Meiji (3):Development of Major Industries

The model of the traditional, manually operated Garabo spinning machine, 1873.

Modern Ring spinning frame made by Platt, U.K., 1896.

Chapter 5

In this chapter, we will examine three important industries in detail.
As noted earlier, raw silk was the top export commodity throughout Meiji andbeyond. The cotton industry was the most dynamically emerging manufacturingindustry; it successfully achieved import substitution and became Japan’s majorindustry far beyond Meiji. Meanwhile, the machinery industry was taking root
but still relatively weak. During Meiji, Japanese machines were cheap but inlow quality, and could hardly compete with American or European products.

1. The silk industry
Silk production has been a traditional industry in Japan dating back toancient times, perhaps to the 4th or 5th century AD. During the Edo period,
many hans produced cloth and kimono made of high quality silk. When Japan
opened its ports and resumed foreign trade in the mid 19th century, Japanesesilk suddenly found an enormous overseas demand, especially in the UnitedStates. This silk boom had several important effects.
First, naturally, silk production—mulberry cultivation, silkworm raising and silk spinning—was greatly stimulated and spread to all over Japan,
especially in the eastern regions. Virtually all farmers and villages which could
produce silk tried to do so. This raised rural income significantly. Today, you
can hardly see mulberry trees or silk production in Japan. But in those days,
they were observed everywhere.
In many developing countries today, rapid industrialization and external liberalization often impoverish farmers and widens the income gap between
urban rich and rural poor (UNCTAD, 2004). In the case of Meiji Japan, however, international integration did not increase the income gap thanks to the silkboom. The tea export boom and rice inflation also contributed to this trend. But
at the same time, rural prosperity now depended critically on the price trends ofprimary commodities such as silk and rice. When these prices were high,enriched farmers and landowners enjoyed higher consumption, low tax rates(since the amount of land tax was nominally fixed) and staged a political movement demanding a national constitution and criticizing the government. Whenthese prices plummeted, however, their movement lost momentum and many
indebted farmers became landless. This can be called the risk of international

72

Meiji (3): Development of Major Industries

integration arising from domestic and global market fluctuation, which is present in any country even today.
Second, a new class of merchants emerged. As foreigners were confined to the designated foreign settlements and their surrounding areas (thelargest foreign settlement was Yokohama), they could not build their own distribution network in Japan (this would violate the requirement of national treatment under WTO today). Thus they had to rely on Japanese merchants to procure silk and tea for export and supply British clothes to local markets. Japanesemerchants who played this role were often new people unconnected with big
merchant families in the Edo period. They communicated price information,
provided short-term trade credit to producers, established marketing channels,
and even assisted in installing new machines and acquiring new technology.
Those who did business directly with foreigners were called Yokohama merchants, but there were also other types of new merchants as well. Renownedsilk-producing localities included Nagano, Yamanashi, Gunma and Tohoku
Region (all Eastern Japan) where merchants played critical roles in restructuring the producers. When successful, merchants made huge profits together withproducers. Quick and spontaneous emergence of a merchant class with highly
productive functions as described above, instead of simply exploiting producers, was a unique Japanese feature not always visible in other countries.
To be fair, however, it must be said that Meiji merchants were far
from perfect. Foreigners often bitterly complained about the dishonesty andcorruption of some Japanese merchants. Silk was sold by weight, so water wasoften added before weighing. Foreigners had to check if the merchandise wasdry inside. At one time, the quality of Japanese silk became so low that its
demand and price fell significantly in the global market. In response, the government was forced to impose quality standards.
Third, continued silk exports were accompanied by the transformation of production methods and organization. Manual labor was graduallyreplaced by machine spinning (IM*; see chapter 4 for notation). At first, silk

production used to be farmers’ side job, but later it was undertaken by factories(M*M). More precisely, silkworm raising still remained family-based anddecentralized across the country, but silk spinning became automated in modern
factories.

73

Chapter 5

Silk remained the top export item for nearly a century. Silk exports
were a stable source of foreign exchange for Japan, contributing to industrialization.

2. The traditional cotton industry
Roughly speaking, the production of cotton contains the following
steps: (i) cotton harvest; (ii) ginning and cleaning; (iii) spinning (yarn); (iv)weaving (cloth); and (v) sewing and cutting (garment). Other processes such as
dyeing may be added. As Konosuke Odaka emphasized (chapter 4), indigenous
and modern sectors often co-existed in Meiji industrialization, and the cotton
industry was no exception. For this reason, we will discuss the traditional andmodern cotton industry separately. This section looks at the traditional production.
Like silk, the cotton industry has a long history in Japan. But theindigenous method of using wooden looms and household labor was far lessproductive than Western technology. The traditional production was often
organized as a putting-out system, where a merchant had contracts with individual farm households to produce specified goods. The merchant provided allmaterials and sometimes even tools, received finished products and paid commission. Production took place in each farmer’s house using family labor (usually that of the wife). The question is: how could this antiquated mode of production survive the onslaught of British imports and modern technology? Why
were they not wiped out?
There are several reasons. First, domestic demand for cotton productsrose so fast that, while imports increased, domestic production could also
expand. Domestic demand was rising because (i) farmers were enriched by thesilk and tea booms as noted earlier, and they switched from homemade or second-hand clothes to external purchase; (ii) new merchants succeeded in establishing a nationwide sales network; and (iii) the price of clothes relative to thegeneral price level declined, which further stimulating demand.
Another important reason was that Japanese and British cotton products were differentiated and not easily substitutable. Japanese cotton used lowcount fibers and was thicker, while British cotton used high-count fibers and74

Meiji (3): Development of Major Industries

was thinner. These products had different uses and did not compete directly.
This is a point much stressed by Kawakatsu (1991).
However, even though the traditional cotton industry survived, theimpact of international integration significantly reorganized its production. Vertically integrated producers which combined the production of raw cotton, yarn
and fabric declined, while specialized weavers using imported yarn prospered.
Demand for plain white cloth fell while high-value, more differentiated products such as creased, patterned and colored cotton found a larger customer base.
Some cotton villages disappeared while new ones popped up. Whether or not
traditional cotton regions survived the integration shock depended very muchon the existence of helpful merchants who introduced imported materials anddeveloped new domestic markets for the producers (Saito and Tanimoto, 1989).
Again, the merchant’s role was essential in adjusting to a new environment.
Toward the end of the Meiji period, machines began to be introduced
even in the traditional sector. This was prompted by the need to improve efficiency in the face of (i) rising wages; (ii) the worsening of the terms of trade,
namely, the falling price of output (fabric) relative to input (yarn); and (iii) textile recessions. Even though machines were introduced, they were not exactly
the same as the Western original. Production scale was smaller and modifications were often made, including the use of as much wooden parts as possible inplace of steel. These can be considered modifications of the indigenous method
(I

I*).

3. Modern cotton industry
We now turn to the modern cotton industry. This industry had to be
introduced as an entirely new technology (MM).

In early Meiji, Japan imported a large amount of cotton yarn as an
input to domestic cotton cloth production. The government considered yunyu
boatsu (import substitution) of cotton yarn to be an important national goal.
Model factories in cotton spinning were established in the 1870s, but thesestate-owned enterprises (SOEs) did not succeed commercially. The reasons forthe failure included: (i) lack of capital; (ii) small capacity of only 2,000 spindles; (iii) use of water power which was constrained by location and operation75

Chapter 5time; and (iv) lack of expertise.
The turning point came when the private Osaka Spinning Company(Osaka Boseki Kaisha) was established in 1883 by the strong initiative of Eiichi
Shibusawa, the super businessman (chapter 3). Worried about rising cotton yarn
imports, Shibusawa decided to create a new company that could overcome thedefects of SOEs. In particular, Osaka Spinning Company introduced the following innovations (Abe, 1990):
It was a joint stock company subscribed by big merchants and former
daimyos who were personally persuaded by Shibusawa to invest. As toworking capital, loans from the First “National” Bank, at which
Shibusawa was the president, were made available.
It boasted a sufficiently large capacity of 10,500 spindles to enjoy
economies of scale.
Use of the steam engine which permitted 24-hour operation.
Located in an urban area, which facilitated worker recruitment.
Takeo Yamanobe was hired as chief engineer (see box below).
Use of low-cost Chinese cotton instead of domestic cotton.
Use of more advanced machinery, especially the adoption of the Ringmodel rather than the Mule model.
Osaka Spinning Company was an instant success. Although 1883, theyear of its establishment, was a recession year (Matsukata Deflation, chapter 4),
the company was profitable from the outset. The lesson we can draw from theexperience of Osaka Spinning Company is that competitiveness depends critically on the choice of appropriate technology which includes the size, locationand mode of operation. In addition, the combination of strong managerial leadership (Shibusawa) and deep practical knowledge (Yamanobe) was instrumental. Without these, purchasing expensive machines alone would not haveachieved efficiency.
The success of Osaka Spinning Company had a powerful demonstration effect. Soon, several spinning factories modeled after Osaka Spinning
Company were established. Largest among them were the spinning companies
of Hirano, Amagasaki, Settsu, and Kanegafuchi (later renamed to Kanebo).
These large-scale cotton spinning factories were concentrated in the Kansai areain Western Japan. Initially, the product of these companies (i.e. yarn) was sold76

Meiji (3): Development of Major Industries

Modern Spinning—The Sangenya Factory of Osaka Spinning Company in late Meiji.

to domestic traditional weavers and contributed to import substitution. Later,
their product was also exported, as well as used internally to weave cloth withinthese factories. Young female workers were recruited to work in these factories
often under inferior working conditions. Factories competed fiercely to hire andkeep these workers. As to competent engineers, they were in even greater shortage.
As the modern cotton industry became the pillar of Japanese manufacturing, it faced two problems. The first was the recession which peakedaround 1900 forcing even large factories to restructure, merge or even close.
The number of modern spinning factories declined from 78 in 1899 to 49 in
1904. After the shakeout, the three largest spinners, Osaka, Toyobo and Dainihon, began to dominate the industry.
Another problem was the conflict of interest between ownership andmanagement. The shareholders of spinning companies were rich merchants andformer daimyos who were not interested in the textile business per se and only
wanted quick and high returns on their investment. By contrast, top managers
and high-level engineers were well-informed about technology and market conditions. Their priority was to expand the business in the long run throughinvestment and technical innovation. Thus, the former demanded large dividends while the latter preferred retained profits for re-investment. This tension
sometimes escalated to the level where shareholders demanded the resignationof the management.

77

Chapter 5

4. The machinery industry
Meiji industrialization was basically light industry industrialization,
especially in textiles, while the machinery industry was still feeble and internationally uncompetitive. Japanese machines were imitations of western models.
In Meiji, “Made in Japan” meant low price and low quality. The machineryindustry still heavily depended on foreign technology and imports. During
Meiji, machinery was only imported; there were virtually no exports. Nevertheless, technology was being absorbed, and preparation for the giant leap in the
Taisho and Showa periods was being made (Sawai, 1990).
Initially, military SOEs dominated the machinery industry. Backed by
the government, they were large in size and equipped with the newest machinesimported from Europe and America. By contrast, private companies were
smaller and less modern, and used second-hand or Japanese machines.
But private-sector manufacturing was also growing, albeit gradually.
Largest among private companies were shipyards and railroad carriage factories. Medium-sized ones included electrical companies such as Shibaura (nowToshiba), NEC, Oki and Hitachi. Meanwhile, small companies produced various parts and devices. The input-output linkage between large and smaller firms
was still weak. Large factories imported most machines and produced theremaining machines and inputs internally. Domestic procurement from otherJapanese companies was insignificant at first. In other words, supporting industries did not exist during Meiji.
Engineers preferred to move among factories for experience and skillbuilding. Inter-firm migration of engineers facilitated technology transfer andabsorption. Graduates from the Institute of Technology and technical highschools (chapter 4) first worked at SOEs or at relatively large private companies. After acquiring skills and knowledge, many of them moved to smaller private companies or established their own factories. In this way, Western technology was diffused widely within the machinery industry.
In Tokyo and Osaka, small and medium enterprises (SMEs) began to
be concentrated in certain areas and formed industrial districts. They tended togather around large factories. In Shiba area in Tokyo, near Tokyo Tower andHamamatsu-cho Station today, large factories such as Shibaura Engineering78

Meiji (3): Development of Major Industries

Table 5-1 Largest Factories by Employment Size (1902)
RankingEnterprise

1
2
3
4
5
6
7
8
9
10
11
12
13
----

Kure Naval Factory
Yokosuka Naval FactoryTokyo Military Factory
Mitsubishi Shipbuilding
Sasebo Naval Factory
Osaka Military Factory
Kawasaki Shipbuilding
Shimbashi Factory (railroad cars)
Japan Railroad Omiya Factory
Osaka Steel
Kobe Factory (railroad cars)
Uraga Shipbuilding
Naval Weapons Factory
Shibaura Engineering Works (Toshiba)
Seikosha (Seiko Corporation)
Nippon Electric Company (NEC)

Numberof workers
12,378
6,761
6,452
5,058
3,612
3,120
3,060
1,721
1,700
1,623
1,566
1,522
1,521
502
211
150

Ownership
State
State
State
PrivateState
State
PrivateState
PrivatePrivateState
PrivateState
PrivatePrivatePrivateSource: Sawai, 1990, p.221.

Works (private; “Shibaura” means Shiba Beach), Naval Weapons Factory(SOE) and Mita Manufacturing (SOE) were located. Around them, private companies were established to produce mechanical devices and parts1. Anotherindustrial district in Tokyo was the Honjo-Fukagawa area on the left bank of
the Sumida River. This district specialized in metal products like nuts, bolts,
springs and so on. In these industrial districts, SMEs not only competed but also
cooperated with each other. If one factory did not have the right machine to doa certain work, it was possible to ask the neighbor to do it, and vice versa. Someof the SMEs became subcontractors of larger firms. However, the accounting
method of SMEs long remained imprecise and pre-modern.
Japanese managers and engineers were generalists rather than specialists, and job-hopping was very common. Workers were also characterized bytheir lack of discipline and low savings. The Japanese labor force at that time
was more “neoclassical” and quite different from the labor force in the post
1

Later, in 1939, Toshiba was created by merging Shibaura Engineering Works and Tokyo
Electric. Even today, one can see Toshiba Head Office from Yurikamome train; that is where
Shiba industrial district used to be. However, the area was completely destroyed by the earthquake in 1923 and the US aerial bombing in 1945, so no sign of Meiji industrialization remains.

79

Chapter 5

Figure 5-1 Duration of Male Employment in Manufacturing
(%)
35
30

1902
1912

25
20
15
10
5
0
1

2

3-4

5-6

7-9

10
(Years)

Source: Sawai, 1990, p.218.

WW2 era. To further promote industrialization, Japan had to transform theselight-footed engineers and workers to stay in one factory in order to absorb anddevelop firm-specific knowledge and skills. Japan later succeeded in doing thisduring war time (1937-45)—see chapter 9.
Let us look at some of the large private firms.

5. Railroad carriages and locomotives
Railroad carriages and locomotives are quite different in theirrequired technology. The latter are far more difficult to manufacture than theformer. As for carriages, about 25 percent was imported and the rest was
domestically produced throughout Meiji. Among domestic producers, Shimbashi Factory (SOE) and Kobe Factory (SOE) were the largest, which together
accounting for 64 percent of domestically produced carriages.
As for locomotives, all had to be imported at first. The government
wanted to promote domestic production (i.e. import substitution). In 1900, thefirst locomotive was test-produced through the cooperation of the state and private sector. Shimbashi Factory, an SOE, provided the blueprint to Japan Railroad and Kansai Railroad (two private companies), and engineers were mutually exchanged. In 1912, the Railroad Agency nominated four private companies

80Meiji (3): Development of Major Industries

to copy-produce locomotives. But since these companies were still technically
incompetent, the government provided them with technology, material inputs,
production management, training (which included opportunities to study
abroad), and the promise of official procurement. Hence the market was
secured. In this way, the government pampered the burgeoning railroad industry
which, thanks to such assistance, eventually came to possess world-leading
technology during the inter-war period.
During the Meiji period, both state-owned and private companies laid
railroads. However, in 1906, the government nationalized virtually all railroad
companies. Nationalization was carried out partly for military reasons and partly because many of the private railroad companies were unprofitable. One serious problem with railroads was over-building; local politicians maneuvered toconstruct too many railroads to please rural voters for the next election. Thiskind of vote-buying remains a big problem even today.

6. Shipbuilding
Among domestic shipyards, Mitsubishi Shipbuilding in Nagasaki(private) and Kawasaki Shipbuilding in Kobe (private) dominated. Both wereformer SOEs sold to influential businessmen. In the early days, ship repairing
was more profitable than building new ships.
About half of the newly built ships were purchased by domestic private customers. The rest were produced for the navy or exported to China,
Thailand, and other countries. The government supported the shipbuilding
industry by offering subsidies for building large-sized ships above 700 tons
(later, above 1,000 tons). The construction of naval ships was not very profitable but the government supplied materials for them. Due to the lack of supporting industries, shipbuilders produced most parts internally.

7. Electrical machinery
Shibaura Engineering Works (later Toshiba) was founded by Hisashige Tanaka, the inventor. Initially, it was a relatively small operation with 502
workers, producing military goods. When naval factories stopped procuring81

Chapter 5

from Shibaura since they now could produce the parts internally, Tanaka’s factory shifted to the production of electrical machines for private use such as generators and transformers. When Shibaura Engineering Works faced a financial
crisis, Mitsui Zaibatsu came to the rescue. Shibaura also established businesscooperation with General Electric (USA). Similarly, Mitsubishi Electric Company cooperated with Westin House (USA) and Furukawa Electric Company
cooperated with Siemens (Germany).
Even with efforts for domestic production, imports still dominated theJapanese market of generators and transformers. Foreign products, mainly fromthe US, accounted for about 75 percent of the total in 1911. Toshiba’s market
share was 16 percent and concentrated in low capacity generators comparedwith US products.
There was a debate within the Japanese government as to whether thenational telephone network should be laid privately or publicly. The government finally decided to build it by itself. The supply of telephone equipment
was considered highly lucrative. To win this business, Oki Electric wasapproached by Western Electric to produce needed equipment but Oki refused.
Western Electric then set up Nippon Electric Company (NEC), a joint venturewith Japanese partners, in 1898 with the capital share of Western Electric being
54 percent. Oki and NEC subsequently competed for the official procurementof telephone equipment.
NEC was initially only a sales agent for Western Electric products,
but soon began to produce its own products and became more independent from
Western Electric. NEC’s success was due to foreign technology and capital,
secured markets through government procurement of telephone equipment, andthe company’s high technical absorptive capacity.

82Meiji (3): Development of Major Industries

Shibusawa and Yamanobe
In 1877, Takeo Yamanobe was a 26-year-old student majoring in economics andinsurance theory in London. One day he received a letter from an unknown gentleman
in Japan. The sender’s name was Eiichi Shibusawa. The letter said something like
this: “Dear Yamanobe, your name was mentioned by a friend of mine. Japan imports
too much cotton yarn today. We need to establish a domestic spinning industry. We
need people who know both management and technology. Will you please study the
cotton industry? I will create a company.”

Eiichi Shibusawa (1840-1931)

Takeo Yamanobe (1851-1920)

Perhaps Yamanobe was annoyed. Who is this man to tell me to change my subject? But after thinking a bit, he decided to follow Shibusawa’s advice. He went toKing’s College where he studied textile industry theory. But theory alone was notenough. He moved to Manchester, the capital of global textile industry. He posted ads
in newspapers: HIRE ME AS COTTON INDUSTRY TRAINEE, WILL PAY, but nocompany responded. Finally, he met Mr. W. E. Braggs who allowed him to work andabsorb practical knowledge in his factory for eight months. Learning included technology, marketing and shipping. He worked very hard. Shibusawa sent him 1,500 yen
to support the study. Shibusawa later recollected that this was a huge sum even for
him and he sent it as if he jumped off the stage of Kiyomizu Temple (a phrase implying a bold and risky decision).
When the study ended, Yamanobe placed an order to buy textile machinery and83

Chapter 5

steam engines from manufacturers such as Platt and Hargreaves, and returned toJapan. In 1882, Shibusawa and Yamanobe selected an appropriate factory site. To
establish the company, 250,000 yen was collected from rich merchants and friends of
Shibusawa. Shibusawa’s bank, First National, would lend working capital. Osaka
Spinning Company was successfully launched in 1883. Yamanobe became the chiefengineer of the factory.
Around 1900, there was a severe textile recession. Shareholders demanded higher
and quicker returns. But Yamanobe insisted on long-term development of the company. Even the General Director criticized him. Being desperate and wanting to quit,
Yamanobe visited Shibusawa’s residence. Shibusawa assured that he would support
Yamanobe 100 percent and requested him to continue to work for the company. So
Yamanobe stayed. After a while, the recession ended and Yamanobe was promoted to
the President of Osaka Spinning Company.
Let us introduce one more person. Masazumi Fuji was a super factory manager ofKanegafuchi Spinning Company (Kanebo). He graduated from Keio University andworked in the sales department of Suminodo Factory of Kanebo. This factory wasfacing obsolete machines, lack of work discipline and low capacity utilization. He
worked 18 hours a day to replace or repair old machines and recruited 500 new workers. He restored the factory to full operation in three months. He was then promoted to
the Managing Director of Kanebo’s Tokyo Factory. This factory was another disaster.
He repaired, invested, and improved. He reduced the work force from 4,000 to 1,620.
After three years, the factory became very profitable. If Mr. Fuji were still alive, I
would like to send him to your country as a JICA expert.
What do we learn from these stories? Meiji industrialization was achieved bythese powerful and risk-taking individuals with energy, vision and leadership. Meiji
was full of such people, and Japan relied on them for industrial revolution. New laws,
deregulation and level playing fields are perhaps not enough. If Shibusawa did notwrite the first letter to Yamanobe, Japan’s textile industry may not have started. If so,
the real question is, how can we generate such wonderful people continuously in asociety?

84

Meiji (4):Budget, Finance and the Macroeconomy

The picture of the completed Bank of Japan building.

Chapter 6

1. Two wars and Postwar Management
One of the national goals of Meiji was external expansion. To be
more precise, Japan felt it necessary to create an area of influence around its
territory to protect its interests against the West. During Meiji, the greatest
potential threat to Japan was the eastward expansion of Russia’s Romanov
Empire. To guard its national interests, Japan wanted to construct its “line ofinterest” beyond its national border. That specifically meant placing Korea
under Japanese influence.
In his famous speech at the first imperial parliament (1890), Prime
Minister Aritomo Yamagata argued as follows:
There are two ways to secure national independence and defense. The first is
to protect the line of sovereignty. The second is to protect the line of interest.
The line of sovereignty means the nation's border and the line of interest
includes the area closely related to the safety of the line of sovereignty. Thereis no country that does not try to defend both lines. Under the present circumstance, to maintain our independence and stand against the Western powers,
defending the line of sovereignty is not enough. We need to protect our lineof interest as well.

But China’s Qing Dynasty considered Korea as its protectorate.
Japan’s ambition over Korea naturally clashed with Chinese interests. In Korea,
the political situation became unstable, as the Japanese army staged military
provocation and the assassination of a Korean queen. Finally, Japan and China
opened fire over Korea (Japan-China War, 1894-95). Japan’s new battleships
and military strategy won over China's older method of fighting. Although the
Chinese equipment was also modern, its strategy was poorly designed. After
this victory, Japan obtained reparations amounting to 310 million yen in gold,
the territory of Taiwan as Japan’s first major colony, and China’s Liaodong
Peninsula. But shortly after, Japan was forced to return the Liaodong Peninsula
to China under the joint pressure from Russia, Germany and France. Japan felt
deeply humiliated at this because it meant it was still a weaker power than theWest.
Even after Japan’s victory over China in 1895, Korea and the Northeastern region of China remained under Russian influence. This inevitably collided with Japan’s expansionist policy and, within ten years, the Japan-Russia

86Meiji (4): Budget, Finance and the Macroeconomy

The Japanese Colonial Administration in Korea, located in the center of Keijo (Seoul).

War broke out (1904-05). Most foreign observers predicted an easy Russian
victory. But surprisingly, the Japanese navy decisively defeated Russia’s Baltic
Fleet. Immediately after this naval triumph, the Japanese government asked theUnited States to mediate a peace treaty between Japan and Russia since the continuation of the war would surely lead to a fiscal crisis (the approach to the US
government had been made in advance). The victory over Russia was considered to be a proof that Japan had finally become a first-class country on a parwith the West. National pride ballooned. But at the same time, the Japanesepeople and media were infuriated because Russia paid no reparations. By contrast, the Japanese government was happy simply because the war ended before
Japan went bankrupt.
Japan annexed (colonized) Korea in 1910. Meanwhile, Russia’s
Romanov Empire collapsed in 1917 and a communist regime was established(Russian Revolution).
What impact did the two wars have on Japan’s macroeconomic policy
stance? To consider this, we need to look back a little.
When the first imperial parliament was convened in 1890, the key

87

Chapter 6

Figure 6-1 Structure of Gross Domestic Expenditure

Japan-China War

Japan-Russia War

(%)
80
75
Householdconsumption

(%)
25
20

70

Total
government
expenditure

Private fixed
capital formation

15
10
5
0

Government fixed
capital formation

Government
consumption

(%)
25
20

Import15
10

Export

5
1885

90

95

1900

05

10

0
14
(year)

Source: Nishikawa and Yamamoto, eds, 1990, p.5.

issue was whether Japan should adopt fiscal expansion or fiscal austerity. The
government wanted to accelerate spending for industrialization and militarybuildup, but the opposition parties demanded tax and spending cuts. The latterreflected the voice of voters, most of whom were rich farmers obliged to pay
the land tax. But gradually, some opposition parties changed tactics and began
to cooperate with the government. Instead of demanding a small government,
they asked for more rural public spending (in their constituencies).
During the two wars, military spending sharply increased. In the caseof the Japan-Russia War, foreign bonds were floated in America and Europe tocover roughly half the war expense. This practically terminated the debate over88

Meiji (4): Budget, Finance and the Macroeconomy

In 1896 the parliament approved the budget for building a modern
state-owned steel plant. Yahata (also pronounced Yawata) Steel wascompleted in 1901. Initial technical difficulties were overcome byadjusting German technology to local requirements. Yahata Steel waslater merged several times to become Nippon Steel Corporation.

the fiscal policy stance as budget spending increased in reality. Fiscal activism
became generally acceptable.
Moreover, after each war, fiscal activism was adopted instead ofmacroeconomic contraction. For this reason, the size of government did notshrink after each victory but continued to expand (the fiscal ratchet effect). The
term Postwar Management refers to the aggressive public investment andspending programs of the central and local governments after the Japan-China
and Japan-Russia Wars, which included:
Continued military spending, especially battleship construction
Railroad construction
Integrated steel works in Yahata (SOE, established in 1901—see photo)
Building of the national telephone network
Taiwan Management—administration of and investment in the newly
acquired colony
Infrastructure building, such as roads and water supply, which was undertaken mainly by local governments
Education spending undertaken mainly by local governments
As a result of continued fiscal expansion, the balance-of-paymentspressure mounted and the Bank of Japan quickly lost gold reserves. It can besaid that Japan prior to WW1 was facing an increasingly serious macroeconomic crisis.

89

Chapter 6

2. Exchange rate policy
Britain adopted the gold standard in 1821 and all other major Westerncountries, including the United States, shifted to the gold standard by the end of
1870s. While the West was on the international gold standard, Japan remained
externally on the sliver standard—gold, silver and copper coins circulated internally but silver was the means of international settlement. This in turn was
mainly because the silver standard was dominant in East Asia. Shanghai(China) was the center of Asian foreign exchange markets.
The price of silver gradually declined against gold in the late 19th
century. This meant that the Japanese yen, tied to silver, automatically depreciated against the world’s major currencies, which provided a favorable condition
for export promotion. However, Finance Minister Matsukata, the man who previously generated what was called Matsukata Deflation in the early 1880s, now
insisted that Japan should adopt the gold standard as soon as possible because it
was the standard practice among first-class countries. Ignoring opposition, Matsukata introduced the gold standard in 1897. The initial gold reserves weresecured by the reparation gold paid by China after the Japan-China War. Fromthen on, the Japanese yen was fixed against major currencies at the parity of 2
yen to the US dollar.

Figure 6-2 Yen-Dollar Exchange Rate
(USD per 100 yen)
120
100
80
60
40
Yen depreciation
20
1940

1935

1930

1925

1920

1915

1910

1905

1900

1895

1890

1885

1880

1875

0

Source: Management and Coordination Agency, Historical Statistics of Japan, Vol. 3, 1988.
Note: Two lines indicate highest and lowest for each year.

90

Meiji (4): Budget, Finance and the Macroeconomy

As a consequence, the automatic depreciation of the yen ended.
Japanese inflation converged to world inflation, which was close to zero. Due tothe absence of the exchange risk, it became easier for the central and local governments to issue foreign currency-denominated bonds.

3. Creating modern banking
In early Meiji, the Japanese banking system was chaotic, to say theleast. The initial policy of creating “national” banks (1872), copied from the US
system, was not very successful (“national” here means “chartered by thestate”; these banks were actually private). This decentralized system had nocentral bank, and each “national” bank could issue bank notes with the backingof gold reserves. But holding gold reserve was costly and only four banks were
set up. Later, the gold reserve requirement was relaxed and the total of 153
banks were created. But eventually, this system was regarded as ineffective andlater abolished.
The modern banking system began to take root with the creation of acentral bank (Bank of Japan) in 1882, which became the only entity to issue thenational currency. In addition to commercial banks, the following specializedbanks were created to fund investment projects:
Japan Kangyo Bank (later, Daiichi Kangyo Bank; now part of the merged
Mizuho Financial Group created in 2000. Kangyo means industrial promotion.)
Hokkaido Takushoku Bank (bankrupted in 1997; Takushoku means opening new land for cultivation)
Industrial Bank of Japan (now part of the Mizuho Financial Group)
Agricultural and Industrial Bank (set up in each prefecture; merged into
Japan Kangyo Bank by 1944)
In addition, postal savings began to collect people’s savings. Insurance companies, agricultural credit unions and urban credit unions also functioned as financial intermediaries.
But until late Meiji, Japanese banks were not true financial intermediaries in the sense of taking deposits and making loans. At first, paid-in capital,
reserves and government deposits dominated the liabilities of the banks. For

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Chapter 6

Table 6-1 Sources of Borrowing by Farm Households
and Manufacturing Enterprises(%)
Borrowing from:
Modern financial institutions
Banks
Cooperatives
Official low-interest credit
Traditional institutions
TOTAL

1888
7.2
7.2
--92.8100.0

Farmers
1911
35.7
32.7
2.5
0.5
64.3
100.0

1932
47.3
26.7
16.0
4.6
52.7
100.0

Manufacturers
1932
60.8
59.8
1.0
-39.2
100.0

Note: Prof. Juro Teranishi’s estimates (1990). Manufacturers’ data are for Tokyo and Kobe only.
Traditional institutions include money lenders, merchants, relatives, and mutual financing.

early banks, designation as the government’s fiscal depository was very profitable, because they did not have to pay interest on official deposits between thetime taxes were collected and the time they were transferred to the government.
Only towards the end of Meiji, banks began to rely more on private-sector
deposits. But even then, many banks remained unsound with the general lack of
information disclosure, risk management, portfolio diversification or project
evaluation. Banks were often captured by one or a few business enterprises,
providing financing exclusively for them. Such banks were called kikan ginko,
which literally means “institution banks.” This situation subsequently caused anenormous bad debt problem in the 1920s (chapter 8).
All this points to the fact that creating a sound banking system in adeveloping country is a very difficult and long-term endeavor. New banking
laws and financial deregulation will not be enough to achieve this.
As for the capital market, stock exchanges were created in Tokyo andOsaka in 1878. But initially, few stocks were traded and these exchanges functioned mainly as a secondary market for government bonds. Former samurais
who received government bonds in exchange for the previous rice salary often
wished to sell them as they faced financial distress. In the 1880s, as many railroad companies were established, railroad bonds gradually became the mostimportant instruments for trading. In the 1890s, the shares of maritime transportation companies became popular. After 1906, when private railroads were
nationalized, the shares of textile and food companies replaced railroad stocks.

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Meiji (4): Budget, Finance and the Macroeconomy

4. Savings mobilization
Where did the funding for Meiji industrialization come from? Data
are incomplete, economic historians are still debating, and we do not have adefinite answer. Here, let us look at the estimates provided by Juro Teranishi(1990).
Teranishi estimates the savings-investment balance of Japan from
1899 to 1937. He does not have data for early Meiji, before 1899. He classifies
the economy into four sectors: private farms, non-farm private enterprises, government, and the external sector. He additionally estimates the size of agricultural taxes. The following interpretation by Teranishi is consistent with his estimates (although other interpretations may be possible).
First, in pre-WW2 Japan, the largest funds for industrialization camefrom private enterprises themselves. Retained profits, family savings, and theresources of rich merchants seem to have financed private investments within
the business sector through self-finance, the creation of joint stock companies
and so on. The role of banks as a financial intermediary did not appear very
great, especially in the early periods.
Second, in addition, the fiscal transfer mechanism from agriculture toindustry must have played an important role to the extent that land taxes paid byrural communities were used to finance public investment and various subsidies. But Teranishi somewhat downplays the role of landlords as major contribTable 6-2 Savings-Investment Balance by Sector(In millions of yen)
1899-1902 1903-1907 1908-1912 1913-1917 1918-1922 1923-1927 1928-1932 1933-1937
Private farms
Savings
Investment
Non-farm private sector
Savings
Investment
Government
Savings
Investment
External sector

1
121
120
62
180
118
-59
24
83
5

13
159
146
123
310
187
-233
-142
91
-97

4
175
171
-87
212
299
15
205
190
-68

43
240
197
175
752
577
120
317
197
338

207
657
450
81
1724
1643
-146
441
587
143

23
523
500
-290
858
1148
-112
801
913
-380

-12
402
414
631
1498
867
-626
251
877
-6

222
580
358
931
2637
1706
-1162
-298
864
-10

Memorandum item:
Agricultural taxes

104

115

154

166

290

291

188

145

Note: Prof. Juro Teranishi’s estimates (1990). Private farms’ S-I balance shows transfer of surpluses
to the non-farm sector through the financial system while agricultural taxes are transfer of surpluses
through the government budget.

93Chapter 6

utors to saving mobilization since the ratio of agricultural tax to total investment declined over time. Nevertheless, such fiscal transfer may well haveplayed a crucial role in early Meiji, for which Teranishi does not have data.
Third, foreign savings played some role toward the end of Meiji asforeign-currency denominated bonds were issued by the central and local governments—see the next section.

5. The role of external funds
Quantitatively speaking, the contribution of foreign savings to industrialization was relatively small during the Meiji period. Almost all necessary
funds were raised domestically. Meiji Japan did not welcome FDI or foreignloans for industrialization, except for the public-sector borrowing in late Meiji
for the purpose of war execution and Postwar Management as mentioned above.
Initially, as a matter of principle, the government rejected external liabilities forfear of foreign control. This was in sharp contrast to other latecomers, such as
Russia and Italy. Russia borrowed heavily from London’s financial markets tobuild railroads during the 1860s and 70s. Italy also accepted large amounts offoreign investment in all sectors in the late 19th century.
However, the reliance on foreign saving did increase in late Meiji. Let
us see what happened step by step.
In early Meiji, the government issued foreign bonds twice. After that,
there was some internal debate on the desirability of further borrowing for the
purpose of creating a modern monetary system. But actual borrowing was notconsidered or made until the mid 1890s.
After the victory in the Japan-China War (1894-95), the situation
changed. With the introduction of a fixed exchange rate and the gold standard
which was made possible by the receipt of reparation gold from China, it
became easier for Japan to issue foreign bonds. The policy of fiscal activism
also required additional financial sources. The establishment of the Rikken
Seiyukai Party, which strongly supported spending policy, and its assumptionof power in 1900 accelerated this trend. In order to ameliorate financial crises
and credit shortage, the business community also began to call for external borrowing.

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Meiji (4): Budget, Finance and the Macroeconomy

During the seven years following the end of the Japan-China War, theJapanese government issued foreign bonds in three installments, totaling 190
million yen ($95 million) to fund its public investment. During the Japan-Russia War (1904-05), the government again issued foreign bonds worth 800 million yen ($400 million) in four quick installments to execute the war. Thesebonds were denominated mainly in British pound or US dollar (the exchange
rates were 2 yen per dollar and 4.87 dollars per pound). Between this war andthe outbreak of WW1, the bond issue was repeated seven more times, mainly toredeem domestic government bonds and release more funds for domestic industries.
After the Japan-Russia War, local governments also began to actively
borrow abroad. Local government bonds and corporate bonds issued by local
SOEs were the two major forms of such borrowing. Funds raised through these
instruments were used for building infrastructure, such as railroads, gas andwater supply, electricity and so on.
Both Teranishi (1990) and Kamiyama (2000b) interpret the external
public borrowing of this period as a way to finance the balance-of-payments
deficit while continuing fiscal activism. Without it, macroeconomic policies
had to be tightened but Japan did not want to do this.
As for FDI, inflow remained negligible in terms of both establishmentof new enterprises and purchases of existing stocks by foreigners. As theunequal commercial treaties with the West were revised, foreigners wereallowed to invest in Japan. The restriction of foreign investment to the designated foreign settlements was lifted in 1899. But that did not cause any increase in
FDI inflow. There were only two companies in which foreign ownershipexceeded 50 percent.

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Chapter 6

After successful modernization, Japan becomes a new
threat to East Asia and the world
By the 1910s, the three national goals of early Meiji—namely, industrialization,
political reform, and military expansion—were more or less achieved, and Japanbegan to consider itself to be part of the first-class world. Achievements by the end of
Meiji can be summarized as follows:
Industrial revolution was achieved in light industries, especially cotton textiles, although machinery and chemical industries were still embryonic.
Japan now had a Western style legal system equipped with a constitution,necessary laws, and a functioning parliament.
As the unequal treaties were revised step by step, Japan regained tariff rights
and the right to judge foreign criminals. Taiwan and Korea were colonized,
and the threats of China and Russia were repelled.
After WW1, Japan began to attend important international conferences as a member of the “Big Five.” The other members were US, Britain, France and Italy. But
Japan’s accomplishments and emerging assertiveness created new doubts among boththe West and the Asian neighbors. For the West, Japan was now a dangerous military
power which might imperil their interests. For the rest of East Asia, Japan acted as a
new imperial invader in the region threatening their independence.
During WW1, while Europeans and Americans were absorbed in fighting, theJapanese government issued the “Twenty-One Demands” to China in 1915. These
included the demand for transferring German-occupied Chinese territory (Shandong
Peninsula) to Japan, expansion of Japanese interests in Southern Manchuria and Eastern Inner Mongolia, a new industrial joint venture, prohibition of yielding Chinese
territories to other countries, acceptance of Japanese advisors, and others(“Manchuria” is a term then used to refer to the Northeastern Region of China). The
Chinese government first resisted the Twenty-One Demands, but with an ultimatumfrom Japan, it finally accepted them. When China’s protestations against the Japanesedemands were rejected at the Paris Peace Conference, a large-scale anti-Japanese
movement erupted in China in 1919 (May 4 Movement).
After the Russian Revolution, the major powers sent troops to topple the newcommunist government, but the attempt was eventually unsuccessful. Japan sent the96

Meiji (4): Budget, Finance and the Macroeconomy

largest number of troops to Siberia and kept them there the longest, after all othercountries ended intervention.
These actions increased global suspicion against Japan. Even the United States, a
traditional ally and the largest trading partner of Japan, began to express displeasure.
Another thorny issue with the United States was the mistreatment of and discrimination against Japanese immigrants in the United States. Thus, during the 1920s and
30s, Japanese diplomacy was facing a grave choice: whether to restore friendship with
the West and East Asia or continue to assert its way against global criticism.

Figure 6-3 Japan’s Territorial Expansion
110°

120°

130°

140°

150°

Siberia
RussiaMongolia

China

Manchuria

Sakhalin
50°
1905
Kurile Islands
1875

Liaodong
Peninsula
1895

40°

Guandong
Korea 1910
Seoul

30°

1875 The Sakhalin-Chishima Exchange Treaty

Taiwan1895
Peng Hu Islands
1895

1895 The Treaty of Shimonoseki
1905 The Treaty of Portsmouth
1910 The Japanese-Korean Annexation Treaty

Note:
After the Japan-China War, Japan received Liaodong Peninsula from China in 1895 but wasforced to return it in the face of diplomatic pressure from Russia, Germany and France in thesame year. After the Japan-Russia War, Japan obtained the southern half of Liaodong Peninsula from Russia, and named it Guandong (Kanto-shu). Guandong included the military portof Lushun and the commercial city of Dalian.

97