7

SHOJI NISHIJIMA

76

the realized price p is only random variables (this oocurs under the assumption ofrational expectation, as we see later). Figure 1 depicts the demand curve omitting
random variables :y= -ep+cg
where, e== a(1 -a)+b(1 -B).

If a and B are less than unity (O<a<1, O<B<1), the demand curve is downwardsloping to the right with the intercept cg. A rise in price lowers real balance andappreciates real exchange rate, inducing a rise in interest rate and a shift in demand

from domestic goods to foreign goods, that is, a fa11 in demand and output. On theother hand, in the case of fu11 aocommodation (a= B==1, then e becomes zero), thedemand curve stands vertically, where demand is held constant indifferent of price.

Therefore, the more accommodative are the rules, the more becomes demandinsensitive to price changes.

We now turn to the supply side. Supply prices are determined by wage costs
and the costs of imported intermediate goods through the mark-up principle. Withthe terms of cost share (Åë, 1-Åë), the price equation is written in growth rates:

P-p..i=Åë(w--w.t)+(1--Åë)(e-e-i), O=<Åë$1, (2)where, w denotes nominal wage rate. The domestic price of intermediate goods is
given at their exchange rate, because we assume that the foreign price of these goods
is unity. Substituting the exchange rate rule into the price equation, we get:P-P-i=:di(M,-W-i)+(1-Åë)B(p*-p-,*). (3)Notice that the expected price of period t-1(p-i") is formulated at the end of periodt---2, so p-i' is a known variable at the end of period t- 1.

Suppose that the wage adjustment rate is determined by both the wage indexing

rule and the market condition. The wage indexing rule is specified so that theauthorities detertnine the wage adjustment rate according to the rationally expected

inflation rate for period t formulated by themselves at the end of period t-1. The

market condition follows the so-called Okun law. Combining these adjustments,
we specify the inflation rate of wage as follows:

w-w-i=r(p"-p.i)+q(y-Y), OSr$1,OSq,
where, Y denotes the normal output level and r measures the extent to which thewage rule is accommodating.
Substituting the wage adjustment equation into equation (3), we get the aggregate supply function with a random variable:
p -p-i= : [Åër+(1 - di)B] (p" -p-t) +Åëq(jv-Y)+(1-Åë)3(p-,-p-,*)+u, (4)The random variable represents supply shocks such as unanticipated wage disturbances deviated from the wage rule, changes of the foreign currency price ofimported intermediate goods and climate conditions, etc. We assume white noise

INDEXING POLICIES AND MACROECONOMIC STABILITY IN BRAZIL:
77
RATIONAL EXPECTATION MODEL
Figure Z

B=7=l

p

B<I

X 7<i
-ttvt

-C-

- '

t

t '

'

t-

'

-t
-t
tt
'B
tt
..
../
-t
'
ttv/-/'
--tA
!t
tt-

o

j

'y

process and the absence of correlation among the random variables.
Figure 2 reveals the implications of equation (4). As well as in the case of thedemand curve, we assume that the difference between p..t and p-i* is only randomvariables to simplify the matter. Then, we obtain the following equation:p -p-i- [ipr+(1 - Åë)B] (p" -p-i) +Åëq7(y-V).
This supply curve is depicted in lilgure 2, where the random variable u is omitted.

The dotted line shows the short-run supply curves which have different expected
infiation rates and the straight line shows the long-run supply curves with the different

extent of accommodation of the exchange rate rule and the wage rate rule. If theparameters B and r are less than unity, the coeMcient ofP'(iiip"-p-i) is also lessthan unity. Therefore, the long-run supply curve which is defined by P=P', shouldpass through the points A, B and C along the upward-sloping line to the right. In
other words, so far as B<1 and r<1, a rise in price reduces real wage and real costsof imported goods, inducing a rise in output. On the other hand, if the two rules are

fu11y accommodated (B=1 and r=1), the long-run supply curve turns to a verticalone. In this case, the world of the natural rate hypothesis appears and the supply
curve becomes identical to the Lucas type. It is apparent that the more the rules areaccommodative, the less the change of output is responsive to the change of price.

3. Rational Expectations
So far, we assumed that the authorities execute the policy rules in accordance with

their expected price and inflation rate. Now, we assume the rational expectation
formulation where the authorities have total current available informations about

the macroeconomic structure, and their own expected price js equal to the mathematical means of prioe. That is:SHOJI NISHIJIMA

78

From equation (1) and (4), we derive the reduced form of the price equation:[1+(a+b)Åëop]p=(1-Åër)pmi-(1-Åë)Bp.i*+[Åër+(1-Åë)B+Åëop(aa+bB)]p*+Åëq(cg-P)+Åëqe+u.
Getting the conditional means of both sides of the equation, given the total informations available to the authorities at period t-1, we obtain the rationally expected
price of period t:

E(p) =6ip-i-62p-i"+6s(cg-P)
where, 6i-(1-Åër)/[1-dir-(1-di)B+Åëdi]62-=(1-Åë)Bl[1-Åër-(1-Åë)B+Åëqe]63=Åëgl[1-Åër-(1-Åë)B+Åëope]e-=a(1-a)+b(1-B).
Then, the realized price of period t is given by substituting E(p) into the reduced form

equatlon:

p== 6ip-i-62p-i'+63(cg-P)+[Åëop!r]e+[1/r]u (6)where, r= 1 +(a+b)Åëop.
Comparing p and E(p), therefore, it proves that the realized price is equal to therationally expected price and the random variables:p- E(p)+[diop/r]e+[1/r]u. (7)For the analysis of the long-run equilibrium in the next section, we get the difference

equation of realized price by using the following relations. As long as we assume therational expectation, the relations in equation (5) and (7) are also satisfied at periodt-1:
E(p-,)=p-i*
p-i=E(p-t)+[Åëg/r]e.t+[1/r]u-i.
From these equations, it is apparent that the difference between the realized pricein period t-1 and the expected price for period t-1 is only random noise:p-i=p-i"+[Åëoplr]s-i+[11r]u-i.
Substituting the above relation into equation (6), finally we get the difference equationof the realized price :p=6`p-i+a3(cg-j))+[g5q)/t]e+[62g547fr]e-i+[11T]u+[621r]u-i

where, 64=[1-dir-(1-di)B]1[1-Åër-(1-Åë)B+diqe]. (8)Now we turn to real output. Appling the same process, we can derive therealized output under the assumption of the rational expectations:

y=-e64pri+e63I+64cg+[1/r]e-[(a+b)/r]u-[62ediqlr]e-i-[62elr]u-i. (9)The effects of the policy rules on output is clear and note-worthy. In the case of fu11

accommodation in the supply side (B== r=1.), from 04==O and 03=11e, the realized
output depends only upon the normal output level and random variables:y==Y+[1/r]e-[(a+b)/r]u-[62eÅëqlr]e.i-[62e/r]u-i•

INDEXING POLICIES AND MACROECONOMIC STABILITY IN BRAZIL: 79
RATIONAL EXPECTATION MODEL
Hence, one of the standard implications of rational expectations appears: in thiscase, it can be said that discretionary (fiscal) policy is neutral to real output even in

the short-run. It is apparent that fu11 accommodation excludes stickiness in wage
adjustment, arising vertical short-tun supply function. Notice, however, that (i) the

exchange rate also should be fully accommodated since we introduced imported
intermediate goods as one of the cost factors, and (ii) price and output might beindetermined when the three rules are fully accommodated at the same time. On thecontrary, as far as B and r are less than unity, the fiscal policy has effects on output

in the short-run and furthermore the authorities can control the power of the fiscai

policy by changing the extent to which 3 and r are accommodated.
On the other hand, in the case of full accommodation of the money supply andexchange rate (a= B=1), from e==O and 64=1, output depends upon only fiscal
expenditure and the random variables:

y==cg+[11r]e-[(a+b)/r]u.
This case implies that the demand curve stands vertically and output is demand-

determined, completely neutral from supply conditions except the random noise.
However, be aware that this random term includes the noises which have their origin
in the supply side. In this sense, strictly speaking, full accommodation in the demandside can not completely eliminate the factors in the supply side (vice versa in thecase of fu11 accommodation of the supply side).
For the Iong-run analysis, subtracting p.i, we can rewrite equation (9) in termsof a difference equation ofy as:

y=6`y-i+e6sP+[1/r]s-[(a+b)/r]u-[6`(1+eÅëq)/r]s-i+[6`(a+b-e)lr]u-i. (10)
4. Long-Run Analysis
This section analyzes the impacts of the rules on price and output in the long-run.
First, we derive a long-run equilibrium solution. If there exsists stable solution, long-run equilibrium solution is expressed in terms of mathematical means. Getting theunconditional means of equation (8) and (10), we derive the long-run solution ofprice and output:

E(p)==(cg-y)/e
E(y)--Y
where, E( ) denotes unconditional means.
It is worth mentioning that the long-run price movement is affected by the accom-

modating ru!es: the money supply and the exchange rate rule. With more accommodation, the multiplier becomes smaller, that is, the price trend turns out higher

as far as cg>P, impling a inflationary spiral of accommodation, whereas r has no

SHOJI NISHIJIMA

80

affect at all. As expected, the output trend is equal to the normal level which isdetermined by exogeneous factors completely independent of the accommodating
rules.

Now we turn to the analysis of deviation from long-run equilibrium. Let's define
the deviations using long-run solution:

P-p-E(p)V -y-E(y)g=e-E(e)fi=u-E(u).
From equation (8), we get the price equation in terms of deviation:

P==6`P-i+[Åëg/t]E+[62Åëqlr]g-:+[11r]ti+[621r]fi.i. (11)
If the characteristic root of the homogeneous part of the equation is smaller thanunity in absolute terms, a steady state solution exists and P has stochastic move-ments around E(P)==O with a certain variance. The characteristic root of thehomogeneous equation is given as:p=6`==[1-Åër-(1-di)B]/[1-Åër-(1-Åë)B+ÅëÅëe]and as far as O<B<i and O<r<1, O<p<1 is satisfied. And the asymptotic varianceofP following ARMA (1, 1) is:E(P2)=[1 + (p+6t)2/(1 - p2)] {[Åëqlr]2a,2 +[1 /r]26.2} .

With regards to output, we can derive the steady state solution using the sameprocess:

Y=pY-i+[1/r]e--[(a+b)/r]fi-[6,(1+eÅëq)lr]g.i+[64(a+b-e)lr]fi-i (12)E(Y)=-O

E(Y2)= {[11r]2+[peÅëop/r]2/(1 -p2)} o,2+{[(a+b)/r]2+[pelr]21(1-p2)}o.2.
After the above preparations we now investigate the effects of the accommodating
rules focusing on p and asymptotic variances. Since characteristic root p implies a

convergence speed from some deviated point to the steady state, p indicates theextent to which deviation is persisting. Hence, considering that a higher absolutevalue of p means a slower convergence speed, we understand that a higher value ofp has a more persistent effect of disturbance on output and price, that is, the economy

is more instable. The question then arises whether the accommodating rules ac-

celerate or decelerate the convergence speed. We get, therefore, the partial
differencials of the three rules on p:

Op/Oa>O, Op!OB><O, OplOr<O.
Each rule has different effects on p. With a more accommodating money supply,
the real money stock becomes less sensitive to a price change. Hence, if the economy

has an excess demand, for example, price should be adjusted to a greater extent in

INDEXING POLICIES AND MACROECONOMIC STABILITY IN BRAZIL: 81
RATIONAL EXPEcrATION MODEL
order to clear the excess demand. On the other hand, a higher accommodating wage
rule induces a lower value of p and rises the convergence speed. Since more accommodation reduces stickiness in the wage adjustment, real wage rises more quickly,
so.that the excess supply, for example, might be cleared by a lesser price change.

With regards to the exchange rate rule, whether a higher accommodation rises orlowers the persistence of the disturbance, depends on the relative extent of twochannels in the demand and supply side. The sign Op/OB depends on:

bÅë(1-r)-a(1-a)(1-Åë),where a greater share of imported goods in costs (smaller value of di) tends to makethe sign negative. Needless to say, when we ignore the imported intermediate goods,

the exchange rate rule operates only in the demand side, and its effect on p
is exclusively positive.

We now observe the variability of price and output. The impacts of unanticipateddisturbances on price and output are also influenced by accommodating rules. In
our model, the steady state solution ofP and V oscilate around E(P)=O and E(Y)=O
with certain variances, which can be considered as one of the factors that rise theinstability of the economy. The effects of the rules on the asymptotic variance ofPand Y are :OE(P2)/Oa>O, OE(P2)/OB><O, OE(P2)/Or><OoE(y2)!oa<O, oE(y2)laB<O, aE(Y2)/Or<O.
Where, since the partial differencials of the coeMcients of ae2 and a.2 have the same

sign in each case, the results are shown in terms of E(P2) and E(Y2). The
accommodation of the money supply and that of the exchange rate in the demandside rise the effects of stochastic disturbances on yariance of P through rising p,

whereas the wage indexing and exchange rate accommodation in the supply side
operates vice versa. But, being affected by prediction errors of price in period t-1(p-i-p-i") generated by the introduction of imported intermediate goods, the signsof the rules in supply side are undetermined. On the other hand, the variances of

Y are always reduced by accommodation. In spite of the persistent effects of therules in the demand side, each rule operates to stabilize real dernand, real wage andreal cost of imported goods, then reducing the effects of random variables in net
terms. This will be easier to understand when we remember that more accommodation

makes both the demand and the supply curve more vertical.

Finally, it is obvious from equation (11) that, when both money supply andexchange rate rules are fully accommodated at the same time, a steady state solution

does not exist and P follows a "random walk" as:P =P-i+pt
where, "=[Åëop/r]e-+[11v]fi+[62op/r]e--i+[621r]a-iE(e-u-')=O, E(EE,-,)=O, E(fifit-k)=O•

SHOJI NISHIJIMA

82

5. Sticky Wage Adjustment
Taylor [6] developed a macro model of the sticky wage adjustment of overlapping
wage contracts where disturbances have persistent effects on output and price; Here

we discuss another form of sticky wage adjustment, in which the stickiness appears
because the wage indexing rule is applied to the inflation rate of the previous period(p-i-p-2), as it is true for the Brazilian wage indexing rule.

Suppose that the wage adjustment is determined by the wage indexing rule andthe market condition as:

w-w-i=:r(p-i-p-2)+q(y-P)•
Since at the begjnnjng of period t, the infiation rate of the preyious period t-1 isknown to the authorities, the expectations now disappear in the wage adjustment.
Neglecting imported intermediate goods for simplification, we get the aggregate
supply function:p-p-i=r(p-i-p-2)+q(y-P)+u•
Using the same process as in the preceding section, we obtain the rationally expected
price, the realized price and output in the form ofa second order difference equation:
E(p) == [(1 + r)1(1 +qe)]p-i- [rl(1 +qe)]p-2+ [ip/(1 +qe)] (cg -I)

p==E(p)+[op/n]e+[1/n]uwhere, n== 1 +(a+b)q
y== -e[(1 +r)/(1 +qe)]p-i+e[r/(1 +op)]p-2+e[op1(1 +qe)]Y+[1/(1+qe)]cg+Ellz]E+[(a+b)!rr]u.
Because of the existence of the stickiness in the wage adjustment, even when theindexing rule is fu11y accommodated (r==1), the Lucas type supply curve does notappear now and output is not neutral to price and fiscal policy. It is interesting to note,however, that if the two rules in the demand side are fully accommodated (a== 1 andB = 1, then e=O), output is still neutral to p.i, p-2 and ji} depending oniy on cg andrandom noises as in the preceding section.
Now let's turn to the long-run analysis. Defining the deviation ofprice from thelong-run equilibrium as:

P==p-E(p)where, E(p)==(cg-P)le,we get the price equation in terms of deviation:

P=:[(1+r)/(1+qe)]P-i-fr!(1+qe)]P-2+[qlre]i+[1/rc]ti.

From the homogeneous part of the equation, the roots are given by quadratic
formula:p==-il'( ii++ie Å}VX( ii++ie )2- itrqe 1 .

INDEXING POLICIES A.ND MACROECONOMIC STABILITY !N BRAZIL: 83
RATIONAL EXPECTATION MODEL
If the roots are real, as far as the condition r>ope is satisfied, the two roots in absoluteterms are less than unity and the solution is stable. If the roots are complex, theabsolute value of the roots are given as Vr![1+qe], impling less than unity. However,when supposing the probable value of the parameters, we should accept the complex
roots as stable roots. The effects of the accommodating rules on p in the case ofcomplex roots are given:

OplOa>O, aplOB>O, 0plOr>O.
The difference with the preceding model is that more accommodation in wage
indexing lowers the convergence speed and increases persistent effects, since thestickiness, introduced by the lagged indexing rule, is enforced by the accommodation.

The steady state solution ofP is expressed as follows:

P==pP-i+[qln]g+[1ln]aE(P)- O
E(P2)=[qln]2[11(1-p2)]ae2+[1/n]2[11(1-p2)]a.2.

Another information to observe the macro instability is the variance ofP and Y
produced by stochastic disturbances. The effects of the rules on variance ofP are:oE(p2)locr>o, oE(p2)/oB>o, oE(p2)/or>o,where, the partial differencials of each rule on the coeMcient of oe2 and a.2 have thesame sign. As we expected, the accommodation in the three rules rises the asymptotic
variance ofP, that is, it rises the instability of price, In the same way, the long-run
solution of output is given as:

E(y)-YP -- pY-i+[lfn]E-[(a+b)ln] fi +[p(1 +eop)fn]g-,+[p(aa+bB)ln]ij-i
E(P) == O
E(Y2)={[1ln]2+[p2e2q21(1-p2)rr2]}a,2+{[(a+b)ln]2+[p2e2/(1-p2)z2]}a.2.
Hence, the effects of the rules on the variance of output are:oE(y2)loa<O, aE(y2)/aB<O, oE(y2)10r>O.
Although accommodations in the money supply and the exchange rate reduce thevariance of output by stabilizing demand, wage indexing rises it. The reason is clear:more accommodation not only rises stickiness in the wage adjustment but also
induces a lower convergence speed. Thus, with more accommodation in the lagged
wage indexing, the steady state solution of output has a path with higher variance,
which can be interpreted as greater instability of the economy. This point is importantin the context of the Brazilian wage indexing rule.

Finally, the model in this section also displays the price random walk in case of

fu11 accommodation. When cr = B= r=1, the solution has equal roots p=1. Then,

P=P-i+pt

SHOJI NISHIJIMA

84

where, g==[q/n]g+[1/z]fi.

6. Tests of the RandoM Walk Hypothesis
In the preceding sections, we developed a macro model of the accommodating policy
rules, in which, with fu11 accommodation prices in terms of deviation from the long-run trend, follow a random walk. It is widely accepted that since 1968 Brazi1 has

experienced almost fu11y accommodated exchange rate and wage indexing policies.
And if we accept the assertioni' that the Brazilian money supply also has been accommodated to price levels, it is worth testing the random walk hypothesis2'.
We specify estimating equation by using the inflation rate as a proxy for the
price deviation from trend, because the data for the deviation are generally diMcultto obtain, and the following manipulation can derive a random walk process in termsof the inflation rate without any loss of generality. Subtracting both sides of thefollowing equations respectively,

P-P===P-i-P+pt
P-i-P==P-2'P+pt-i
the random walk in the inflation rate can be derived under the assumption of thewhite noise process. The stimating equation is:

P= ae+aiP-i+pt
From the definition of the random walk, we expect the following three properties :(a) The constant term should not differ significantly from zero.
(b) The slope coethcient should not differ significantly from unity.
(c) The residuals should not be serially correlated.

The equation was estimated using quarterly data for two periods: (1) 1968.I-1982.IIand (2) 1974.I-1982.II. Two kinds of infiation rates were calculated using the dataof International Financial StatisticsllMF: whole sale price index (IFS line: 22363)
and consumer price index (IFS line: 22364). The resulting OLS estimates are reported

in Table 1, including other regression results; R: coeMcient of determination, DW:

Durbin-Watson statistics, DH: Durbin's h statistics, DF: degree of freedom, ( ):t ratlo.

As can be seen, the results are consistent with the hypothesis, In all cases, thenull hypothesis can not be rejected at the 95% confidence level, that is, ao and ai do

not differ significantly from zero and one respectively. Furthermore, DW and DH
statistics are consistent with the hypothesis of serially uncorrelated residuals at the

95 O/. confidence level except DH of CP in 1968.I-1982.II. Thus, we can accept, nothighly robustly, the hypothesis that the Brazilian inflation rates follow "random
1) See Cardose [1] and Contador [31.
2) See Cardoso [21.

BRAZIL:IN
INDEXINGPOLICIES AND MACROECONOMIC STABILITYRATIONAL EXPECTATION MODEL
Table 1. Estimation efP==ao+aiP-i+p

R2

DW/DH

DF

O.9189O.8oo1
O.'8os9(1.5400)

2.1693-O.7269
2.4865-2.078656(1.3359)O.9266'(1.2328)

WP

O.0223,O.8557(1.5899)

CP

O.0242

O.8321(1.9654)(1.7167)

2.0578-O.1985
2.4140-1.469532(1.8125)ao

cr1

O.Oloo(1.5387)

i968J-1982.II

WP
CP

O.oo9356

1974,I-1982.II
O.7271

O.683932

WP: whole sale price inflation rateCP:

consumer price infiation rate 1

Table 2. Test of Joint Hypothesis: F yalue

1968.I-1982.II

WP
Brazi1

Argentina' ChileColombia
West GerTnany
FranceIsrqe]

Japan

Korea
Mexico.
Portuga1

United Kingdom
United States

Venezuela

1.18907.7802
14.1980
8.63998.341311.6499l.5018i18. 84•9.5173.
5.162312.7140
4.9562
1O.0929
14.4985

1974 I-1982 II

WP

cp

1.66456.44181.95506.14954.383912.3555
15.31613.96682.1995
1O.6625
10:2350*

116.6741
12.4146'5.1415

19.1207.12,7944

2.2'1475.18418.6198CP
1.19737•. 5608

29,3972
1O,0770
25.78486.00656.8546
1.8963'5.11387.46903.I596
6.7S2914.4421

DF:F (2,56)

DF :F (2,32)

1 % point: 5.01

1 % point: 5.34

5O/. point: 3.17

5e/. point: 3.30

8.4678
S.07762.87325.5402
8.92842.858935.4194
7.965218.8741

5,8oo8(") The period is 1970.II-1982.II, then DF is F (2,46).

walk".
In addition to this, we estimated the joint hypothesis that the constant terms are
zero and the slope coefucients are unity. Hypothesis testing forjoint hypothesis isdone with the F test and its results for various countries are shown in Table 2. As

we see, very few countries (Brazil, Israel, CP of Mexico and WP of United Kingdom
in the second period) ar.e, not able to reject thejoint hypotheses at the 5 O/. singnificancelevel. Almost all other countries can rejeqt it at the 1 O/. Ievel. Furthermore, it is shownthat Brazil and Israel have the lowest F values among these countries. Rememberingthat Israel is the country which applies indexing rules in broad areas like Brazi1, we

85

SHOJI NISHIJIMA

86

can say that our estimation reveals the closed relation between accommodation
policy rules and price instability as analized in the model.

7. Concluding Remarks
In this paper, we developed a stochastic macro model, in which accommodating policy

rules are analyzed. The demand side of the model comes from the standard IS-LM
model and the supply side is based on the Lucas function. The model treats threeaccommodating rules in money supply, exchange rate and wage adjustment. We
assume that the authorities apply these rules aoeording to their expectations. Under
the assumption of rational expectations, we investigated the effectiveness of the ruleson the stability of price and output, focusing on persistent effects of disturbanceand variability ofprice and output which are affected to the extent to which the rules

are accommodating. The main conclusions are as follows: (1) Full 4ccommodationin the exchange rate and wage adjustment produces the same implication as thestandard rational expectation model, and also fu11 accommodation in the demandside (in money supply and exchange rate) demonstrates the same situation in which
the discrecionary (fiscal) policy is neutral to output. (2) More accommodation in themoney supply rises persistent effects, whereas that of wage indexing lowers them.

The exchange rate rule affects through two channels because of the existence ofimported goods, (3) The model reveals the stability trade-off between output andprice level in the context of variance. It is shown, however, that the existence ofimported goods and lagged wage indexing affects the relations between the accommodating rules and the output-price trade off. (4) The model suggests that pricedeviation from trend follows "random walk". We tested this hypothesis using the
inflation rate as a proxy for Brazil and we accepted the hypothesis.

References[1] Cardoso, E., "Moeda, renda e inflagao: algumas evidencias da economia
brasileira," Pesquisa e Planejamento Econ6mico, 7 (2), 1977.

[2] Cardoso, E., "Indexagao e acomodagao monettiria: um teste do processo inflacionirio brasileiro," Revista Brasileira da Economia, 37 (1), 1983.

[3] Contador, C., "A Exogeniedade da oferta de moeda no Brasil," Pesquisa ePlanejamento Econ6mico, 8 (2), 1978.

[4] Dornbusch, R., "Exchange Rate Rules and Macroeconomic Stability," inExehange Rate Rules, (ed.) John Williamson,,Macmillan, 1981.

[5] Dornbusch, R., "PPP Exchange-Rate Rules and Macroeconomic Stability,"
Journal of Political Economy, 90 (1), 1982.

[6] Taylor, J.B., "Staggered Wage Setting in a Macro Model," American Economic
Review, Papers and Proc. 69, 1979.

A SIMPLE GENERAL EQUILIBRIUM MODELINVOLVING A MAXIMIZING LABOUR UNION
Kazuo SHIMOMURA

1. Introduction
The purpose of this paper is to construct a fairly simple general equilibrium model

involving a maximizing labour union and to outline the micro-economic theory ofa maximizing labour union. Kemp [1] provides a similar framework as the one
which we are concerned with here. The distinctive features of the model presented
in this paper are;(1) The determination ofunits oflabour service supplied by each worker is explicitly
taken into account.
(2) The utility function of the union takes a general form.

'(3) A suMcient condition for the existence of a unidn-ridden
equili6rium involving'
unemploymentisobtained.
' '' '

Assumptions and basic framework are stated (Section 2), preliminary analysis' to the behavior of workers carried out (Section 3) and some resultswith respectobtained (Section 4). ' •'2. Assumptions and Basic Framework
At first let us state the assumptions.

A.1 There exist N, households who earn their income only from providing theirlabour services measured by time, say hours. Let this kind of household be called"worker." Each worker has his preference regarding consumption and leisure whichis represented by the following utility function;(1) u=or(c, T-l)
where c is the amount of the consumption good, T the total available time for eachworker and the arnount of labour service. So that T-l isthe time for leisure. Eachworker determines c and lfora given real wage rate so as to maximize (1) subject
to his budget constraint(2) Rllc,where R is the real wage rate, and(3) T-l)O
A.2 There is another type of household which provides a non-labour factor of

KAZUO SHIMOMURA

88

production and which expends all income to purchase consumption goods.
A.3 There is only one kind of consumption goods. Each firm which produces thegood is quite small so that the market can be .regarded as perfectly competitive,

The production function is denoted by(4) Y-f(L)where L is the amount of labour service measured by time, say L hours. The functionf( ) has the following properties.

(6)f'(L)>Of"(L)<O(7)f(o)-o(5)

for any L>O
for any L>O

lim f(L) == oo

(8)

L-co

limf'(L) ==O

(9)

L--co

(1O)

limf'(L)=oo
L-O

Each firm seeks to maximize its profit(11) f(L)-RL
by choosing an appropriate L. Then one obtains, as a necessary condition for
optimality,'(12) f'(L)-R
A.4 Just a single labour union exists, to which all workers belong. What the labour

union is concerned with are supposed to be (i) the level of welfare each employedworker can enjoy and (ii) the number of employed workers. Let (ii) be N. The unionnegociates with the firms about (i) and (ii). In the present paper we assume that theunion enables firms to pay for each employed worker at least a certain level of wage
rate, say R.i. and that, regarding the volume of labour service, the firms decide it
according to (12). With respect to the determination of R.t., it is assumed that theunion is rational enough to hold perfect knowledge about the structure of theeconomy which includes even the preference of each worker and that for a given levelof ti the union seeks to solve the optimal problem;(13) Minimize Rc, l, R

subject to abSu(c, T-l)

T-l}:O
and

Rllc
Under some regularity conditions on the utility function, the optimal e, l and R canbe uniquely obtained. R.i. then is defined as the optimal R. Obviously R.i. is thefunction of ab.

Based on the foregoing argument on the determination of R.i., it might be

A SIMPLE GENERAL EQUILIBRIUM MODEL INVOLVING 89
A MAXIMIZING LABOUR UNION

fairly reasonable to assume that the union's utility is the function of the welfare levelof each employed worker and the number of the employed;(14) U=U(u,N)oU(15)
ou=U.>OoU(16) aN !E UN>OOne should notice that u might be different from ti which the union seeks to ensure
for each employed worker, although the former will never be smaller than the latter.
It is also apparent that the inequalities(17) ulti).u"=-u(O, T)
are always held. As will become clear through the subsequent argument, u and N
are the functions of ti, i.e.,(18) U-=U(u(ti),N(ti))
The union's objective is to maximize (18) by choosing an appropriate ti.

We have stated the main assumptions for the present argument. Now before
starting the analysis, Iet us define two equilibrium concepts.

(i) Equilibrium; defined as the equality between the demand for the consumption
good and the supply of it for a given level of ti.

(ii) Union-ridden equilibrium; defined as the equilibrium where the union chooses
the optimal ti.

3. Prelirninary Analysis
First of all let us carTy out a simple analysis on the optimal
The Lagrangian function of the problem is(19) H=-R+pi(u(c,T-l)-ti)+p2(T-l)+ps(Rl-c)
Then one obtains, as the necessary conditions for the optimality,
(20)
(21)

OH

OH

R=O, oR
aR='1+lpsSO

OH

aH

'OH

aH

.c=O
oc =piu,-ps50
, oc

(22)

l=O
al
-o-l ==-piu2-p2+psR$O,

(23)

aH
ap, =u- ti IO , op, .pi =O

(24)

OH
OH
op, =: T-llO , op, P2 =O

(25)

OH

(26)

R).O,l=>O,c-->O,p,).O,p,).O,p,).O

. OH
OH

ps=o
==Rl-clO
Ops,

Ops

problem (13).

90 KAZUO SHIMPMURA
Having a look at these conditions, one can obtain the following lemmata.
Lemma 1: If ti is chosen as being greater than u*, then the optimal l and R, Rmi.,
are positive.

Proof: Suppose that l is zero. Then from (20), R must be zero. Thus, considering(25), c must be also zero, which implies that u(O, T)-ti=u"-tilO, a contradiction.
Next suppose that R.i. is zero. Then from (25) again, c must be zero, which implies

that O$u(O, T-l)-di<u"-ti, a contradiction.

QED
Lemma 2: Under the same presumption as lemma 1, Rl==c.
Proof: If Rl is greater than c, then ps is zero. Therefore, from (20), R must be zero,a contradiction.

QED
In order to make the present argument clearer, we add a restraint to the shape ofthe utility function of each worker. In what follows, it is assumed that leisure is"indispensable", i.e., for any clO, e'lO and llO where T-llO,(27) u(c, T-l)lu(e',O)
Under this additional condition, one can obtain the following lemmata.

Lemma 3: T-lis positive.
Proof Obvious from (27).
Lemma 4: pi and ps are positive.

Proof From (20), it is obvious that ps=l-i>O. Thus, considering (21) or (22), pt
must be positive.

QED
Then one obtains
Proposition 1: If ti>u" and tt(c, T-l)lu(c', O) for any nonnegative e, e' and l, then
the necessary conditions for optimality with regard to the problem (13) are(28) Rui(e, T-l)==u2(c, T-l)(29) u(c, T-l)=ij(30) Rl-c
One can easily understand what these conditions are by looking at Figure l.
Assuming that the utility function is strictly quasi-concave like the figure, the point
E is the sole optimal solution. Now, let us examine the effect of the change of ab(ab->ti'like Figure 1) on the optimal e, l and R. Totally differentiating (28), (29) and (30),

we have

1 >O(3 1)dRda :luidc dl

However,regarding ddi and dti, the signs depend on the relative extent of the in-come effect to the substitution effect. See Appendix. In the meantime we assume

A SIMPLEGENERAL EQUILIBRIUM MODEL INVOLVING 91

A MAXIMIZING LABOUR UNION
Figure 1

C

,
a

e
c

Et
l
l

il'=u(C,
ar

i
l

1
l

l

l
:

:
:
:
:
:
:
:
:
:
T-l):
l
l
,
l
l
l
,

R

l

fi=u(C, T-O

Rmin

l
l
T

T-t

beisurethat the substitution effect overweighs the income effect, so thatdc(32) dti >Odl(33) -tt>Odl •Later the case that du- i's negative shall be briefly mentioned. In fact both cases are
possible in reality.

4. Equilibrium Locus and Union-Ridden Equilibrium
Suppose, for a while, that the labour union fixes ti at a certain level which is greaterthan u*. Then, based on the argument of the previous section, R.i. and l are regarded
as the functions of ti, R.t.(ti) and l(ij). Making the bargaining with the firm, theunion claims (1) the firm's paying at least R.i. (ij) for each unit of time provided aslabour service, l, so as the following inequalities to be held;(34) ti$u(Rl, T-l), RIRmin(ti)See Figure 1. If R is equal R'. then the segment aE'a' represents the region where(34) is held. If R is equal R.i. (ti), only l(ti) is chosen as the amount of labour service

provided by each employed worker.
Now suppose that the firm accepts R.i.(ti). Then the firm demands for an amountof labour service to the extent of L satisfying(35) Rmin(ti)==f'(L)Thus the number of the employed isL(36) N- l(ti)KAZUO SHIMOMURA

92

which is the function of ti, considering (35). Furthermore, N increases as ti falls. For,(i) L increases as ti falls from (37) and (ii) l(ti) decreases as ij falls from (33).

For a given a, two possibilities can be considered; NIN, and Ai<N,, Let us
inspect both cases in turn.

NllV, If N happens to be equal ,IV,, an equilibrium without unemployment isestablished. The market R is also equal R.i. (ti). Denote such ij by tib in what
follows. Next if N>IV,, at R=R.t. (ij) an excess demand for labour occurs and R
rises over R.t.(ti). As a result, L, now determined by R=f'(L), decreases. On theother hand l, now depending on R, rises because of (33). So that, N decreases andcomes to be equal N,. In equilibrium both the market R and the level of welfare
u are greater than R.i.(ti) and a, resPectively. It is also apparent that such ab issmaller than ab. Not only this, one can state that u is equal tib.

N< N, Although the labour market is in disequilibrium at R=R.t.(a), some workers
are unemployed since R cannot fall under R.i.(ti). Equilibrium involving unemployment is established. It is obvious that the market R is equal R.i.(ij) and that such ti
is greater than tib. Considering (33), one can also state that N decreases as ij rises.

Based on the foregoing inspection, one can obtain the relationship between thelevel of welfare each employed worker enjoys in equilibrium, u, which obviously
depends on ti, and the number of the employed. The relationship can be described
like the curve ab in Figure 2, Letting the curve ll' be an indifference curve of theunion's utility function U=U(u, N), the point E. represents the union-ridden
equilibrium involving unemployment, where the level of welfare each worker enjoys,
the wage rate and the number of the employed are expressed as ue, R.i.(ue) and Ne
in the figure, respectively.

Whether the union-ridden equilibrium involving unemployment is established or
not depends on the difference in the slope at b in Figure 2 between the equilibrium

Figure 2

tl:

u

l
1•
Ue

.---.-.---"".-. Eu l

, tt
rl

-1 1l
u-ut
l-------------- -- b11-------------------I

fib

il

+e
1t
11
t1
tt
1l
1I
te
------."--..---;----.------.--.-------a'
lI
Il
lI
Ne

Ns

rv

A SIMPLE GENERAL EQUILIBRIUM MODEL INVOLVING 93
A MAXIMIZING LABOUR UNION

curve ab and the indifference curve of the union's utility function which happens
to pass through b. If at this point b the absolute value of the slope of the indifference

curve is greater than the one of the slope of the curve ab, then the point b is theunion-ridden equilibrium. On the contrary, if smaller, b cannot be such a point andthe union-ridden equilibrium, if it exists, must involve a certain level of un-

employment.
Proposition 2: Suppose that the union-ridden equilibrium, at any rate, exists. It

involves unemployment if at the point b the marginal rate of substitution of theunion's utility function

(3D

Uv
U.

is smaller thandN(38) dti t.h,ecurve

Now let us make some remarks on the existence and the uniqueness of theunion-ridden equilibrium. If the indifference curves of the union's utility function
are like tii, ti2, dis,..., in Figure 3, i.e,, if the union attaches much importance to thewelfare of the employed even when the rate of unemploymet is quite high, then theunion-ridden equilibrium might not exist.

Remark: A suMcient condition for the existenoe of the union-ridden equilibrium isthat the elasticity of substitution between u and N of the union's utility function issmaller than 1.

Literally, this condition means that the union does not sacrifice the volume of

employment in order to raise the level of the welfare of the employed when thenumber of the unemployed is quite large. Regarding the uniqueness, one cannot
figure 3
u
a

ti3

fi2

in

---

bl

al

1

l

1
I
l
l
Ns

N

KAZUO SHIMOMURA

94

Figure 4
u
a

U

U
'
l
l

l
l

1
l

Ns

N

Figure Su

N.v

Nexclude the possibility of multiple union-ridden equilibria. In fact it is possible thatthe curve ab is like the one in Figure 4 where two union-ridden equilibria exist.

We have assumed that with respect to the preference of each worker between
consumption and leisure the substitution effect is large enough to overweigh theincome effect.

On the contrary, if the income effect is negative and exceeds the substitution
effect, thenlrises as di takes on greater value. Then it might be realized that the curve

ab has an upward portion like in Figure 5.

Appendix Let us examine the system composed of (28), (29) and (30). Substituting

A SIMPLE GENERAL EQUILIBRIUM MODEL INVOLVING 95
A MAXIMIZING LABOUR UNION(30) to the other equations, we have(39) Rui(Rl, T-l):==tt2(Rl, T-l)(40) zt(Rl, T-l)==ab
Differentiating (39) and (40) with regard to R, l and ti,(41) (R2u,,-2Ru,,+u,,)dl+(Rlu,,+or,-lu,,)dR=O(42) lui, dR ===daFrom (42), one can obtain (31)., Further,dl ui+l(Run-u2i)(43) dti - (2Ru,,-R2u,,-tt22)IUi
Strict quasi-concavity ensures that (2Rui2-R2un-u22) is positive. However the sign
(ui+Run-u2i) is indefinite. It depends on, as stated earlier, the relative extent of theincome effect to the substitution effect. To see this, consider the following simple

optimal problem ;(44) Maximize u(c, T-l)c, lsubject to A=c-Rl
for given A, R and T
The Lagrange function is(45) H=u(c, T-l)+p(A-c+Rl)
The fi'rst onder conditions for optimality is thenOH==u,(c, T-l)-p=O(46) ocOH(47) ol =-u,(c, T-l)+pR=O

OH(48) -oL p-rm--A-c+Rl=-O
Differentiating (46), (47) and (48) with respect to c, l, R and A, we haveot u,+l(Ru,,-u2i)(49) aR l(44)= (2Rui2-R2unmU22)-

ol (44)=(2Rui2-R2Uii-U22)'(Ruii-U2i)(50) oA
Next check the optimal problem(51) Minimize A=ic-Rlc, lsubject to di=u(c, T-t)

for given R and ti
The first order conditions for optimaiity are again(52) Ru,-u,=Oand(53) u-a==O

96 KAZUO SHIMOMURA
From (52) and (53),di u,(S4) dR (sl)= 2Rui2-R2un-U22
which is definitely positive. Therfore, from (31), (50) and (54), (43) becomes

dli dlOl(55) luidti (43)=dR (sl)+loA (44)
The first term of the RHS is definitely positive and represents the substitution effect,

while the second term whose sign is ambiguous the income effect.
At last let us check the relationship between N and ti. Considering (l2), (42)and (43), we seedd(56) da N==''di. (LLt"):=: -l- [-7rw-l-t-t1 - N. --Sl/ll-]

dl

d '

So that, as for as dti is positive, dti Nis negative.

Reference[1] Kemp, M.C., "Labour Unions, Wages and Unemployment," Kobe Economic
and Business Review, the present issue, 1984.'

KOBE ECONOMIC & BUSINESS REVIEWCONTENTS
NO. 21 (1975)
Regional Development Policies of Japan in Recent Quarterof the Twentieth Century ..............................................,.Minoru Beika

National Income and Expenditure
at Factor Cost in Japan 1955-1970:
A Macro-Accounting for Growing Economy .....................Nobuko IVosse
EMciency and Acceptability in Optimal Growth Path.................................Hikoji Katano

An Equitable Distribution of the Costs and Benefits of Economic
Integration ............................................................Yoshitrki IVishimukai

Japanese Business Abroad: Past, Present and Future .....................,.....Hideki Yoshihara

NO. 22 (1976)
Pioneering in Australian Direct Trade
Life of F. Kanematsu, 1845-1913 ....................................Tadakatsu Inoue

Productivity Bargaining and the Change of Labour
Management Relations in the Japanese Foreign-going
Shipping: 1965-1973 ................................................Hiromasa Yamamoto
On an Interpretable Depreciation Method ...................,............................Isao Ntwkano

A New Type of Data Banking System-BEICA System- ...................................................Hiroshi Sedamichi
Expectation in the Shipping Exchange ...................................................Tetsnji Shimojo

International Capital Movements andReal Capital Aocumulation .............................................Kazuhiro Igawa

Lega1 System of the Free Movement of Workers and Migration
Trends in the European Economic Community ...........................Kunio Soh

NO. 23 (197D
AIternative Approaches to the
Accounting for Education ................................................Nobuko IVosse

Personnel Management of Japanese Companies
in Thailand:A Field Paper ..........................,..................Hideki Yoshihara

Evaluation of Perfotmance Using
Multiple Criteria ........................................,...................Komayuki Itow

Some Bargaining Process Models in
the Shipping Exchange ...................................................Tetsnji Shimol'oAsset Diversification under the Flexible
Exchange Rate System ...................................................Kazuhiro Igawa

NO. 24 (1978)
The Demand for International
Currencies and Reserves ............................,...................Masahiro Fujita

Nobuo Miyata
Studies for the Prediction of Shipping Markets-A Survey and their Applications- ..............................Tetsuji Shimojo
A Note on the International Transmission of
Policy Effects under Flexible Exchange Rates ..................Klrzzuhiro lgawa

A Control Estimation Approach toTime-varying Pararneter Models.......................................,..rukio Uchida

NO. 25 (1979)
Redundancy of Seafarers and the Practjoe
of Permanent Employment .................,.....................Hiromasa Yamamoto
Japanese Multinational Enterprises:
A View from Outside ..................................,...,,.,,........ffideki Yosltihara

A Comment on the Bayaraa's Algorithm ..................,..........................Komayuki Itow
Effects of Ship's Size and Cargo Lotson the Ocean Freight Rates ..,.................................,........Tetswfi Shimojo

Direct Foreign Investments and Foreign Exchange Rate :A Model of Specific Factors and Non-tradable Goods. . . . . . . . . . . .Kazuhiro Igawa

NO. 26 (1980)
Economic Policies under the Flexible Exchange

Rate System: a Stock Approach and a Long-run
GovernmentBudgetConstraint..........,...............................KazuhtroIsamu

Estructura de las ventajas comparativasy
politica comercial-El caso de las exportaciones deproductos industriales en el Brasil .........................,..........S'hoji ?Vlr'shijima

Technological Progress and Capital Accumulation ..............................Kazuo Shimomura

NO. 27 (1981)
Aocounting Systems of Non-Market Oriented Activities .................,.........Nobuko Nosse

Current Situations of World Econorny andGlobal Adjustment of Industries ...........................,...........Hikoji Katareo

Current Cost Accounting and the Concept
ofSpecific Purchasing Power Capital ..............,...............,.....Isao Nalcano

An Input-Output Table for Evaluation of the
Shipping Activities ......,,...........,.........................,.......,...Tets"ii Shimojo

The Function of Modern Corporate Financial Reportingin a Mass Democratic Society ...,.....,.............................Hidetoshi YamaJ"iNO. 28 (1982)
The Internationalization of Japanese Commercial Banking-Experiences in the 70's-- ....................;......,.........

........A•fasahi,'o Fifiita

K'eni('hi lshigaki

A Synthesis of Simultaneous Equations Estimators ...................

. . . . Uiroshi Sadamichi

A Database System of Economic Time Series ....,.,..,...,..,..............

.....HiroshiSadamieki

Yas"o Nunokami

NO. 29 (1983)
An Interpretation of Conventional Accounting
Income Information .................,.................,....,....,...,A Production System for Transport Services .....,...............,......,.

...........Isao Nakano.......Tetstiji Shimojo

Some Evidences between Foreign Direct Inyestments

and Foreign Exchange Rates:
A Preliminary Note .....................,........................,........

...,..Ka2uhiro Igaiva

Two Types of Railroad Regulation by Statesin the 19th Century of the U.S.

-Search for the Social Foundation of Modern
Corporate Financial Reporting- ................,.....,...........,.,,....H[irYetoshi Yamoji

KOBE UNIVERSITY ECONOMIC REVIEW 28, 1982
Edited by Faculty of Economics,
Kobe University, Kobe, JapanCONTENTS
Recent Developments of Political Economy .....................,.............,......Joseph Schumpeter
Analysis of the Feasibility of Large-Scale Owner-Tenancy in Japan ..................Osamu Tanaka
Dimensional Analysis in Economics .........................................................Nobuo Okishio

The Personal Distribution of Profits and Wages in the Transforming
Capitalistic System-With the Emphasis on Dominant Class-Forming Powery ...............Toshimasa Mukai
The World Economy and International Economic Order ...........,...............Kiyoshi Ikemoto
A Comparison of Prof. J. Tobin's Beginning-of-period
and End-of-period Mode]s ............................................................Yoshio Ttzkigawa

KOBE UNIVERSITY ECONOMIC REVIEW 29, 1983
CONTENTS
A Theory of the Supplies of Labor and Homemakers' Services .....................Osamu Tanaka
Eine sozialmorphologishe Betrachtung des Wirtschaftswachstums und desWirtschaftsgeistes in Japan ...............,..................,............................Taketoshi Noiiri

Innovation under Monopoly and Competition ..........................................Hideyuki Adachi

On the Output and Employment Decisions,of an Egalitarian
Labor-Managed Firm .......................................................,................Mataru Fukuda-,11tlll),E-".i,ddltl"t,."'ht•.ttltllte-,•h,.,•-illlltltt,-"i,,,•,rlHT"l,•h,,t..,ttlllSlt,-h-,tr-ITIIItll,.',,"f-leltllft,.'",i,•qt!Mtt,.'it-i,,11MIIth"',w,itttlllli,'t,,,i,,ltV"ln}"i

THE ANNALS OF THE SCHOOL OF
BUSINESS ADMINISTRATIONKOBE UNIVERSITY No. 27, 1983
Edited by the School of Business Administration,

Kobe University, Kobe, JapanCONTENTSDie Entwicklung des Lohn- und Tarifsystems in der DDR ...........................Ekkehard Sachse
Characteristics of Socialist Economy .........................................................Gtinter Schmidt

Determination of Labour-Inputs for Joint Products
by Determining Main Products .........................................................Kazuhisa Matsuda

Die neue Entwicklung in der Versicherungswissenschaft .............................,.,.Atsuski Takao
Bank Liabi!ity Management and Financial Instability ....................................}.<oichi Iwasa

THE ANNALS OF THE SCHOOL OF
BUSINESS ADMINISTRATIONKOBE UNIVERSITY No. 28, 1984
CONTENTS
Ergonomie als Bestandteil der Ingenieurausbildung in der DDR .....................Helmut Kulka
Humanization of Work as Quality of Working Life ....................................KoJ'i Olcubayashi

An Evolutional View of Organizational Adaptation
United States vs. Japanese Firms ................ ...................Tadao Kagono, Ikuiiro Nouaka,

Kiyonori Sakakibara, Akihiro Okumura
A Disequilibrium Analysis in an IS-LM Framework-The Economics of the Interest-Rate Regulation- .........,.........,............,...Yoiehi Iwasa."MltP..).-t--ttmaP,-1,,"t,e"ttltee-"",-mo",,t..-"tll"-hny,t,.stM"",-"d,",e"ljP,,,-,,,tlvallh.",w,tnlpm,.-,-,,qMnle,-".,e-tl"NtVhth,".tei"sc),."

KOBE UNIVERSITY LAVV REVlliW
International Edition No. 16, 1982
Edited by Faculty of Law
Kobe University, Kobe, JapanCONTENTS
Recognition of New States and Japariese Practiceafter the Second World War (2) ............................................................Kentaro Serita

The Effectiveness of Legal Control in Japanese Labor-Management Relations;
A Study of Dispute Processing under the Japanese "unfair labor
practice" law (1) .........,,.....................,..................................,.......Shiro Kashimura

KOBE UNIVERSITY LAW REVIEW
international Edition No. 17, 1983

CONTENTS
Gewerkschaften, Arbeitskampf, Tarifvertrag und Mitbestimmung-Aspekte
Kollektiven Arbeitsrechts in Japan und der Bundesrepublik
Deutschland ...........................................................................Hans Peter Marutschke

Recognition of New States and Japanese Practioe after theSecond World War (3) ............,...........................,..,............................Kentaro Serita

The Effectiveness of Legal Control in Japanese Labor-Management Re!ations;
A Study of Dispute Prooessing under the Japanese Unfair Labor
Practice Law (2) ..............................................................................Shiro Kashimura

RESEARCH INSTITUTE FORECONOMICS AND
KOBE UNIVERSITY
BUSINESS ADMINISTRATION,HISTORICAL SKETCH
In 1919, a reseqrch organization named the Institute for Commerce was founded in Kobe
Higher Commercial School, one of the chief predecessors of Kobe University, with a gift
made by F. Kanematsu & Company, a leading mercantile firm in Kobe. The organization
Was designed to carry on and facilitate integrated research on business and commerce and toformulate and publish the results of these studies and investigations in such form as to makethem available to the business community.

With the founding of Kobe University of Commerce, successor of Kobe Higher Commercial School, in 1929, the Institute extended its research activities by adding several

diyisions. One was the famous Latin-American Library, which soon became the center of
research in this field in Japan. A room for statistics equipped with various computing machines was established and began publication of JdiyO TOkei Keizai monthly and Sekai Bo-eki
To-kei annually. A filing room was prepared to deposit press clipping files systematicallyarranged by topics and dates. Another room was designed to become the center of all possible
original records and data having to do with the beginning and progress of Japanese business.

On the campus of Kobe University of Commerce, another organization mamed theInstitute for Business Mechanization was founded in 1941 utilizing business machines
donated by the IBM Corporation and others. With Professor Yasutaro Hirai as its head abroad and forward-looking plan for business mechanization in Japan was developed.
In 1944, Kobe University of Commerce changed its name to Kobe University of Economics. After the War, however, the University was consolidated with three other collegesin Hyogo Prefecture to become Kobe University. With this development, the two Institutes

were also amalgamated into the Research Institute for Economics and Business Administration, Kobe University. At present, the Institute, with its nineteen full-time professional
staff members, carries on studies and investigations in international economics, internationai

envlronment, comparatlve economlcs, international

business and management information

systems.

ORGANIZATIONThe Institute consists of five sections. Each section and its research subjects are as
follows :1. International Economic Studies

International Economics, International Monetary Economics,
Maritime Economies, International Labor Relations
2. International Environmental Studies

Resource Development, International Organizations,International Industrial Adjustment
3. Cemparatiye Economic Studies
Pacific Basin I (Oceanian Economy),
Pacific Basin II (North and South American Economics)
4. International Business Studies
Comparative Business, Multinational Enterprise,International Business Finance

5. Management Information Systems
Business and Accounting Information, Information Processing System,
Internatiorial Comparative Statistics

In addition to the ordinary work of each section, several research committees, whose
members are not limited to the Institute staffs, are ;egularily held to carry onjoint studies.

At present, there are seven standing research committees, as follows: Experts Group on theWorld Trade Structure, Committee of International Finance, Committee of Maritime
Economics, Committee of International Studies on Economic and Industrial Strpcture,
Committee of International Comparative Economics, Committee of International Business'
Behavior and Committee of Management
lnformation Systems. ' 'For convenience and greater eMciency in carrying out its research activities, the Institutehas a general oMce which is responsible for 1) the collection and preservation of a com-prehensive collection of books, periodicals, pamphlets, and original records and data offinance, trade, commerce, industry and business generally; 2) the ctassification, cataloguing,indexing arranging, annotation and compilation of these research materials; and 3) the
formulation and publication of the results of the investigations and studies accomplished by
the professional staff members of the Institute.

As an athliated institute, the Documentation Center for Business Analysis has been
established in 1964. It is the first systematic information facilities in the field of businessadministration in Japan that has been recognized and authorized by the Ministry of
Education. The purpose is to collect and to make intensive control of all kinds of materials
on business administration and to make them ayailable to scholars, universities, governments,

and business world with the aid of modern documentation techniques.

`iii• RESEARCH
1
Director:l secretary:l

INSTITUTE FOR
ADMINISTRATIONKOBE UNIVERSI]TY

i ECONOrVllCS & BUSINESSl

Hikoji KATANO

Hideo HAsmMoTo

I INTERNATIONALECONOMICSTUDIESl' International Economics

Prof. Hikoji KATANo
Assoc, Prof. Kazuhiro IGAwA
Prof. Masahiro FuJrrAll International Monetary Economicsl Maritime Economics

Prof. Tetsuji SHiMoJo

i International Labor Relations

Prof. Hiromasa YAMAMoTo
Assoc. Prof. Kazuo SmMoMuRAlProf. Kojiro NllNol INTERNATIONALENVIRONMENTALSTUDIESi Resource Development

Prof. Tetsuji SHiMoJol International organizations
i International lndustrial Adjustment

Prof. Masahiro FuJrrA
Assistant Hideki IzAwA
Prof. Hiroshi SADAMICHIiProf. Akira NEGIsHI

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i COMPARATIVEECONOMICSTUDIESl pacific Basinli (Oceanian Economy)

Assoc. Prof. Kenichi IsmGAKi
Prof. Yoshiaki NisHIMuKAi
Assoc. Prof. Shoji N[sHIJiMAI
ii INTERNATIONALBUSINESSSTUDIES
l comparative BusinessProf. Tadakatsu INouE
Assoc. Prof. Kenji KoJiMA
Prof. Hideki YosHiHARA
Prof. Isao NAKANOAssoc. Prof. Hidetoshi YA/MAn

I Multinational Enterprisell International Business FinancelProf. Akio MoRilli MANAGEMENTINFORMA[IONSYSTEMSl Business and Accounting lnformation] Information Processing System

Prof. Isao NAKANO
Prof. Nobuko NossE
Assoc. Prof. Komayuki ITow
Prof. Nobuko NossE
Assoc. Prof. Yasuo KoNisHi

i International Comparative Statisticstt;l'l, RoKKo,
omce: KoBE,

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Prof. Yoshiaki NismMuKAIl pacific Basin lli' (North and South American Economies)

The Kanematsu Memorial Hall

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UNIVERSITY
JAPAN

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