recognize the role of government with a wider range than before in responding to market failures during development, and this fact may be looked upon as a great change appearing in the 1990s.

In the sections that follow, we want to make clear the role of the government in countries in transition to market economies. The next section explains transmission of the function of market mechanism in the 1980s by historical analysis. Also, we illustrate new examples of market failures, particularly from Stiglitz (1988a), (1988b). Industrial policy is focused on to discuss the role of government in section 1-3-3. Our discussion is based on “The East Asian Miracle” (World Bank, 1993), which is useful to find the optimal policy mix of the “market-friendly” view with the “developmental state” view.

## 1 -3-2 Function of Market

## (1) Market Mechanisms

The precipitous drop of share prices on Wall Street, New York, referred to as “Black Thursday,” which occurred in October 1929, marked the beginning of a worldwide depression. In order to prevent the birth of such a bubble in capitalism, as well as the onset of panic caused by a “negative bubble”, a financing system was established and maintained according to regulations created after the panic. Nevertheless, about forty years later (around 1970) there was a dramatic change in the economic environment. On the one hand, there was the remarkable recovery from the World War II in Japan and in West Germany, and on the other, a loss of economic power began to appear in the United States due to factors such as the Vietnam War.

Under such conditions, the world economy was forced to make a major shift in orientation toward deregulation. Moreover, there was an inevitable adjustment of relative prices, as pointed out by Miyohei Shinohara, professor at Tokyo International University. Examples include adjustment of exchange rates, of crude oil prices and of the price of gold. After World War II, the yen rate was fixed at 360 yen to the US dollar, but a floating exchange rate system was introduced in 1973, and the yen steadily appreciated. Up to 1970s the price of oil was held constant under the control of the major oil companies, but in the 1970s it climbed dramatically following two “oil shocks”.

One of the great currents in the course of the world economy after 1970 was the transmission of the function of market mechanisms due to deregulation. In the midst of this current, the former Soviet Union and Eastern Europe collapsed, and socialist countries which had depended upon assistance from the Soviet Union were forced to shift to market economies. Similarly, the socialist countries in Asia, including Vietnam, Laos and Mongolia, began to shift to market economics.

Early in the 1980s, the budget deficits of nations worsened drastically and calls for economic liberalization became frantic. The national leaders who appeared at this time in the United States, England and Japan were Reagan, Thatcher and Nakasone, respectively, and each was a firm advocate of economic liberalization. In the realm of economics, the Keynesian policies of intervention through the national budget lost their effectiveness, and it was even declared that Keynesian economics had died. Meanwhile, in the realm of policy, the school of hypothesis of rational expectations, who advocated laissez-faire in line with