ECONOMICBUSINESS&
34th

REPORT
ANNUALs"SVIE'"Oee/SB,,es >s

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
1989

KOBE

ECONOMIC & BUSINESSREVIEW
34th
ANNUAL REPORT/k."tV'`"o.).k,.

S v )vRESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY

1989

CONTENTS
Page
Recent Inflation of Land Prices in Metropolitan

Areas of Japan-A Case Study of Regional Accounting-••••••••••••••••• Nobuko NossE

1

Little Basjcs and Employeeism

Japanese Management inInternational Perspective••••••••••••••`••••••••••••••••••• Hideki YosHiHARA

15

Bank's Loans to Developing Countries:
A Normative Approach••••••-••••••••••••-••••••••••••••••••••• Kazuhiro IGAwA

27

Japan's Trade Diplomacy:
Yesterday, Today, Tomorrow•••••••••••••••••••••••••••••••• Peter DRysDALE

39

A Labour Union in Every Country-A Game-Theoretic Approach-••••••••••••••••••••••••• Kazuo SHiMoMuRA

61

The Costs and Benefits for Firms of
Accounting Information Disclosure ••••`•••••••••••••••••••• Hidetoshi YAMAJi

75

Increasing Returns to Scale and Optimal
Investment Policy of the Regulated Firm ••••••••••••••• Seiichi KATAyAMA

85

Fumio ABE
Problems and Method of Economics ••••••••••••••••••••••••••••••• Nobuo OKisHio

101

Industrial Organization and International Trade-Textile Industries in theWestern Pacific Region- •••••••••••••••••••••••••••••••••• Katuhiko IKEDA

109

RECENT INFLATION OF LAND PRICESIN METROPOLITAN AREAS OF JAPANi)-A CASE STUDY OF REGIONAL ACCOUNTINGNobuko NOSSE

1. Introduction
Although regional accounting has been encouraged to improve thanks to the present
SNA2), studjes on this line have been few and their interests have only forcussed on

current activities in certain regions.3) Regional accountants have neither tried toobserve accrued capital gains nor losses caused by holding assets and debts held withinsome regton.
In Japan, however, one of the urgent problems is the enormous capital gains
accrued by the rapid rise of urban land prices in the two metropolitan areas, i.e., theTokyo area and the Osaka area. Especially, the land price rise in the Tokyo
Metropolitan area which started in the mid-1970's has had effects on many Japanesehouseholds and institutions owning or occupying land therein. Hence it is needed todevelop an idea of reconciliation accounts in order to analyse capital gains due to land
price inflation in these metropolitan areas, as construction of reconciliation accounts

is the first step to make a grand design by revitalization of urban policy.

Our purposes in this paper are; i. to show the background of our problems`) andthe theoretical framework, li. to get the least square estimates which explain the hyperinflation of land prices for residential use, iii. to observe the results obtained in ii,

to explore the usefulness of regional reconcilation accounts for the analysis of risingland prices and related factors in order to derive an effective urban policy making.

'1) This paper is an outgrowth and substantial modMcation of "A Reconcdiation Account for Analysing Hyper

Infiation in Land Prices, Paper prepared for reading at 20th General Conference of IARIW, 1987.
2) United Nations, A System ofNationalAccounts, ST/STAT/SER. Series F No. 2 Rev.3, 1968, Par.1.90.

Pars.9, 21-9, 30. .,3) J.V. Sourrouiile, ``Regional Accounts; Theoretical and Practical Problems in the Recent Experience ofArgentina", The Review ofJncome and Wealth series 22, 1976, pp.13-36. RJ. Walters, "A Framework
for Regional Accounts; An Austrakan Perspective," The Review oflncome and Wealth, series 33, 1986,

pp.401-415.
4) OECD Group on Urban Affairs, Urban Pob'cies in Japan, 1986. See also, J. Hibbert. Measuring the Effects

of Infiation on Income, Saving and Wealth, 1983.

NOBUKO NOSSE

2

2. Background and Theoretical Framework
i Background
The reason why we intend to limit our observation to Metropolitan areas i.e. the Tokyo

Metropolitan area (abridged as TM) and the Osaka Metropolitan area (abridged as OM)
and neglect the rest of Japan is the following:

Binary comparison of TM and OM is important because Tokyo, the capital since1868 and Osaka, the neighbour city of the former capital, Kyoto, have been far more
urbanized and centralized and congested than any other regions in Japan. The recent
tendancy has been more rapid inflation of land prices in TM because of its far more
fiourishing expansion than in OM. In both areas, however, common factors are working
and it is worth while analysing them. Although our final object of research is to explain

the inflation of land prices in overall areas of TM and OM5), the scope of this paper

is obviously limited. As representative and matured residential quarters, we haveselected six districts for TM and OM each, and among these we have taken four
districts of the inner city wards (abridged as U) in TM and OM each and two suburbs(abridged as S) in TM and OM respectively.
Identifying these, we have given numbers which represent the grades of residential
land prices and their quality and add as subscripts the symbols of four selected areas.

Figure 1. Land Price and its rate of change
Land price for residential use P and its rate of change AP/P in the Tokyo and the Osaka Metropolitan
areas (1or5-1986)

P\10,OOO (per m') •-o•- TUI -o- TU --A- TS--e- ou -" os

580

tp
f"tt

435 !
tl
tl

290 't145 .
O " "' '-' F- " -- " -= ut;u's:-rÅí
it

lt
6

tt '(S .tr ..A..D...- o--"19 75 76 77 78 79 80 81 82 83 84 85 86 87 year5) In this paper we limit Tokyo Metropolitan area to Tokyo-to (Tokyo inner city and suburbs) and to Osaka

Prefecture (Osaka city and suburbs) respectively. They are the central part of each Metropolitan area
in broad sense which include more three surrounding prefecture (Kanagawa, Chiba and Saitama in Tokyo
area and Kyoto, Hyogo and Nara in Osaka area) respectively.

RECENT INFLATION OF LAND PRICESIN METROPOLITAN AREAS OF JAPAN

AP1P
e/o

-- o-- TUI--o- OU-o- TU -A- TS.o- os

160

r---g

tlt

120

/li

80

t/ ltl "x"N

tllx
/ IA,
40

IA ... ... SkN

so{.,. ..l ,,'1'-.,i;'e.

"'-o-ig•'(k.

N
19 76 77 78 79 80 81 82 83 84 85 86 87

year

Source : National Land Agency, Official Land Prices, 1975'88 editions.

Those are then as follows: TUi,..., TU4, TSi, TS2, OUi,..., OU4, OSi, OS2. The
prices in 1975-19876) are shown in Figure 1.

For simplification, the average urban land prices in TM and OM are shown as TU

and OU while the average suburban land prices in TM and OM are shown as TS
and OS. In Figure 1, these average prices in TU, OU, and OS and an actual price ofTUi are shown.
From Figure 1, it is clear that the inflation of land prices for residential use has

prevailed in the two metropolitan areas, and that it is more serious in the inner cityof Tokyo.

The figure suggests also that capital gains by holding land has risen in various
ways depending on the different movements of the land prices. Incidenta11y, the annual
rate of increase" in the CPI" in te76-re86 is 3.8oro, therefore, the annual increase
rate of the average relative capital gains8) in these areas is not less than 14oro for TU,

and for TUi, 20oro, and for OU 69o respectively.
'In the calculation of the annual rate of increase, we use the following form throughout this paper:
Pt=Po(1+r)t, where r is the annual rate of increase.
6) Source: National Land Agency, Japan, Othcial Land Rri'ce. Ig75-D88 editions.
D Source: Statistics Bureau Management and Coordination, Consumer Price Index Survey, re85. Monthly
Statistics ofJapan, No.310, te87.
8) J. R. Hicks (1946), M. B. McElrpy (1971), R. Eisner as80) and T. P. HM (te84) make clear the compositionof capital gains; gross capital gains consist of the portion of the change in genera1 price inflation andrelative capital gains, the ponion of the change in individual prices of assets net of the change in generalprice inflation. The literature of inflation accounting is seen in P. S. Sunga (ro87).

34 NOBUKO NOSSE
il. Theoretical Framework
We intend, in the first place, to estimate the factors which determine the rates ofrising prices of land in limited residential districts of the two metropolitan areas where

no new supply of land can be expected. Such a situation is prevailing not only in the
districts of our observation, but in the entire inner Metropolitan city areas and thewell developed suburbs. The areas where there is no new supply of land are denoted

as Z=Z, where Z means square km of residential area divided by the number of
population in each district.

The factors which have an effect on rising rates of land prices in these areas are:i. the net increase (decrease) in population, li. the annual income of inhabitants, lii.

the distance from CBD, iv. the time for commuting between the householders' home
and their place of work (or usualy CBD), v. the level of lagged land prices, vi. theproperty tax per head of population as the cost for holding such residential sites, vli.
the level of CPI, and vhi. the amenity factors in each residential area, such as physicaland/or social environmental factors.

In this paper we select districts which are located within a circle of 30km from

CBD, so that we can neglect the distance factor iil. Hence in th'ese areas where
Z=Z , we can also neglect the factor which affects the rising rate of prices due to the
supply factor.

For our 12 districts with a net decrease of population together with rising land
prices, we set the foilowing equation for rising land prices:

AP/P=Åë(AN, Y, r, P-i, Tf/N, Pc, A)
where P is land price, AP is net increase (decrease), N is populaton9), AN is net
increase (decrease) of N, Y is householders' annual income, T is time for commuting'O),

P-i is the level of lagged land price, Tf/N is property tax paid in the
district divided by the number of inhabitants;'), Pc is CPI'2) and A is a symbol for9) Source: Tokyo Statistical Association, Tokyo-to Statistical Yearbook, vols. 27-36, II. Osaka Prefecture
Statistical Association, Osaka Rrefecture Statistical Yearbook, lg76-D85 editions, ch.3. 0saka City Planning

Bureau, Annual Report of Statistics in Osaka, 1on5-1985 editions, 14.
10) Source: Bureau of Statistics, Othce of the Prime Minister, Housing Survey, 1978 and 1983, vol.3,
Pts., B and 27. Table 12 (`78 Survey), Table 14 (`83 Survey).
11) Source: Property Tax for the Tokyo Metropolitan Area, Data compiled by the Bureau of Taxation,

T.M.G.
For the Osaka Metropolitan Area, Data compiled by Osaka Prefecture. The figures of Property tax
are divided by the registered population in corresponding districts. The Registered population are
derived from the Yearbooks and Annual Reports cited in note 8.
rz) See note 5.

RECENT INFLATIONOF LAND PRICESAREAS OF JAPANIN METROPOLITAN
denoting amenity variablesi3). Our effort goes toward estimating the above equationin an operational way.

We intend, in the second place, to show the idea of constructing a regional
reconciliation account as an instrument to analyse, the hyperinflation of land prices.
Even in our pure analysjs (Z=Z ), the usefulness of the account for providing the seriesof P, APIP and of CPI, and for measuring the series of capital gains and relative
capital gains in metropolitan areas becomes clear. Moreover, in order to analyse thefactors affecting the rapid rising prices and to devise an urban policy, jt is necessary
to obtain a well filed series of data of these related factors together with a land pricedata series.

Some of the factors are to be found in the common national accounts but otherfactors such as time and distance from CBD, population, and amenity variables must

be taken from corresponding socio-economic accounts andlor SSDS. This gives thepossibility to widen the use of the regional reconciliation account for the analysis of
the well-being of people in metropolitan areas especiaky regardmg the housing problem.
The hyperinflation of land prices for residential use in metropolitan areas is a typicalexample.

3. Estimation of

the Least Squares Estimates

The equation shown in the previous section has, by the reason of present data
availabilities, to be modified in two points: First, we must use local tax paid in thearea divided by population N as a proxy variable for personal income earned per headin the districts. The local tax burden per head is denoted as TylN where Ty is local
tax in the district and N is population in the districti4). Second, at present, we cannot estimate the amenity variables A, because such data over this period are not13) Amenity variables consist of environmental (i.e. dean air and water, etc.), social (i.e. well equiped
infrasructure, facdities for cornrnuting to CBD, public order and safety, etc.) and cultural Ci.e. accessibdity

to good schools, museums and hospitals, etc.) factors. Measuring amenity variables such as MEW and
NNW have been tried on by regional base, however, the series of such indicators by our districts during

the period is not available. W. Nordhans and J. Tobin, "Is Growth Obsolete?", Economic Growth,

1972. NNW Measurement Committee, Measuring Net National Welfare ofJapan, 1974.
14) Sources of local tax per head of population in the Tokyo Metropolitan area; Bureau of Taxation, T.M.G.,

Tax Revenue Annual Report: Tokyo Metropolitan Council 1975-1986 editions. For these local tax in
Osaka are Osaka Prefecture Statistical Yearbook, ibid., 344. Annuai Report for Statistics in Osaka, ibid.

For deriving figure of local tax burden per head of population in the Osaka Metropolitan area, dataof the registered population (see note 10) is used.

5

NOBUKO NOSSE

6

available for the two Metropolitan areasth).

The regression equation for the rising rate of land prices in the period 1976-D84

for the four sub-areas, i.e. TU, TS, OU, OS has to be estimated. The total numberof samples is 108, i.e. 36 for TU, 18 for TS, 36 OU, and 18 for OS. Our equation,
in a more operational way than the former equation, is the following

AP/P=di(AN, Ty/N, 7, P-i, TflN, Pc,) (1)where TylN is the local tax burden per head of population. The other symbols are thesame as those in the former equation, though A, the amenity variables is dropped.
We cad equation (1) as Model I.
In estimating Model I, we intend to measure the equation (1) for TUi separately,

since in TUi (the Minato area) the level of prices is the highest and the rise of

prices is the most rapid, as shown in Figure 1 above, because the residential
district is next to the foremost commercial district of Japani6).

Table 1 shows the estimates of regression coefficients of the variables in Model

I by each of the four blocks (TU, TS, OU, OS) and TUi.

Table 1 The Least squares estimates for Model I
const.

AN

Ty/N-52.781 -O.Oll O.449

T

TU (-2.143) (-1.950) (1.476)
TUI

M TS
o

ou

M os

Pc

R

d

F

O.1on -O.953-O.027 O.436

O.742

1.782

5.931

(O.392) (-3.361)(-O.301) (O.846)
O.993

1.8CY721.915

O.881

1.690

6.364

2.235 O.O17

O.635

2.080

3.264

-1.668 -O.491

o.sn

1.806

5.772

r

P-1

Tf/N

-227.201 -O.038 O.238

3.917 -2 .482

1.639 -O.520(-O.233) (-1.563) (O.494)(O.B2) (-7.198)(2.898) (-O.548)

37.126 -O.040 O.689-2.889 -2.751-O.681 1.473(O.145) (-1.108) (O.521)(-O,614) (-2,368)(-O.388) (1.003)-141.944 -O.037 O.423

3.128 -2,290(-2.486) (-2.628) (O.Ml)(1 .850) (-2 .487)-50.378 -O.Oll 2.308(-O.764) (-1.474) (2.055)

1.576 4.439(O.897) (-2.755)(1.704) (3.780)(-O.68n (-O.548)

15) As for the data on amenity variables in our Metropolitan areas over the period, statistics on natura1
environment are only available. Institute of Pollution, T.M.G., PoUution Statistics in TM.G., D84. Bureau

of Environment, Osaka Prefecture, Environment Statistics in Osaka, 1976-1986 editions.
16) Rise of the land price for cornmercial use in Minato ward spurted in later 1onO's and the annual rateof rising in the te81-te87 is 55.8oro and that in the D84-te87 is B6.7oro respectively, while the level ofthe price in D80 is Yl,1,094,OOO per m2 and that in te87 is Y16,474,OOO per m2. Such a high land priceand its annual rate of increase are a result of rapid growth of demand for central cornmercial districtin the centre of the Tokyo imer city (Minato and other such commercial area, Chuo and Chiyoda), whichhave still lasted, and such a sharp rise of land price has induced the price of its adjacent land for residentialuse. TUi, therefore, records both its high level of land price and its annual rate of increase. The annual

rate of the price of TUi rising in the sarne period re81-re87 is 51.7oro and in the te84-1987 is 84.2oro
respectively. lncidentally the annual rate of the CPI rising in D81-D86 is 1.9oro and in D84-or (F.H.) is O.7oro.

RECENT INFLATION OF LAND PRICES 7

IN METROPOLITAN AREAS OF JAPANAfter a stepwise estimation, Rs for the five districts, TU, TUi, TS, OU and OS

show O.742, O.993, O.881, O.635 and O.871 respectively in the right column ofTable 1.
It is remarkable that one regression coefficient 7 in Model I shown in column 4

is positive. The only one exception is TS' T -2.889, though before estimation we
expected all to be negative.
Now we draw a Table from Table 1, where the figures in each row show the estimatesfrom left to right according to their order in absolute value and the nature and effectsof each variables in Model 1 can be compared. The results is shown on Table 2.

Table 2 Comparing the coefficients of the variables of Table 1.
TS

TUI

ou

os

TU

AN

-O.040

TylN

2.308

r

TUI

ou

TS

os

TU

3.917

3.128

-2.889

1.576

O.197

P-1

-4.439

TflN

2.235

Pc

1.437

os

os

ou

TS

-O.038TS

O.689-O.037

TS
O.449

TS

TUI

-2.751-2.482os-1.668

TUI
1.639

TUI

os

-O.520-O.491-O.Oll

ou

O.423

ou

-2.290TS-O.681

TU

O.436-O.Oll

TUI
O.238

TU

-O.953TU-O.027

From Table 2, we can find the following.
First, for AN, i.e. population variables, an regression coethcients show negative
signs. This means that the net decrease (increase) of population has taken place related
to the rising (falling) land prices in each area.

Second, for TyfN, i.e. Iocal tax per head variables, the regression coedicients shows

all positive signs though their absolute values are not of the same extent.
Third, for T, i.e. commuting time variables, the regression coefucients show positive

signs in all districts except only one-that in TS.

Fourth, as for P-i, i.e. Iagged land prices, the regression coethcients show
negative signs in all districts and their absolute values are 1arge, which means the levelof land prices has a depressing effect on the rate of price rises.
Fifth, for Tf/N, i.e. property tax per head in each district, their signs of effects
vary according to districts.

Sixth, for Pc, i.e. consumer price index, the signs of regression coeihcients varyalso according to districts.

ou

O.O17

8

NOBUKO NOSSE
Table 2 explaines more, as it makes clear that the pattern of the regression

coethcients in each district shows quite dfierent directions.

Here, TUi attracts special attention; i. the population net decrease effect is big
and the Tf/N effect, too, li. the Pc effect has a negative sign though its absolute value

is not smad, ili. Ty/N effect, a proxy for income per head in TUi, is the smabest, iv.

by stepwise estimation, at the step II where Pc, T and TylN are omitted, we obtaina high rate of R for the Model, i.e. O.993, and v. the P-i coethcients in the Model arebigger than those of TU. The role of P-i as a depressing factor on the rising rate ofland prices in TUi is, however, limited. We find this by the stepwise estimation andthe fact that its single correlation coethcient is small (O.4(M. As the Pc effect has anegative sign and the Ty/N effect is smallest though it has a positive sign, we noticethat in TUi, during the period, there appeared an indication of speculative demand
expectation for hyperinflation. Hence, the regression coefficient of the net decrease of

population high, and we understand that in TUi there is a tendency to accerelate thedecrease of the population and a rapid rise in land prices.

On the other hand, it is remarkable that the two suburbs TS and OS have somecommon characters-the population net decrease effect on the rising rate of land prices
is strong especially in TS. Despite the figure for OS shown in Table 2, this effect isconsiderable, because of its high single correlation coethcient (-O.719) to APIP and at

the step where only the population is considered as a variable, R is O.718.

As for P-i and TylN, the estimates of the coefficients in two suburbs arelarge, too, though the sign of the former is negative while that of the latteris positive. From the above we conclude that the land prices are rising due to the
population effects, and that, in turn, rising prices bring big decreases in population.
And when the population in the districts is getting wealthier, the inflation in the districts

goes on. Since the early 1950's people has moved to TM, people who intended tomigrate to suburban districts have had to seek new areas farther away to settle andas a result, the whole area of TM has widened.
In the suburbs, P-i and the declining income are depressing factors for the riseof land prices, while a decreasing population and a shortening of commuting time inTS, as mentioned above, are accelerating factors.

There are some differences between TS and OS. One concerns the estimates of
the Pc coethcient and the other concerns the estimates of the TflN coeracients. As
for the latter factor, we can neglect it because in the two districts by stepwise estimation

the Tf/N effects are quite few. As for the former, however, the Pc effects in the two

suburbs are big. In TS, the coefficient is big and has positive signs.
So, in TS we consider Pc as an accelerating factor for land price rises, while in OS

OF LAND PRICESRECENT INFLATION
AREAS OF JAPANIN METROPOLITAN

9the Pc effect is smader than that in TS and its sign is adverse. We think this situation
is caused by different patterns of the two suburban districts, say, the changes of land

prices in TS are more sensitive to Pc than those in OS.
Third, if we compare the two metropolitan city districts TU and OU, the former
is still fiourishing while the latter has been stagnant and its population decrease has

begun far earlier than in the former. Observing both city districts, however, we findsome characteristic features for the inner city districts. As for P-i, Pc, TylN as aproxy of income per head, and 7, these estimates are small figures. In TU TflN issmall too. This suggests that i. not a single factor but many factors are at work
together, ii. other factors to attract population to the inner city are working and they
can not be spechied in our Model I. Finally, in Table 2, we notice that the net decreaseof the population coeihcient is smaller in TU than that in OU. This reflects the fact

above mentioned and suggests that the net population decrease in TU may be goingon and the TM circle itself is extending farther.

4. Hyperinflation in TM

Reconsidered

Due to the delay of the presentation of data by the taxation office, the estimates in

the previous section cannot be extended to the most recent years. However, by using
the official land prices which have been published for the two metropolitan areas after1985"), it seems worth while noting the specific feature of land prices byn"i.-sS
g"

tis
"-t

200

ttti ."

•ri

X Aas

50

t"'---e-M; .xt'kNN"zz Ss as3 o-s

.E

10

o
m.

:
E
,:

:

vpt
Å~

pt

17) Source:iiiX-SO elj9 ttsu it:710 iiit]iHIS:iss:2soN bNstk?N NXtx... toj-

20

s

1
it

tt

a

g

N

N

slqX

eAee
eT

r'eHl

100

8
.2

t
'

/ '
' '

' t

{"n -ut s-a -xSNx.. e2o 1 :i AssNNN

' '
' '

' '

aHH

ss :T FN S: .-NSsl HaPl NNAH4 11:ls '- -e"'ts- --ktirl :e:-s=i:>"sS6 ig 1 N Nx..ttt

1
l e77isI X:7elid-ST LS4Iessl
2 li:ig .,.,'s :i.. ; :,1
O.5

i e7b ,,"lSx---.--L-L"m-Lt/ l

o TU,

TU
A TS

o

x oU
e vs

<

t"'
lo ls •25
35 50 7o 100 150 20e 3oo soo
P(Land price, \10,OOOInf)

Figure 2

Scatter diagram of the net increase in land prices
on the land price, 1976- 1988

Othcial Land Price,

ibid., 1986-1988 editions.

tt

AHS

--s.. ..s Me2 sz NN793 mN Ni

5' '10 NOBUKO NOSSE
drawing a scatter diagram, which explores the relation between land prices and its
rising rates. Particularly it makes clearer the present hyperinflation of land prices whose

foreshadow was already seen in TUi in the previous sectign. In Figure 2 are thus
shown the net increase in land prices in relation to the land price itself.

Note that al1 figures are shown in logarithmic numbers.
From Figure 2, we can clearly recognise three phases during the observed period.
In the first phase of 1976-78, the rising rate of land prices was slow in each district
while almost maintaining the level of the land price itself. Their patterns were almost

identical except for the dfference in the level with the highest in TUi. In the second
phase until mid-80's, we clearly identify that there exists a barrier of the level of land
prices to oppress the rising rate of its price. It is seen in every district that the higher

the land price the lower the rising rate of land price. It may well be that there isa constraint of this sort in the normal condition of the land market. This situation stillholds in the district of Osaka (OU and OS) after 1979. But the constraint has lostits effect in the three Tokyo areas: TUi was the first which lost the land pricebarrier after 1985, followed by TU in 1986 and TS in 1987. They are then in thethird phase, where both land price and its rising rate increase together almost
proportionately. This is nothing more than the specific character of the hyperinflationin the Tokyo Metropolitan area. We must, however note the P and AP/P in each
districts in 1988, the end year of the Figure 2 TU and TUi move to right and bothgo out from phase III. The 1988 the position of TUi in the figure which showsa right most but low situation is notable. In both TUi and TU a tremendous fallingin APIP has happened. While TS in 1988, due to the lagged effect of land prices in
TM, stil1 stays in the phase III which showes highest P and APIP too. On the other

hand, in 1988 OU is going out from phase II and OS is getting into phase III.
From the above observation, we obtain the conclusion that the land price inflation

seems to have ceased temporarily in the Tokyo area in 1988, while in the Osaka area
we find continued mild price rising and in the end of the period prices spurt to risei8).

Hyperinflation of land prices which started in TUi and transferred to TU and TS
appears to be transmitted to Osaka now. This might have a possibility to be again
be transmitted to not only the whole Osaka area but to other metropolitan areas i.e.
Nagoya, Fukuoka, etc. The position of each districts in 1988 seems to forshadow land
prices in Japan.
18) Such a movement of price has continued in 1989. The rates of land price increase in each districts
are: TU; -39o, TU; -7.1oro, TS; -5.9oro, OU; 38.1oro, OS; 43.5eqo (the figures are those of base points

in maps of land prices respectively.) •Source: Nippon Keizai Shinbun, lst of Apri1, 1989.

RECENT INFLATION OF LAND PRICESIN METROPOLITAN AREAS OF JAPAN5. Regional Reconciliation Account as an Instrument toAnalyse Hyperinflation in Metropolitan Areas of JapanAs the amounts of capital gains have been growing in the recent three years, the people's
attention has been directed towards the reconciliation accountN). The rate of rising land

prices is, however, quite different according to region even in the metropolitan areas
as stated in the previous section. It is, then, needed to constmct a reconcMation accountfor measuring capital gains and rising prices according to region, because a different
policy by area is urgently required.
The virtue of a reconciliation account for a selected region is even greater, andthe reason is the following.

We denote the value of land for residential use in a densely populated region as
PZN where P is the price in such a region, Z is land per head of population in sucha given area and N is the number of inhabitants. In this paper we assume Z=Z.
As shown in S3, Models for explaining the rise of the land prices in metropolitan
areas depend on population increase (decrease), local tax per head of population, lagged

price, property tax per head of population, CPI and commuting time. Among these,some factors such as Pc, property tax and local tax must be derived from the usual

nationai accounts, but population and commuting time can only be derived from thedemographic account and the time-use account on the regional level. In the case where

we can estimate and compare the amenity variables according to regions during any
given period, we also get the figures, not from the national accounts but from thesocio-economic accounts according to region. Then, we consider that the constructionof a reconciliation account offers the possibility to extend the use of the reconciliationaccount beyond its proper use, as the concentration of the Japanese population in
the metropolitan areas is stil1 continuing especially in TM and the level of prices ofland in TM remains enormously high though its rising rate is a little falling, while theprice rise in OM is now going on. For the analysis of the well-being of the inhabitants,

therefore, the construction of a regional reconcdiation account, which records proper' socio-economic items (below the line items), is the first but mostitems and thoseimportant step indeed.
When we observe the metropolitan area in a wider sense, we must of course relax
our assumption Z= Z . The items in the account explaining variables are identical, though

in this case we must introduce `distance from CBD' factor and the price ofD) Nipponkeizai Shinbun, lst of Apri1, 1987. The editorial mentioned that capital gains accrued in Japan byland price inflation amounted to 213 of GNP in te86.

11

NOBUKO NOSSE

rz

aghculturnl land for development into residential land, as in these areas the land use
maintains a hybrid character.

6, Summary and Conclusion
From the analysis in the previous sections we obtain the following conclusions:i. Observing the rising land prices for residential use in both metropolitan areas under

the condition of Z=Z, during the period lg76-1987, there has been a high growthof land prices. In the Tokyo Metropolitan area the annual rate of price rises amounted
over 20oro, double of that in the Osaka area, while the acceleration of the land pricerise was faster than in the Osaka area. During the 1970's the rising trend of land
prices was parallel in both areas but after 1980 the land prices in the Tokyo area
showed a tremendous rise and in re85-1987, the last three years of the period, theannual rate of price rise was amounting to 45oro while in the Osaka area it was isless than 5oro20). A tremendous rising tendency in Osaka has appeared since 1988.
ii. Having obtained the least squares estimates of the regression coefficients which
determine the rate of price rises in the period 1976-1984 for which all related data
are available, we find that the factor P-i was related to P. As for T, TflN, and Pc,
their signs and magnitude of effect on the rate of the land price rise depend on thecharacter of the district, and in the case of common depressing factors (accelerating
factors) the effects vary. The causes for such differences lie mostly in the characterof the district, i.e. whether the district belongs to the Tokyo Metropolitan or the Osaka

Metropolitan area and whether it is an inner city district or a suburb.
iii. The district showing the clearest distinct situation is TUi where the level of andthe rate of land price rises is the highest. There we find that the signs of Pc coefficientand AN coeficient are negative, the sign of TylN coethcient is positive but its magnitude
is negligible, and the sign of P-i coethcient is negative but its magnitude is smak. After

1984 the foreshadow of a hyperinflation emerged, the land prices of TUi doubled
in one year and it spread to TU and then to TS.
iv. Under these circumstances, the role of the reconciliation account by region is
obviously important; it measures the magnitude of capital gains (both absolute andrelative) by regions. When the rise of land prices begins to show a vicious circle likein the Tokyo Metropolitan area, its role becomes more important as a warning of thesituation. Another role of the reconcMation account by the region is to provide regularly

the data of AP/P and of capital gains over a certain period. If these data are combined20) Source: Official Land Price, ibid.

RECENT INFLATION OF LAND PRICESIN METROPOLITAN AREAS OF JAPANwith the data derived from socio-economic accounts such as population, commuting
time, etc. by regions, they offer a base for the analysis of land price inflation by areas

though this has never been tried by national accountants.
Our object, the rising land prices and the causes in metropolitan areas, is limited
to the short period of 1975-ro88. But of course the great rise of land prices did not
happen ovemight, but was the result of the past 40 years of economic policy in Japan,
including its agriculturnl policy and taxation policy2i) added to the natural scarcity ofland with a dense population. These structural elements are likely to remain22).
Then if does inflation of land prices occur and is expected to continue due to theinelasticity of land supply, speculation for land emerges, and reduces irrvestment in othertangible assets.

Therefore, the next step is to construct a reconciliation account for the otherassets, and development should be directed towards housing on the land of metropolitan

regions. Also, the relaxation of our assumption Z==Z requires the measurement of
the other items of account, say, agricultura1 land and investment in the infrastmcture.

The construction of a reconciliation account by regions, as our simple experiencesuggests, is able to afford the analysis of the well-being of the people in urban areas,

where the majority of the Japanese population now lives23).
21) Taxes on capital gains have hardly been charged on the landholders, because by the Japanese tax low,
capital gains realized by selling land for residential use are exempted when the seller buys another landof the same amounts within one year. This tax device has helped to spread land price inflation in the

Metropolitan areas.
22) As for a tax system, for improving this notorious system on capital gains, the Japanese govemment
concidered to abolish the system in priciple and the government, instead to introduce capital gain tax,
decided to charge present income tax rate on such gain acquired by transaction of capital assets in 1988.
The rate itself is very low (109o and 15oro for over Y70 million) compared to enormous a mounts of capitalgains, so the effect of this is rather negligiable. Source: Nippon-no-zaizei, te88 edition, pp.158-159.
23) The population of Japan is rz1 million in re85. In TM it is 11.83 mthon while in OM 8.67 million, andpopulation of TM in broader sense (our TM plus surrounding three prefectures) is 30.27 mihion whilethat of OM in broader sense (our OM plus surroundmg three prefectures) is 17.84 million. Source: Statistics

Bureau Management and Coordination Agency, Tokyo, 1985 Population Census ofJapan, vol. 2. te87.

B

14 NOBUKO NOSSE
References[1] Association for Real Estate in Osaka Prefecture, Statistics of Real Estate in Osaka Prefecture,

1958-1960 editions.
[2] Association for Real Estate in Tokyo-to, Map of Land Prices of Real Estate in Tokyo-to, and The

Urban Planning Map for Greater Tokyo, 1958-1961 editions. i[3] Bureau of Environment, Osaka Prefecture, Environment Statistics In Osaka, 1976-1986 editions.
[4] Bureau of Statistics, Othce of the Prime Mmister, Housing Survey ofJapan, 1978 and 1983, vol.3,

Pts. 13 and 27.
[5] Bureau of Taxation, T.M.G., Tax Revenue Annual Report: Tokyo Metropolitan Council, 1975-1986
editions.
[6] Eisner, R., "Capitai Gains and Income: Real Changes in the Value of Capital in the United States,
1946-1977", in The Measurement of Capital, D. Usher, ed., vol. 45, National Bureau of Economic

Research Studies in Income and Wealth, 1980.
[7] Hibbert, J., Report on a Study of the Effect of Ini7ation on the Measurement of Income and Saving,

Statistical Office of the European Communities and Secretariat of the OECD, DESINI/82.2, OECD,
Paris, 1982.
[8] Hicks, J.R., Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory,
2nd ed., Clarendon Press, Oxford, 1946.
[9] HM, T.P., Infiation, ``Holding Gains and Saving,'' OECD Economic Stuclies, No. 2, OECD, Paris,
1984. Institute of Pollution, Pollution Statistics in T.M.G., 1984.

[10] McElroy, M.B., (1970-a) ``Capital Gains and Concept and Measurement of Purchasing Power'',
Proceeding of the American Statistical Association, Business and Economic Statistics Section, 1970.

[11] National Land Agency, Japan, OMcial Land Price, 1975-1986 editions.
[12] Nipponkeizai Shinbun, lst of Apri1 1987.
[13] Nipponkeizai Shinbun, lst of Apri1 1989.
[14] NNW Measurement Committee, Measuiing Net National Weifare ofJapan, Mmistry of Finance, Tokyo,

1974.
[15] Nosse, N, A Reconcdiation Account for Analysing Hyper-inflation in Land Prices'', paper presented
at 20th General Conference of International Association for Research in Income and Wealth, 1987.
[16] Nordhans, W. and J. Tobin, "Is Growth Obsolete?'', Economic Growth, Fiftieth Anniversary Coloquium

V, National Bureau of Economic Research, New York, 1972.
[17] OECD Group on Urban Affairs, Urban Policies in Japan, OECD, Paris, 1986.
[18] Osaka City Planning Bureau, Annual Report of Statistcs in Osaka, 1975-1985 editions, 14.
[19] Osaka Prefecture Statistical Association, Osaka Prefecture Statistical Yearbook, 1976-1985 editions,ch.3.
[20] Sourroville, I.V., Regional Accouts: Theoretical and Practical Problems in the Recent Experienceof Argentina'', The Review of Income and VVealth, series 22, 1976. pp. 13-36.
[21] Statistics Bureau Management and Coordination Agency, Consurner Price Index Survey, 1985. Monthly
Statistics ofJapan, No. 310, 1987.
[22] Sunga, P.S., "Adjusting Net Worth for Price Changes with Reference to the Canadian System of
National Accounts'', the Review of Income and Wealth, series 33, No. 1, Mar., 1987.
[23] Tokyo Statistical Association, Tokyo-to Statistical Yearbook, vols. 27-36, II.

[24] United Nations, A System of IVational Accounts, STISTAT/SER F121Rev. 3, 1968.
[25] Walters, RJ., ``A Framework for Regional Accounts: An Australian Perspective'', The Review ofIncome and Wealth, series 33, 1986.

LITTLE BASICS AND EMPLOYEEISM
JAPANESE MANAGEMENT IN INTERNATIONAL PERSPECTIVE

Hideki YOSHIHARA

1. Manufacturing Basics"5S" Campaign
What impressed Prof. R.H. Hayes of the Harvard Business School when he visited
Japanese factories was that they were extremely quiet and well ordered.i) In general,
Japanese factories are clean and workshop discipline is strict.

Why are Japanese factories clean? Some say Japanese culture. The Japanese likecleanliness and for this reason they keep their factories clean. Is this cultural explanation

nnrrnnfP
SiViLS"VL.

I have visited many American factories but not many were as clean and well orderedas the Japanese factories. Can this lack of order also be explained by similar arguments

relating to American culture? .
In December 1970, I went to the United States with my wife for a year and ahalf, when we were invited many times to the homes of Americans and had
opportunities to see the inside of their homes. I stil1 remember well how impressed

we were at the cleanliness and order we found there. If you ask me about my own
home, I can say that, certainly, the guest room is properly in order. But guests stay

only in that room and are not allowed to go elsewhere such as the kitchen, thechildren's rooms, or the living room, because these rooms are untidy, and we(especially my wife) would feel embarrassed.
In America I also had the opportunity to see the othces of professors at Harvard,
Stanford, M.I.T., and other universities, and they were cleaner and more orderly thanthe oihces of university professors in Japan. I expect that government othces are
likewise clean and in order. Generally speaking, however, American factories are not1) R.H. Hayes, "Why Japanese Factories Work,'' Harvard Business Review, July-August, 1981, p. 59.

16

HIDEKI YOSHIHARA

as clean in comparison to U.S. othces and houses. The opposite situation occurs inJapan, where if one visits a plant after seeing a Japanese home or othce, one finds
the plant exceptionaly clean.
What could be the reasons for such a state of affairs?

The ``5S'' campaign is practiced in many Japanese plants. It centers people's
attention on putting into order (Sehi), good order (Seiton), cleaning (Seisoh), cleanliness(Seiketsu), and traming and discipline (Shitsuke).2)

Japanese factories are clean and in good order largely because of this ``5S''
movement. Everybody from the top executive or manager at the factory all the way
down to the machine operators exerts himseif or herself, incessantly and for long periodsof time, in order to keep factories clean and in good order.

Improvements of the Production System Using Inventories as a Lever
When for some reason or other the supply of parts from vendors is behind scheduleand there is not enough inventory in the factory, production has to be stopped. For
this reason, the existence of an inventory is indispensable to ensure smooth production.
But, if the inventory is excessive, inventory maintenance costs rise. Thus, in order todetermine the optimum level of inventory, consideration is given to both the inventory

maintenance cost and the cost arising from interrupting production.
Japanese companies' approach to rnanaging irrventories is different from the approachtaken by American companies. The optimum level of inventory at American companies
is in general determined by specialists. Moreover, once they determine the optimum
inventory level, it remains fixed for relatively long periods. In contrast to this, theinventory level at Japanese companies is not considered fixed, but is regarded as

something that should decrease over time in conjunction with improvement in the
ethciency of the production system.
This Japanese view, which assumes a reversed direction of causality, maintains thatthe level of ethciency of the production system is gradualy improved by gradually lowering

the inventory level. Inventories act as a buffer in the production system. If inventory
levels are high, maintaining smooth production is a relatively easy task. However, wheninventory levels decrease, problems and weaknesses in the production system, which

previously had been hidden by the buffer, come to the surface. When this occurs,
workers, technicians, and supervisors pay close attention to the problem and work

towards a solution. When they find a solution, the ethciency of the production
2) Proper translation of these five words is not easy. Even in Japanese, the difference between
Seui and Seiton is not necessanly clear.

LITTLE BASICS AND EMPLOYEEISM 17
system is improved, and production is canied out smoothly on the basis of a reduced
inventory level.

If the inventory remains at the new level, the ethciency of the production systems

does not improve any more. However, jf the inventory level is reduced again and new
problems and weaknesses hidden by the buffer come to the surface, attention is directed

towards these problems, and efforts are made to correct them. When the new problems
are solved, efficiency further improves by another degree.

The efficiency of the production system thus improves step by step according to
the following cycle: inventory is reduced - - > latent problems surface - - > efforts

are made to solve the new probiems - - > problems are solved and the level of the
production system is improved. The assiduous repetition of this cycle is one of the
distinctive characteristics of Japanese production management.3)

In-house Design and Fabrication of Production Equipment
Matsushita, Toyota, and Canon are primanly assembly manufacturers. Matsushita
assembles electrical products such as color TV sets; Toyota's business is assembling

automobiles; and Canon assembles cameras, othce machines and other precisionequipment. However, these three companies design and manufacture production
equipment to be used for assembly operations.
In the U.S., manufacturers who assemble such items as electrical appliances andautomobiles, order and purchase production equipment from external equipment

manufacturers.`) Why, then, do Japanese assembly manufacturers design andmanufacture equipment rather than purchase it?
The first reason is that they want to have production equipment that perfectiy meets

their company's production needs. Equipment manufacturers are very good atmanufacturing general-purpose machinery. However, it is not that easy to acquire fromexternal manufacturers special purpose equipment that meets exactly the special
production requirements specific to each company.

The second reason is that designing and manufacturing production equipment
in-house results in developing high-level human resources capable of building that
equipment. Since some employees (technicians, foremen and skilled workers) will beassigned to design and inanufacture production equipment, they acquire know-how,
specialized knowledge, and technical knowledge about their production equipment.
3) R.J. Schonberger, Japanese Manufacturing Techniques, Free Press, D82, p. 15.
4) Hayes, ``Why Japanese Factories Work;' p. 64.

18

HIDEKI YOSHIHARA

The third reason is that people become attached to equipment designed and built
in their own company. Whereas machines bought from outside manufacturers are ``theirequipment," those built in-house become "our own equipment." Due to this attachment
to production machines built with their own hands, workers and engineers usually feel
affection for their machines, handle them with care, and provide adequate and timely

marntenance.
The fourth reason is that employees take an increasing interest in the production

equipment and are motivated to try to improve it. When we talk about designing andbuilding production equipment, we also include partial improvements and modifications

to machines that are already in place. Successive improvements and reforms on
production equipment are part of the realities of the Japanese factory. In many instancesthese small improvements to the production machinery are based on ideas andsuggestions made by workers and first-line supervisors.

Finally, production equipment manufactured in-house becomes a powerfu1
competitive weapon. When a new product is launched, competitors can easily buy itand study it. In countries such as Japan where competition is extremely severe,
competitors usually launch very similar products within one year of the time a new

product is introduced, and in some cases after a mere two or three months. While
competitors have ready access to a firm's new products, the production equipment

itself can be concealed from competitors because people are not allowed to see
competitors' factories. Therefore, protecting the secrets of production technology is

far easier than keeping product technology away from competitors.

Quality as a Key Success Factor
In Japanese factories, quality is important to the president and average employees alike.

Ail of them are fully convinced that, by paying attention to quality, their products'

competitive strength wil1 increase, and consequently so will profits. In fact, thecompetitive strength displayed so far by Japanese companies in world markets, as wellas the spectacular growth achieved by these firms, provides evidence of the validityof this belief.

Quadty means the following. First, it means having few claims or complaints madeby customers regarding products sold in the market. Next, it means that defective

products occur with minimum frequency during the company's production process.

Fumhermore, outstanding quality means offering products that adequately meetcustomers' requirements.
In order to insure quality, carefu1 inspections during the production process

LITTLE BASICS AND EMPLOYEEISM 19
have to be carried out, and only high-quality raw materials are to be used. A service

organization has to be enlarged to provide better and quicker service in regard tocustomers' claims. Since ab of these measures result in an increase in costs, enhancing
quadty is generady associated with cost increases. This view is widely held in Americancompanles.
At Japanese companies, however, cost and quality are not considered to be indirect proportion to each other, but in inverse proportion. In other words, it is believedthat by enhancing quality, costs go down. At first glance, this way of thinking looks
strange, but its validity is corroborated by the results achieved to date by Japanese

Why does quality improvement reduce, rather than increase, costs? The answer
lies in the following reasons.

Since only high-quality products are sold in the market, there are virtually norequests for repairs from customers and costs associated with providing repair services

are practically ni1. There is not much need to provide human resources and equipment
for repair services and, as a result, related costs can be kept to a minimum and thecost of a poor reputation is avoided.

When the percentage of defects during the manufacturing process is low, costsof remanufacturing are also low. Fumhermore, the number of partialy finished productsthat have to be discarded grows less. If finished goods (which have incurred the useof raw materials, parts, electricity, labor and other input) end up being scrapped becauseof poor quality, the costs incurred have an impact on the price of al1 the anicles ofgood quality. The cost goes up. When the percentage of defects in the production

process is low, then the need to compensate for such related costs goes down.
Furthermore, the amount of effort put into quality control in order to improve
the quality of products also results in improvements in the ethciency of the production

system as a whole, and in the long term produces overab cost reductions.
Let's look at another feature conceming the endeavors that Japanese companies

make in order to improve quality. In American and European companies quality is
generaky maintained and improved by means of inspections. In Japanese companies
inspections also play an important role, but they do not occupy a central position among

the various efforts made to enhance quality.
In order to improve quality, the production process itself has to be improved. The
concept that quality is created by the production process is widely spread throughout
Japanese companies. The quality of products improves with better production processes

rather than with more inspections of the kind I have just mentioned.

HIDEKI YOSHIHARA

20

Production process improvements alone are not suthcient to reduce the numberof defective items manufactured in that process. Rather a thorough analysis has to bemade as to the design of the product. In order to improve quality, carefu1 thought isrequired at dfferent stages of the design process to ensure that the resulting productcan be made by means of a manufacturing process that will not be likely to produce
defective articles, and, at the same time, wM be easy to operate. Thus we can talkabout quality improvements through the design process.
Not only workers, but first-line supervisors and design engineers are responsiblefor quality improvements. In fact, such responsibMty has to be assumed by all company

employees, including the president and other top executives, plant superintendents,
people in charge of purchasing, etc. The basic condition for the realization of long-term

quality improvements is the quality-consciousness displayed by all company employees
while doing their jobs.

2. Mass Mobilization
QC Circle Activities and Suggestion Activities
QC circle activities and suggestion systems are by now well-known all over the world.
In what follows, let us use the case of Sanyo Electric as a concrete example of suchactivities (as of 1979, 1 US$ = 220 yen).5)

At Sanyo Elecnic's Color TV Factory located in Osaka, there was a QC circle
activities group called the Nishio Group that achieved cost reductions amounting to
US$7,273 in one year. Considering the achievements of all the QC circle activities at

the Osaka Color TV Factory, cost reductions reached close to US$2.3 million, and if
the overall company is considered, cost reductions totahing the considerable amountof US$ 16 million were achieved through QC circle activities.

Now let's turn our attention to the suggestion system. Ms. Chiiko Mitsukoshi of
the Osaka Color TV Factory contributed in one year 112 suggestions that resulted incost savings of US$8,491. Cost savings resulting from the suggestion activities at the

Osaka Color TV Factory as a whole amounted to US$16.2 mllion, and at the company
level cost savings for Sanyo Electric reached the surprising amount of US$56 mi11ion.
By adding up cost savings due to both QC circle activities and suggestion activities,

we obtain for Sanyo Electric the staggering amount of US$72 million. The meaning of
this figure becomes clear when we reakze that current profits for that year at Sanyo

Electric were US$130 mllion. The cost reductions resulting from Sanyo Electric's QC

circle and suggestion activities are indeed impressive, especially when we notice5) Based on the author's case study. H. Yoshihara, Sanyo Electric (in Japanese), Nomura Management
School, 1976.

LITTLE BASICS AND EMPLOYEEISM

that they are achieved year after year. Every year important cost reductions amoundng

to approximately US$72 million are realized.

Such results of QC circle activities and suggestion activities are by no means
limited to Sanyo Electric. Matsushita, Toyota, Nippon Steel, as well as many othermanufacturing companies, are obtaining similar cost reductions, year in and year out,
from their QC circle and suggestion activities.
Unnl now, in order to make calculations easier, we have been lookmg at the resultsof QC circle activities and suggestion activities as cost reductions. However, various
kinds of suggestions for improvement are proposed, whose results are not exclusively

cost savings. There are many suggestions that produce improvements in quality ina broad sense, for example, improvement of the appearance of products. Also, themotivating effect that small-group activities has on workers cannot be disregarded.

The main promoters of QC circle activities and suggestion activities are plant
workers. Plant workers do not simply perform the operations assigned to them, butalso make proposals to improve the way they do their job. They think about productdesign, the use of raw materials and parts, production equipment, jigs, tools, operation

instmction forms, inspection tools, inspection methods, and make appropiate proposals

whenever they see room for improvement.
If we think of the company as a society, managers and engineers can be consideredas the elite. On the other hand, plant workers can be likened to masses. The excellent
fruits rendered by the QC circle activities and suggestion activities are really productsof the masses' endeavors. One can say that QC circle activities and suggestion
activities are organizational devices of mass mobMzation that motivate plant workers
in such a way that they can exercise their capabilities. At Japanese companies variousorganizational devices and systems have been developed, apart from QC circle andsuggestion activities, which motivate workers not only to do their assigned jobs but
also to take part in innovative activities.

Information is Fed back to the Worker
Computers are being widely used in the factory for production activities. In regard
to the production information system, there are important dfierences between Japanesecompanies and American' companies.
At American factories, the computer is used to store, analyze and output production
data, such as production volume, percentage of defects, and inventory condition. Thisdata is used exclusively by managers, engineers and specialists, and their is almost

no feedback to the factory workers.

21

22 HIDEKI YOSHIHARA
On the other hand, at Japanese factories, production data, quality data and the

1ike are fed back to the workshop operators, who also use the information.
While visiting a plant that assembles color TV sets I saw a data board similar tothat in Figure. 1 placed in front of the assembly line. The board displayed planned
production level, actual production level, and whether or not defective articles had been

produced. At that plant, information on the board was updated every two hours.
According to production schedule, the quantity that should?t."%,Re.&",tr2.1",,;eg,gg.tg,g,haxs,o>ng,w,a,z,22R.s,eg?•,z",g i::z2zs-::ifictious). If during a given interval not a single defective l 283 ll'------lset is produced,agreen circular marker is displayed at l e l
the bottom of the board. If even one defective set is '--;-r--iproduced, a red marker is displayed. In this way, llllproduction and quality data are fed back to the worker : l
at fairly frequent intervals, and the worker, by looking at I ithat data, can learn for himself or herself the status of l l
production.

Figure. 1

At large factories, such as those assembling automobiles, a similar board hangs from the ceiling so that every worker can see thesituation regarding production and quality levels.
The production information system at Japanese factories is a device that both bringsout plant workers capabilities and stimulates eagerness.

MBA VS. MWA
MBA stands for Master of Business Administration and is a degree awarded to businessschool graduates. In the U.S., business schools are well established and their graduates

occupy central positions in firms. In general, people holding an MBA degree haveindividual oihces, a secretary and do their job using computers. Rarely do they goto the factory shopfloor. From their individual offices separated from the plant they

manage operations by remote control.
At Japanese factories, there are almost no holders of master's degrees in businessadministration among managers and engineers. Japanese managers and engineers display
a pattern of behavior different from that of American MBAs. This pattern of behavior

is well described by the expression MWA.

MWA stands for Management by Walking Around, and is the behavioral pattern
adopted by most Japanese factory superintendents, first-lme supervisors, and productionengineers.6)
6) For the word MWA, I am indebted to TJ. Peters and N.K. Austin, A Passion for Excellence, Harperand Row, 1982.

LITTLE BASICS AND EMPLOYEEISM

Factory superintendents, first-line supervisors, and production engineers can befound in administrative othces located in the middle of the factory. They can often be

seen on the factory shopfioor, where, should a problem arise that cannot be solved
by a worker, they personally look for a solution on the spot. At Japanese factories,
managers' and engineers' othces are usually located in the plant. Moreover, frequently,
the place where first-line plant supervisors and technicians do their job is not an office,but the factory floor, where it is not rare to find only ordinary desks and chairs without

any separation wall.

In the case of the administrative style developed by the American MBA, acommunication barrier is built between the managers and specialists, on the one hand,
and the operators, on the other. This barrier makes it difficult for the feeling to emergethat both managers and operators belong to the same group. On the comtrary, in thecase of the Japanese management style, managers serve as an example to their workers:

they supervise their subordinates while walking around the factory floor (MWA), andwear the same kmd of workmg clothes used by operators. This behavior facMtates mutual

understanding and promotes a feeling of belonging to the same group. From thestandpoint of motivating the factory employees and bringing out the worker's ability

and eagerness to perform well, the Japanese MWA method appears to be far superior.

3. Japanese-style Human Resource Management

Some Features
As we have seen by now, one important characteristics of Japanese-style management
is that it motivates the employees, specially those at the factory fioor, and encourages
them to display their abihty to the fullest. One basic condition for this mass-mobdization

management to be effective in practice is that the company must show concern for
its employees and strive to satisfy their wants.

The main features of human resource management at Japanese companies are as
fo ll ows :-cautlous recrultment-in-house training-job rotations and reshuMing of personnel within companies-long-term competition among employees-emphasis on group-orientation rather than individual performance- egalitarianism-employment security-company unions and cooperative labor-management relations

23

24

HIDEKI YOSHIHARA

The personnel department is directly responsible for carrying out the managementof human resources at Japanese fums. At American companies, the personnel
department does not have a particularly important position, but its importance inJapanese companies is far greater, and it ranks as one of the key department alongsideproduction, marketing, engineering, and finance.

Employees as Intangible Company Assets
Japanese-style human resource management has the general features explained above.

At Japanese companies the employee is the focus of attention, and executives,
managers, personnel specialists, among others, invest much time and energy taking
care of personnel issues. Why is the employee the center of such special consideration?

It is often asserted that one of the features of Japanese-style management is``famly-ism." The firm is regarded as a family. The president and other top executives

play the father's role, and plant employees, salesmen, othce workers and the like aremembers of a big famly, and, as such, have to be supported. Japanese company
workers are treated with great consideration and care, in the same manner that children

in a family receive tender consideration from their father.

Perhaps the family analogy is usefu1 to some extent to explain the Japanesemanagement style. However, famly-ism is not by itself suthcient to explain Japanese-style human resource management.
``Before producing products we must build people'' is the philosophy of Mr.
Konosuke Matsushita, the founder of Matsushita Electric Industrial. And not only Mr.

Matsushita, but many other Japanese executives as well strive to build people. They

think that ``people are the essence of management.''
At the firm there are many intangible resources, such as technology, various kindsof know-how, organizational climate, and management ideology. These intangible
resources shape the individual characteristics of every company, and are, moreover,the basic source of competitive strength. Many of these managerial resources areembodied in engineers, salesmen, plant operators and other employees.

The special consideration given to the employee is probably due in part topaternaksm, but basicady it is due to the fact that the employee is the one who embodies

the company's intangible assets. Keeping the worker employed in the firm anddeveloping his capabMties is in reality behavior designed to accumulate managerial

resources in the company and then develop them further.

LITTLE BASICS AND EMPLOYEEISM 25
4. Employeeism vs. Stockholderism
Among the important characteristics of Japanese-style management the following areoften pointed out: the ``5 S'' movement, improvements of the production system using

stock as a lever, the use of production equipment manufactured in-house, and theattachment of great importance to quality. QC circle activities and suggestion

systems, feedback of information to the workers, and the MWA method have also
been mentioned. To these factors we could add the importance attached to team-work,attention to detail, accumulation of small improvements, etc. These characteristics,
when studied individually, are nothing particularly out of the ordinary, and they do not

require advanced methodologies or techniques. They are very basic things, obvious
prerequisites to carrying out -reliably and properly- production activities at the factory

floor. In carrying out production activities, the entire staff of a Japanese production
plant puts into practice what can be called ``little basics,'' that is, fundamental andordinary principles. At American factories, plant workers are no more than mere
implementors; they simply execute decisions, exactly as they are told by their superiors

and specialists. On the contrary, at the factory level of Japanese companies, workers
not only do their jobs, but also think about ways of improving operations. In contrast

with the elitism of American companies, Japanese factory workers are mass-mobmazed.

In order to accomplish this mass-mobilization, Japanese human resource
management takes concrete actions, such as trying to achieve employment stability
at the company. Based on the idea that ``people are the essence of management,''
the central theme for the executive becomes the administration of human resources,
which starts with developing people. In reality, this theme is based on the idea thatthe company belongs to its employees. In the U.S., the most likely answer to thequestion of whom the company belongs to is: ``The company belongs to thestockholders.'' But, in Japan, if the question is asked to the employees, who are doing

their best for the company's success, the likely response would be: "The company
belongs to us.'' In contrast to the American company's ``stockholder-ism,'' it is possible

to talk about the ``employee-ism'' that pervades the Japanese company.')

7) For the argument of empJoyeeism vs. stockholderism, I am indebted to Professor
See H. Itami, JinponshugtLkigyo (in Japanese), Chikuma Shobo, 1987.

Hiroyuki

Itami.

COUNTRIES:BANK'S LOANS TO
DEVELOPINGAPPROACH
A NORMATIVE
Kazuhiro IGAWA

Optimal conditions of bank loans are shown in the environment of uncertainty andasymmetric information. These normative conditions make clear how to make new bankloans of international commercial banks to firms (or projects) in deveioping countries.

The conditions also make clear some roles of an international organization, which
supervises or assists bank loans for developing countries.

1
How to make contract of bank loans is an important issue, when uncertainty andasymmetry of information exist. In the case that credit applicants have more information

than lenders, the latter must take into account of an incentive of the former to makefavourable contracts. Bester (1985) shows an incentive compatible contract using loaninterest rates and collaterals. A simlar but more rigorous and explicit analysis, especiallyfor an incentive compatiblity and an optimality, is found in Igawa & Kanatas (1985).

In an uncertain world, banks must calculate costs and benefits to accept credit,
considering risks of bankruptcy or default. In this field Krugman (1985) applied a rigorous

theory of bank loans to international debt problems.

This paper addresses to the problems of optimal contrasts for bank loans todeveloping countries, especially in the case that uncertainty of long-term loans andincentive problems of asymmetric information exist. This analysis partially sheds lighton international debt problems of developing countries, though the problems are wideand complicated. The debt problems have two aspects, one is real and the other ismonetary. The real aspect mainly concerns to strategic investments for economic
development to increase a capacity of repayments. The monetary aspect concerns todecrease a debt burden and stimulate a new credit. It is true that these aspects aremutuaky related and total analysis of them is required to set practical policies to thedebt problems. However, for analytical purpose, it is convenient to separate

28 KAZUHIRO IGAWA
the problem into real and monetary aspects, and we can make clear the issue ineach aspect.

The real aspect is substantiaky investigated by development economists and wehave nothing to add in this paper. Our interest is in the monetary aspect, especiallyin the problem how to stimulate new credits to debt countries. Of course, it is importantin practice to seek the way to decrease a debt burden of the past for developing
counnies. But this is rather political matter and economically more interesting issue

might be new credits in the present or future.

In the followings, a model of bank's loans to developing countries is shown insection 2. In section 3, optimal conditions for bank loans are investigated and section

4 makes clear the economic meanings of those conditions. In the last section, we
consider an applicability of our analysis to international debt problems of developing
countries, and there, some roles of an international organization are referred to.

2. A Model of Bank's Loans
To set up a model for bank loans of international commercial banks to the firms or
the projects in developing countries, three types of economic subjects or agents are

introduced. One is private or government firms of a developing country which apply
for bank credits. Second is international commercial banks in developed countries whichmake loans. The other is an international organization. This is not a necessary one
for the bank loan contract between firms and banks, but is introduced for the later
discussion of possible roles of the international organization for international debt

problems.

Clauses or covenants of loan contract of commercial bank are not qualitatively
different depending on credit applicants, firms of developing countries or those ofdeveloped countries. The dffence might be quantitative degree of conditions for loan
rates, collaterals, and others. Therefore, the following analysis is not specific for bank's

loans for developing countries, but we will introduce some features which are typicalto the loan projects of developing countries. rusks of long term project and available
information for the quality of firms or projects of developing countries are explicitly

introduced. 'Usually, contract terms of bank loans concern to loan rates and collaterals.
The latter belongs to debtor if interests and principals are repayed, and belongs toiender if not repayed. Therefore, 1arger collaterals push the debtor to try harder for

success of his project. If the collaterals are not enough, debtor may consume funds
lent. Besides this type of incentive effect of collaterals, there is another type of
incentive problems of collaterals related to asymmetric information. As we explain it

BANK'S LOANS 'ID DEVELOPING COUNTRIES: 29
in detail later, collaterals also play a role to overcome moral hazard of incentive to

mlsrepresent.

When banks and firms have the same information about probability of success offrrms' projects, loan rates wM be lower for projects with higher probabthty of success.

Therefore, if the same contract conditions are used in the case of firms have more
information than banks, risky firms wi11 have an incentive to misrepresent the probabdity

to ask for lower loan rates. When excess supply of bank credits is large, a bank would

lend to lower quality (lower probabihty of success) firms, and the incentive of
misrepresent wM jncrease possjbilities of default, as a result. In the case of excess
demand for bank credits, bauks may spend money for collecting information about firms

and still can set high enough loan rates. However, if the cost of co}lecting theinformation is high, it will be difficult to get rid of an incentive to misrepresent.

Although existence of enough collateral is usefu1 for the incentive not to consume
projects, an appropriate combination of collaterals and loan rates is necessary for the

incentive not to misrepresent. The model in this section focuses only on the incentive

problem of the latter and we assume that quality of firms or projects, which isexpressed by q, is informationally asymmetric. A firm has perfect information for his
own q, but banks do have only a probability distribution of q.

The q of a firm is not an only factor of uncertainty for banks. Economic
environments of the project in future also affect the probabMty of success of the project.

Some project would be succeeded just because of good macro economic conditions,and some would be failed because of stagnations. Of course micro economic conditions
in future are also important factors for success. It is true that subjective expectations

for economic environment in future might be different between agents, but to focus

on the asymmetry of q, we assume the same probability distribution for the future

economlc envlronment.
• Now, bank loans for developing countries are usually used for long term projects

for economic development. Because of this time horizon, uncertainty of economic
environment at the time of the end of project is very large. Therefore some projects

are started for the time being and the decision to continue or not is postponed tothe intermediate time, when the economic environment become certain. In the following

model, we take the case of a long term contract, which include two periods, frompresent to the intermediate, and from the intermediate to the end.
The explicit behaviors of economic agents are assumed as follows. A firm invests
one unit of bank credit for the first of two periods of a long term project. At the
beginning of the second period, the firm applies for additional one unit of bank credit

to complete the project. A revenue of success of the project after two periods

30 KAZUHIRO IGAWA
is X, and a part of which is used for repaying of interests and principals. Here weassume the same X is expected by banks and firms. In the case of falure of the project,

we assume, a firm loses only a collateral or a equivalence. There are many possible

types of the equivalence, but here we only consider one type of guaranty money orinsurance, which is submitted to international organization and is not refunded toa firm but is paid to a bank in the case of default or repudiation. This means that weneglect the incentive not to consume projects because of a collateral, in this paper.

At the beginning of the first period, an international commercial bank shows aschedule of loan rates and guaranty money to firms, depending on reported q by firms,

and bank loans are made if they are agreed. At the beginning of the second period,

an additional loan of one unit is made depending on the outcome of economic
environment and quality q. This decision of an additional fund depends on the gainin the case to continue the project and on the remained value in the case to stop
the project.

To make explicit the conditions of this decision, we assume the following probabMty
structure for success. That is, an environmental uncertainty exist only for the first
period and there are two outcomes, good and bad. The probability of a good conditionis p and the one of a bad condition is (1 - p). A probabdity of success depends not
only on p but q, a quality of a firm. Higher q means higher probability of successof the same project and we assume the probabMty of success in good condition is aq,
therefore the one of failure is (1 - aq). In the bad condition, a probability of successis bq and the one of failure is (1 - bq), where a > b > o.
When a project is succeeded, the lending bank wil1 get interests and principals
of its loans for two periods. One unit of the first period's fund becomesI after two
periods and additional one unit becomes r at the end of second period. If the project

fails, inspite of the additional loan, the bank can get guaranty money from theinternational organization. As assuming no uncertainty of economic environment in thesecond period, the loan rate for the additional fund is risk free rate (r - 1). We also

assume the international organization makes use of money of guaranty at the samerate. Now, we can find explicit conditions for the decision of additional funds.
In the bad outcome, a present value of bank's net revenue, Rs, is
Rs = bq (I + r) /r2 + (1 - bq)K -- (1 + 1/r)
, when additional loans are made and where r is also a discount rate. In the case of
the project is stopped, present value of bank revenue (remaining value) is c and net

revenue Rf is

Rf = c- 1.
Therefore, if Rs > Rf then the additional fund is lent and this condition isq > (1/r +c- K) /b { (I + r) lr2 -K} ii! 4

BANK'S LOANS TO DEVELOPING COUNTRIES: 31,explicitly using q. That is, for the firms ofqSqN, additional fund is not lent in thebad outcome of economic environment. Of course, in the good outcome, additional
funds are always lent.

3. 0ptimal Conditions for Bank Loans'
We are now in the position to derive an optimal schedule of bank loan contracts. Thatis, the conditions of a bank loan is accepted and of loan rates and guranty money are

determined, at the begining of the first period. The conditions depend on reported
q of the firm and constraints of incentive compatibility of truth teMng.

For analytical purposes, firms are devided into two groups, one is the firms ofq>q-V which could get additional fund in al1 outcomes of economic environment,

and the other is those of q E qN which cannot get the fund in a bad outcome.
To each group, we can develop similar arguments and thus we wM mainly concern
to the firms of q > q"V. The firms of q E qA" wM be treated in the simplest way.
The firm of q > q'V , getting credits, expects a revenue of project after success,and the present value the net revenue is V, which is(1) V = {paq + (1-p)bq} (x-r-I)lr2-K.
V of a firm of q E q- is(1)' V = paq (X-r-I)lr2-K.
On the other hand, we assume that banks give credit in competitive credit market

and that banks are risk neutral. Therefore, expected profits of banks are zero inequihbrium, and the following relations should ho!d for bank loans,(2) {paq + (1-p)bq} (I+r) /r2+ {p (1-aq) + (1-p) (lbq)} K = 1+11r.
The first term of the left hand side of (2) is a discounted bank revenue when a firm
succeeds in the project and the second term is a discounted revenue of guranty money
when the project fails. The right hand side is a discounted value of bank loans. The
Simiiar relations hold for a firm of q s q'V,(2)' paq (I+r)/r2 +p (1-aq) K+ (1-p) c= 1.
It is also uncertain for credit applicants whether they can get bank credits or not.
A probabmaty of acceptance z will depend on reported q by the applicants, and expected. u lsnet revenue(3) u = zV.
As already mentioned above, a decision of acceptance and conditions of loan
(I and K) depend on reported q by firms. Ifa firm can misrepresent q and report

32 KAZUHIRO IGAWA
as q', incentive compatibMty condition of truth telling can be expressed asu (q';q) <u(q;q),, where the first argument in u is a reported quality of a firm and the second argument

is its true quakty. If this condition is satisfied, a firm does not have incentive to

misrepresent for q, because expected net revenue is larger in the case of reponing
truth for its quality. We can rewrite this incentive compatibility condition with a local

representation as follows. For a firm of q > qA'(4) u' (q) == z(q) {pa + (1-p)b} {X-r-I(q)}/r2(5) u" (q) > O,where u' = OulOq and u" : Ou'10q. Similar conditions fora firm ofq E q-"are(4)' u' (q) == z (q)pa{X-r-I(q)}/r2
and (5).

A bank can choose a combination of I and K of zero expected profit and expected
profit of a firm, in tern, depends on the combination of I and K. Therefore competition

among banks push them to offer the combination of I and K which maximizes expected
profit of firms. That is, a bank offer the conditions of(n maxfu(q)dF(q), where F(q) is accumulated dencity of f(q). It is assumed that banks know functionof f(q) but do not know the value q of each firm.
We can formalize optimal loan conditions as those of (" with constraints of (1) •(5) forq>qAV ((1)' (2)' (3)(4)' (5) forq E q'V). From (1) - (4), we can get the following

relations of u, for a firm q, q>q-', without using K and I. That is(6)' u' -- - {1-paq-(1-p)bq}u/{pa + (1-p)b}q2+zXlqr2-z(1+1/r)/{pa+(1-p)b}q2 = y.
Therefore, the above optimization problem can be reduced to (O under (6), with condition(5).

The Hamiltonian H of this problem is

H :fu + Xv
, when state variable is u and X is the costate variable. The necessary condition(which are also suthcient in this case) are(9) -X' = OH/Ou = f-X{1-paq-(1-p)bq}/{pa+(1-p)b}q2(10) aH/Oz = X[X/r2q-(1+1/r)1{pa+(1-p)b}q2] l O

BANK'S LOANS ro DEVELOPING COUNTRIES: 33
and (6). From these relations, we can get optimal solution for N z, u. As X is positive,z=1 and bank credits are accepted for a firm of(11) q > (1 +1/r)r 21 {pa +(1-p)b}X = q,but z=O and no bank credits are accepted fora firm ofq 5 q. The solution ofu can get from (6) with z=1, but an arbitrary constant (mitial condition) wM be
explained later. For the firm of q E qN, the relation corresponding to (6) is(6)' u' = -p(1-aq)ul(1-p+paq)q+zpaXl(1-p+paq)r2-z{1-(1-p)c}1(1-p+paq)q e v
and necessary conditions of maximization are(9)' -X' == OH/Ou = f-Xp(1-aq)/(1-p+paq)q(10)' OH/aZ = lpaXl(1-p+paq)r2-{(1-(1-p)c}/(1-p+paq)q] l- O
and (6)'. The condition of bank credits are accepted is(11)' q > {1-(1-p)c}r21paX i q
and a firm of q S q can not get bank loans.

4. Loan Interest Rate and Guaranty Money
Using the solution of u, the solution of K for the firms of q >qAV and z=1 can be
get from the following relations(12) u == {paq+(1-p)bq}X/r2- {paq+(1-p)bq}K-1-1/r, which is derived from (2) for the given solution of K. This is similar for the firmofq S. q-" and we get(12) ' u - pa qXlr2 - (1 -p +pbq)K + (1-p)c-1, which determines K for given u. ``I'' can be get from (2) or (2)'. In this way, abank can derive optimal z, I, K schedules for reported q. A firm report q, looking
at these schedules, and conditions for bank loan contract are determined.
Here we briefiy sketch a behaviour of contract for a bank. For a good project, which

the firm of q S- q- could use a bank loan, the firm of q >q-' can get bank credits

and additional loans, regardless of outcome of economic environment.
The bank determine I and K, using optimal schedules for q >qA' . For the firm reporting

q 5q'V , a bank will accept credit only for the firm of q >q with a condition tostop additional loan in case of a bad outcome. The bank determine I and K, using
optimal schedule for q S- q'V. For a bad project, which the firms of q S- q'- cannot

34 KAZUHIRO IGAWA
get bank loans, only some of the firmsi of q>q-V, that is q>q, could get loans.

I and K are determined using optimal schedules for q>qN

, and in the case of a bad

outcome, the bank may not admit additional loans.
So far, the incentive compatibility condition (5) of u">O is not used explicitly.
We investigate the relation of the condition to the optimal schedules ofIand K. This
clear the properties of I and K schedules. First we take the case of q>qA' . Putting
z=1 in equation (4), and differentiate it with respect to q, we get(B) u" -- -{pa+(1-p)b} I'lr2 'where I' =OIIOq. The condition of u' >O implies I' <O, that is, a loan rate should belower for a better quality firm.

Next putting z=1 in equation (6), and differentiating it with respect to q, we get(14) {1-paq-(1-p)bq} {pa+(1-p)b} q2u" = {pa+(1-p)b} {Xlr2-(1-11r)}-u'.
Therefore, the condition of u" >O implies(15) {pa+(1-p)b} (Xlr2-1-1-/r) >u'.
Differentiating (12) with respect to q, we get the following relations(16) u' - {pa+(1-p)b} X/ff-{pa+(1-p)b} K-{pa+(1-p)b} qK', where K'= OklOq. Using equations (2) and (4), this can be rewritten as' u' - {pa+(1-p)b} (Xlr2-1-1-/r) = -{pa+(1-p)b}{p(1-aq)+(1-p) (1-bq)} qK'.
From the relation (15), the left hand side of this equation is negative and thus K'

must be positive. This is, K'>O, and guaranty money should be higher for a goodquality firm. As I' <O, this is reasonable, because if K' <O every firm misrepresents
and reports the highest q. Differentiating (16) with respect to q, we get(ln u" + 2 {pa+(1-p)b} K' = -{pa+(1-p)b} qK"
where, K"= OK'/Oq. As u">O and K'>O, it is implied K"<O from equation(M. That is, a rate of increase of K becomes smaller as q increases. AboutI"(=OI'/Oq) we get the relation as follows,(18) 2 {pa+(1-p)b} (I'lr2-K') + {p(1-ap) + (1-p) (1-bq)} K"- - {pa +(1-p)b} qI".
This implies I">O, because of I' < O, K'>O, and K"<O. This is reasonable again,
because, if a rate of decrease of I is more than proportional, then a firm might
misrepresent higher q for lower loan rates. Therefore, a decrease of I must be lessthan proportional. We new find that incentive compatibdity conditions imply not only
I' < O, K' >O, but also I" > o, K tt <o.

BANK'S LOANS TO DEVELOPING COUNTRIES: 35
Formally simlar analyses can be applied for the case of q S- q-. Putting z=1 in(6) ' and dfferentiating it with respect to q, the condition of u" > O becomes as follows,(15)' paXlr2 -a{1-(1-p)c}>u'.
putting z=1 in (14)' and dfierentiating it with respect to q, we get(13)' u" = -pa I'lr2
and thus, u">O implies I' <O. Differentiating (12)' with respect to q, and using (2)'and (4)', we getu' -paX/"- a{1-(1-p)c} - -(1-p+paq) (1-aq) K',
and (15)' implies K'>O. Twice differentiation of (12)' gives us(17)'u"+ 2paK'= -(1-p+paq)K"and this implies K"< O, because U"> O and K'> O.
Twice differentiation of (2)' with respent to q gives us(18)' 2pa(I'/r2.K')+p(1-aq)K"- -paq I"lr2
and thus, I">O.
Besides these properties of the I and K schedules, we must decide the exact
levels of I and K with respect to q. This is the determination of an arbitrary constant(or mitial condition) of optimal solution of u, as mentioned. That is, once the arbitrary

constant is fixed, the optimal u function is determined, and thus the I and K functions

are deterrnined. Now, as the guaranty money K is necessary only for incentive
compatibility conditions, a firm prefer to minimize K if possible, however a bank does

not care about a level of K, so long as K works as incentive mechanism. Therefore,K'> O means K is zero for q=q, where q is minimum q of getting bank credits,for q >q-V and a bad project. The value of u of K=O and q=q is determined byequation (12) and thus arbitraly constant for u is determined.

For a good project, where some firms of q S- qN could use bank credits, K is
set zero at q= q. In this case, the arbitrary constant is determined by (12)' with

K=O, and q= q. For the continuity of K schedule, we can set K for q >q'V andq close to q'W, at the value of K (q-') of K schedule for q 5 qN. Thus, we can get

one continuous function of K for ah q. Once K schedule is determined, thecorresponding I schedule can be determined.

36 KAZUHIRO IGAWA
5. Some Remarks and Extentions
From the above optimizing analysis for bank loans to developing countries, we canpoint out the following two. One is, a collateral or some equivalence (guaranty moneyor insurance in our case) is necessary to cope with incentive compatibihty ofmisrepresent the quality, in which credit applicants have advantage. Sovereignguaranty is not enough for an incentive problem when there exist political risks forthe government. In this paper, following the idea of deposit insurance fee of banking

system, we have used guaranty money, which is maintained in an internationalorganization. A bank could get guaranteed money when the firm's project failes. We
could use a collateral if possible, but the collateral should be perfectly controlled by

the lending banks.
The other is a lending procedure to cope with environmental uncertainty of longterm projects. A condition to stop projects should be included in contracts, depending
on outcome of economic environment. Otherwise, a possibility of bank loans is limited
only for higher quality firms, and lower quality firms cannot use bank credits. However,some lower quality firms can use bank credits if the loan contract include the caseto stop projects when the outcome of economic environment is bad. It is true inmany cases, that the costs to stop projects in a middle are not low, but costs tocontinue the projects in bad environment would be much higher. This is important
for the bank loans to developing countries, where firms do not have enough ability
to adjust for environmental changes.

In our model, it is assumed that al1 agents have a same probability for future
economic environment. However in practice, this is not true especially for long term
expectations. Even after the time point of the outcome, the judgement may differ among
agents. This make bank loan contract dithcult, especially including conditionality of
stopping project. Funhermore, if we introduce an uncertair}ty of a revenue X, a problem

of how to evaluate X would produces another dithculty of contracts, between banks
and firms. Uncertainty makes it dithcult to agree between them, especially if agent

are risk averse. We have negrected these problems in above model.
We can discuss some possible roles of international organization, once we introduce
risk averse banks and different expectations among agents. The organization can collectdata for analyzing and forecasting firm's projects and economic environments, and canopen some information, which can be used for bank loan contracts. Even an evaluationof projects, the organization could help to negotiate between banks and firms, with

its own data and information. Information has a property of public goods, andinformation by the international organization might give benefits to economy as a whole.

More active and usefu1 roles of a international organization might be loans by

BANK'S LOANS TO DEVELOPING COUNTRIES: 37
the organization to developing countries. These loans are complement of commercialbank loans. If commercial banks are risk averse then they wM ask higher loan rateand larger guaranty money. This is a rational behaviour but if the risk aversion isexcessive, economic efficiency as a whole is decreased. The project of a firm, which

can use bank loans in the risk neutral case, may not be put into practice if banks
are risk averse. Especially in the case of a bad outcome of economic environments,
banks might become very pessimistic and thus even a good project might be stopped.
In this case, it is better to pool risks and one possible way to cope with this is ause of funds of an international organization. Those projects, which are stopped becauseof risk aversion of commercial banks, could continue with loan assistance of ainternational organization. If the available funds of the organization are limited, assistanceof only the risk premium is enough in practice. Of course it is not necessary to assist

the projects which risk neutral banks stop loans. This role of the organization also
can be extended for the initiai bank credit.
In general, there are two types of difficulties for firms to repay their debts, one
is a liquidity shortage and the other is a default. The illiquidity problem because ofrisk averse behaviours of commercial banks should be sloved, for instance, using risk
neutral international organization. If the organization intervene the project, a confidenceof banks about the project wru increase and cooperative loans of banks and theorganization might increase. However it is not necessary to assist the projects withhigh default risk. If these projects are necessary in some reasons, we should searchfor other funds than bank credits.

References[1]

H. Bester, "Screening vs. Rationing in Credit Markets with Imperfect Inforrnation,'' The American

Economic Review, vol. 75, No. 4, Sept. 1985
[2]

K. Igawa and G. Kanatas, ``Screening, Collateral, and Moral Hazard: Secured Credit vs. Seif-Finance,"

Working paper, 1985
[3]

P. Krugman, "International Debt Strategies iri an Uncertain World," in G. W. Smith & J. T. Cuddington,eds. Inteinational Debt and the DeveJoping Countries. The World Bank, 1985

JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, TOMORROW*Peter DRYSDALE

Japan's Trade Diplomacy: Yesterday, Today, Tomorrowi)

The establishment of a liberal multilateral trading system in the postwar period
presented opportunities for rapid economic growth for Japan, and for other countries
in East Asia and the Pacinc, including Austraia. The strength of the American economy
and American political leadership ensured, for almost a generation, economic and trade
growth that provided the substantial underpinning for the Western economic and security
alliance.2) The success of the liberal international economic system, the rise of Japanand Europe as major centres of economic power and its converse, the declining relative

importance of North America in the world economy, bring new challenges tointernational trade and economic diplomacy,

These challenges focus heavily upon Japan.

Challenge for Japan's Trade Diplomacy
While the United States remains the dominant global and strategic power, the relative

decline of its economic power, and its own growing vulnerabMty to a more interlinked international system, have meant an erosion of its `rule making' authority andcapacity in the international economy and a period of rivalry and confusion among* Peter Drysdale is the director of the Australia-Japan Research Centre and a professor in the Research
School of Pachic Studies, Austrakan National University. He was a guest professor of the Research Institutefor Economics and Business Adrninistration, Kobe University, during the fiscal year period of 1988 to 1989.
1) This paper was prepared while I was visidng professor at the Research Institute for Economics and Business

Administration, Kobe University, and it was completed at the Austraka-Japan Research Centre, Australian
National University, Canberra. I am gratefu1 to colleagues and staff at both instjtutions for commentson the ideas in the paper and support in its preparation and completion.

2) Peter Drysdale, Inteinational Economic Plurai'srn: Economic Policy in East Asia and the Pacific,

Allen and Unwin, Sydney, and Columbia University Press, New York, 1988, Chapter 10.

PETER DRYSDALE

40

its Western allies about sharing the responsiblities for management of the international

economic system.3)
Japan is emerging as a new power with global reach. The world's second largest
economy, the world's third largest trader, the world's largest capital exporter; Japan'srole is pivotal in the restructuring of the regional and international economic system,
as well as the political and strategic system of Asia and the Pacific.

But there are genuine questions about whether Japan is up to the task of trade andeconomic policy leadership and able to serve the role of protector and exemplar of aliberal and open international economic system.

These questions are motivated by two concerns. The first relates to the nature of
the international economic system itself, in a stage of significant change in the structureof world economic power. The second relates to the nature of Japan, its society, polity,
institutional foundations, and driving policy motivations.

This paper addresses the latter concern, albeit in the context of asking whether

domestic processes would encourage or permit Japan to play an important role inprotecting and developing the international economic system and how that role may
realistically be played. Inevitably these questions prompt comment upon the sameprocesses in the United States and their impact upon the international trade and economic

system, not least because the conception of Japan's role in world economic affairs as
being entirely alien to support for an open and liberal international economic system iscurrently deeply rooted in American political thinking.`) That has to be explained; andI shall attempt to do so briefly. The respective roles of the United States and Japan
also require comment. A specific interest, in the development of the argument, is how
Japan has responded to the various proposals from the United States for free trade area
solutions to trade policy problems, particularly to the proposal for a United States-JapanFree Trade Area.5)

Hegemonic Dominance ?
Before tuming to these questions, has Japan's emergence as the world's second largest

economic power, of its nature, been destabilising to the structure of the postwar
3) Peter Drysdale, Nancy VTiviani, Ippei Yarnazawa and Akio VLhtanabe, lhe Austrab'a-Japan Relationship' : Towatds

the Year 2000, Australia-Japan Research Centre, Canberra, and Japan Center for Economic Research, Tokyo,

August 1989, para.3.
4) The most recent example of this thinking is exposed in James Fallows, 'Containing Japan', The Atiantic

Montbly, May te89, pp.40-54.
5) United States International Trade Commission, Pros and Cons oflnitiatt'qg Negotiations with Japan to Explore

the Possibth'ty of a U.S.-Japan Free Trade Area Agreement, Irwestigation No. TA-332-255, USInc Pub.

20, 2rzO, Washington, September ro89.

41
JAPAN'S TRADE DIPLOMACY: YESTERDAY, roDAY, 'IOMORROW

international economic system?

Clearly, in one key respect, the answer is no. The decoupling of economic frommilitary power has made Japan's re-integration into the international community in the

postwar period much less threatening than would have otherwise been the case.
As Inoguchi and Okimoto point out, ``Japan's ... conversion from military power tocommercial state has not only neutralised the danger of Japan's own military
recrudescence; it has also contributed to the stabrasation of East Asia, a region of chronic

instabihty from the nineteenth through to the mid twentieth century."6)Now, let me dispatch the first concern: the question of hegemonic dominance asa requirement for system stability.

As the economic power of the United States has begun to wane, and that ofJapan and Easy Asia has grown, much of the commentary on the transfer of the
responsibimies of international economic leadership around the decline of America's
hegemonic power has been cast in terms of their transfer from one dominant hegemon

to another. Nowhere is this perspective more entrenched in thinking that it is in
discussion of the changing status of the United States and Japan. This is not theplace to enquire into the political or, indeed, the psychological wensprings of thisview of the transfer to hegemonic power, but rather to note simply the limitations ofintellectual analysis along these lines.7)

Obviously adjustment to economic change brings with it dislocation, conflict anduncertainties, all of which have accompanied Japan's rapid rise as a world economic
power. From the perspective of the international economic system, an automatic, but
inadvertent, side-effect of Japan's rise has been the relative decline of American

economic power and hegemonic status. Orthodox theories of hegemonic stability, inthe literature of international relations, suggest that Japan's economic ascendance is

inevhably altering the distributjon of economic power in a way that destabihses theinternational system, weakening the abihty of the United States to maintain rules and6) Takashi Inoguchi and Daniel I. Okimoto, The Political Economy ofJapan: The Changing Internationai
Context. Vol 2, Stanford University Press, Stanford, 1988, p.10.

7) Ole R. Holsti, Randolph M. Simpson, and Alexander L. George, (eds), Changes in the International
System, Westview, Boulder, 1980; Robert O. Keohane, `The Theory of Hegemonic Stability and Changes
in International Economic Regimes; ro67-lg77', in Holsti (eds), Changes in the International System; Robert

O. Keohane, `The Demand for International Regimes', International Oignnization, Vol. 36, No.2, N82;

Stephen D. Krasner, `Structural Causes and Regime Consequences: Regimes as Intervening Variables',International Otganization, Vol. 36, No. 2, te82; Charles P. Kindleberger, `Dominance and Leadershipin the International Economy', International Studies Quarterly, Vol. 25, 1981; Charles P. Kindleberger,`International Goods without International Government', American Economic Review, Vol. 71, No. 1,
March 1986; and Drysdale, International Pluralism, Chapter 10.

42 PETER DRYSDALE
policy behaviour consistent with open trade and capital flows and an orderly internationalmonetary and financial system. In this view, a fundamental requirement for systemstability is hegemonic dominance.
Suihce it to say that analysis which predicates system sfability on the persistenceof hegemonic dominance is built upon a very simple model. It neglects the complex
relationship between economic power and the capacity to use it in determining policy
outcomes;8) it neglects the incentive to coalition or alliance formation among principal

or minor economic powers to preserve critical interests in the system; and,paradoxically, it neglects the rich complication of economic matters by political andsecurity matters in the development of approaches to system maintenance, or the
regime, as an object of international policy.

This is not to say that hegemonic stability theorists may not, in the event, turnout to be right in their forecasts. They may; but if they are so, they wM not be so
because of the predictive power of orthodox theory. The point is that the emergenceof Japan as a contending (or challenging) economic power implies nothing, in the natureof things, about system collapse. On the facts of this matter, the jury should stil1 be

out and concerned about more fundamental issues, to which I shall later turn.

Precept and Practice
Trade policy leadership responsibilities obviously represent a political as well as an

economic burden for which the recompense is only very indirect. They involve theeffort of addressing the tough political problems at home (associated in Japan with freeing

up agricultural trade, reducing support for small scale manufacturing industry,and national procurement arrangements in the service sector)9) and of building up thecredibMty in the international community necessary to make it manageable.'O)
Certainly, in respect of this last point, Japan's trade diplomacy cannot be said
yet to enjoy a good international press.'i) This is partly a product of where Japan's

trade policies have come from, both in terms of precept and practice, and partly
a product of where the international press comes from. What is reflected in the public

8)Bruce Russett, `US. Hegemony: Gone or Merely Dirninished, and How Does It Matter?', in Inoguchi
and Okimoto (eds), Political Econonry ofJapan, pp. 83-1cr7.
9) Peter Drysdale, `Japan as a Pacinc and World Economic Power', AustraLi'an Economic Ripeis, Vol. 27, No.

51, December te88, p. 166.
10) Russett, `US. Hegemony', pp. 103-107.
ll) Drysdale, `Japan as a World Economic Power', p. 167.

43
JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, TOMORROW

press is also a prominent theme in the academic press, especially at its

more popular

end.i2)In the Apnl issue of Harvard Business Review, Taggart Murphyi3)

bluntlya view widely held in the United States:
The world cannot confidently look to Japan as an irnpartial guarantor of an open trading system (p.143)... more likely is that Japan will continue to use its financial strength to further Japanese interests,

which are not necessarily the same as the world's - especially given Japan's seeming compulsion
to dominate every important value-added industry. The uncoupling of financial power and global vision
could lead to a series of political, economic and financial crises like the run on Continental (Bank)or the stock market crash of October 1987 (p.144) ... Japan is reluctant to import manufactured goods

from abroad, but more important, its compensation pattems and wealth distribution make it dithcult
for the country to take over as an engine of global demand (p.146).

In theMay issue of The Atiantic Montbly, James Fallowsi`) concludes:

Unless Japan is contained, therefore, several things that matter to America wi11 be jeopardised; Arnerica's

own authority to carry out its foreign policy and advance its ideals, American citizens' future prospects

within the world's most powerfu1 business firms, and also the very system of free trade that America

has helped to sustain since the Second World War. The major threat to the free trade system does
not come from American protectionists. It comes from the example set by Japan. Japan and its acolytes,

such as Taiwan and Korea, have demonstrated that in head-on industrial competition between
free-trading societies and `capitalist development states', the free traders will eventually lose. The

drive to break up the world into trading blocs - united Europe, North America, East Asia - is1argely fueled by other countries' desire to protect themselves against Japan. Even in their own inroads

into the Japanese rnarket, foreigners are tempted to settle for a small place in the dango ... rather
than pulling for tmiy open competition in Japan. The ideal of free trade retreats, as the states thatdo (not) really believe in it expand (p.M).

These are hardly glowing testimonials for the pretender champion of the liberalinternational economic system!
A principal text, for these and other publicists and politicians in the United Statesand elsewhere, is Chalmers Johnson's, MITI and the Japanese Miracle.i5) Morerecently Karel van Woiferen's piece `The Japan Problem' in Foreigii Affairsi6) and his12) For example, Chalmers Johnson, `The Problem of Japan in an Era of Structural Change', CEDA
Conference, Sydney, 25 May 1989, and see Ross Garnaut, `Comment' for a fu11some critique.
13) R. Taggart Murphy, `Power Without Purpose: The Crisis of Japan's Global Financiar Dominance',
Harvard Business Review, March-April 1989.
14) Falows, `Containing Japan'.
15) Chalrners Johnson, MITI and the Japanese Miracle: the Growth of Industn'al Poficy, 1925-1975, Stanford

University Press, Stanford, 1982.
16) Karel van Wolferen, `The Japan Problem', Foreign Affalts, Vol. 65, No. 2, Winter, 1986/87, pp. 288-303.

states44

PETER DRYSDALE

book, The Enigna ofJapanese Power,i7) have been embraced for their revelations
about what van Woiferen himself unashamedly calls `the Japanese System'.i8)
Van Woiferen builds on Johnson's earlier analysis of the partnership between central

bureaucrats and business in the `interventionist' promotion of the `development

state'.'9) While Johnson would now concede that various forms of governmental
guidance carry less weight with the private sector than once they did (the sub-titleof his book is The Growth of Industrial Policy, 1925-1975), van Wolferen asserts thatthe partnership between state and private enterprise has an industrial policy and trade

strategy which is directed towards `industrial expansion not freedom of the market'(p.293) and that this fiourishing partnership is not likely to break up.20)

Another stream in thinking is reflected in Drucker's2i) notion that Japan engages
in `adversarial trade' , characterised by targeted attacks on established industries abroad(especially in the high technology area) and dogged resistance to imports of high-value

manufactured goods. This argument draws sustenance from theorising in the literatureof intemational economics on the strategic trade policy implications of the presenceof monopoly elements and economies of scale in international markets22) and is used

to give credence tb `results-oriented, managed trade' policy over GATT-focusednegotiations about trade and trade-related barriers and trade rules.23)
The most disturbing manifestatibn of this is the approach to trade policy embodied

in Section 301 (of the 1974 United States Trade Act).2`) Now tumed into Super 301,
17) Karel van Wolferen, The Enigma ofJapanese Power, Macmillan, London, 1989.
18) van Woiferen, `Japan Problern', p. 302.
19) Ibid, pp. 292-3.
20) Ibid, p. 293.

21) Peter F. Drucker, `Japan's Choices' Foreign Affairs, Vol. 65, No. 5, Summer 1987, pp. 923-41.
22) Gene M. Grossman and J. David Richardson, `Strategic Trade Policy: A Survey of Issues and Early
Analysis', Special Papers in International Economics, No. 15, Princeton, Apri1 1985, pp. 1-34 provides
a review of the early literature in this stream.
23) Peter Passell, `Economic Scene: Managed Trade or Open Trade?', 7he New York Times, April 5, 1989.

24)James D. Robinson and James K. Houghton, Analysis of the U.S.-Japan Trade Problern,
Report of the Advisory Committee for Trade Policy and Negotiations, Washington, February 1989.
The issue of Japan's behaviour in the import of manufactured goods has been traversed in the academic

literature. Recent contributions include: Robert Z. Lawrence, `Imports in Japan: Closed Markets or
Minds?', Brookings Papers on Economic Activity, No. 2, 1987, pp. 517-54; Gary R. Saxonhouse andRobert M. Stern, `An Analytical Survey of Forrnal and Informal Barriers to International Trade andInvestment in the United States, Canada and Japan', University of Michigan Research Seminar inInternational Economics, Discussion Paper, No. 215, January 1988, forthcoming in Robert M. Stern(ed.), U.S.-Canadian Trade and Investrnent Relations -iith Japan, University of Chicago Press, 1988;
and for a good review of the discussion, see Kenji Takeuchi, `Does Japan Import Less Than It Should?',

Working Papers, Intemational Economics Development, The World Bank, July 1988. Gary B. Saxonhouse,`Comparative Advantage, Structural Adaptation, and Japanese Perforrnance', in Inoguchi and Okimoto,
Political Econorny ofJapan, pp. 99 & 225-48, provides a thorough rebuttal of Lawrence's arguments.

45
JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, TOMORROW

under 1988 legislation, the Act requires the United States Special Trade Representative

to designate by 30 May foreign countries whose `unfair' trading practices make themcandidates for unilaterally imposed retaliation. Numerical targets would be set, sector

by sector, for the volume of American goods that foreign nations would be expected
to buy. If they failed to reach that volume, the United States would retaliate.25)

Although Trade Representative HMs declares she does not want to use her `results-oriented, managed trade' powers,26) last month's report by James D. Robinson(American Express) and James R. Houghton (Corning Glass), co-chairmen of the UnitedStates Advisory Committee for Trade Policy and Negotiations, advocated importtargeting and managed trade.27)
Contrary to these perceptions, the reality is that Japan has the cleanest importsystem for manufactured goods among all OECD countries; othcial non-tariff barriers
have almost no effect on trade at all. The relatively low proportion of manufactured

goods in Japanese imports, and low import penetration ratios in manufactured
commodities of which other developed countries are major exporters, have led
protectionist interests in North America, Europe and Australasia, and sometimes
othcials and independent commentators in those same countries, to postulate a majorroie for non-othcial barriers, perhaps with oracial sanction.28) Of course, Japan still has

an agricultural sector which is among the most highly protected in the world, andJapanese agricultural protection increased rapidly (around the quantitative restrictions

on trade) over the last two decades when Japanese commercial policy ostensibly pointed
towards liberalisation. In this respect, Japan is only a front-runner among the industrial

country pack.

The evidence provided by careful studies of Japan's trade dependence and tradestmcture, such as those of Stern and Saxonhouse (1987)29) and Saxonhouse (1988),30)
suggests that there is no significant dfierence between Japan's trade structure andthose of other industrial countries, when account is taken of cross-national dHerencesin factor endowments, including capital, labour and a variety of natural resources.
The contention that Japanese institutions, or reliance on a variety of informal baniers(or the `Japanese System'), signjficantly influence the structure of trade cannot be

supported on this evidence, nor can `a convincing case be made that Japan's25) Passell, `Managed Trade'.
26) Jbid.

27) Robinson and Houghton, U.S.-Japan Trade Probiem.
28) Saxonhouse, `Japanese Performance'.
29) Saxonhouse and Stern, `Informal BarTjers'.

30) Saxonhouse, `Japanese Performance', p. 240.

46 PETER DRYSDALE
trade and domestic policies are the root causes of the existing bilateral tradeimbalances'.3i)

In his most recent study, Saxonhouse undertakes the illuminating simulation of
examining what might happen to Japanese and United States trade structure if theUnited States were to give Alaska to Japan.32) The peculiar lack of change in Japan's

non-energy imports between the early 1970s and early 1980s vanishes and Japanese
performance is virtually identical with the character of changes taking place in most
European countries and in the United States. The ratio of manufactured goods imports

to GNP for Japan rises above the United States ratio. He further assumes that East

Asia (other than Japan) has the same economic size as Europe. The ratio of
manufactured imports to Japanese GNP rises to 6.7 per cent, not significantly below
European levels.33)

As Saxonhouse suggests,34) for many Japanese citizens, foreign complaints aboutlack of access to the Japanese market over the past decade must be little short of

totally incomprehensible. They can patronise McDonald's or Kentucky Fried Chicken

even at remote stops around the country. They may work at a company that uses

an IBM mainframe computer and on weekends may drink Scotch Whiskey or CocaCola, lounge in US designer jeans, and take their children to Tokyo Disneyland. In
al these cases, domestic substitutes are available, but they will choose a foreign productor foreign-licensed product. If they are a bit younger, an excursion to get geared up

at Vivre 21 in downtown Kyoto wil1 produce an entirely Korean, Chinese or European
designer-made ensemble. Of course, at the same time, on the basis of a foreign trip,
they will grumble at the high price of beef and other foodstuffs in Japan.35)

How does this Japan-side perception and the hard analytic evidence stack up
against all the anecdotal evidence of street-wise American journalists, businessmen
and politicians?

As Saxonhouse36) acknowledges, the best-known and most influential anecdote isthat told by Lionel Olmer, former United States under-secretary of commerce forinternational trade. Whiie employed by Motorola, Olmer attempted to sell highquakty, inexpensive pager phones to Nihon Telephone and Telegraphic (NTT). Despite
offering a phone that was qualitatively identical to that supplied by NTT's aifiliate NEC,at a very competitive price, it took years for Olmer's company to conclude a sale.

31) Saxonhouse and Stern, `Inforrnal Barriers'.

32) Saxonhouse, `Japanese Performance', p. 240.
33) Ibid, p. 241.

34) Ibid, p. 233.

35) Idem.
36) thid, pp. 233-4.

JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, TOMORROW 47
This, Saxonhouse concedes, is a good story. There are others in Prestowitz's bookTrading Places37). But it is not a uniquely Japanese phenomenon.38) It similarly took

many years for German and Japanese steel producers to sell their cheaper steel toGeneral Motors in the United States. As Cooper's study of North American metals

markets in the 1970s shows, the lagged response to relative price change iswidespread.39)

It is true that Japanese corporate and distribution systems contain powerfulconservative bias, delaying the emergence of large scale imports beyond the time when

they appear to have become competitive. Such biases are not unique in Japan.`O)
Moreover, the evidence since the appreciation of the yen in 1985 suggests that, despite

the lags, the normal competitive pressures operate for Japan. Japan's imports ofmanufactured goods from Asian developing countries have been increasing at morethan 50 per cent per annum since 1985. The share of manufactures in Japanese total
imports has also been increasing rapidly over this period, although not so strongJy
from the United States.`')The moral of this story is, perhaps, that if you spend too much time reading dated

scholarly tracts and writing books, you end up in kipp van Wolferen-Land!

But what has produced this perception gap between the United States, othercountries and Japan and where is it leading?

United States-Japan Problem
Heightened tension in the management of the United States and Japan relationshipin the first half of the 1980s resulted mainly from the impact of macroeconomic policies

in both countries and the lack of effective macroeconomic policy coordination. This
was a recurrent problem from the late 1960s but extreme imbalance, focused on rising

United States current account deficits and Japanese surpluses, emerged very rapidly
between 1980 and 1985. An American current account surplus of US$6 billion in 1981
had been transformed into a deficit of US$141 bMion by l986, a deficit amounting to37) Clyde V. Prestowitz, Trading Places: How We Alrowed Japan to Take the Lead, Boni Books, New

York, 1988.
38) Saxonhouse, `Japanese Performance', p.234.
39) Richard N. Cooper, `Natural Resources and National Security', Resources Policy, Vol. 1, No. 4, June

1975.
40) Peter Drysdale and Ross Garnaut, `A Pacific Free Trade Area?', Paper for Institute of International

Economics Conference on `More Free Trade Areas?', Washington, 31 October-1 November 1988, p. 16.
41) Drysdale, `Japan as a World Economic Power', p. 170.

48 PETER DRYSDALE
3.3 per cent of American GNP. A Japanese current account surplus of US$4 bmnon

in 1981 had grown to US$86 bmaon in te86, running at 4,2 per cent of Japanese
GNP.`2) The dramatic turnaround in international payments coincided with Japan's
arrival at great economic power status.

While the basic causes of each country's problem were separate and domestic,
Japan's current account surplus become a symbol to many Americans of the foreignsource of America's trade imbalance problem. Japan's surplus and the American
deficit were not significantly a consequence of either Japan's `closed economy'(as many American commentators insisted) or America's `lack of competitiveness'(a popular view in Japan). They were mainly the products of extremely high savingsand low government spending in Japan and high government expenditure and a strong
dollar in the United States in the first half of the 1980s. The sharp contraction ofJapanese government expenditure in the early 1980s and capital market liberalisation
saw Japan emerge as the world's largest capital exporter, and coincidentally, a primary

funder of America's high expenditure (and dissaving) in the first half of this decade.
Japanese capital market liberalisation provided the avenue for Japan to finance the growthof American debt.`3) As the range of American financial and other assets acquired by
Japanese institutions, corporations and individuals has broadened, American anxieties

about Japan's economic power have multiplied.

LiberaIisation of Japan's trade baniers is an important objective in itself(for Japan and now for the health of the libera1 trading system), but it would have madelittle difference to Japan's bilatera1 surplus on current account with the United Statesat this time if al1 Japan's trade barriers had been removed immediately. During theperiod of rising current account surpluses, Japan's protection was falling. Eliminationof Japan's trade barriers would have led, it has been estimated, to a US$5-8 bilHon

expansion of American exports at most.") The main adjustments for both Japanand the United States had therefore to be on the macroeconomic front, andthese adjustments, set in train rather belatedly after the Plaza Agreement of

September 1985, forced the pace through the large exchange rate shift. The
macroeconomic adjustment in the United States stM has a long way to go. Furthermore,

the adjustment in Japan will not eliminate Japan's current account surpluses. The

42) Ibid, p. 163; Hugh T. Patrick, `The Management of the United States-Japan Trade Relationship and Its
Implications for Pacific Basin Economies', Background feper for Project on the Impact of Japan-U.S.
Relations on Other lhchic Basin Nations, U.S. National Committee for fecthc Economic Cooperation, Dew.
43) Drysdale, International Plumh'sm, Chapter 7.

44) Fred C. Bergsten and Williarn C. Cline, The United StatesJapan Problem, Institute for Internatiofial

Economics, Washington, January Dor.

JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, 'IDMORROW 49
circumstance of large Japanese savings (current account surpluses and capital outflow)

wru persist for at least a decade or more. Hence, while the direction of adjustmentin the structure of trans-Pacific payments imbalances should relieve some of thepressures, considerable dangers remajn along the path of adjustment.
Elsewhere`5) I have suggested that the main danger arises because both countries

are diverted into attempts to resolve their global trade imbalances by action
directed at each other (both negative and positive action: specific restrictions orsurcharges and bilateral market access arrangements). In the conduct of the UnitedStates-Japan relationship, specific trade issues come to dominate the policy approach.

Resolving these issues one by one has the cumulative effect of aggravating American
perceptions of Japanese intransigence and unreasonableness and Japanese perceptionof American scape-goating. The pattern involves Japanese procrastination on specificissues. American pressure igaiatsu), mobMsation of American pressure to shift positionsin Japan,`6) heightened American frustration, politicisation of the problem in America,

and the lesson that Japan wil1 respond if hit hard.
A related and important danger, for Japan's other trading partners, is that Japantargeting by the United States and the American obsession in Japan leads both parties
into negotiating bilateral deals damaging to third parties as well as the whole trading

system.

Bigemonic Solution
The idea, with which former United States Ambassador to Japan, Mike Mansfield, hasbeen associated, of a United States-Japan free trade area, is in part directed at providing

a safety valve to head off the continuing pressures in the United States-Japan
relationship.`n It also falls, however, within a class of proposals which the UnitedStates fioated in the lead-up to launching the new GATT Round, when the UnitedStates shifted towards a trade diplornacy based on the conditional most-favourednation approach, seeking `free trade area solutions' to its trade policy problems. The

agreement with Israel and the negotiation of a free trade arrangement with
Canada were important targets in this policy approach (as well as the much-heralded

Caribbean free trade arrangement). There were also suggestions at this time forsome so,rt of `free trade area' association between the United States and Western

Pacjfic countries (ASEAN, Australia and others).`B) On the face of it, jt seems
45) Drysdale, `Japan as a World Economic PowerZ46) Drysdale, International Plurali'sm, Chapter 7; Kent E. Calder, 'Japanese Foreign Economic Policy Formation:

Explaining the Reactive State', World Politics, Vol, XL, No. 4, July te88, pp. 517-41.

4D U.S. Trade Commission, IVegotiations'with Japan, Submission from Mike Mansfield, pp. A2-A4.
48) Drysdale and Garnaut, `Pacific Free Trade Area?, pp.33-47.

50 PETER DRYSDALE
that not all these United States suggestions were aimed at setting up `free tradeareas' as such; rather they were aimed at establishing a dealing mechanism between
the United States and certain Western Pacific countries, separately from or together
with Japan.

Similarly, Mansfield declares that his proposal has as a primary interest giving
impetus to a successfu1 GATT Round.`9) Its major motivation, however, is bilateraland political; stemming from `... the belief that the (United States) should switchfrom approaches which politicize trade issues, exacerbate friction, raise emotional
stakes, erode public support (in Japan) for American objectives and risk undermining
both countries' commitment to the alliance.50)

While Mansfield's conception of a United States-Japan agreement is potentiallyconsistent with the nature of a joint commitment by both economic powers to theestablishment of a core area for free trade and global policy interests, exploration of
the idea explicitly involves consideration of the effects of exclusion on third parties

in Asia and Europe,5') and the American politics of the idea make little sense except
in terms of Japan's yielding specific concessions to the United States. Significantly,

Mansfield's bold attempt to capture the American protectionists for the free tradecause through his `free trade area' proposal engaged the early support of Senators
Gephardt, Baucus and Byrd, as well as the interest and attention of Brzezinski andKissinger.

Mansfield's objectives may be laudable, but the limitations of his proposal indealing with the trade and other dimensions of tensions in the United States-Japan

relationship are serious. While large gains would certainly flow from genuine andcomprehensive freeing of trade and service transactions - including removal of
pervasive Voluntary Export Restrictions (VER) in the United States and service
trade barriers in Japan - between the world's two 1argest economies, the chancesof negotiating such an exchange of concessions on a non-exclusive (or most-favourednation) basis, so that the benefits would be open to all third parties, are minimal.

This is readily acknowledged in the United States International Trade Commission's
review of the proposal.52) Moreover, the likelihood of an exclusive traditional-style

free trade arrangement's being subject to important exemptions, thus limiting gains

to Japan, the United States and the world, is extremely high. •The reakty of free trade areas and customs unions in practice is that exceptions
are important to the politics of their establishment, especially in the critical early years.
49) U.S. Trade Commission, Negotiations with Japan, Mansfield Submission, p. A2.
se) Ibid, p. M.
51) Ibid, p. A4 and passim.
52) thid.

JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, 'IOMORROW 51
Where they have not been, the establishment of the free trade area has been associatedwith increased barriers to trade with the rest of the world.53) This outcome is driven
by an important asymmetry in the political economy of protection policy, between thehighly focused opposition to trade creation by established interests in protectedindustries, together with the highly focused support of established interests in trade

diversion, on the one hand, and the difuse beneficiaries from trade creation on theother. 54)

One would be blind to the realities of the political economy of protection to ignore
the likelihood that, in a United States-Japan free trade area, the process of negotiationand compromise would favour trade diversion over trade creation. It is precisely suchrealities that invest in the proposal its political appeal in the United States.

Yet, as many who gave evidence to the International Trade Commission
investjgation jn the United States saw clearly, there would also be no guarantee of
its relieving tension in the politics of managing the bilatera1 relationship.55) Rather,such an initiative is likely to generate false expectations in America, raising the politicalstakes in the Japan relationship and compelling negotiators to reach a deai in neither

the United States' nor anybody else's best interest.sc) Nor would it eliminate theneed to resort to pressure tactics, since it is impossible, in any polity, to resolve
thorny trade issues, such as agriculture and construction in the case of Japan, without
raising them to the highest political levels.5"

The policy approaches adopted here are of systemic importance because the mostimportant game-play in intemational trade diplomacy revolves around the managementof the economic relationship between the United States and Japan. This is the mostimportant relationship in the Pacific economy and among the most important in theworld.

Their policy approaches are crucial as they are the maintainers or underminersof the GATT-based open international trading system, because of the impact of theresolution of their trade policy problems upon the rules of the trading system andupon trade policy behaviour more broadly.
Certainly Japan's role in trade liberalisation and the negotiation of international
settlements on other commercial policy, exchange rate and macroeconomic policy issues
is a central element in international economic diplomacy, but it will only be supportive53) Drysdale and Garnaut, `Pachic Free Trade Area?' p. 41.
54) Idem, p. 41.
55) US. Trade Commission, Negotiations with Japan, pp. 20-7.
56) Ibid, pp. v-vi.

50 Ibid, p. v.

52

PETERDRYSDALE

of broader Pacific and global objectives if it finally eschews the `specinc reciprocity'

implied in the United States-Japan free trade area proposal and does not neglect third

country interests. Japan's interests are broader. The importance of the East Asianand Western Pacific relationship, the growing significance of the relationship with

Europe, the delicate development of interdependence with China, the emergence of
the Soviet bloc and the opportunity for the emergence of Vietnam and the DPRK fromtheir past isolation are only some of the factors which extend Japan's `third country'

interests and commitments to the multilateral trade and economic system.
It is instmctive to observe how the Japanese policy process dealt with the UnitedStates-Japan free trade area proposal.

The frrst result was a massive diversion of policy resources into considerationof the Mansfield-Byrd idea. The Ministry of International Trade and Industry (MITI),

the Mmistry of Foreign Affairs (MOFA), the Economic Planning Agency (EPA), andthe Ministry of Finance (MOF) all set up task forces or study groups to evaluate theinitiative.58) Much policy energy, not only in Japan but throughout the East Asian andPacific region, 'was engaged in the assessment of Japan's policy interests. Because
of inter-agency jurisdictional interests, much of this effort was duplicative; its
external effect was confusing in policy direction and draining of policy resources rightaround the region.

Nevertheless, Japan's fundamental interest in a GATT-based, non-discriminatory
approach to trade diplomacy emerged clearly and relatively soon, in response to theexpression of third country concerns and, for example, the Hawke-Takeshita initiativein establishing a joint study group of Japanese and Australian othcials to review thisand other policy proposals. It was also clear in the steady institutional and substantialcommitment of the Ministry of Foreign Affairs to multilateralist perspectives. Initially,

MITI's stance was less certain, but the rhetoric sQon shifted towards commitment
to multilateral interests and `open regionalism', albeit with a particular emphasis on

East Asian newly industrialising economies' and ASEAN's trade and investment
relationships with Japan as a counterpoint to North American influence.59)

Two other elements deserve note. Keidanren (the Federation of Economic
Organisations) made clear its priority in putting more effort into making the Uruguay58) Ibid, p. A-Z; a review of the issues in the United States-Japan free trade area proposal from a Japaneseperspective is contained in Boeki to Kanzei, [Trade and Tariffs], Vol. 37, No. 1, Japan Tariff Association,

Tokyo, January 1989, in the following articles: Masamitsu Muto, `Nichibei Jiyu Boeki Kyotei
Chukanhokoku no Gaiyo', [The Surnmary of the Interim Report of the Japan-U.S. Free Trade Agreement]

and Masao Satake, `Nichibei Jiyu Boeki Kyotei Chukan-hokoku wo Yomu', [The Reading of the Interim
Report of the Japan-U.S. Free Trade Agreement].
59) Personal communications, May te88-May 1989.

53
JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, TOMORROW

Round successfu1 and to merchanclise and service trade liberalisation on a global
basis.60) The brief from which business leaders spoke caked for total rejection ofbigemonism (nikokushugi) on the grounds that it would reinforce regionalist andmanaged-trade tendencies in internatjonal economic policy. Press and academic
commentary was also overwhelmingly skeptical of this direction for Japan's trade
diplomacy. Kojima (of the NikkeD and Funabashi (of the Asahj) in the press and the

majority of influential academic commentators stressed the multilaterist, nondiscriminatory interest in Japan's foreign trade diplomacy.

In short, the image of Japan's trade policy philosophy that is revealed in thisexperience is not that which could be recognised easily from the descriptions inMurphy, Fallows or van Wolferen. Rather, there is considerable evidence here to
support the conclusion of Komiya and Itoh that `the dominant philosophy among Japan's
economic policy authorities and the Japanese public has changed considerably' in thelast two decades (post-Chalmers Johnson) and certainly since the earlier postwar
period. `The philosophy that free trade is basically the most desirable policy for theJapanese economY has gained acceptance among policymakers, leading businessmen
and knowledgeable people.6i) At its institutiona! roots, MITI may well be full ofinterventionist/coordinator recidivists, but in its top policy councils, mercantvast thinking

is in retreat, if not entirely routed. At the same time, Japan's regulation-oriented

economic policy philosophy has been steadily evolving towards a free-competitjve,
market-oriented philosophy.

Reactive State Diplomacy
Yet Japan's foreign trade diplomacy may seem to some a weak reed on which to rely
in managing these important international economic policy problems.

There are two reasons for this anxiety; one external to Japan and one internal

to the nature of Japan's policy process, which has just been oudined throughexample.
On the first front, clearly the problem for Japan and other countries in managing
challenges to the liberal trading system is that large scale trade liberalisation in Japan,

East Asia, or for that matter Europe, is incapable of contributing in a major way tocuring United States imbalance problems. There is no reliable prospect for addressing60) Personal communications, February 1989.
61) Ryutaro Komiya and Motoshige Itoh, `Japan's International Trade and Trade Policy, 1955-1984', in
Inoguchi and Okimoto, Politicai Economy ofJapan, p. 205.

M

PETER DRYSDALE

current international tensions independently of United States progress in moderating

domestic demand, in the pursuit of more balance in current external payments.
A broader dialogue on macroeconomic adjustment issues, not only between Japan andthe United States, but also including their other partners in the Pacinc, might be helpfu1
to progress on that front.62}
On the second, let me finally turn directly to Japan's policy process and trade policy
motlvatlons.

As Japan's centrality to the international economy has come to be more widely
understood, Calder and Okimoto63) emphasise the point that both foreign and Japanese
analysts have developed quite divergent conceptions of what Japanese foreign economic

policies are and how they have come to be what they are. Some see Japanese policies
as remarkably liberal in view of Japan's pervasive resource vulnerabilities; others see
the same policies as rapaciously mercantilist.

These divergent perceptions are clearly partiy in the eye of the beholder. It isalso true, as Calder suggests, that views are limited by lack of serious Western andJapanese scholarship on the character of the Japanese state in its complex relationshipwith the global economic system. (I should say that much good work in this area has
been done by the new generation of Australian scholars - George, Rix, Home, Sheard,

Lesbirel and Miller - but the impact of their work and that of Calder and Okimotoin the United States is only now beginning to be felt on American scholarship).6`)
A key to reconciliation of many of these divergences of view has to be found in the

rapidity with which Japan has been transformed from the status of small-to-middle

ranking economic power to that of economic superpower. In the language ofinternational economics, all the assumptions of the small country model have to be
replaced by all the assumptions of the big country model, and that has significant

implications for trade policy strategy. Japan has been catapulted into a positionof particular influence and responsibility in an extremely short time. Policy attitudes

and institutions have had to adjust equally rapidly to this new circumstance.

It wM be clear already that this transformation in policy philosophy has indeed
tnken place remarkably swiftly. But there are institutional lags. It will also be clearthat very often the distonions of time and space make today's perceptions more a62) Drysdale, Viviani, Yamagawa and Watanabe, Towards 2000.
63) Calder, `Policy Formation', p. 517; Daniel I. Okimoto, `Political Inclusivity: The Domestic Structure ofTrade', in Inoguchi and Okimoto, Political Econonty ofJapan, pp. 305-44.
64) Calder, Crisis and Compensatr'on, Princeton University Press, Princeton, 1988; Okimoto, `Political
Inclusivity'; see also J. A. A. Stockwin (et al.), Dynamic and Immobilist Politics in Japan, Macmillan,

London, ro88.

55
JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, TOMORROW

product of yesterday's than today's reality.

Yesterday, in the first two decades or so after the Second World War, Japan wasa relatively smal1 element in the world economy and trade. Under the umbrella ofAmerican political and economic power, paradoxically, it enjoyed a measure of foreign

economic policy independence. The trade regime and other countries trade systems
were immutable in the formulation of its own approach to trade policy,65) and its own

approach to trade policy was powerfUlly motivated by the need to promote exports
in the face of an initially vastly overvalued yen.66) The policy nuance, if not thereality, was mercantilist. The transformation of Japan's economy and trade structurein the 1960s and the 1970s was accompanied by rapid trade and economic liberalisation,in pragmatic response largely, but not entirely, to United States pressuring and related

international commitments. On many objective measures, Japan's liberalisation in thisperiod was more rapid than that of Germany.67) In all of this, Japan played a roleunambiguously supportive of American trade and broader diplomatic interests.

Today, Japan can no longer take the actions and policies of its partners as
immutable to its own behaviour. Its scale and influence within world markets assign
to it a prominent role in setting the parameters for stabdity in the global system.68)
Policy philosophy is attuned to this. In an historic development in July 1988, Japan

delivered reform of its beef trade system consistently with the important GATT
principles of `transparency' and `non-discrimination'.69) Japan is now committed to astaged reduction of protection on beef imports based on the removal of quantitative

controls and the provision of global access under reducing tariffs. The systemic
importance of this development is difficult to overestimate. It signals the extent towhich broader strategic objectives are coming to discipline the pursuit of narrowsectional interests in the formulation of Japan's trade diplomacy (even in highly sensitive
areas such as are involved in Japan's beef trade). The signs, in Japanese policy circles,
are of vastly increased awareness of the need for this. Yet this discipline was obviously

not generated entirely from within the Japanese policymaking process. Indeed, Japantargeting by the United States, coupled with active third-country Australian economic65) Drysdale, International Plurnk'sm, Chapters 2 and 9. This overstates the case, in the sense that, with
American patronage, Japan was able to negotiate significant modifications to the trade regime in this period

through entry to GATT and the gradual extension of most-favoured-nation treatment. See Tatsuo Akaneya,

Japan's Accession to GATT (ANU Ph.D thesis; forthcoming).
66) Komiya and Itoh, `Japan's Trade', pp. 1ts-224.
67) Henrik Schmiegelow, `Japan's Exchange Rate Pblicy: Policy Targets, Nonpolicy Variables, and Discriminatory

Adjustment', in Michele Schmiegelow (ed.) Japan's Respanse to Crisis and Change in the World Economy,

Sharpe, New York, D86, pp. 28-43.
68) Calder, `Policy Formation', p. 535.

69) Drysdale, `Japan as a World Economic Power', p. 167.

56 PETER DRYSDALE
diplomacy, clearly helped Japanese policymakers deliver a policy outcome in this casewhich will be greatly system-strengthening. Ominously, in February 1989, Japan

negotiated its first VER around the threat of dumping action against rapidly
growing imports of Korean knitwear. Against this action there was no cross-diplomatic
buffer.'O) Japan struggles with the problem of delivering real leadership in trade andeconomic diplomacy.
Tomorrow, the assumption of trade and international economic policy leadershipgives rise to expectations of a purposefuI and pro-active role for Japan in keeping theinternational trade and economic system together and open.
While the economic basis for a more pro-active Japanese global trade policy roleis graduaky being established, the reactive character of Japanese foreign trade diplomacy

remains remarkably pronounced. ,In 1986, in an essay for the Japanese journal Economi'cs Today,M I suggested
that the Japanese political economy was best depicted as a reactive system for twolmportant reasons.
First, in response to the conflicts and pressures of rapid change in trade, industrial

and social structure, there was a clear tendency in Japan to compensate for the costsof change in a mode not untypical of other industrial economies. In this conception,
the picture of an interest-group-dominated reactive political economy is rather different

from the image projected by Johnson's idea of a strategically oriented `development
state'.n) The most notable example of compensating protection of tightly organised

interests, of course, is in aghculture.rs) Each conception may be relevant to adifferent era. Yet MMer'`) has shown in devastating detail that, in the hey-day of`industrial policy', the same was true for manufacturing. In this period too, protection
was delivered to declining industries (as in other industrial counnies), not importantly

to the fast growers.

Second, Japanese policymakers were heavily influenced by foreign pressure,focused strongly on the American partnership and highly sensitised to American70) On 3 February te89, Korea acquiesed in imposing voluntary restraint en the export of knitwear to Japanand the Japanese Federation of Knitwear Manufacturers decided to withdraw its dumping appeal to theJapanese Government, Nthon Keizai Shimbun, 3 February te89.
71) Peter Drysdale, `Osutoraria kara mita Nihon no "taibei izon shokogun"' Uapan's dependence on the
United States: an Australian perspective], translation of an English manuscript `Japan's Trade Diplomacy:

A VTiew from the Western Pacific', Economics Today, Vol. 1, Spring N86, pp. 96-102.

M) Johnson, MITI.
73) Drysdale, `Japan as a World Economic Power', p. 166.
74) B. L. Miller, The Political Economy ofJapan's TariffPoficy: A Quantative Analysis (ANU Ph. D Thesis),

July ro87.

JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, TOMORROW 57
diplomatic, political and economic pressures.75) These two circumstances - thepowerfu1 interest group and bureaucratic inertia in Japanese policymaking processes
that inhibits trade policy leadership, and the American satehite syndrome - are criticalin judging Japan's capacity to assume a proper trade policy leadership roie.
Calder has recently undertaken a much more thorough-going and insightful analysis
of Japan as a reactive state in the context of foreign economic policy formation.76)

He observes correctly, in my view, that the reactive aspects of Japanese foreign
economic policy behaviour are strongly entrenched, particularly `considering thecountry's economic strength, the strategic inclinations of its technocracy, and theturbulent circumstance' it faces in the international economic system.'7) In his
analysis, the reactive state also has two essential characteristics. The state fails toundertake major independent foreign economic policy mitiatives when it has thepower and national incentive to do so and it responds to outside pressures forchange, although erratically, unsystematicaky and often incompletely.
Calder identifies two principal causes of the reactive nature of Japanese foreign

economic policy: heavy dependence on the United States for capital, markets anddiplomatic support, rendered specially acute by Japan's resource vulnerabdities anddiplomatic isolation; and the fragmented character of state authority in Japan, making
decisive action more difficult than in countries with strong chief executives, such as

the United States or France. Calder notes that the problem of domestic coordinationis compounded in Japan by the lack of both a functionally-oriented administrative corps

and authoritative codification of ministerial responsibthties to dampen bureaucratic
disputes over jurisdiction.78) Japan has, as van Woiferen puts it, `a hierarchy, or acomplex of overlapping hierachies without a top',79) the intermittent attempts offigures such as former Prime Minister Nakasone to play a transcendent leadershiprole notwithstanding.80)

This feature of Japanese political process I call `the headless chook syndrome'.

This is a vivid but apt metaphor, as any of rural origin wil1 readily understand.
It is starkly evident in the current political crisis in Japan. It was less evident under

the Nakasone administration, as Calder implies, with its more decisive resolution of

conflict over foreign economic policy in the Cabinet room.

75) Drysdale, `Japan as a World Economic Power', pp. 166-7.
76) Calder, `Policy Formation' and Crisis and Cornpensation.
77) Calder, `Policy Formation', p. 526.
78) Ibid, pp. 526-30.

79) Van Wolferen, `Japan Problem', p. 289.
80) Calder, `Policy Formation', p. 529.

PETER DRYSDALE

58

This brief synopsis does not do justice to Calder's richly Mustrated andsophisticated analysis. But the main points are clear.

Calder draws the important conclusion that foreign pressuring must continue toplay an instrumental role in the formulation of Japan's foreign economic diplomacy.
A corollary conclusion is that, in the near term, the reactive character of the Japanesestate in dealings with the United States helps to prolong the period of United Stateshegenomy in international trade and economic diplomacy.8i) A number of authoritative

Japanese commentators share the same view.82) He cautions, however, that `reactive
Japanese economic diplomacy and the intensifying foreign pressures that motivate it,

have potentialy fatefu1 long-run consequences within Japan. They are stimulating
nationalism, as Japanese people become increasingly sure of their country's relatively
high economic efficiency and global prominence, just as the barrage of global criticism

against Japan intensifies. The Japanese government continues to respond to mostdemands, while popular support for such action is growing thinner'.83)

Shared Leadership
Economic changes in the last decade have dramatically increased the capacityof Japan to interact with the international system and play a more decisive leadershiprole. The massive Japanese capital outflows in this period are one such change.
In 1980, only 2 per cent of the production of Japanese corporations took place offshore,

compared with 10 per cent for United States firms. Last year the proportion for Japanwas over 5 per cent.M) The international reach and capacity of Japan's corporate
community and Japanese society is making rapid strides.

Yet Calder's analysis of foreign economic policy immobilism seems essentiallycorrect and the condition is set to persist. Japan is no different from other modern
industrial states in this respect. But, ironically, in view of many prevalent views of
the authority of the Japanese state, there is a peculiar weakness in the constraining
presence of government, in Japan, in resolving the inevitable domestic conflicts aroundthe detemination of foreign economic and trade policy approaches, precisely at a time

when it is caled for in large measure.85) Like other countries, even more so, Japan81) Ibid, p. 539; see also Russett, `U.S. Hegemony'.
82) Kenneth B. Pyle, `Japan, the World and the Twenty First Century', in Inoguchi and Okimoto (eds.),

Political Economy ofJapan, pp. 446-86.
83) Calder, `Policy Formation', p. 538.

84) Embassy of Japan, Canberra, May re89.
85) Calder, `Policy Formation', pp. 539-40.

59
JAPAN'S TRADE DIPLOMACY: YESTERDAY, TODAY, roMORROW

is porous to jostling on policy position, but the natu.e and American source of jostling

will rapidly diminish its capacity to produce desired outcomes.

The external `frame of reference' is an important element in policy formuJationin any society, and perhaps especially so, it seems, in Japan. A constructive approachis to recognise this characteristic in Japan's poiitical circumstance and leadership styleand to work purposefu!ly to make a virtue of its necessity. Indeed, in the sharing

of international economic leadership responsibilities, such as wM be required ashegemonic dominance is no longer sustainable, such reticence could be a distinct
advantage.

My conclusion is not pessimistic.
A key requirement, then, is redefinition of the framework within which foreign
demands on Japan, and Japan's representation to its partners, can both be focusedand qualified so as to make them more reasonable and digestible to both the Japaneseand international polities alike. This interest has long been an important rationale behind

efforts to develop broader dialogue on policy matters among the countries of the Pacificwith which Japan has close relationships and to re-orient the United States-Japan
partnership within that framework.
If Japan's adjustment to its leadership role in trade and economic diplomacy is

dithcult, American adjustment to the sharing of economic power and leadership
responsibilities (not simply the bills and the burden) is no less so.

Two generations of Americans have ingrained perceptions founded on the UnitedStates' centrality to the international economy and its primacy in determining the major
shifts in international capital and commiodity markets. This is no longer the situation.

The change is hard to adjust to, psychologically, institutionally and in terms of thedomestic political debates. Acceptance of the diminution of economic power and thesmall country rules in ordering economic policy is new in America, even to theknowledgeable. And it is complicated by a political debate coloured with the perceptionthat the adjustments required of Americans are, to complete the ironic circle, required
solely at the dictates of Japan.

A LABOUR UNION IN EVERY COUNTRY"- A GAME•-THEORETIC APPROACH -Kazuo SHIMOMURA

1. Introduction
In Kemp and Shimomura (1984, 1985, 1989) and Shimomura (1984) we examined someof the implications of the formation of labour union for the general equMbrium in the

trading world consisting of two countries. It was assumed commonly in those papers
that only one of the countries is of union-ridden type in the sense that workers in
the country can form a nation-wide labour union; in the other country the labour market
is perfectly competitive.

However, if workers can organize themselves in one country they can organize
themselves in all countries. Accordingly, we now allow for the possibdity that there
is such a union in each of the two countries. The unions wru recognize that they standin a strategic relationship, rather like that of tariff-imposing national governments. Sinceboth unions are supposed to be rational and well-informed, it seems appropriate that

we confine attention to Nash equMbria.

In the present paper we shab concentrate on the constmction of the basic
framework for our subsequent analysis to come after the present paper. Thus, thescope of our analysis here is restricted to questions of existence and uniqueness ofequilibrium and to the propenies of equdibria: Detailed comparative statical calculations

are omitted.

2. Assumptions
To make way for the complication of a strategic relationship between unions, weconcentrate on a special case. Thus, throughout the present paper it is assumed that

there are two countries called the home country and the foreign country in the* This paper can be regarded as a by-product of the joint research with Professors, M.C. Kemp and
N.V. Long, concerning the economic behaviour of rational labour unions. I would like to show here
my deep acknowledgement to, particularly, Professor Kemp for pemitting me to publish this paper under
my own name. Needless to say, no one but myseif shcnild take the responsib-ty for any part in this paper.

62 KAZUO SHIMOMURA
trading world and that there are two produced and tradeable consumption goods, with
one commodity produced in each country. The assignment of commodities of countries
is not an outcome of the analysis; it is simply imposed. Specifically, it is assumed

that the home country produces only the first commodity and the foreign country

only the second commodity. The technology of each country is described by a
production function which is homogeneous of degree one in capital and labour; thus

Yi = F'(Ki, Ni)- Kifi (xi) i-- 1,2
Let

xifi' (xi)ei(xi) ifi (xi)and-fi'(xi) [fi (xi) - xi fi'(xi)] .

uixifi(xi)(xi) fi " (xi)ii! ,l= 1,2
As well-known, ui(xi) is the elasticity of factor substitution with regard to the ith

commodity. In what follows, it is assumed that ei(xi) + ai(xi) is a decreasing
function and that the equationei (xi) + ui (xi) - 1 = o
has a solution xi = x-i. Of course, ui(xNi) < 1.

Moreover it is now assumed that the same preferences prevail everywhere, athome and abroad and among capitalists and workers; specifically, it is assumed thatthe preferences of each household can be described by a strictly quasi-concaveand constant-returns-to-scale utility function. It follows that, if y is a household's

income (in terms of the first commodity) and if p=p2/pi, we can write the unit

expenditure function e(p) and the household's demand for the second commodity

ye'(p)/e(p).
In each country the workers form a single all-embracing labour union. Following

Shimomura (te89), under the assumption on preferences stated in the previous
paragraph the objective function of the home union isNw•
U == Ne(p) =xw
ze (p)
and, distinguishing foreign variables by asterisks, the objective function of the foreignumon ls

A LABOUR UNION IN
EVERYCOUNTRY

U* =

N*w*

x* w*

N"e (p)z" e(p)63

Both labour and capital are internationally immobile. Formally, then, our model ofa world trading economy is equivalent to that of a closed economy with two industries,
with four specific factors (two for each industry), and with our factor organized in eachindustry.

3. Analysis
Since capital is internationally immobile,the stock of capital owned

employed wholly in that country. Hence

the

(P)

max

X5Z

U-!
z
e' (p)

s. t.

homeunion solves theby a country

isproblemfi'(X)(1)e (p)(x*)] = hf2[f, (x) + phf,

(x")

(2)

e (p)

and the foreign union solves the problem

(P")

max
x Ez

**

X*

Pf2'(X")

z*

e(p)

U* =

er (p)s. t.

[fi (X) +phf2 (x*)] = hf2

(3)

(x")

e (p)

where h Ei K"/K and (2) expresses the requirement that world demand for the second

commodity equal world supply.
From (P) we see that any adjustment to x directly affects xfi'(x) and therefore U. We see also that x influences p through the world equdibrium condition (2)and thus exercises an indirect influence on e and U; specifically, an increase in x
gives rise to an increase jn the output of the first commodity and, in view of thehomotheticity of preferences, to a reduction of its relative price. If the home union

should fai1 to recognize the indirect link between x and U through p, it would

choose x=x-i, See Figure 1. A similarly myopic foreign union would choose
X* = X'V 2'(2)

SHIMOMURA
KAZUO

ol

:

:
:
:
:
h

:
1

]

:

xif'i(xi>

,

'y

xi

xi

Figure 1

We seek the Nash equihbrium of the game [ (P), (P ")], with each union making fu11
akowance for the indirect link between x and U or between x" and U' . Until further

notice we neglect the inequality constraints x:z and x" 5z", that is, we neglect
questions of feasibMty.

From the common constraint (2),fi(X) ,. e(P) .-p., di(p) (4)hf2 (x*)(p)e'Hence, differentiating totally,

P= o, (p) [e,(x)2-e2(x")S"] (5)where

Vi dY/Y, Y= p, x, x", anda. (p) = -- e' (P) [e (P)- Pe'(P)] > ope(p)e"(p)
From the objective functions (1) and (3), on the other hand,O- [i- ii,e('.()X) ]2-e.(p)p (6)and'O" == [1-1i,e(.2(i)")]s*+[1-e.(p)]p (7)ALABOUR UNION IN EVERY COUNTRY 65
wheree.(p) iii pe'(p)le(p). Making use of (5) to eliminate P, (6) and (7)ti = {[i- i7,e(.i(i) ]- e,(p)u.(p)ei(x)}2 (s)+ e.(p)a.(p)e2(x")2"'

and

O" = {[i - i i,e( .2 (i)") ]- [i --- e. (p )] o. (p) e2 (x")} S" (g)+ [1-e.(p)] u.(p)ei(x)2
Eqs. (8) and (9), together with eq. (4), constitute the starting point for all further

calculations. However we cannot comiortably proceed without additional restrictions

on the functional forms employed. Henceforth it is assumed that the expenditureand production functions are of the constant-elasticity type; of course, ai<1,

i =1 2.
'

If x" is held constant then, from (8),O -- -xU- l,,) = 1-'Sl- [1-ei(x)]-ee(p) ue oi(x) (lo)ee1/aeB--------------

C 1llltail'-+"-tiil)11Ill-vtt=fetlile,tlb---ltM'Mlo

Dp

4seA::::,lti)btt111Ittftt---.etI

KNtxXtX

xxX
F

xIxx}x--------"--V--N-"--INxts"---

Il,ti-----.---dI,

QE.Xx,E Gb]-r----------tb
"""J

H
e,
FG:the graph of(P,ei)satisfying 1-(1-ei)lai-a.eie.(P)==O

Figure 2(a):ae<1e,KAZUO SHIMOMURA

66

And, if x is held constant, then, from (9>,O= tt." 1(,>= 1--il; [1-e2(x')]-[1-ee(p)] ue o2(x') (11)In the absence of the constraints x5z and x* Ez*, (10) and (11) would be satisfied
in a Nash equilibrium.

From (10) we can hope to obtain ei as a function of P, and from (11) e2, also as afunction of p. Eq. (4) can then be used to eliminate p, leaving two equations to besolved for ei and e2. We examine three cases in turn.

Case 1: o. < 1 In Figure 2(a), AaB is the graph of ee = [1-m l'(1-ei)]lueei,

obtained from (10); and DbC is the graph of e.= e.(p), the latter monotone
ee

B

C l,

iiil•IAI

DJJ'o
xl
/z

p

Ei 1E'

G4501,,t

F1!---..----..1--Y.-.---."--l!-1

Mlt=:r--/-NF"-.r-----"----t-

t!

e,

Mt

-"-ny--------

He,
FG:the graph of (P,e2) satisfying

1-<1-e,)/o2-(1-ee(P))a.e2=O
Figure 2(b>,: a.<1

decreasing because a. is constant and less than one. From AaB and DbC one thenobtains FEG, the graph of the relationship between ei and p. In simlar fashion, one
obtains from (11) the relationship between e2 and p, depicted in Figure 2(b) as thegraph FEG.
Now consider eq. (4). Since a. and ai (i -- 1, 2) are constant, the equation canbe written asp (1- e,)ai ae /(1- a!) (rz)hae (1- e2) U2 Ue /(1-a2)

A LABOUR'UNION IN EVERYCOUNTRY
Let e2 take on some given value between zero and one. Then the relationshipbetween p and eidefined by (12) can be depicted in Figure 2(a) by the dashed curve
MEJ. Evidently MEJ intersects FEG at E. If e2 increases in value, the dashed curve

pivots on J in an anti-clockwise direction, taking the new position M'E'J andintersecking FEG at E'; when e2 = O, ei = eiO, where eiO is the solution to theequationeXee (1-e,)Oi Oe/(1-Oi) = lilg[1-(1-ei)1u,]l
and, as e2 approaches one, ei goes to ii = 1-oi, the solution to

1- (1-ei)lu, = O
Thus we obtain the relationship ei = 72(e2) defined by (10) and (12); it is depicted
in Figure 3 by the curve AB. In sjmiJar manner we obtain the relationship e2 = 7i(ei)defind by (11) and (12) and depected in Figure 3 by FQ.')

e,
A

1

,

lil4ll

FlltE,i,e?
e2EE--' Trr r-

ilII--- F-g-lll)e,(zb '- EolI1)lt+-T'f-"'

e,

rl

1

4

J---

Q

--.+-

E,

--rt--"T'o- e, e,, llee--1e,
e,(z)

-

B

e,:1-(1-e,)/a, --O (i-1,2)e?:1-Å}<1-e?) = a. e? e. [f(1-ep, )ai ae/[i-ail
eS:1-lll (1-eS) -- o, eg l 1-o, [h(1-es)at ae/ci-a!,] -i }e, (Z) ! Zfi (Z)/f, (Z), e, (Z') ! Z'fi (Z")/f, (Z')

Figure 3:d. < 1
1) Thus if e2 takes seme given value between zero and one then the relationship between P and e2
defined by (rz) can be depicted in Figure 2(b) by the dashed curve MEJ. Evident!y MEJ and FEG
intersect once, at E. As ei increases, the dashed curve takes the new position M'E'J', intersecting

FEG at E'. When ei= O, e2=e8, where e8 is the solution toi- i'.e22 - { i- ee {ha-e2)02ae i(i'e2) ]'i} ae a2 = o;and, as ei approaches one, e2 goes to e2 = 1-a2, the solution to

1-(1-e2)/a2 = O
Thus we obtain the required relationship e2 = == 7i(ei), depicted in Figure 3 by FQ

67

KAZUO SHIMOMURA

68

As Figure 3 makes clear, there exists a pair (eiE, e2E) such that eiE = ei(XE)and e2E = e2 (X :), wherexE- arg [m2x U- X.f3 '((pX)) s.t. (2)] (13a)andx." -- arg [m.a.x U'= PX.".fi'((pX)") s.t. (2)] (13b)Case 2: o, > 1 We begin again by studying the relationship between ei and p.
From (10),11- e,11ee = u. {ai(ai -i)]'represented by curve AB of Figure 4(a). In the same figure, the curve OC represents

the function e. (p), now increasing since o. < 1. From AB and OC one then obtains
the required graph FEG. The dashed curve MEJ, on the other hand, is obtained four(12) by holding e2 constant at a value between zero and one. The two curvesintersect at E. As e2 increases, the dashed curve takes the position of M'E'J, thenof M'E'J etc. As e2 approaches one, the point of intersection of the two curves
approaches F, which implies that ei approaches one. Thus we obtain the required
relationship between e2 and ei, depicted by the curve AEB of Figure 5(a).

ee

ee

B---1

-------------

C

C-----------------

1

l

li

:
l:
1:

B

l

l.f.-.--.--"+.-..-'A

11ae----

l

:
I.

i

p

M" M' :Me,

Å~ xl x

xN XX
XIN

:

p

F T---Tr-"---

a-i E'r xX.,Nx

e,

-r'

ittl
FJ

'

,

ll

,45"

F
t

,

:
:

-t
tt

I
:
J

:

ol

,Jtt

i

XI x NN.X.N .ii)tx lil

xXN
F t-------

J

l,tll

H

111

I'

M./M'..-l/--lQ'-=--'=::------

G-'t-

QJ-'-----•-.----.

b,

FG:the graph of(P,ei)satisfying

1-(1-e,)1ai-a.eie.(P)=O

FG:the graph of(P, e2) satisfying

Figure 4 (a): ae >1

1-a-e,) c,-q-e.(p)) a. e, =O

Figure 4(b)> 1e,

A LABOUR UNION IN EVERYCOUNTRY

69

e,e,---•-------- B

1

:
:

E'

:

1

-.--"--.--

:
:

E

:

:

e,o

D

:

;
'

:
:
:
l

e,

e,

i, me, 1 !-1 1
'

IA
Ic
I
l
l
i

:
:

B
;-

l
i
:
l
1
l
l
l
i
1
i
l

D
l

l

l

d,

ei and e? defined in Figure3 t,+t,-ae
Figure 5(a)CD :1< a. <2
AB: ae >2
Figure 5(b)A further relationship between e2 and ei is obtained from (11) and (12). From(11),

ee == 1(1-11a. u2 )+a.e, ( a2 -1) (14)which is represented by the curve AB of Figure 4(b). From AB and OC we obtain

FEG, the curve MEJ, on the other hand, is derived from (12) by holding ei
constant at a value between zero and one. The two curves intersect at E. As ei
approaches one, the dashed curve approaches QGQ'O; thus, for ei close to but lessthan one, the curve coincides with M'E'J'. It follows that the locus (ei, e2)corresponding to the intersection of MEJ and FEG in Figure 4(b) can be depicted in

Figure 5(a) by DEB e, possibly, by DE'B.

It remains to determine which of the curves DEB and DE'B of Figure 5(a)prevails. If DEB prevails, the point of intersection E of AEB and DEB is determinedby (10)-(12). Alternatively, from (10) and (11),e2 =-ei(1-11a2)

ei [(11a,) + (11a,)- a,] + (1-1/ui)(15)

KAZUO SHIMOMURA

70

Evidentiy (10)-(12) and (15) are not independent equations. The graph of DEB or DE'B

must pass through any point of intersection of AEB and the graph of (15); and thegraph of (15) must pass through any point of intersection of I)LEB and DEB (or DE'B).
The graph of (15) is like AB or CD of Figure 5(b). From Figure 5(a) it is clear that

if o, < 2 then the graph of (15) must intersect AEB and DEB (or DE'B). This implies
that DE'B is impossible; that is, there is a point like E in figure 5(a).

Case 3: u. = 1 It remains to consider the singular case in which o. = 1.
Then e. is constant and we can add Figure 6 to Figures 3 and 5. 0bviously (ei(xE),e2(x.") and (x., x.") are unique.

e,1

T-----------------'-

r,,1bblllFEl

e2E

e,, 1

e,

elE 1=- o, e2E t=1- a,
1- di ee ' 1- a2 (1-e.)
Figure 6:Oe ==1(eE constant)Thus we arrive at the following summarizing proposition.
PROPOSITION: If the expenditure function and the production functions are of CES
type and if the elasticities of factor substitution are less than one in magnitude then
(XE,XE") exists if and only if oe <2 and is unique if a. is suthciently close to unity.

If (X., X.") is feasible, it is a Nash equdibrium of [(P), (P")]. We now
examine the circumstances under which (xE,xE*) is and is not feasible; moreover wedeterrnine whether there exists a Nash equilibrium when (XE, xEl> is infeasible
and, if there is an equilibrium, we characterize it.

A LABOUR UNION IN EVERY COUNTRY
Let us suppose until further notice that a. <1. Then in Figure 3 we may distinguish(i) Point E, at which both labour forces are unionized;(li) Point Eo, at which neither labour force is unionized;(hi) Point EH, at which only home workers are unionized; and(iv) Point EF, at which only foreign workers are unionized.

Which of these four points are feasible depends on the position of Eo (ei(z),e2(z")). Consider Figure 7.
(a) If E, lies in the region OPEM, all of (i)-(iv) are feasible.
(b) If Eolies jn MEB or in FEQ, (li)-(iv) are feasible but (i) is infeasible (because

ei is less than ei(z) in MEB and e2 is less than e,(z*) in FEQ).
(c) If Eo is in BEQJ, (li) and (iv) are feasible, (i) and (hi) infeasible.
(d) If E, is in EFRA, (li) and (di) are feasible, (i) and (iv) infeasible.
(e) If Eo lies in AEQS, only (li) is feasible.

e,

1

R- J

A

-S

l

U8

l

ur

I

F

l
l
l

E

P

;

U6'
u;t

u, l

Ul

l
F

UI

U,F

Q

1

1

UG

Uel t

i
1

l

l
t

OL

B

M1

iJ

e,

Ui Uf :indifference eurves of U (uo > ui >")U; U;' :indifference curves of U' (u8 > ur > ..)Figure 7
We proceed to examine cases (a)-(e) in turn.
Case (a) If Eo lies in region OPEM of Figure 7 then E is feasible and therefore
constitutes a Nash equilibrium. With the aid of the two mion indifference curves throughE, labelled uEu' and u"Eu"', we can divide OPEM into the disjoint sub-regions

uEu" and (OPEM minus uEu'); see Figure 8. If Eo lies in uEu" (like Eg of71

72 KAZUO SHIMOMURA'
Figure 8) then the pay-offs associated with the several possible stages of unionization
satisfy the inequakties

U(E*i) < U(E) < U(E3) < u(Ei)andU" (E,) < U* (E) < U(E 8) < u* (E*i) -In particular, in the non-cooperative situation assumed, the pair (U(E), U"(E)) ischosen even though .
(U(Eidi, U'(Eio)) >> (U(E), U"(E))
Home workers know that if they do not organize themselves then foreign workers
will do so, thereby forcing home workers to accept the lowest level of wellbeing; andsimilarly for foreign workers. Thus workers in each country find themselves in the``prisoner's dilemma.''e,

1 R-----. A -.----.----.-,s
:

U"' I

Fi,

P,

E

,
E'i
E.2) b"-rT---t---'-r

i

l'
itlr
i

l
l

U u. Egl,"-gl
1

EbL.-,

o

:
U'' l
,
,Q

Eit:

l--

" E2IJ l

Bl

M

e,

uEu' :an

indifference curve of U

u'Eu" :an

indifference curve of U'

Figure8

If, on the other hand, Eo lies in(OPEMminus uEu*) then the workers of one

country are released from thedilemma. For example, if Eo coincides with EZ of

Figure 8 thenU* (E *2) < U* (Ei) <U* (E)< U"(E*2)

and foreign workers prefer to ' ' umomze whatever
the decision of home workers.

ALABOUR UNION IN EVERY COUNTRY 73
Ui,
E

att

: E- a'
:

lt
ll

)

IU

:,a E
1 U*: lQ

li1
tl1
1li6
( E? ': Eg
Figure9U,

MB'Case (b) If E, belongs to MEB or PEF of Figure 7 then either xE>z
or X." > z" ; thus E is infeasible and cannot be a Nash equilibrium. Suppose that E,

belongs to MEB and consider Figure 9. 0ne can verify that E is a NashequMbrium. Thus home workers can move in the direction of the arrow from E toa' ; however, if x* is unchanged, such a move will reduce U. Similarly, unless home
workers change x, foreign workers cannot raise U" by moving in the feasible directionof a (Or of a").

Cases (c) and (d) If Eo belongs to BEQJ or EFRA of Figure 7 then, as in case(b), E is infeasible. However a Nash equMbrium exists. For example, if Eo coincedeswith Eg of Figure 9 then E- is a Nash equilibrium.

Case (e) Finally, if Eo belongs to ASQE of Figure 7 then Eo (not E) is a Nashequilibrium.

Our findings to this point are summarized by Figure 10.

e,

1 Rh-.--- -A +-. - ---------nS
f, FQ:e, == 7i(ei)F IV M i AB:e,-7, (e,)'`Ns. s. i RegjonI(oDEM):er == e,,, ex=e,,e,,D NN E 1 Region ll (RAED):e"-e,(z), e;-7,(e,(z))
Xx I Region m(AsQE):er --e,(z), e; =- e,(z')
X Qi Region Iv (EQJM):er - 7,(e,(z*)), e; - e,(z')

x ll lI
M

x - Figure lO:oe<1
N1
Nl
Nl

NB '

O e,, 1 ei

KAZUO SHIMOMURA

74

undertaken when a. > 1. 0mitting the

A similar analysis can be
simply display the results in

calculations, weFigure 11.

e,
1

R

rv

E'
B'

m
e2E

F
E

l -/

-- 1

- -

D

-ft
t
Iti

ll

'

'

'

Al

e,, 1

e,

M

--•1
l
I
i
'
'
1
1
l
t
,
i
1
,
i
1
j
t
t
i
j
,
t

B

,J

DEB : e, - 7i (ei)AEB: e, - 72(e2)Region I (oFEM) :eV - e,, e; - o,,Region ll (EMJBB'):e" t- e,(z), ecr -= 7,(e,(z))
Region M (EB' BE') : er -= e, (z), e; -e,(z')

Region IV (FEE'BR):e" t- 72(e,(z')), e; -= e,(z')

Figure 11:C. >1

4. ConcludingRemarks
From our dissection of Case (a)-(b) there emerge two broad conclusions, valid forall o. < 2. First, a Nash equMbrium exists. Second, universal unionization always
leaves some workers worse off than in the absence of unionization, and it may reduce
the wellbeing of all workers.

References[1] Kemp, M.C. and K. Shimomura, ``Labour unions and the theory of intemational trade", paper readto the Sydney meeting of the Econometric Society, 1984.

[2],"Do labour unions drive out capital"?, theEconomic Joarnal, vol. 95, 1985.
[3],``A neglected corner: Labour unions and thepattern of international trade'', in G.W. Feiwel ed., Joan Robinson and modern economic theory,
Macmi11an, 1989.
Shimomura, K., "International trade and a rational labour union'', the Kokumin-Keizai Zasshi, vol.

149, 1984. (in Japanese)[4] ,``Industrial relations and economic growth -agame-theoretic
approach -", the Research Institute for Economics and Business Administration, 1989. (in Japanese)THE COSTS AND BENEFITS FOR FIRMS OF
ACCOUNTING INFORMATION DISCLOSURE
Hidetoshi YAMAJI

This paper demonstrates that there is an information disclosure equdibrium point where
the net benefit of firm from the disclosure js maximized. The possibMty that the pointof the equilibrium would not be evaluated as any specified goals is also referred to.

Key word: accounting information disclosure, stock market, labor market, collective

bargaining, product market, mass democratic society

1. Introduction
In traditional accounting theory, information is usually treated from the viewpoint of
the information receiver. Typically, for example, information is defined in terms of the
reduction of the information receiver's uncertainty about business activities. But sucha treatment seems to be based on methodological individualism which is inclined tooverlook the surrounding social affairs of accounting. If the analysis of accounting

information disclosure should be done from a social viewpoint, it is very important

to treat information from the viewpoint of information suppliers, that is, thecorporations. This means that the analysis should be done by using the concept ofequilibrium of information disclosure. In other words, the concrete problem is why
a firm currently discloses a certain extent of accounting information with a certain
quality. It should be resolved by taking the profit maximization of firms into account.

But we must recognize that there can be various kinds of theories depending upon
the levels of current accounting practice which these theories select as a subject.

In this paper, we will explain the qualitative and quantitative extent to which
contemporary firms disclose accounting information although such a problem must
appear extensive and vague.
As a next step, we must choose those factors which affect the extent of current
accounting information disclosure for the purpose of making an explanatory model.

76 HIDETOSHI YAMAJI
Stock Market The imctions of accoundng information in securities markets have been
analyzed by rnany researchers and are being analyzed by using modern finance theories.
There are lots of empirical data which demonstrate the relationship between accounting
information disclosure and the behaviors of stock prices (see Beaver, 1981 and Watts
and Zimmerman, 1986). So it can be conversely said that the conditions of securities

markets have effects on the accounting information disclosure carried out by firms.
Labor Market Some researchers have aiready pointed out that accounting information
functions in collective bargainings between labor and firms (see Forey and Maunders,1977 and Palmer 1977). Empirical researches show that there is a correlationshipbetween the level of accounting information disclosure and the level of wages so that

information disclosure has very important significance for both employers and laborfor pursuing their own benefits. Therefore the conditions of the labor market or ofcollective bargaining have some impacts on accounting information disclosure done byfirms.

Product Market Managements are usually opposed to the extension of information
disclosure because they were inclined to think that such extension could be related
to the leakage of business secrets. But we have never seen any data for and against

this proposition. We do not know exactly to what extent business secrets can cometo light by using current financial statements. We do not deny the possibdity of theleakage of business secrets, however. So the inclination of managements to keepbusiness secrets influences accounting information disclosure done by firms.

Mass Society There can exist interest groups surrounding big businesses which do
not directly contribute money, economic goods and service to firms. For example, thepublic watch the business activities of big businesses in order to maximize their own

utdities. They may demand, for example, the regulation of big business by means oflobbying activities for getting back clean air. Big businesses should meet the public's

demands for regulating their economic behaviors in a mass society. Under suchconditions big businesses can adopt accounting information disclosure as business policy

for appeasing the public. So the relationship between the public and businesses canaffect accounting information disclosure done by firms (see Yamaji, 1983).

Many factors have been pointed out which infiuence the extent of information
disclosure carried out by firms and moreover the fact that the ways of influence are

dfierent from each other has also been pointed out. In the subsections of Section 2

each of those factors will be discussed in more detail and an equMbrium model ofTHE COSTS AND BENEFITS FOR FIRMS OF 77

ACCOUNTING INFORMATION DISCLOSURE

a firm conceming accounting information disclosure wil1 be presented. Last, someaccounting problems will be analyzed by adopting our model.
The following assumptions will be valid throughout this paper.
i) The costs and benefits of accounting information disclosure can be measured in acertain value unit.

li) To avoid the problem of transfoming quality into quantity, the extent of information

disclosure can be measured like the amount of products.

2. Partial Equilibrium of Firm's Accounting Information Disclosure

2-1. Stock Market
In this subsection the problem of why a firm disclose its accounting information insecurities markets or communicate it to stock investors will be discussed. How we
can imagine the equilibrium point at which a firm maximizes its net benefit accmingfrom information disclosure in the stock market will also be addressed.
First of al1 we discuss the kinds of benefit for a firm accruing from accounting
information disclosure in the stock market. The firms can earn a largest benefit frominformation disclosure in relation to their capital fund raising activities. If firms constantly

disclose accounting information conceming their business results and financial positions
regardless of whether they are in a good business cycle or a bad one, security investors

can trade the stocks of these firms with relatively less uncertainty. The reputationof such `less uncertainty' is very usefu1 for the firms in raising the capital funds by

issuing new stocks. In a certain economy firms can borrow suthcient funds at a certain

constant interest rate. But in a real economy, risky firms must pay higher interest
rates than riskless firms for raising necessary money. Theoretically firms with the samerisk can borrow money at the same interest rate. So firms can suppress their interest
costs by keeping their investors' risk evaluation in favorable conditions. Such a policy

can be undertaken by means of accounting information disclosure. This is the first
benefit.

The second benefit is related to the persuasion function of information disclosure.

Managements can be easily supported by stockholders when making their capital stock
investment decisions or general management decisions if they keep the relationshipbetween firms and stockholders in the good health by constant information disclosure.

This is the second benefit.
Next, the kinds of cost accrued from information disclosure in the stock market

78 HIDETOSHI YAMAJI
must be listed. Although contrary to the above, it is possible that the more detailed
the information disclosed the rigider the risk evaluation of the firm by stockholders
becomes. This means that information disclosure is not always related to the reductionof interest costs. Moreover, the stockholders may become critical of management
decisions as a result of having more detailed information. This is also a kind of costaccrued from information disclosure for managements.
Figure I depicts the relationship between the costs and benefits for a firm fromaccounting information disclosure in securities markets. The benefit wM degressively

increase as the extent of information disclosure increases because in the beginninga drastic reduction of interest cost wil1 be expected but later such a reduction wil1
not occur proportionately. On the other hand, the cost wil1 progressively increase as

the extent of information disclosure increases because a strong dividend demand anda criticism of management resulting from more information wM often occur. The
equilibrium point of cost and benefit accruing from accounting information disclosuremust necessarily meet the following condition (1);

Ts(Qs) = Rs(Qs) - Cs(Qs)-Rs'(Qs)=Cs'(Qs)(1)
in which rs(Qs) is the net benefit accruing from information disclosure, Rs(Qs) is thegross benefit from it and Cs(Qs) is the gross cost irom it. The dash indicates thefirst deviation of the function. Of course the point Qs represents equilibrium point.

Cost & Benefit

Cs
Rs
1

1

J

rrs(Qs

'
i
1

l
t

Qs

Extent of
Figure 1

Information DisclosureTHE COSTS AND BENEFITS FOR FIRMS OF 79

ACCOUNTING INFORMATION DISCLOSURE'
2-2. Labor Market

In this subsection the equdibrium of information disclosure carried out by a firm in

the labor market wM be discussed. The costs and benefits for a firm of accounting
information disclosure in the labor market (or labor negociations) are detected in thesame way as those in stock market.
The main benefit in the labor market consists of the reduction of strike costs orconflict costs, because managements can persuade labor by the strategic use ofaccounting information disclosure. As often pointed out, managements used to neglect

the demand of workers who wanted to fully understand business conditions. This
inclmation sometimes caused over long wage negotiations and unnecessary strikes whichbecame extra labor costs for firms. Recent researchs show that strikes involve
enormous costs which do not necessarily bring about direct cash expenditure (seeNelson, 1973 and Geyal and Geyal, 1978). So managements can suppress labor costs
if they keep themselves in good relationship with the workers by disclosing fu11
information. But this cost-down effect of information disclosure does not proponionately

increase with the extent of information disclosure.

The second benefit is recognized in the long-term. If firms continue to disclose
their business information including accounting information, they will become able toemploy capable and ethcient workers. This personnel effect also degressively increases
with the extent of accounting information disclosure.

The next step is listing the cost of information disclosure in the labor market.

A.G.Hines reported that the long tendency of the wage level jn the United Kingdom
could be regressed to the rate of change of labor unionization (see Hines, 1964). Thisempirical research concerning the Philips Curve substantially demonstrated that therising of the bargaining power of labor unions has an effect on raising the wage level.
In particular, continuous information disclosure will give the factual basis on which labor

unions can criticize management's wage policy so that it raises the bargaining powerof labor unions (see Yamaji, 1986). This fact means that it wM cost a firm extra labor

expense. This effect will progressively increase with the extent of information
disclosure. The relationship of the costs and benefits in the labor market may be simlar

to the one shown in Figure 1. The necessary condition of equdibrium is represented
by the equation (2).

TL(QL) - RL(QL) - CL(QL)

eRL'(QL)-CL'(QL)(2)
in which TL(QL) is the net benefit accruing from information disclosure in labor market,

HIDETOSHI YAMAJI

80

RL(QL) is the gross benefit from it and CL(QL) is the gross cost froln it. The dashindicates the first deviation of the function. Of course the point QL represents
equMbrium point.

2-3. Product Market
In this subsection the costs and benefits for firms in product markets wM be analyzed.
What is the benefit for firms in product markets when firms disclose their information?

Generally firms must establish a good relationship with consumers or fellow firms inthe same industry. Some firms have been confronted with civil movements demanding
the disclosure of product costs. If they neglect such public opinion, they could possibly
suffer from boycotts activities of their products. These are, of course, costs for frrms.

Tuming our attention to fellow firms, the firms which may take price leadership ina product market must establish a good relationship with other firms within the industrial

firms group. If firms can establish the above-mentioned good relationship by adopting
strategic accounting information disclosure, that means a benefit for firms in a productmarket.
Subsequently the cost of information disclosure for firms in product markets must

be detected. It involves the most notorious and vaguest cost. Usually managements
are afraid of leaking business secrets if they disclose their accounting information. As

we already know, the conservatism of firms has prevented the development ofaccounting information disclosure. Managements have an inclination to think that more

information disclosure weakens their competitive powers. Low competitive power isrelated to lower sales which is of course a kind of cost for firms. Recently an empirical

study indicates the possibility that the productivity of a firm can be estimated basedon the research and development (R & D) cost (see Sveikauskas). Taking such things
into account, managements' care about leakage of business secrets can not be brushedoff. Such costs can progressively increase with the extent of information disclosure.
In the same way as in the previous subsections, the equilibrium of information disclosurein product markets can be conceptually shown as in Figure I and the necessary conditionof equilibrium can be written as the equation (3)Tp(Qp) = Rp(Qp) - Cp(Qp)eeRp'(Qp)=Cp'(Qp)(3)
in which Tp(Qp) is the net benefit accruing from information disclosure in productmarkets, Rp(Qp) is the gross benefit from it and Cp(Qp) is the gross cost from.it.

The dash indicates the first deviation of the function. Of course the point Q

pTHE COSTS AND BENEFITS FOR FIRMS OF 81

ACCOUNTING INFORMATION DISCLOSURE.
represents equdibrium point whichcorresponds to Qs as shown in Figure 1.
2-4. Mass Society
In this subsection our attention wM be paid to the fact that there can exist accounting

information disclosure of which the purpose is not to communicate something toa certain market but to appease the public. The reason why such information
disclosure should be considered was clarified in my previous book (see Yamaji,
1983, Part 3). It can be conjectured from the boycott activities in product markets.

Moreover we can imagine as an example the anti-monopoly movements which, bylobbying activities, require legal regulations of firms. They may develop as far as toimpose taxes on the extra profits of monopolistic firms, which are costs for thefirms. So big businesses are forced to take measures against the anti-monopolistic

movements. One of the measures is accounting information disclosure.
The public is likely to suspect if big businesses earn huge profits, divide themamong stockholders, and accumulate a portion of them to become much bjgger.
This suspicion is not based on exact data but on slight but unusual emotion.
But it can be a cause enough for political regu!ations over big business. Consequently

big businesses must disclose their accounting information for communicating theirethciencies and profitabilities in order to assuage the public.

The firm's costs and benefits in mass society of information disclosure can also
be imagined like those in Figure 1. That is, the benefit degressively increases but
the cost progressively increases with the extent of information disclosure. In the same

way as the previous subsections, the equdibrium of information disclosure in a masssociety can be conceptually shown as in Figure 1 and the necessary condition ofequihbrium can be written as the equation (4).

Tm(Qm) = Rm(Qm) - Cm(Qm)-eRm'(Qm)=Cm'(Q m) (4)in which Tm(Qm) is the net benefit accruing from information disclosure in a masssociety. Rm(Qm) is the gross benefit from it and Cm(Qm) is the gross cost from. it.

The dash indicates the .first deviation of the func.tion. Of course the point Qm
represents equilibrium point which corresponds to Qs as shown in Figure 1.

HIDETOSHIYAMAJI

82

3. Total Equilibrium
Informationof Firm's Accounting
Disclosure

We have clarified the costs and benefits of accounting information disclosure in eachof four situations (markets) and drawn four net benefit functions and four equilibrium
conditions.

But there remains one problem. We separately treated the four partial equmabriums
of information disclosure in four situations (markets) though the real firms simultaneously

consider the four market factors and decide on the absolute extent of information. (Qt). This extent is not always equal to each of four equilibrium points ofdisclosure-e(?s,e"digclosyre
9L, Qp, Qm) and also not equal to the total extent of four points((Qs+QL+Qp+Qm)• Thus we must think of the total equilibrium of information
disclosure carried by a firrn as follows. First of all, total net benefit of information

disclosure (T(Qt)) can be represented as.(Qt)= {Rs(Qt) ' RL(Qt) + Rp(Qt) ' Rm(Qt)}-{Cs(Qt) ' CL(Qt) ' Cp(Qt) ' Cm(Qt)}- R(Qt) = C(Qt)
So the total equdibrium is conditioned by-eRt(Qt)-C'(Qt) (5). equilibrium point Qt derived from (5) is
What does it mean, the fact that the total
generally different from the four partial equilibrium points? In the next section themeanings will be presented as our conclusion.

4. Conclusions
Interest groups demand different fixed extents of accounting information disclosure

from a firm, depending on their own interests. But the firm decides the extent of
information disclosure in order to maximize its own net benefit. So the real extent
of disclosure is not characterized as the optimal level of disclosure from the viewpointsof the specinc interest groups which are involved in the four situations (markets). For

example, both firms and investors may be simultaneously able to maximize their own

THE COSTS AND BENEFITS FOR FIRMS OF 83

ACCOUNTING INFORMATION DISCLOSURE

benefits in the stock market by extending the extent of informatjon disclosure. But
it is possible that true extension of information disclosure can not really occur becausesuch extension may bring about a huge cost to firms in other markets. So legal
regulations conceming accounting information disclosure in securities markets may not

be supported by business firms even if they bring about benefits to both frrms andinvestors in the stock market.

References[1]

Bal, R. and P. Brown, `An Empirical Evaluation of Accounting Income Numbers,' Joumal ofAccounting

Research, Autumn 1968.
[2][3]

Beaver, W., Financial Reporting: An Accounting Revolution, Prentice-Hall, New Jersey, 1981.
Craft, J.A., `Information Disclosure and the Role of the Accountant in Collective Bargaining',
Accounting, Organizations and Society, Spring l981.

[4]Foley, B.J. and K.T.Maunders, Accounting Information Disclosure and CoUective Bargainihg, The

MacMMan Press, 1977.
[5][6]

Geyal, S.K. and P.L.Geyal, `Decision Making during Strikes', ManagementAccounting, May 1978.
Gospel, H., `The Disclosure of Information to Trade Unions; Approachs and Problems,' Industrial
Relations Joutnal, Auturrm 1978.

[n

Hines, A.G., `Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom,[8]

Nelson, N., `Accounting for Strikes', Cost and Management, NovemberlDecember 1973.

[9]Palmer, J.R., The Use ofAccounting Inforrnation in Labor Negotiations, National Association of

1862-1963: A Reappraisal,' Revievv of Economic Studies, February 1968.

Accountants, New York, 1977.
[10]

Sveikauskas, L., `The Contribution of R & D to Productivity Growth', Monthiy Labor Review, March,[11]

Watts, R.L. and J.L.Zimmerman, Positive Accounting Theory, Prentice-Hall, New Jersey, 1986.

[12]

Yamaji, H., Accounting Information Disclosure, The Research Institute for Economics and Business

1986.

Administration, Kobe, 1983, in Japanese.
[13], `Collective Bargaining and Accounting Disclosure: An Inquiry into the Changes in Accounting
Policy', The International Journal of Accounting, Fall 1986.

INCREASING RETURNS TO SCALE AND OPTIMALINVESTMENT POLICY OF THE REGULATED FIRM*
Selichi KATAYAMA and Fumio ABE"

Abstract

This paper investigates the optimal investment behavior of the regulated profitmaximizing monopoly that exhibits increasing returns to scale. The Averch-Johnson
effect of overcapitalization is reconsidered in a dynamic adjustment cost model with

non-concave revenue function. We show that there may be three cases ofundercapitalization, overcapitalization and neutrality. In particular, we make clear therole of the assumption of increasing returns to scale or the non-concave revenue

function and show that the crucial point in the Averch-Johnson argument is not
the economies of scale but the level of the regulated rate of return.

1. Introduction
In the economics of regulation, studies on the `fair-rate-of-return' constraint havebeen extensively made since the seminar work by Averch and Johnson (1962).
One of the results which is known as the Averch-Johnson (A-D effect is that theconstraint induces the profit maxirnizing firm to have the larger stock of capital thanunder no constraint. Among many studies conceming the behavior of the firm
subject to the fair rate of return constraint, the discussions in the early stage aremostly concerned with the static case in which considerations over the investment
behavior through time are ignored. The present paper is to examine the behavior of
the firm facing a regulatory constraint and the economic implications of the regulationin the dynamic setting.

The dynamic versioh of the A-J original static model has been developed byPeterson and vander Weide (1976), El-Hodiri and Takayama (1981) and Dechert (1984)
and others. Peterson and vander Weide (1976) show that the regulated firm under the'* We are gratefu1 to Takao Fujirnoto and Takateru Inoue for valuable comments and suggestions.
* * Professor of Economics, Kagawa University.

86

SEIICHI KATAYAMA AND FUMIO ABE

binding constraint may invest at a rate which is less than the one by the'unregulated

tirm at each instant of tme. Hence they suggest that the A-J hypothesis does notnecessarily hold. El-Hodiri and Takayama (1981) criticize the conclusion in Peterson
and vander Weide and assert that the A-J thesis holds in the dynamic as well as in thestatic context. These arguments are made on the basis of the assumption of a concave

revenue function. On the other hand, Dechert (1984) emphasizes the importance ofincreasing returns to scale phenomena in the regulated industry and incorporates it

into a dynamic model. And he shows that the A-J effect does not necessarily occur

under the increasing returns to scale condition, and states that the concavity

assumption of the revenue function plays an important role to support the A-J
thesis. Katayama and Abe (1987) show that the A-J thesis does not necessarily
hold even under the concave revenue function, and assert that it depends specificallyon the level of the regulated rate of return.

Considering the significance of increasing returns to scale, we incorporate thenon-concave revenue function assumption into a dynamic model of the regulated
firm and see its economic implications. This is the purpose of our present paper.

Besides these theoretical works, empirical studies on the A-J effect havebeen made. Among them, Spann (1974), Petersen (1975) and CourvMe (1974)
found statistical supports for the A-J hypothesis. On the other hand, Boyes (1976)
and Cowing (1978) concluded the regulation to be ineffective. Moreover, the recent
analysis of Nelson and Wohar (1983) partly supported the existence of a regulatory

bias of the A-J type. The variety of these results reveals the lack of concensus
about the topics. This suggests that further studies from the theoretical as wellas empirical stand points are necessary.

We show that increasing returns to scale are not essential concerning the above

problem, and that it can be a factor to determine the level of the capital stock

at which the firm has to operate under regulation. As a result we see that the
vakdity of the A-J thesis is crucially dependent not on the shape of the revenue
function but rather on the relative level of the regulated rate of return itself.

This paper is divided into six sections. In section 2, the model and a set ofnecessary conditions for optimakty are explained. In section 3, we shall discuss
the optimal employment and investment policies of the regulated firm. Section 4 isdevoted to the discussion of the optimal paths and the'A-J thesis. In section 5, we

present the comparative dynamic analysis conceming the impact of change in theregulated rate of return on the steady state of capital and the investment policyof the firm. In section 6, some concluding remarks are given.

RETURNS TO SCALE AND OPTIMAL
INCREASING
POLICY OF THE REGULATED FIRMINVESTMENT

87

2. Model and Necessary Conditions
The optimal control problem is formulated

as follows:

Maximize S: [R (Q) -wL-C (I)]e-rt dt(1)

Q,L,I
subject toR(Q)- P(Q) Q,.

(2)

K=I -6K, K(O) - Ko(>O),
QSF (K, L),(3)

R(Q) + wL IO,

(5)

sK -

were K and L are two factor inputs, i.e., the stock of capital and labour
respectively. We also assume that K(t)IO and L(t)IO are satisfied. Q denotes theamount of output which is a control variable and P(Q) is the inverse demand
function. The constraint (4) which is introduced in Dechert (1984) means that thefirm is allowed to carry out inefficient productioni). The symbol I stands for thelevel of gross investment. C(I) denotes the total cost of investment including

adjustment costs. It is assumed that C(I)IO, C''(I)>O and C(O)=02'. F(K,L)
denotes the production function of the firm which is assumed to have local convexity
with respect to K and L. Although any type of increasing returns to scale is possible,

it seems plausible to assume a typical form of local convexity shown in fig. 1-3 ofDechert (1984)3). Parameters s, w, r, and 6 are the regulated rate of return, thewage rate, the discount rate, and the rate of depreciation respectively. They are
assumed to be positive constants.
If there exists an optimal solution in the problem, the necessary conditions for
optimality are derived as follows`).

1) Dechert states that the constraint (4) is assumed in order to eliminate an indetermhacy in the problem.

Without that constraint (4), however, there exist two different optimal levels of employment. See

Peterson and vander Weide (1976, p.53).
2) It should be noted that, foilowing Dechert (1984), I lO is not assumed in the present paper. See Dechert(1984,p.3).
3) See also Dechert (1984, Fig.1 and Fig.2). In addition he assumes that for each level of the capital stock,

the production function is convex for smak values of L and concave for large values of L. And he also
assume that the revenue function has the same type of non-concavity as the production function.
4) It is obvious, for example, by applying Lemma(iv) in Takayama (1985, p.648) that the constraint
qualification in this model is satisfied if R'(Q)FL-w = O when the constraints (4) and (5) are binding.

(4)

SEIICHI KATAYAMA AND FUMIO ABE

88

The Lagrangian W is defined as

W = R(Q) -wL -C(D + q(I - 6K)+e [F(K, L) - Q]
+ p[sK - R(Q)+ wL].

(6)

Assuming an interior solution, there exist functions q(t), e(t) andp(t) which

satisfy. I -- 6K, K(O) = Ko(>O),K=(3)

q= (r+6) q -pa s-e Fk(K, L),(7)(1 -pt)R'(Q) - e - O,

(8)

(1 -p)w - e FL (K, L) = O,(9)

q - C' (I),(10)

eIO, e [F(K, L) -Q] - O, Q5F(K, L),(11)

palO, pt [sK-R(Q) + wL] = O, sK-R(Q) + wLIO.

(12)

In addition, since we consider the infinite horizon case, the following

transversality

condition is assumed,

lim e-'t q(t) IO, lim e-rt q(t)K(t) =O, (13)t. eo t. co

In the above necessary conditions (3) and (7)-(12), q(t) is a costate variable. e(t)and pt (t) are the multipliers associated with the constraints (4) and (5) respectively.

Since both the constraints (4) and (5) do not contain a control variable I(t) in themodel under consideration, we should take account of the possibility that the
costate variable q(t) jumps at the junction points between unregulated and regulated

intervals. Therefore, in general, we should consider the following jump condition[see, for example, Seierstad and Sydsaeter (1977)],q(T ') - (T-)-b [s-Rk (K(r), L(T))], blO, (14)where r is the time when q(t) is discontinuous. In what follows, however, we treat
only no jump case for simplicity as Dechert (1984).

INCREASING RETURNS TO SCALE AND OPTIMALINVESTMENT POLICY OF THE REGULATED FIRM
3. 0ptimal Investment and Employment Policies of the Firm
We now consider the optimal investment and employment policies of the firm.
As is easily seen from (8) and (9), there are the following three possible cases withrespect to the signs of e and p5):(a) e = R'(Q) >O and pa = O,(b) e > O and O< pt <1 [el(1 - pa) = R'(Q)],(c) e = O and pa =1,
It is obvious that one of the above three cases is observed at each point of timealong an optimal path. Let us examine each case in turn.

Case 3- (a) e>O and pa =O
In this case the regulated constraint (5) is not binding and the constraint (4) is
effective. Therefore the optimal path must satisfy the following equations6):

RO=IO-6KO, (15)qO == (r+6) qO-R' (QO) Fk(KO, LO), (16)R'(QO)FL (KO, LO)=w, (17)qO=c' (IO), (18)F(KO, LO) ., QO. (19)It should be clear from (17) and (19) that the employment level is determined so
as to satisfy the following well-known efficiency criteria of monopoly: the marginal
revenue product of labour is equal to the wage rate. If this is the case for the wholeplanning period, the optimal path has the same propenies as those depicted in
fig.1 of Dechert (1984, p.6). In other words, this case turns out to be the unregulated monopoly firm with increasing returns to scale. There may be two steadystates where one is a saddle point and another is an unstable focus. Therefore there

may exist an optimal path which goes to some point on the K--O line. In what
follows, we simply focus our analysis on the path converging to EO in fig.2 as the
optimal unregulated path. We shall compare it with the optimal regulated path later.

5)

See Takayama (1969, p.257, footnote 9) about the assumption that the marginal revenue is positive,i.e., R'(Q)>O.

6)

The superscript *(Sbinding (not binding).

on variables and functions denotes paths where the regulatory constraint (5) is89

SEIICHI KATAYAMAANDFUMIOABE

90

Case 3- (b) e> O and O<pa<1
Since both constraints (4) and (5) are effective in this case, the following threeequations must hold: R'(Q)FL=w, Q=F(K, L) and sK-R(Q) + wL=O. The twojunction points, !S and K, are determined for a given fair rate of return as depicted

in fig.1.7). Fig.1 corresponds to the situation satisfying these equations simul-

taneously. This case is possible only in these two junction points K and K(K < K), where a set of junction points V for each given s is defined as follows:

V - {(K, L, Q;s) :(20)
R' (Q) FL - w, sK - R(Q) + wL- O, Q - F(K, L) }.

Thus it holds thats= T(K) , (21)r+6

(r+6)K

where T(K) is the maximum short-run profits after adjusting variable input L,
and is defined as follows:

T(K)=max[R(F(K, L))-wL]. (22)L
The left hand side of (21) indicates a horizontal line at q=s/(r+6) and the righthand side is obtained by multiplying the average rate of returns on capital by

1/(r+6). We refer to the curve q= T(K)/(r+6)K as a switching curve. Whenincreasing returns to scale are introduced in the same way as in Dechert (1984),

there is a possibdity for two intersections between a horizontal line q=sl(r+6)
and the switching curve q= T(K)/(r+ 6)K. The range of the capital stock between

LConstraint

Contour
R. == w

L,
L

1

1
-HHmJmm
l
l
l
l
1

1

s

r

1

t

,

!

L,

:

1

1

1

:

T

:

1

1

1

1

1

T

1

1

E

,

t

l
'

1

K- K,

locus

1

,

K-V K-

K

Fig. 1
7) Here a constraint contour is defined assurface of the rate of return function Q =s. See also Katayama and Abe (1987).

the projection onto a (K, L)-piane[R(F (K, L))-wL]/K and the plane Qof the intersection of thes for a suthciently smad

INCREASING RETURNS TO SCALE AND OPTIMALINVESTMENT POLICY OF THE REGULATED FIRM
these two points, [K, K], is called the regulated region of the capital
simply thestock, orregulated region.

Case 3- (c) e=O and p ==1
We first consider the employment policy of the firm in this case. Suppose that thelevel of the capital stock is at K=K, in fig.1. Since the constraint (5) is binding,

Ki lies in the regulated region [K, K]. Then it is optimal for the firm to choose

any point in the range of employment level [Li, L,] in fig.1, if he determines

the combinations of output Q and labour L satisfying sK-R(Q)+wL=O for the
given s and Ki.
This is the case that the capital stock is in the interior points of the regulated

region [!S, K]. Then the optimal path is described by the following equations:.* * *

K-I -6K, (23)q"=(r+6)q"-s, (24)q" -C' (I"), (25)
Q' 5F(K", L") (26)sK"-R(Q")+wL'=O. (27)This system has a unique steady state of capital k' which is a saddle point. Thus
if this case occurs throughout the whole planning period or for the final period, theoptimal path goes along the horizontal line q=sl(r+6), since only such path cansatisfy the transversality condition (13). Furthermore it should be ngted that thesteady state ofA*
capital K decreases as the regulated rate of return decreases. As
wil1 be seen below, this is an important point when considering the possibility of the
A-J effect of overcapitalization.

4. 0ptimal Path and the A-J Thesis
Now we turn to the analysis of the optimal path and the discussion of the A-J thesis

in such a general case that includes the possibdity of changing regulatory phases.

First we have to notice that the following qC=O locus is derived from theswitching curve and the different levels of s,91

92 SEIICHI KATAYAMA AND FUMIO ABE
R'(Q)Fk(K, L)' for KL<K<K ork<K

r+6 '

'
q,= pas+ (1 - pt) R' (Q) Fk (K' L) , o<p<1 for K= !S or i<r+6

S for K<K<kwhere superscript C denotes the optimal path in this general case and KL is thelevel of capital under which the maximum revenues net of wages is zero.
Then there are the following six ranges of the regulated rate of return each ofwhich deterrnines the relative magnitudes of kO, k", i( and K,

S, = { s: k" <Ks kO<k},
S, = { s: k" < kO <KEk},
S, = { s: Ks k" < kO<k},

S, = {s: !s<kO<R' sk},S, = { s: K< kOsk< k* },S6 = { s: KsK< kO< k* }.
. that the K= O locus and the switching curve q=T(K)1(r+ 6)K
It should be noticed.
on the K-q plane determine the sets Si (i=1,.. ., 6). When the K:O locus
does not intersect with the switchng curve, the possible cases are only s E Si and. that the K=O locus intersects the switching curve at
sE S2. In the situation

two points in the region of K<K, Si, S2 and S3 are non-empty. Here K
denotes the value of the capital stock which attains the maximum of average
profit T(K)/K. Finally .when the K=O locus and the switching curve intersects

at two points, i.e., one in the region K<K, and the other in the region K<K
respectively, all cases Si 7E th for i= 1, 3,..., 6 are possible except for i :2.

Case 4.1:s E Si (k" <KskO < i()--See fig.2. Since the K= O locus intersects the qC=O locus on the vertical segment

at !!, the steady state of capital KC is K. Therefore KC(co)=K<kO.KO(oo).
Thus undercapitalization is resulted in this case.

INCREASING RETURNS TO SCALE AND OPTIMAL 93
INVESTMENT POLICY OF THE REGULATED FIRM •Wenow investigate how the optimal path is determined to the various levelsof the initial stock of capital Ko. In this case, as seen from fig. 2, the level ofqc(t) iS lower than the one under no regulation throughout the whole planning

period, i.e., qO(t)>qC(t) and hence it holds that IO(t)>IC(t).

->->-> unregulated pathq

- regulated pathk-=o-)-X -'N kl7- .

R'(Q) F,(il? il)o )r+6 ---r-xM
l
/

SIN

"' Ks.

It1 N. A(
ll

N.

N .-

ll

rr(K)

lt
s

r+S

:i

---- Ec
t

t

'

1

;

,

,

,
t

o

q= (r+6)K

l

'

ll
[1
tl
II
11

1

qo.Eo

qc=!o

K. 2• K--Kc KN KFb k- K

Fig. 2 Case 4.1 sES,(ie*<K-g AKe < k)Case 4.2: s E S2 (k" <kO<Ksi<). the K=O locus intersects the qC=O locus outside the regulated
See fig.3. Since
region [!S, K], the steady state of capital KC is kO. If Ko < !S, it is optimal for thefirm to go along the unregulated path converging to ECtiiroughout the whole plarming

period. If KoE [!S, K], the optimal path goes along one of the paths satisfying(23)--(27) for the initial period. And after aniving at -K, the optimal path enters
the unregulated region and hereafter follows along the unregulated path convergingc-to E . If K < Ko, the optimal path passes through three regions, i.e., the unregulated

region (i<, Ko], the regulated region [K, K] and the unregulated region [ke, i().
In all cases mentioned above, each optimal path converges to EC. Thus it holds
that KC(oo)= kO conceming the steady state of capital. We cak it the neutral case.
In other words, the A-J effect of overcapitakzation does not occur in a strict sense,
As for the investment policy of the firm, there are a few types accordmg to various
levels of the initial stock of capital. If Ko< K, the optimal investment rate is notaffected at all by the regulatory constraint throughout the whole planning period.

On the other hand, if KoE [!S, K] or K< Ko, the optimal regulated investment rateis larger than the case with no regulation as seen in fig.3.

SEIICHI KATAYAMA AND FUMIO ABE

94

k-o

q

Ec

R'(Q) F, (ft? i])O )

r+6

l
,
,

s
r+a

J-

tl
tt1

N NF.

r.

Å~

.N
111
IiIllll
llIl
qlli
11I
lll
lll
lli
lll
ltl
lll
O K, ii,. Cilo=KcK
K- K
l

1

qo=Ot
1
1
,
,
,
l
,
1
t
fi
1
t
[

qc,-O

rt(K)

(r + B)K

Fig. 3 Case 4.2 sES,(ie"< ile<K$K-)
Case 4.3: s E S3 (Ks k' < kO < il)
See fig.4. In this case,. since the K = O locus intersects the horizontal segment of theqC=O locus in the regulated region [IS, i<], the steady state of capital KC is k'.

It should be noticed that s<R'(QO)Fk(kO, LO) and hence KC=k'<kO hold.
If Ko E [K, i(], the optimal path goes along the qC = O locus throughout the wholeplanning period and converges to EC. On the other hand, if Ko < !S or K< Ko, theoptimal path goes along one of paths satisfying (15)-(19) until it arrives at K or K andhereafter goes along the qC=O locus and coverages to EC. In both cases, the optimal

path converges to EC and hence it holds that KC(co)= k" < kO. Therefore the A-J
thesis does not hold and undercapitalization is realized. We can see that thisresult depends on k" < RO.
Next turn to the investment rate of the firm. In this case, we can observe theimpact of the regulatory constraint on the optimal investment rate. As seen in fig.4,
the optimal investment level under regulation is lower than under no regulation, although

it is not necessarily obvious in the region of kO< K.

INCREASING
RETURNS TO SCALE AND OPTIMAL

95

POLICY OF THE REGULATED FIRMINVESTMENT

k-o
- l'

+t

Rt(Q) F, (k? tO )

----1

r+a

NN
- - t- m-- HNN

" .-

-s

S'.>. N

/

s
r+a

E

INN
.< -.

Ec
l

,
'

Fig. 4

l

,

,

,

'

,
'

1

,

1

,

'

1

,

1

,

1

'

'

'

d

K-

K,

,

,

,

o

;

1

ier. - Kc

'-

(N

Ns

l

Nx

dc-o

l.

IqO=O

ll11
llII
ll
'l1
I

n(K)

q= (r+olK
K

K-

{K7t,

A A -Case 4.3 sES3(K$K'<KO<K)

Case 4.4: s E S4 (K<kO< k" sk)-.

See fig.5. Since the K-- O locus intersects the horizontal segment of the qC=O locus

in the regulated region [K, il], the steady state of capital KC is k*. It should benoticed, however, that s>R'(QO)Fk(kO, LO) and hence kO< k" =KC hold. Therefore, the A-J effect of overcapitalization occurs.

As for the investment policy of the firm, we can show some interesting
propenies. As seen in fig.5, it seems that the optimal regulated path intersectsq..>- - - >-

-

l ij

s
r+6
R'(Q) F, (il? i])o )

k-o

s Npt

Ns. EC!

+l----EoF
1il
l lll

r+a

1 11

-i
/ÅÄ q'cl'?l

r.
rsf N

r- s

1

t
1

'

7r(K)

,

l iij

q- (r+6)K

'
l
t

1
'

o

1 11t

1
1

K KtCKbKA.KKc

K,

Fig. 5

Case 4.4 sE! S, (K< {K;b< ib. K. K-)

qo .= oKSEIICHI KATAYAMAANDFUMIOABE

os

the optimal unregulated path at the interior point, say K', of the regulated region.
Therefore, in the range of the capital stock smaller than K', the optimal investment
level of the firm under regulation is lower than under no regulation in the unregulated

region'of the capital stock (K <!S) as well as in the regulated one. On the other
hand, in the range of the capital stock larger than Ki, the former is higher than thelatter.
qs
r+6R'(Q) F, (k? i]o )

r+a

t7 "
T'

-----/A-"-t Mit --

k-o
NA.
1

E

:

1EO l Yx
1

1
l

1
1

I

1
1
1
)

,
'
,

t

l

1

t t
'

'

1

1

N .vN

l S-rT.

1

I
1 '
'
I l
'
'
' ' 1
1 1 '
l t '
, 1 1
, 1 1
' l t
1

Ns

1

s

'

O K, Kdc •il,k ie7. K
Fig. 6 Case 4.5 SeS,(Kff< fto$K-< k")Case 4.5: sE Ss (K<kOEii<k')-.

See fig.6. Since the K=O locus intersects the qC=O locus on the venical segment
at K, the steady state of capital KC is K. Therefore it holds that kOsK = KC. Thus
overcapitalization occurs in this case.

As for the optimal investment rate of the firm, we can observe the similar
propenies to the one in case 4.4

Case 4.6: s E S6 (KER<kO< R"). since the K= O locus intersects the qC=O locus outside theSee fig.7. In this case,regulated region [!S, K], the steady state of capital KC is kO. Then the optimal

path has the same propenies as in the case ofsE S2. That is, if K<Ko, theoptimal path goes along the unregulated path converging to EC. If Ko E [K, K], theoptimal path goes along one of the paths satisfying (23)-(27). Furthermore,
if Ko<K, the optimal path may pass through three regions, i.e., the unregulated

INCREASING RETURNS TO SCALE AND OPTIMALINVESTMENT POLICY OF THE REGULATED FIRM

97

region [Ko, !S), the regulated region [!S, k] and the unregulated

region (Tt < ko]by turns. In ak cases, the optimal path converges to the steadykO. Thus the A-J effect of overcapitalization does not appear. We

state of capitalsummarize theresults in table 1.

q

r"" ')' NA. k-olN-- "NEc'"--l----7//r'f '"i N.;.
i li' el
l
lIlt
llll
llll
Illj

l l l il
1lt
l ll 1/o

Iil1K,

Fig. 7 Case 4.6

sES,(KSK<-AAKO< K.)

S2

Sl

S3

s

S5

su

s<R'(QO)Fk(RO,LO)s<R'(QO)Fk(kO,LO)

rangeofsK-AA K.
K KKO

steadystate

K

ko

k*

k*

k

ko

A-Jthesis

underneutral

under

over

over

neutral.mvestment

IC<IO

IC2IO-

IC<IO

note:

over denotes overcapitakzation, under undercapitalization,

KC(.) . kO.

Table 1

IC;IO-IC>IO
respectively,

ICEIO

where neutral means that

98 SEIICHI KATAYAMA AND FUMIO ABE
5. Comparative Dynamics
In this section, we present some results of comparative dynamics regarding theimpact of change in the regulated rate of return on the steady state of capital andthe optimal investment path. Table 2 summarizes the results.
First of all, it should be noted that when the regulated rate of return changes,

the qC=O locus changes partly and .other curves such as the K=O locus and theswitching curve q = T(K)1(r + 6)K are kept unchanged. We first consider the effectof change in the regulated rate of return in the cases of s E S2 and s E S6.
As seen in section 4, the optimal path essentially has the sirnilar properties inthese two cases. That is, although it may pass through the regulated region of
the capital stock, it finally converges to the unregulated steady state of capitalkO which is in the unregulated region. Therefore the optimal path is affected bychange in the regulated rate of return only when it stays in the region of KSK

for the case sE S2 and in the region of KEK for the case sE S6, respectively.
Then, as seen in fig.3 and fig.6, we can obtain the results shown in table 2.

We next investigate the cases of s E S3 and s E S4. The optimal investment
path has also the same characteristics in these two cases. That is, although it
may pass through the unregulated range of the capital stock, it finally converges

A* of capitalto the regulated steady state
K regulated region. Then we
which
is in thehave the results in table 2.

Finally consider the cases s E Si and s E Ss. In these cases, the optimal pathconverges to the lower limit of the regulated region of the capital stock in the caseofsE Si and the upper limit in the case of sE Ss. Therefore we have to noticethat the effect of change in the regulated rate to the steady state of capital is opposit

in s E Si and s E Ss. Considering these we obtain the results in table 2.

Ko<K-

ICs>O
KCs(co)>O

Sl

S2

ICs(t)=O

IC,(t)<O

KCs(co)>O

KCs(oo)>O

ICs(t)>O

S3andS4

KCs(co)>O

ICs(t)<O

S5

S6

k<Ko

KoE[K,R]-

KCs(eo)<O

ICs(t)>O
KCs(co)=O

Table 2IC,(t)=O
KCs(oo)=O

INCREASING RETURNS TO SCALE AND OPTIMAL 99
INVESTMENT POLICY OF THE REGULATED FIRM
ttt
6. ConcludingRemarks''

In the preceding sections, we have considered the optimal..investment. andemployment policies of the regulated firm under the assumption of increasing
returns to scale. Here as concludmg remarks we summarize the main results andrefer to some dfferences between our analysis and the similar one by Dechert (1984).

First, our analysis shows that there are a few types of the optimal regulated
paths corresponding to the various levels of regulated rate of return. There is thepossibhity of three cases of undercapitalization, overcapitalization and neutrality.

The possible patterns of the optimai path are determined by the relative magnitudes
among the four levels of capital stocks, i.e., kO, k',,!g and i(. The six possible
sets of the regulated rate of return is obtained by these four variables. It is clearthat the pattern of the optimal path crucially depends on which set the regulated
rate of return belongs to. In this sense the level of regulated rate of return is a key

parameter to the solution.
Secondly, the A-J effect of overcapitalization may appear in the cases s E S4 andsE Ss in which kO< R' holds. However, even though RO< k' in the case sE S6,
the A-J thesis does notJs*
hold because K is outside the regulated region of the

A* K cannot be the steady state unless it is in the regulated region.
capital stock.
Dechert (1984) states that in the dynamic model formulated in El-Hodiri and
Takayama (1981), the falling marginal and average profits with respect to the stockof capital lead to their main result of the A-J effect of overcapitalization, andtherefore the importance of the concave revenue function is emphasized. Katayama

and Abe (1987) show that under the concave revenue function, the A-J hypothesis

holds only when kO< k"sk. Here we have shown that under the non-concave
revenue function, the A-J hypothesis holds only when K < kO< k' si(. On thisbasis, the point in the A-J argument is the relation kO< k'(si<) and even under

the non-concave revenue function, it holds only when kO<k"(si(). As thepreceding analysis and Katayama and Abe (1987) show, the situation kO< k'(sR)and k"<kO(sR) are possible depending on the levels of the regulated rate of
return under the non-concave and the concave revenue function. In this sense theform of the revenue function does not necessarily play a key role in the A-J argument.

Then what detemines the relative magnitude of kO and R" ? As easily seen fromthe figures, it depends on the relative magnitude of the regulated rates and themarginal revenue product of capital evaluated at the unregulated stationary states,

R'(QO)Fk(kO, LO). If we could interprete R'(QO)Fk(kO, LO)1(r+6) as a suitable
capital cost in the infinite horizon mode!, the crucial point in the A-J argument

SEIICHI KATAYAMA AND FUMIO ABE

100

is which is larger the capital cost or the discounted regulated rate. If the regulated

rate is smaller than the capital cost, the shadow price of capital qC(t) becomessmaler and the terminal capital stock becomes less than the unregulated case.
Undercapitakzation is reakzed. This point is the same as the case of concave revenue
function.

Finally, the presence of increasing returns to scale may set a certain positive lower

limit to the regulated region of the capital stock K, while we can regard !S as zerounder the assumption of the concave revenue function. This means that increasing

returns to scale would make the regulated region for the firrn smaber thanotherwise.

References
[1]

[2]
[3]

Averch, H. and L.L. Johnson, 1962, Behavior of the firm under regulatory constraint, American
Economic Review 52, 1053-1060.
Boyes, WJ., 1976, An empuical examhation of the Averch-Johnson e'

ffect, Economic Inqtziry 14, 25-35.

CourvMe, L., 1974, Regulation and ethciency in the electric utility industry, Bell Journal of Economics

and Management Science 5, 53-74.
[4]

Cowing, T.G., 1978, 11ie effectiveness of rate-of-return regulation: an empin'cal test using profit

limctions, in Fuss, M.A. and D.L. McFadden, eds., Production economics: a dual approach to theory
and applications (North-Holland, Amsterdam).
[5]

Dechert, D.S., 1983, Increasing retums to scale and the reverse flexible accelerator, Economics Letters13, 69-75.
[6]Dechert, D.S., 1984, Has the Averch-Johnson effect been theoreticaly justhied ?, Journal of Economic

Dynamics and Control 8, 1-17.

m El-Hodiri, M. and A. Takayama, 1981, Dynamic behavior of the firm with adjustment costs underregulatory constraint, Journal of Economi'c Dynamics and Control 3, 29-41.
[8]

Katayama, S. and F. Abe, 1987, Optimal investment policy of the regulated firm, Working paper 95<Kobe University of Commerce), fombcoming in Journal of Economic Dynami'cs and Control.
[9]

Nelson, R.A. and M.E. Wohar, 1983, Regulation, scale economics, and productivity in steam electric
generation, International Economic Review 24, 57-79.

[10]Petersen, H.C., 1975, An empin'cal test of regulatory effects, BeVJournal ofEconomics and Management

Science 5, 111-126.
[11]

Peterson, D.W. and J.H. vander Weide, 1976, A note on the optimal investment policy of the regulatedfirm, Atiantic Economic lournal 4, 51-56.
Seierstad, A. and K. Sydsaeter, 1977, Suthcient conditions in optimal control theory, International

Economi'c Review 18, 367-391.
[12]

Sparm, R.M., 1974, Rate of return regulation and ethciency in production: an emphical test of the

Averch-Johnson thesis, Bell Journal of Economics and Management Science 5, 36-52.
[13]

Takayama, A., 1985, Mathematical econonv'cs, Carnbridge University Press.

PROBLEMS AND METHOD OF ECONOMICS
Nobuo OKISHIO

1. Living Things and Human Beings
A human being is one of the variety of living things which appeared during the evolutionof all living organisms which in itself was a part of the development process of nature

on Earth. So, in order for human beings to continue to exist, they must do the same
basic activities as al1 other kinds of living things to survive.

Any kind of living thing must be able to control, more or less, the surrounding

environment to maintain homeostasis of its own system. Not only is it passively
infiuenced by the surrounding environment but it must also actively control it. This
active control is the very condition for the existence of living things.

Of course, a human being cannot continue to live without this active control overthe surroundmg environment. Human beings remarkably improve their abMty to control
the outside environment in distinctively different way from other kinds of living things.

The typjcal characteristics of mankjnd's control over the surrounding environment are
as follows: (1) Their activities are conscious (thinking animals). (2) They work on nature

with not only their own hands and feet but also with their produced tools (tool-making
animals). (3) They work on nature not isolatedly but in a socially cooperative way (asocial animal).

These three characteristics are not separated but interrelated to each other.
For human beings to be able to act consciously they must have a certain developmentof the cerebrum and of language. However, they could not have developed the cerebrum

without having been extensively omnivorous, supported by the use of fire and theirown hand-made tools. And there would have been no language without sociallycooperative activities. For human beings to work on nature with their own tools, social

cooperation and the capacity of foresight are indispensable. So we can say that theultimate basis of human beings' remarkable control over external environment is thathuman beings have worked socially and cooperatively.

102

NOBUO OKISHIO
2. Productive Forces: Ability to Control Nature

We cal1 human being's conscious control over nature `productive activity' or labor.
And we call human being's abbity to control nature productive forces. It is important tonote the following facts about productive forces.

(1) Human being, strictly speaking, cannot create matter at ak and can only control
the conditions of matter existing in nature. Humans' control over nature is not confined

to local control such as producing portable, divisible and privately ownable goods but
extends to global control, in time and space, which brings irreversible changes to nature.

For example, local control could be the production of medicine that takes effect only

within the takers' body, and global control could be hygienic measures to get rid of

the germs of a disease from a wide area.

(2) Humans' controlling actions over nature are originally not an end in themselves.

They are a means of stabMzing the human condition and assuring the human progress.
In order to stabdize the human condition, service activities such as nutrition, sanitation,

medical treatment, childcare and education are necessary. For human being to survive
their controlling actions over external nature must be used to promote these activities.

(3) It is a mistake to measure human productive forces simply from the viewpointof whether one can produce more products at less cost. As productive forces are theab-ty to control nature, this control abdity cannot be said to be highly developed, unless

we can not only produce a'great amount of electric power and steel at a fixed cost
but also recognize wide changes in nature caused by our productive activities and thus
take proper measures to rectifY them. As mankind's power to change nature increases,
the recognition of the broad effects on nature of our productive activity and the necessityof measures to cope with them grow in importance.
(4) If our productive forces in the above sense could not develop further, humanbeing's survival could not be guaranteed. Because nature, which is the object of ourcontrol, tends to change. It is not only that nature itself experiences irreversible
historical movements, but also mankind's productive activities change nature radicallyand extensively. If mankind's mode of controMng nature remains fixed in spite ofchanges in the objects of control, it would become impossible to control them and humanbeings would cease to exist. We hurnan beings can survive only if we study nature more

PROBLEMS AND METHOD OF ECONOMICS 103
and make more effort to control it, accepting modestly that we still know almost nothing

about nature.

3. Production Relations'
Man can have a more sophisticated abihty to control nature than other animals,
because of his social cooperation and joint activities towards nature. We call social
relations between man and man concerned with production as ``production relations''.

Production relations consist of various kinds of relations. The main production
relations are the following: (1) Cooperative relations in production (cooperation, divisionof labor), (2) Property relations of the means of production, (3) Relations between

those who make decisions on production and those who are obliged to obey, (4)Relations between people who are free from labor and those who are compelled towork, (5) Relations concerned with the distribution of products.

Man must have these various kinds of relations conceming production in any
society. In various social forms they appear differentiy. Among production relations
which characterize any social form, property relations of the means of production playa most basic role in the sense that they detemine other relations. At first sight, theproperty relations of the means of production look like the relations between men andthe means of production. Rather than being the relations between objects and men,they are the relations between men and men in connection with the means of
production. For example, the fact that A privately possesses a means of production
X means that A excludes other people's (B, C, D, ...) intervention on decisions about

the means of production and that he thus grasps the decision-making apparatus.
So if it is once decided who possesses the means of production in a society, it
determines mostly who makes the decisions about production, who cannot but takecharge of the labor, and how the products are distributed.
Though the specific property relations of means of production, which we call basic
production relations, determine the other production relations derivatively, the relations

thus deterrnined help this basic production relations to reproduce and survive fora certain historical period. For example, the means of production are possessedprivately by capitalists in a capitalistic society. As a result, fundamental decisions about

production are made by the capitalists, and those people who are excluded from theownership of the means of production are obliged to be employed as wage-laborers.

Capitalists exploit surplus products which exceed the level necessary for the
reproduction of labor power. Consequentiy wage-laborers, again excluded frompossession of the means of production, must reappear at the labor market to sell

NOBUO OKISHIO

104

their labor power, where capitalists reappear as monopohrer of the means of production.

In this manner, any society possesses the mechanism to reproduce its own production
relations.

Besides such a built-in mechanism to reproduce production relations, the society
has an organ which is designed to maintain and strengt]ien its own production relations.
This organ is caked the ``state'', and it consists of three parts: an ideological device,a legal device and a violent device. Out of these three the ideological devise is mostfundamental, because if it does not work, the society cannot assure peopie's voluntaryor reluctant consent and consequently the other devices have dithculties in working.
Proper functioning of the ideological device depends on whether the productive activities

function well under the production relations in question.

4. Productive Forces and Production Relations
It is not random and arbitrary what kinds of production relations a society has in acertain specific historical phase. The main primary factor which determines what kindsof production relations take place and reproduce themselves in a certain spechic historicalphase are the level and character of control abihty over nature i.e. the level of the

productive forces which the human society has in that phase.
For capitakstic production relations to settle and work, what level of human capacity

to control nature is needed?

Capitalistic production relations cannot settle, if human abihty to control naturedoes not reach a certain lower limit.

(1) Labour productivity must be high enough to be able to produce enough surplus
products, or else the exploiting class cannot exist and the society cannot afford thewaste inevitably caused by commodity production.
(2) Social division of labor must prevail, or else commodity production cannot become
general, and there will be no capitalistic society.

(3) Labor productivity must increase as the scale of enterprise increases, or else
capitalistic firms cannot squeeze out small independent enterprises and compel them

to become wage-laborers.
Capitalistic production relations cannot work effectively, if human ability to control

nature exceeds a certain upper limit.

ECONOMICS
PROBLEMSANDMETHOD OF(1) As the productivity of labor climbs remarkably high, the unemployment problem
becomes crucial. And as the scarcity of products disappears, capitalistic society, needmg

scarcity as one of the basic prerequisites for its very existence, cannot work well.

(2) If the minimum required fund to develop new production techniques and tocontrol nature globally exceeds the limit privately financed, the mobdization of publicfunds by the state becomes indispensable. This contradicts the rules of capitalism
which are based on investment of private capital, and bribery becomes the order ofthe day.
(3) If mankind's abdity to control nature increases so noticeably that it becomesable to change nature globally, then human productive activities not only change
the local environment within factories but also heavily influence the wider environment

in general and human bodies in particular. This means infiuences on seawater, theatmosphere, weather conditions, the human gene and so on. At such a stage private
profit seeking decisions on production wi11 have serious rarnifications for the very survivalof the human race.
(4) As mankind's abdity to control nature becomes global, the results of productive

activity (products) become difficult to confine into the form of commodities.
For example the results of medical and hygienic activities over a wide regiori are ditlicult

to commercialize on the give and take principle and it would be a foolish thing to do

so. Capitalism is a society which is based on dominant commodity production, so the
spread of such global activities eventually tends to conflict with the existence ofcapitalism.

(5) As the human abMty to control nature increases, so too does the human abdity
to process information, because such control activity necessarily follows the activityof processing information. The abihty to process information consists of material means(electronic computers, communication equipment etc.) and human factors. With theincrease of productive forces, the abihty to process information spreads among membersof the society. However capitalists' ownership of the means of production and theirmonopoly of important economic and political decisions are the very basis of capitalistic

society. In other words, this society can maintain itself only by the exclusion of the

majority of society's members from decision making. At the stage where the abdity
to manage information belongs oniy to a few people and most people do not have it,such a society can be stale. But as this ability (which js also a decjsion making abdity)

becomes universal, it gets more and more difficult to cut out people who possess thedecision making abihty from the final decision.

105

OKISHIO
NOBUO

106

Today, human beings have arrived at the stage where they are grasping theabdity to control nature globaky. It is the most important question whether this abdity

will lead to massacres, war and the large scale destruction of the natural environment

caused by private profit seeking decisions or whether it wi11 ensure the survival of
humanity by global social decision making.

5. The Problems of Economics
Economics which studies economic phenomena in any society must theorize about thefollowing problems with facts and logic. (Refer to the figure corresponding to thenumber)EconornicEconomic
Phenomenart)Phenomena
(7)

{3)
(5)

(6}

EconmicActivites(2)

ProductionRelations(1}

ProductiveForces(1) What is the necessary level of human ability to control nature for the society

in question to become established and work? At such a stage what kind of production
relations, especially property relations of the means of production, are ethciently

workable and necessary?
(2) What other kmds of production reiations are derived from the property relationsof the means of production which characterize the society? How do people act in suchproduction relations? Who grasp economic decision-making and how do they decide?

(3) What economic phenomenon appears as a result of people's actions? Whentreating capitakstic society, we must explain exchange, money, wages, profit,
accumulation, crisis, business cycles, unemployment, technological innovation etc., fromthe basic characteristics of a capitalistic society.

(4) How are economic phenomena, caused by people's actions, mutuallyinterrelated? The analysis of simultaneous and intertemporal relationships is important.
And mathematical tools are helpfu1 especially in this field.

PROBLEMS AND METHOD OF ECONOMICS 107(5) How do the thus caused economic phenomena function to maintain andreproduce production relations which characterize the society? In other words, we needto reveal the built-in reproduction mechanism of the society. For example in a capitalistic

society even economic crisis, unemployment and low wages function to maintaincapitalistic production relations.

(6) How do economic phenomena caused in the society change man's abdity tocontrol nature? What is the mechanism which increases the productive forces?
What is the threshold value of the abmaty to control nature which leads to incompatibihty

with the society in question?

'(7) How do the economic phenomena caused in the society mature the factors
which sublate the production relationships in the society? For instance, a capitalistic

society gives birth to the human capacity to control nature which contradicts withcapitakstic production relations, and yet on the other hand, creates people which has

the awareness and capabmaty to produce new production relations.

Of the above-mentioned relations, (1) shows the basis and characteristics ofthe society, and (2), (3), (4) and (5) constitute the mechanism of social reproduction.

(6) and (7) constitute the mechanism by which the social form is replaced with anothersocial form sooner or later. It is necessary that we study the society not only
from the viewpoint of reproduction, but also from the viewpoint of sublation andtransformation' Dialectic.

'

Replacing the social form which has begun to endanger human survival with anothernew social form can be called a highly sophisticated feedback peculiar to human society.

By this feedback mechanism the survival of human society is guaranteed.

6. Schools of Economics
Various schools of Economics are classified hereafter, depending on which problems
they specialize in:(A) A school which merely analyzes mutual relationships among economic
phenomena. Problem (4)(B) A school which only analyzes how economic phenomena are caused by humanactions and how they interrelate with one another. Problems (3), (4)(C) A school which only analyzes the reproduction mechanism of production
relations. Problems (2), (3), (4) and (5)(D) A school which only analyzes how economic phenomena function to sublate
the production relations which cause these economic phenomena. Problems (2), (3),(4), and (7)108 NOBUO OKISHIO(E) A school which analyzes al the problems from (1) to (7) and reveals thenecessity of sublation through affirmative comprehension of the society.

(A) and (B) are the type seen in so•-called ``Modern Economics''. They are
subjective'in the sense that they see neither the objective bases of the economic

phenomena nor the social bases of the motives of human actions. And they are
unhistorical and conservative in the sense that, though they do see the dual effectsof human actions and economic phenomena in the society itself, they ignore historicalchange in society.')

An example of (C) is found in the so-called Uno's theory. These schools study
capitalistic society oniy as a permanently perpetuating systern and do not theoreticallyanalyze those moments of irreversible movement which eventually sublate capitalistic
society. In this sense Uno's theory is unhistorical.2)

An example of (D) is Rosa Luxemburg's theory. And this school is apt to be ashallow radicalism. Ignoring the mechanism by which capitalistic society reproduces
itself, they merely indulge unrealistically in finding moments to sublate capitalisticSociety.3)(E) is what K. Marx pursued in his ``Das Kapital''.`)

1) J.A. Schumpeter, Das Wesen und der Hauptinhalt der Theoretischen Nationalokononu'e, Duncker &Humblot, Leipzig, 1908.
J.R. Hicks, Value and Capital: An Inquiry into Some Fundamental Pn'nciples of-Economic Theory,
Oxford, Clarendon Press, 1939.
P.A. Samuelson, Fundations ofEconomic Analysis, Cambridge, Harvard University Press, 1947
2) Kozo, Uno., The methodology ofpob'tical economy, Tokyo University press, 1962.
Ishisuke, Mita., The Uno's theory and Maixian pofitical economy, Aoki shoten, 1968.
3) R. Luxemburg, Die Akkumulation des Kapitals
4) K. Marx, Das Kapital
K. Marx, Zur Kritik der Potitischen Oekonomie.
B.ta. JleHnH, Vmo marcoe '1'llpy3bs Hapoaalin narc oHu 6ororom npomu Coopuan-aeu"orcpamoe?

INDUSTRIAL ORGANIZATION AND INTERNATIONAL TRADE-TEXTILE INDUSTRIES IN THE WESTERN PACIFIC REGIONKatsuhiko IKEDA"

1. Introduction
The purpose of this paper is to study the textile industries in the Western Pacfic region

from the viewpoint of the industrial organization theory. Those industries are currently

in different stages of development: the Japanese, South Korean, Taiwan, Thai andAustralian textile industries are in the different stages of development. They will havedifferent relationship between market structure and performance. The relationship ofmarket structural element, such as export ratio as an index of industrial development,

to market performance, such as profitabihty wM be tested empirically. In conclusion,
the characteristics of industrial organization of the textile industries in the Western
Pacific region will be explained.

2. Theoretical Hypotheses and Review
Vernoni} and Akamatsu2) formulate the pattern of the product cycle. According to thistheory, an industry wil1 develop from the import-substitution stage through the exportingand developed stages to the matured stage. The measure which characterizes thesestages is export ratio. Export ratio will increase from the early stage of development,

and reach the highest in the exporting stage and decrease in the matured stage.
At each stage of development, industrial organization theory assumes the structure-

conduct-performance paradigm. Market structural elements are concentration ratio,
degree of product differentiation, entry barrier, growth rate and international tradesuch as export ratio, import ratio and intra-industry trade. These influence market

conduct and performance. We assume certain relationships between market structure
and performance and test them empirically. This is shown in Table 1.
Among structural elements, it is irnportant to consider the effect of export ratio

on market performance, because all industries in an economy are different in their'Professor, Kwansei Gakuin University. A member of the Research Group for Comparative Economic
Studies, RIEBA, Kobe .University.
1) Vernon [13]2) Akamatsu [1]KATSUHIKO IKEDA

110

stages of development. We assume a hypothesis about relationship between export
and profitabdity, and test it to know where the industry is. This wM give a critical
viewpoint to the industrial organization analysis which includes ak industries in different

stages of development. Because there are some matured industries with highconcentration but low profitabMty and other developing ones with low concentration
but high profitability. This will lead to some misleading results, unless we analyze
industries classified by stages of development.

Thus, it would be necessary to assume some hypotheses on the export ratio andmarket performance and test them by the regression analysis based on the productcycle theory and the industrial organization theory.3)

Table 1. Industrial Organization in the Product Cycle
stagesof
development

trade

introductionofindustry-IMPOrtearly

development.IMPOrtdeveloprnent

maturenewstage

export.IMPOrtexportcompetition

oligopoly

competition

increasing

large

decreasing

increasing

high

low,

high

entrybarrier
product

high

low

high

dfferentiation

high

low

high

high

growthIow

highverylowhigh

Conduct

competitiveor

substitution
industrial

noneorganization

rnonopolisticcompetition

Structure

numberof
firms-concentration

ratio

competitive.cooperatlve

competitive.cooperative

Performance!tlgljgyoli

bad.anti-trust

policy,,protection

verygood

verybadfreecompetition,freetradecartelization,.protectlon

good.antatrust

policy,reducing.protectlon

3) Porter discusses market competition in the dfierent stages of development. But, from the viewpointof industrial organization, these hypotheses have not been fully developed to analyze the major problemsof the industrial organization. Porter [11]

INDUSTRIALORGANIZATION AND INTERNATIONAL TRADE111

The hypotheses to be tested are as follows.
(1) We assume as the main hypothesis on the relationship between export ratio andprofitabmaty that export ratio will be positively related to profitabdity in thedeveloping stage. In the developing stage firms have international costcompetitiveness. South Korea, Taiwan and Thailand wM be profitable by exports.
On the other hand, export ratio will be negatively associated with profitabdity inthe matured stage of development. In this stage an industry has lost international
cost competitiveness. Japanese textile industry wM lose profit in exports. In theearly stage of development, export will be negatively related to profitabdity,

because the industry has not yet enough international competitiveness,(2) Growth rate wil1 be positively related to profitability.
(3) Concentration ratio will have a positive relationship to profitabMty because of market

power or economies of scale or both. However, if firms export a 1arge proponionof output, as in South Korea and Taiwan, the concentration ratio wil1 not always
have any significant relationship to profitabdity.

(4) A high degree of product differentiation or product quality will have a positive

relationship to profitabihty. Higher quahty but more expensive products willproduce more profit despite incurring more cost, as in the case of Japan.
(5) Productivity and tariff will have a positive, but capital labor ratio a negative
relationship to profitabMtJy. The textiie industry is so labor-intensive that an increasein capital labour ratio will decrease profitability in the short run.
(6) Intra-industry trade will have a positive relationship to profitabruty. Industries whichhave lost international price-competitiveness, as in Japan, will earn profits byexporting high quality products and imponing products for ordinary use. Intraindustry trade due to product dfierentiation wi11 increase profitabthty.

3. Research Design and Methodology
The above hypotheses are tested by the multiple regression equations, relating
profitabikty to export ratios and other variables.

The model used here and the variables will be presented.
The Statistical Model

The general structure of the model used here is the following:nJJ J

Yit == ][) tsi Xit+ILit

J=1

Yi :dependent variables : j variable (1-n)

M:explanatory variables : t time (1-1)

KATSUHIKO IKEDA

112

tsi :parameters to be estimated : i firm (or industry) (1-m)
pt :residual element
This equation is estimated by the OLS technique.
Dependent Variables: Profitab-ty
Profitabhity is measured by retum on equity before tax and return on sales before
tax and return on assets before tax. The data sources are the annual reports of firms
and publications of the textile industries and the statistics.

Explanatory Variables
Among the explanatory variables included are: export ratio (firm-level, industrylevel, and world-level), sales growth rate (tirm, industry and world), concentration ratio(the largest 4 sellers' concentration ratio), import-domestic demand ratio, degree of
product differentiation (ratio of higher quality products), capitalrlabour ratio (fixed capitalper employee), productivity (value added per employee and value added per capital),
nominal tariff rate, and seding and general management cost-sales ratio, and effective
rate of assistance.

4. Empirical Evidence
The estimated results are shown in Table 3. The signs of the significant parametersof the regression analysis are shown in Table 2 in order to explain the empirical results.

1. JapanIn the Japanese texnle industry, the industry export ratio is found to be negatively

associated with profitability. Therefore, the hypothesis conceming export andprofitability is supported. But, firms make profits by raising the ratio of theirhigher quality products (cotton and chemical fiber), or promoting intra-industry

trade (cotton fiber). We found that the firm growth rate (cotton and chemical
fiber) contributed to profitability. The ratio of selling and general management
cost to sales is positively related to profitabdity through sales and management
effort.

Having lost their international cost competitiveness, the Japanese textile firms

have pursued profits in their domestic markets by increasing the percentage ofhigher-quakty products in sales.`) They could not make profits by exporting

goods with larger scale of economies. So they tend to export them during
4) In Japan, 20S, 30S, and 40S cotton yearns with 1arge scale of economies can not compete internationahy

any more, but fine cotton yarn with high quakty stM can. Examples of high quakty synthetic fiber are
the modified crosssection fiber, non-sizing fiber, multi-color effect yarn, and triroval fiber. Ikeda [5]113
INDUSTRIAL ORGANIZATION AND INTERNATIONAL TRADE

a recession in the domestic market. Such exponing would cause profitabdity tofal. Therefore, the Japanese textile industry tends to reinforce its international

non-price competitiveness by supplying products and services of higher quality,
and thus to promote intra-industry trade by exporting products with higher quality

and importing products with 1arger scale economies.5)

2. The Republic of Korea
We found that almost all export variables were negatively associated withprofitability. The reason is that export or growth is chosen as the purpose of

the macroeconomic policy of the Korean government. Therefore, firms choose
export or growth as their goal rather than profits. The export ratio already hasreached a high level so that increasing the export ratio must have caused
profitability to fall. Profitability is decreased because the Korean textile industry

has a lower international competitiveness in higher cost of labor and materials

than other developing countries. Therefore, the hypothesis about the positive
relationship between export and profits is rejected. On the other hand, according

to the monopoly price regulation policy (under the Korean Fair Trade Act), thedomestic price regulation of cotton fiber and local export price regulation ofchemical fiber (the list price system) are to be noted as one of the reasons for
decreased profitability in spite of increased exports though the Korean textile

industry is in the developing stage.6) We found, in addition, that industry
growth, tariff and labor intensity contributed to the increase in profitabdity. These

results supported the hypotheses. Concentration ratio has no significant effect.

3. Taiwan
We found that the•economic performance in Taiwan followed the economic
principle because Taiwan is organized according to a free economic system. The
market stmcture is more competitive than that of Korea, although the productive5) The Japanese textile industry is at a disadvantage in price competitiveness on world market. Therefore,

Japan must export by strengthening non-price competitiveness. The main source of non-pricecompetitiveness is technological development for higher-quality products, and a better sales service.
Examples of the latter are world-wide sales networks, and trustworthiness of trade, such as prompt
delivery and adequate treatment of constimers' claims, which are mainly due to the Shosha. But wecould not get the measurements of these factors of non-price competitiveness. In addition, we mustevaluate the ethciency of vertical organization in the chemical fiber textile industry in the domestic market.

Ikeda [5], [6](6) The Korean government adopted a price regulation policy which controled the price of cotton yarn fordomestic demand and set the guide price or list price of chemical fibers for local export. The former
is set to control inflation, and the latter to hold the stability of chemical fiber used for export. Thistended to restrain the profitability of cotton and chemical textile fums. Ikeda [6]KATSUHIKO IKEDA

114

capacity is the same size.7) It is found that the Taiwan textile industry exports

contributed to the increase of profitabMty because of their strong international
competitiveness, and also a firm growth rate and labor, productivity contributed
to profitabdity. It is characteristic of a developing country such as Taiwan thatlabor intensity is positively related to profitabdity. These empirical results
supported our hypotheses. Concentration ratio has no significant effect becauseof a large share of export.
4. Thailand
We found that, in the polyester cotton textile industry, both the export ratio
and the protective tariff were positively associated with profitabdity. So thisindustry is in the developing stage. Thailand had adopted an import-substitution
policy and an export-promoting policy. In the polyester cotton industry an increasein export caused the industry to grow and new firms to enter, so that the change
into a competitive market structure decreased profitability. In the chemical fiberindustry, which is stM in the import-substitution phase, tariffs are negatively
related to profitability, because the protective tariff rate was raised when an

increase in imports caused the profitability to fall. It is found that growth
contributed to profitabdity. These results provided support for the hypotheses.
5. Australia
The Australian texdie industry is characteristic of a high import ratio, a low export

ratio (except early processing), a limited market growth and a high protection.
Because of scarcity of the data, we tested the hypotheses about the determinantsof profitabdity based on the industry data. We found that a high and increasinglevel of protection maintained•profitability to be positive in the textile industry.

Export had no significant effects (Table 3-5-1). We can say that the Australian
textile industry has never followed the product cycle. It has been staying in theearly stage of development or might have fallen into the matured stage without
experiencing the export stage. It is mainly because it has been highly protected

since the 1920s. We found also that value added per employee has a negative
relationship to profitabMty. It is because an increase of wage would be higher
than that of productivity due to the strong bargaining power of the Australiantrade unions.

n

The cotton texote industry in Taiwan has a more competitive market structure than that of Korea.
In spite of the same size in productive capacity of 3 million spindles, the largest 4 firm concentration

ratio is 149o, and 112 firrns in Taiwan, but 43eqo, and 23 firms in Korea. Ikeda [6]INDUSTRIAL ORGANIZATION INTERNATIONAL
AND
TRADE
5. Concluding

Remarks

The empirical evidence shows that different empirical results between the export ratio
and profitabMty reflect the characteristics of durerent stages of industrial development.

Indeed, we found a negative relationship between the export ratio and profitability inJapan and South Korea. The reason is that the Japanese textile industry has lost its

international competitiveness so that exports could not be profitable in overseas
markets. Therefore, it tends to sell goods mainly in the domestic market except somekinds of differentiated products, but sell them in overseas markets only during arecesslon.

The Korean textile industry has been in a developing stage with a high growthrate and a high export ratio. The reason is that the gove'rnment has fostered an export-

promoting policy, and the firms have pursued maximization of growth or export insteadof profit maximization. This is characteristic of the behavior of firms in the developing

stage of industry. Exports in a large scale resulted in a decrease of profitabmsty
because of the entry of rivals or of excessive supply.
On the other hand, the Taiwan textile industry in the same stage of development
as the Korean industry showed a positive relationship between exports and profitabihty.

Taiwan is managed in a free economic system so that active export efforts resulted
in an increase of profits and growth. The Thai textile industry began to export in thelatter half of the 1970's. The polyester cotton textile and garment industries contributed
to profitabdity, but other texdie industries are stil1 now in the import-substitution stageof industrial development. They are protected by high tariffs or import regulations.

The Australian textile industry has had a long experience, but has been staying
in the early import-substitution stage. We would like to say that a very high level ofassistance is responsible for the performance of the industry.

The empirical results show the characteristics of the behavior and performanceof firms in different stages of industrial development.

115

KATUHIKO IKEDA

116[Symbols (Tables 2 and 3)]
CR3, CR4 : 3 and 4 1argest firm concentration ratio

EA : equity-asset ratio
EN : rate of entry (number of firms)
ET : effective rate of assistance (Austraka)FF: flament fiber textile industry

Gf: firm growth rateGi

: industry growth rateIM

: import-dornestic demand ratio

IT

lXi-Mi1 i - lxi.Mil (M; export, Mi; import)
i. ,i ,tpriat-.iMF,"bS,t,ry,,ttrga,de'KLPL: output-labor ratio

NT : nominal tariff rate
NT* : nominal tariff rate plus import surcharge
pc : polyester cotton textile industry

PD : degree of product differentiation, ratio of combed cotton yarn in total cotton yarn production, andratio of speciakzed higher quality chemical fiber in total chemical fiber productionPF: polyester fiber textile industry

PR : polyester rayon textile industry
RA : return on assets (pre-tax)
RE : return of equity (pre-tax)
RS : return on sales (pre-tax)

RF : gross operating profit on funds employed (Australia) (= RA)

MS : seding and management cost-sales ratioSL: sales-labor ratio

VL : value added-labor ratio
EXf : firm export-output ratio
EXi : industry export-output ratio, export-turnover ratio (Australia)

XG : export change rate
EXw: world export ratio, industry export in the world import----

Table 2.

Comparison of the Empirical Results

International

Independent(explanatory)Variables

Korea

Japan

Dependent
Variables

RetumonEquityReturnon
Sales

RetumonAssetsIndustry

TaiwanThailandAustralia

Industry

EM PD CR IT

IM

Gf

+

+

+

cottonspinning-chemicalfiber

-

+

+

+

-

cottonspinning-chemicalfiber

PeriodofAnalysis

-

+

+

+
+

+

+

+

+

+

+

1978-83(cottonspinning)
1975-83(chemicalfiber)' These are the signs of parametersof signMcant(t-values are significant at the 109olevel.)

explanatory-chemicalfiber+-

chemicalfiber--

textile++EXi EXwXG NT KL
textile+cottonspinningchemicalfiber

VL KL MS-+-

EXw Gf KL SL EXf

+

+

-

+

+

+

+

-

+

chemicalfiber

n.a.

+

Gi

NT EN ET VL

+

+
+

+

+

n.a.

1975-82(chemicalfiber)++

textile1975-81(textile)

variables.

Gi

-

z
U
m
-Z
>
v
o
pu
o
>
z
-N
>
.N
o
z
>
zU
N
2
H
m
x
Z
>
H
N
o
Z
>
v
-ge
g
Åë

-

-

n.a.
n.a.

+

-

1971-80

+

n.a.

+

-

n.a.

1976-82

1971-81--.

-stIKEDAKATSUHIKO

118

Table 3. Empirical

Results

Table 3-1. Japan
Table 3-1-1 Determinantsof ProfitabMty of the Japanese Cotton Textile. Industry

const.

IM

EM

PL

PD

IT

74.0272.269(a)(3.343)-O.339fo)-O.875

O.431(a)(-2.45D-1.359ib)(-2.618)RS

27.050O.507(a)(2.985)-O.124(a)(-3.611)-O.503(a)(-3.876)RA

32.195

O.565(a)-O.141(a)(-3.705)-O.509(a)RE

Table 3-1-2(3.01"(-3.55D(3.85n-O.294(-1.3os)

O.119(a)(4.265)

O.393-O.539fo)(-2.173)

O.150(a)(4.861)

O.440

VL

EXf

KL

EXi

PD

IT

R2

2.954

-1.462(-1.298)-7.140(a)6.741(-3.560(1.447)1.467fo)(2.622)

O.407

RE -295.905(O.691)RS

1.278

2.085(a)(2.996)

O.251(a)(3.121)-O.759(a)(-4.140)-O.545-O.869O.104(-1.673)(-1.146)(1.139)en-11.9761.243fo)(2.287)

O.209(a)(3.312)-O.470(a)(-3.266)-O.555fo)(-2.172)-O.231

O.090(-O.386)(1.259)Determinants of Profitabmaty of the Japanese(speciakzation ratio is larger than 659o)

const.

RE -824.671

106

e In dustry (1978-83) (specialization

1.128(b)(2.283)

Table 3-1-3

N

O.318

(-O.973)

Determinants of Profitability of the Japanese Cotton Textil
ratio is larger than 65oro)

const.

R2(1960-70)

VL

EXi

CR4

O.157(b)(2.155)-1.092(a)11.498(b)RS -148.370

en -170.757(-3.41D(2.1sa)-O.335(a)(-5.916)

2.222(c)(1.931)-O.277(a)2.433(a)(2.826)G6.192)KL

Chemical Fiber Textile

R2

O.514
O.267(b)(2.717)

PD

MS

R2

RE -53.346

2.737th)(2.509)O.634

RS-8.458O.435(a)(2.426)

O.273(a)(4.125)O.647

en-7.186

O.481fo)(3.046)

O.268(a)(3.576)

O.637

O.482

Industry(1978-83)

N

36'

O.594

and Product Differentiation of the Japanese(1975,80,81) (speciakzation ratio is larger than 65oro)

1.583(a)(3.934)42

O.477

Table 3-1-4 Profitabdity

const.

O.481

N

Chemical Fiber TextileN12source, Annual Report of Textile Industry, Japan Textile Association, annual e dition.

'significant level: (a)19o, (b)59o, (c)10oro, Figures in parentheses are

t-values.

'R: Revised determinant coeihcients, N: Sample size

Industry

INDUSTRIALORGANIZATION
TRADE
ANDINTERNATIONAL
Table 3-2. The Republic of Korea
Table 3-2-1 Cotton Textile Industry (1975-81)
Gi

XG

EXw

RE 130.121

4.662(a)(3.206)-4.601(a)(-3.036)

q5.886(a)RS

O.631(a)(3.573)-O.618(a)(-3.359)-6.573(a)(-3.587)

const.

20.729(-3.039)

R2

N

O.103

67
O.1509

Table 3-2-2 Cotton Textile Industry (1975-81)
const.

RE

26.300

RS

5.931

EXf

VL

KL

R2

O.063

1.691

(O.326)(O.838)-3.559(b)(-2.117)

O.025-O.566(b)(-2.633)

O.074

O.O17

O.133

(O.692)(O.514)N
62

Table 3-2-3 Chemical Fiber Industry (1975-82)
const.

RE

24.930RS 24.930

EXi

VL

KL

R2

-O.835(b)O.190(-2.osn(O.868)-O.232(b)(-2.692)

O.240-O.046fo)(-2.117)

O.309-O.275(b)O.O02(-2.665)(O.030)N
42

Table 3-2-4 Chemical Fiber Industry (1975-82)
const.

RE-2.688RS-3.795

NT

E-

KL

R2

O.292(c)-O.068(1.n2)(-O.797)-O.201(b)(-2.503)

O.275

O.135(a)(3.332)(-1.090)-O.047(b)(-2.4oo)

O.439

O.022

N
37

source, Statistics of Korean Textile Industry, Korean Texule Association, annual'significant level: (a)19o, (b)59e, (c)10ore, Figures in parentheses are t-values.

"R2: Revised deteminant coethcients, N: Sample size

edition.

119

KATSUHIKO IKEDA

120

Table 3-3 Taiwan
Table 3-3-1 Textile Industry (1971-80)
const.

Gi

SL-22.M8O.210(a)(5.202)6.433(c)(1.809)-14.121O.230(a)(5.798)-9.151

O.057(a)(3.623)RE

en-5.546(6.M9)-2.81829.726(a)(-1.155)(5.75D11.597(a)(5.818)

O.070

O.700

(e.7o3)(O.703)-11.121

O.071(a)(3.233)-8.494O.e81(a)(3.682)

RS

33.700(a)5.604(a)(4.069)3.789(c)(1.949)

O.316(O.235)

R2

EXw

KL

N

O.447
O.438
O.379

133

9.813(a)(4.662)

O.202

16.624(a)(5.908)

O.334

15.334(a)(5.394)

O.314

Table 3-3-2 Chemical Textile Industry (1971-80)
const.

-22.718

RS

KL

EXw

-1.85722.266(a)(6.095)(-1.276)(-1.036)22.909(a)(5.723)-22.286-6.788(c)(-1.865)

30.147(a)(3.299)-22.084-6.992(c)(-1.778)

29.578(a)(2.951)-7.518-1.824(b)(-2.319)

10.770(a)(5.453)-1.556(c)11.518(a)(5.348)-22.948

REen-7.784-1.627(-1.Ml)

R2

EM

N

O.450
-O.021(-O.40D

O.443
O.251

O.O19
(O.144)

66
O.240
O.453

-O.025(-O.880)

O.451

source, Annual Report of Taiwan Textile Industry, Taiwan Textile'significant level: (a)19o, (b)5oro, (c)109o, Figures in parentheses are"R2: Revised deteminant coethcients, N: Sample size

Association,
t-values.

annual edition,

KATSUHIKO IKEDA

121

Table 3-4. Thailand
Table 3-4-1 Deteminants of ProfitabMty of the Thailand Polyester Cotton Textile Industry
const.

PC(5fums)(8firms)

RE -475.302

NT

EM

EN

R2

N

4.397(b)(2.062)

8.571-O.040(1.509)

O.079

35

O.107

35

O.312

32

1979-82

RJt

N

Period

O.616

14

O.683

14

O.604

14

R2

N

PeriodO.641

12

1977-82

R2

N

Period

O.440

24

O.152

24

(-O.O03)

RE 476.168

4.395(b)8.578(2.19D(1.669)RE 425.396

O.325(o.41n3.522(c)(1.759)Period1976-82-23.086(a)(-3,146)

Table 3-4-2 Polyester Fiber Industry

PF(2firms)

const.

NT*

EN

RE

80.348-1.261(a)(-3.863)-6.546RE

4.123-O.997(a)(-5.pa8)RE-6.624-1.215(a)(3.709)Gi

CR3(-1.080)

41,184(c)(1.896)

O.650(O.844)1976-82

Table 3-4-3 Polyester Rayon Industry
const.

PR(2firms)

RE 1565.355

NT

EXf

EN

4.295(b)-38.431(b)-198.713(c)(2.735)(-2,394)(-2,099)

Table 3-4-4 Polyester Filament Industry
const.

FF(2firms)

RE -49.899

NT

EA

O.962(a)(3.174)

O.558(c)(2.088)RE -49.010

CR3

7.126(c)(2.060)EM
O.601(1.251)

1971-82

source, TTMA, Statistics of Thai Textile Industry; Annual Reports of Financial Statement of the
textile companjes.
'signincant level: (a)1oro, (b)5oro, (c)10oro, Figures in parentheses are t-values.

'R2: Revised determinant coethcients, N: Sample size.

KATSUHIKO IKEDA

122

Table 3-5. Australia
Table 3-5-1 Texule (ASIC

RF
(RA)

234)
-R2

d-w

O.267(b)(2.820)

O.689

1.475

O.281(b)(2.948)

O.681

1.777

O.312(a)(4.054)

O.702

1.638

O.272(a)(5.239)

O.720

1.786

const.

VL

EM

IM

ET

18.454-1.846(c)(1.529)(-2.ogn

O.240(O.830-O.371(-1,089)

6.918-1.816(c)(-2.034)(-O.115)(1.179)(1.480)-1.775(c)(-2.070)

7.123-1.826(c)(-2.2ou)

10.280-O.O19-O.135(-O.722)N

Period11

1971-81source, ABS, Manufacturing Establishments, Austraka; IAC, Austrakan Trade 1968-69 to 1981, working
paper, Mar. 1985; IAC, Annual Report.
RF : gross operating profit/funds employed (== RA)
VL : value addedlemployee, deflated by index of wholesale price of manufacturing

EXi : exportltumover
IM : import/domestic demand
ET : effective rate of assistance'significant level: (a)1oro, (b)5oro, (c)109o, Figures in parentheses are t-values.

'R2 : Revised determinant coethcients, d-w: Durbin-Watson ratio, N: Sample size

References[1] Akamatsu, K., Catching-up Product Cycle of Japanese Industry Development, Hitotsubashi Ronso,
Hitotsubashi Univ. Nov. 1956.

'[2] Caves, R.E. (ed.), Symposiurn on International Trade and Industrial Organization, Journal of Industrial

Economics, Vol. 29, 1980, pp. 113-220.
[3] Caves, R.E., International Trade and Industrial Organization, European Econon"'c Review, Vol. 28,

1985, pp. 377-395.
[4] Ikeda, K., International Trade and Industrial Organization of the Textile Industry in Thailand, The

Kwansei Gakuin University Annual Studies, Vol. 33, Dec. 1984.
[51 lkeda, K., Non-Price Competitiveness of the Japanese Texnle Industry, The Kivansei Gakuih University

Annual Studies, Vol. 34, Dec. 1985.
[6] Ikeda, K., Industrial Organization and Intetnational Trade of the Textile Industry (The Sanrei Shobo

Co., Tokyo, Japan, 1985).
[7] Ikeda, K., Industrial Organization and International Trade: Textile Industries in Japan, Korea, Taiwan

and Thalarid,' South East Asian Economic Review, Vol.9, No.1 (ROSECONS, East Balmain, Austraka,
Apri1 1988).
[8] Iwasaki, K., N.Doi, M. Nishida, K. Shinjo and S. Tanaka, A Study of Market Internationaization
and Industrial Organization in Japan (Kansai International economic Research Center, Osaka, Japan,1985).
[9] Jacqemin, A., Imperfect Market Structure and International Trade, Kyklos Vol. 35 No. 1, 1982, pp.

75-93.
[10] Ministry of Industry and Trade of Japan, Toward an Industry in Advanced Countries - A Vision of
the Textile Industry in the IVew Era (MITI, Tokyo, Japan, 1984).
[11] Porter, M., Competitive Strategy (Free Press, 1980).
[12] Utton, M.A. and A.D. Morgan, Concentration and Foreign Trade, NIESR (Cambridge U.P., 1983).
[13] Vernon, R., International Investment and International Trade in the Product Cycle, Quarterly Journalof Economics, Vol. LXXX No.2, May 1966.

KOBE ECONOMIC & BUSINESS REVIEWCONTENTS
NO. 25 (1979)
Redundancy of Seafarers and the Practiceof Perrnanent Employment•••••••••••••••••••••••••••••••••••--•••••••••••••••••••ny•• Hiromasa Yamamoto

Japanese Multinational Enterprises:
A View from Outside ••••••••••••••••••---••••••••••••••••---••••-•••••••••••••••••••-•••••••••••• Hidekr+ Yoshthara

A Comment on the Bayaraa's Algorithm•••••••••-••-••••-••••••••••••••••••••--••-•-••••••••••••••••• Komayuki Itow

Effects of Ship's Size and Cargo Lotson the Ocean Freight Rates••••••••••••••••••••••••••••••••••-••-••••••-••••••••••••••••••••••••• Tetsuji 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
Government Budget Constraint••••`••••••••••••••-•--•••••••••••••••••••••••---••••••••••• Kazuhiro Igawa

Estructura de les ventajas comparativasy
politica comercial-El caso de las exportaciones deproductos industriales el Brasil--••-••••••••••••••••••••--•ny••-•••••••••••••••••••••-•••••••••••••• Shoji Nishi'ima

Technological Progress and Capital Accumulation••••-•--•••••••••••••••••••ny-•••-••••••••••••••• Kazuo Shirn' omura

NO. 27 (1981)
Accounting Systems of Non-Market Oriented Activities•••••••••••••••••••••••--t•••••••••• Nobuko Nosse

Current Situations of World Economy andGlobal Adjustment of Industries ••••••••••••••••-••••••••-••••••••••••-••••••-•+•••••••••••••••••••• Hikoji Katano

Current Cost Accounting and the Conceptof Specific Purchasing Power Capital•••+•••••••••••••••••••••••••••••••••••••-•••--•••••••••••••••• Isao Nakano

An Input-Output Table for Evaluation of the
Shipping Activities •••••••••••••••••••-•••-••••••••••••••••ny•-•--••••••••••••••••••ny-•••--•••••••••••• Tetsuji Shimojo

The Function of Modern Corporate Financial Reportingin a Mass Democratic Society •••••••••••••••••••••••••••-••--••••••••••••••••••••••••--•••••••• Hidetoshi Yamaji

NO. 28 (1982)
The Internationakzation of Japanese Commercial Banking-Experiences in the 70's-••••••••••••••••••••••••••••••••--••••••••••••••••••••••••••••• Masah'ro Fujita' Kenichi Ishigakr'
A Synthesis of Simultaneous Equations Estimators••••••••••••••••-••••••••••••••••••••••••••••• Hiroshi Sadami'chi

A Database System of Economic Time Series ••••••••••-----••••••••••••••••••••••••••••-----••• Hiroshi Sadamichi

Yasuo Nunokami

NO. 29 (1983)
An Interpretation of Conventional Accounting
Income Information ••••••••••••••••••••••-t••••-•••••••--••••••••••••••••••••••t•••••----••••••••• Isao IVakano

A Production System for Transport Services•••••••••••••••••••••••••••••••••••••••••••••••••••••••• Tetsuji Shimojo

Some Evidences between Foreign Direct Investments
and Foreign Exchange Rates:
A Preliminary Note••••••••••••••••••••••••••••••••••••••••••••••••••••ny•••••••••••••••--•••••••••••• Kazuhiro Igawa

Two Types of Railroad Regulation by Statesin the 19th Century of the U.S.
-Search for the Social Foundation of Modern
Corporate Financial Reporting-••••t••••••••••••••-•-•••••••ny•••••••••ny•••••••••••••••••••••••• Hidetoshi Yamaji

NO. 30 (1984)
National Monetary Policy in an International
Capital Market •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Jtirg Niehans

Craft Unions, Wages and Employrnent•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Mmmy C. Kemp

On the Applicabvaty and ImplementabMty ofthe (Finite) Compensation Principle •••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Mumy C. Kernp

Internationalization of Japanese Commercial Banking-The Recent Experience of City Banks-••••••••••••••••••••••••••••••••••••••••••••••••••• Masahi'ro FuJ'ita

Kazuya Mizushima
Ryoit hi' Mikr'tani
Ethciency of the Least Squares Estimators in

Linear Models with Idernpotent Covariance 'Matrix of the Error Terrns ••ny••`••••••••••••••••••••••••••••••••••••••••••••••••••••••-••••••• Hiroshi Sadamichi

Diversification of Large Japanese
Manufacturing Firms••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Hideki Yoshihara

Indexing Policies and Macroeconomic Stabthty in
Brazil: Rational Expectation Model••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Shoji IVishiifma

A Simple General Equrubrium Model Involving
a Maximizing Labour Union•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Kazuo Shimomura

NO. 31 (1985)
Toward the Nagative Picture Theory of Commercial
Double-entry Bookkeeping and Financul Accounting-•••••••••••••••••••••••••••••••••••• Isao Nakano
Stabdity of the Demand for Money: Austraian Experiences •••••••••••••••••••••••••••••••••••• Kenichi Ishigain'"Emphical Study of Changes in Accounting Policy" in the Case ofJapanese Enterprises ny••••••-•••••ny-•••••••••••••••••••••••-•••••••t••••••••••••••••••••••••••••••• Hidetoshi Yamaji

An Empirical Study on International Short-Term Capital
Movements in Japan•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Hideki Izawa

NO. 32 (1986)
Import Demand Structural Change in the PacificBasin Countries••-•••••••••••-••••••••••••••••••••••••••`•••••••••••••••••••••••••••••••••••• Seiichi Katayama

Kenichi Ishigaki
A Synthetic Analysis of Structurakst and Monetarist
Theory of Latin American Inflation•••••••••••••••••••••••••••••••••••••-••••••-•••••••-•••••-•••• Shoji Nishi'ima
Staghation -Causes and Policies- ••ny•••-••••••-••tny-••-•••ny-••-•-•••-••••••••••••••••••••••••••••••••• Nobuo Okishio

A Computable General Equmabrium Model of theJapanese Economy-••••••••-••--••••ny•••-••••••-••••-••-••••-••••--••••••••••••••••••••••••••••••••••••• Mitsuo Ezaki

NO. 33 (1988)
Agency Problems and Accounting Communication••••••••••••••••••••••••••••••••••••••••••••••• Isao Nakano
Strategic Corporate Innovation andJapanese Management••••-•••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Hideki Yoshihara

Financial Deregulation and Financial
Relationships between Japan and Austraka•••••••••••••••••••••••••••••••••••••••••••••••••••• Keni'chi Ishigaki

Keynes' User Cost and the Theory ofInternational Trade••-••••••••••••••••••••t•••••••-•••-•••••-••••••••••••••••••••••••••••••••••••• Kazuo Shimomura

A Note on International Transmission ofDisturbances and Policy Interdependence
under Flexible Exchange Rates•••••••••••••••••••••••••••••••••••••••••d•••••••••••••••••••••••••••• Hideki lzawa

Monetary Policy and Foreign Disturbances

in a Smak Open Economy under Flexible
Exchange Rates and Rational Expectations••••••••••••••••••••••••••••••••••••••••••••••••••••••• Hideki Izawa
A Sketch of the Theory of Trade Cycle••••••••ny••••••••••••••••••-•••••••••••-••••••••••••••••••••••• Nobuo Ola'shioKOBE UNIVERSITY ECONOMIC REVIEW 34, 1988
Edited by Faculty of Economics,
Kobe University, Kobe, JapanCONTENTSOn Marx's Reproduction Scheme--•••••••••••••••••••-••••••••••••••••••-•••••••••••••••••••••••••••••- IVobuo Okishio

Aggregate Dernand Policy in theOpen Macro Economy •••-•••••••••••••••••••••••••••••••••••••-•-t•••••••••••••••••••••••••t••• Takeshi Nakatani

The Structure of Lucas-Type
Neutrakty of Money-••••••-••••••••••-•ny-••-••••••••••••••••-••-•••••••••••••••••••••---•••••• Toshitaka Fukiharu

Transfer of Rural Labor Forcein Contemporary China --••••••••••••••••-••--••••••••••••••••••••••••-••••••••••••••••••••••••--••• Hiroyuki KatoDevelopment of the Soviet Computer
Industry: Can the USSR be a High-Tech Econorny?•••t•••••••••••••••••••----••••••••••• Masahiko Yoshii

Intra-Industry Trade and Effective

Demand: Product Differentiation,
International Price Competition, andVintage Model ••••••••••t•••••••••••••••••••••••••••-•••••••••••••••••••••--••---•••••• Tsuyoshi Toshimi'tsu-•-t,s•-s•i••s•i••s••s,su•s,s,i•s•-s•-,i•-•s•i•s•g••g••s••s•ss-t••s•i,i•i.s••s-s•s,i,i,tssn•s.s•sn••s,s-ss,s,s.i,tni,i'•s,S,

The ANNALS OF THE SCHOOL OF BUSINESS ADMINISTRATIONKOBE UNIVERSITY No. 33, 1989
Edited by the School of Business Administration,

Kobe University, Kobe, JapanCONTENTS
A Case Study of Communications Patterns in
a Japanese Manufacturing Company in the UK•••••••-•-••-••••••••••••••••••---•••••••• Geoffrey A. Broad

On the Optimal Thresholds and Targets
for Money Holding under Uncertainty•••••••••••••-•••••••••••••••••••••-• Yuzo Honda and Hiroshi Ohta

Social Status of Professional Engineers
in Japan••••••••••••••••-••---•••••••••••••ny-•••---•-••••••••••••••••••-•--•••••••••••••••-••••••-•••••• Koji Okubayashi

Note on Indexation of Bargaining Outcomes•••••••••••-••--•-•••••••••••••••••••••••---•••••••••••-t•• Hideo Suehiro

Grundstitze Ordnungsmtidiger Buchfuhrung (GoB)
und True and Fair View••••••••••••••••ny•••-••••••••••••••••••••••••.-••••••••••••••••--•t•••••• Klaus v. Wysocki'••s-s••s,s•s,N.n,ss,mn.s•sei••n••n.t•i•t•n,n,i.-,s-t-i,i,J,s•-s,t,s,ts•s,s,s.s,Tni•N.n••r•s,rn-.tt.s,

KOBE UNIVERSITY LAW REVIEW 22, 1988
International Edition No. 22, 1988
Edited by Faculty of Law Kobe University, Kobe, JapanCONTENTS
AIternative Dispute Resolution:
A Conceptual Overview••r•••••••••••••••••-••••••••••••-•••••••••••••••••••••••••••••••••••••••••• D. Paul Emond

Anfhrige der Gewerkschaftsbewegung in Japan-Yuaikai und die EntwUrfe
eines Gewerkschaftsgesetzes- •••••••••••••-•••••••••••••••••••••••••••••••••• Hans Peter Marutschke
The Legal Status of Aliens in Canadian Law••••••-•••••••••••ny••-••••••••••••••••t--••••••••A. L. C. de Mestmi

Social Movernents and Contemporary rughts in Japan:
Relative Success Factors in the Field ofEnvironmental Law••••••••••••••••••••••••••••••••••••-••-••••••••••••••••••••}••••••••••••••••••• Setsuo Miyazawa

RESEARCH INSTITUTE FOR ECONOMICS AND
BUSINESS ADMINISTRATION, KOBE UNIVERSITYHISTORICAL SKETCH
In 1919, a research 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 facMtate integrated research on businessand commerce and to formulate and publish the results of these studies andinvestigations in such form as to make them 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 divisions. 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 .Jijyo Keizai ITokei and
Sekai Bbekt' lbkei annuaky. A filing room was prepared to deposit press clipping fles

systematicaby arranged by topics and dates. Another room was designed to become
the center of ak possible original records and data having to do with the beginningand progress of Japanese business.

On the campus of Kobe University of Commerce, another organization named
the Institute for Business Mechanization was founded in 1941 utilizing business machines

donated by the IBM Corporation and others. With Professor Yasutaro Hirai as its heada broad and forward-looking plan for business mechanization in Japan wis 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 othercolleges in Hyogo Prefecture to become Kobe University. With this development, thetwo Institutes were also amalgamated into the Research Institute for Economics andBusiness Administration, Kobe University. At present, the Institute, with its twenty
full-time professional staii members, carries on studies and investigations in international

economics, international environment, international comparative economics, international

business, management information systems and international cooperation.

ORGANIZATIONThe Institute consists of six sections. Each section and its research subjects are
as follows:

1. International Economic Studies
International Economics, International Monetary Economics,

Maritime Economics, International Labor Relations

2. International Environmental Studies
Resource Development, International Organizations,International Industrial Adjustment

3. International Comparative Economic Studies
Pacinc Basin I (Oceanian Economy),
Pacific Basin II (Latin American Economy),

Pachic Basin III (North American Economy)

4. International Business Studies
Comparative Business, Multinational Enterprise,International Business Finance

5. Management Information Systems
Business and Accounting Information, Information Processing System,
International Comparative Statistics

6. International Cooperation
In addition to the ordinary work of each section, several research committees,whose members are, not limited to the Institute staffs, are regularily held to carryon joint studies. At present, there are ten standing research committees, as follows:

Committee of International Economics, Committee of Maritime Economics, Committeeof Labor Market, Committee of International Studies on Economic and Industrial
Structure, Committee of World Link Model, Committee of International Comparative

Economics, Committee of International Comparative Monetary Systems, Committee

of International Business Finance, Committee of Management and Accounting
Inforrnation Systems, and Committee of International Comparative Statistics.
For convenience and greater ethciency in carrying out its research activities, theInstitute has a general oihce which is responsible for 1) the collection and preservationof a comprehensive collection of books, periodicals, pamphlets, and original records

and data of finance, trade, commerce, industry and business generally; 2) theclassdication, cataloguing, indexing, arranging, annotation and compilation of theseresearch materials; and 3) the formulation and publication of the results of theinvestigations and studies accomplished by the professional staff members of theInstitute.

As an affiliated institute, the Documentation Center for Business Analysis has been
established in 1964. It is the first systematic information facdities 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 ad kinds ofmaterials on business administration and to make them available to scholars,
universities, governments, and business world with the aid of modern documentation
techniques.

RESEARCH INSTITUTE FORECONOMICS & BUSINESS ADMINISTRATIONKOBE UNIVERSITY
Director: Hiromasa
Secretary: Takashi

YAMAMOTOYAMAZOE

INTERNATIONAL ECONOMIC STUDIES
Intemational Economics
International Monetary Economics

Prof. Kazuhiro IGAWA
Prof. Kazuhiro IGAWA
Assoc. Prof. Hideki IZAWA

Maritime Economics

Prof. Hiromasa YAMAMOTO
Assoc. Prof. Masahiro TOMITA

Intemational Labor

Prof. Hiromasa YAMAMOTO
Assoc. Prof. Kazuo SHIMOMURA

Relations

ProL Nobuo OKISHIOSTUDIESINTERNATIONAL ENVIRONMENTAL
Resource Development

Prof. Hikoji KATANO
Prof. Hiroshi SADAMICHIProf. Hiroshi SADAMICHI
Assistant Ko MIYAZAKI

Internatjonal Organjzatjons
International Industrial Adjustment

Prof. Akira NEGISHIINTERNATIONAL COMPARATIVEECONOMIC STUDIES
Pacific Basin I

Prof. Kenichi ISHIGAKI(Oceanian Economy)
Pacific Basin II

Prof. Yoshiaki NISHIMUKAIAssoc. ProL Shoji NISHUIMAProf. Yoshiaki NISHIMUKAIAssoc. prof. Seiichi KATAYAMA(Latin American Economy)
Pacific Basin III(North American Economy)

INTERNATIONAL BUSINESSSTUDIES
Comparative BusinessProf. Hideki YOSHIHARA
Assoc. Prof. Kenji KOJIMA

Multinational

EnterpriseProf. Hideki YOSHIHARA

Intemational

Business Finance

Assoc. ProL Hidetoshi YAMAJI

ProL Akjo MORIMANAGEMENT INFORMATION SYSTEMSBusiness and Accounting Information
Informatjon Processing System
Intemational Comparative

Prof. Isao NAKANOProÅí Isao NAKANOAssoc. ProE Komayuki ITOW
Prof. Nobuko NOSSE
Assoc. ProL Yasuo KONISHI

Statistics

INTERNATIONAL
COOPERATION

Prof. Murray Chilvers Kemp
(scheduled)

Othce: The Kanematsu Memorial Hah

KOBE UNIVERSITYROKKO, KOBE, JAPAN