How the 1940 System Made Japan's Miracle — and Then Destroyed It | A Brief History of Things

In the 1950s and 1960s, when both resources and capital were scarce, the 1940 System made sure resources went first, and strategically, to the industrial sectors the state had chosen, helping Japan achieve postwar recovery and industrialization.

The 1940 System means the system of wartime state control over Japan's economy. That the postwar system was continuous with the wartime one is by now close to a consensus among scholars, but the general reader is unlikely to be clear on how the 1940 System won legitimacy after the war, how it produced the Japanese miracle, and how, by refusing to leave the stage, it later dropped Japan into three lost decades. Noguchi Yukio — a participant in the postwar miracle and one of the first people to see the bubble of the 1980s for what it was — writes about this at length in Postwar Japanese Economic History (《战后日本经济史》), his memoir of a career spent in both government and academia. It makes for eye-opening reading, and it upends a good many received ideas.

Take one. People generally assume that latecomers such as Germany and Japan lean toward bank-led allocation of capital, while early movers such as Britain and the United States prefer to raise money directly in the capital markets. In fact prewar Japan also relied mainly on direct financing. Only during World War II, under the 1940 System, did Japan settle on "bank-centrism" — shutting shareholders out of control over companies and handing the job of funding them to banks such as the Industrial Bank of Japan.

Under this arrangement, ownership and management steadily parted ways. Shareholders could no longer tell management what to do, as they had before the war, and top executives came to pick their own successors. The result was that the managers of Japan's large companies all rose from inside them.

The Industrial Patriotic Association, set up company by company to smooth labor relations and cut down on disputes, likewise turned after the war into the unions of individual companies. These company unions — rather than industry-wide unions of the European and American kind — did not make fighting management their main business. They worked instead to keep labor relations in balance and to help the company grow.

In other words, the postwar Japanese way of running companies and handling labor, with "loyalty to the company" as its hallmark, dates from the war years.

Or take another. People once believed that Japan's zaibatsu and its military had conspired to push the country into the abyss of war. In fact most of postwar Japan's large companies grew fast during the war on government support and military orders.

People also often assume that Japan's rural reform was entirely the work of MacArthur's military government, when in fact the groundwork was laid during the war. Wartime rural legislation badly weakened the landlord class. The Food Control Act of 1942, for instance, required tenant farmers to deliver their grain to the state; the state paid the farmers, and the farmers handed part of that money to their landlords as rent. Laws like this turned rent from payment in kind into payment in cash, and the government fixed the rent at a set amount that did not move with prices — which protected farmers and lightened their burden considerably. The government also set up a dual price for rice, buying grain from farmers at a high price and from landlords at a low one. Conditions in the countryside improved markedly, at the landlords' expense.

The conventional view is that the democratic reforms of the postwar years brought Japan its economic recovery, and that companies founded after the war achieved the rapid growth. Noguchi argues the opposite: it was the 1940 System, the national-mobilization system formed in wartime, that produced the postwar recovery, and it was companies that had grown up during the war that produced the high-speed growth.

In fairness, it was the relay of reforms run during the war and after it that swept the prewar ruling class away, laying the foundation for the social structure later called "a hundred million, all middle class." In the further land reform pushed through after the war, for instance, the government forcibly bought up most of the landlords' land and paid them in government bonds, whose real value was then gutted by climbing inflation.

Urban landowners' incomes fell sharply too. Under the Land Lease Act and the House Lease Act, both revised during the war, a landlord had no right to raise the rent on his own, and once a lease was signed it could not be terminated without a "just cause" the courts would accept. Owners therefore could not raise rents to keep up with inflation, and the value of their urban property shrank badly as well. The Property Tax Act of 1946 then taxed personal assets above 15 million yen in assessed value at rates as high as 90 percent. Japan's landlord class and its wealthy class could not help but decline.

Beyond making society more equal, Japan's economic bureaucrats used the 1940 System in the early postwar years to hold down bank interest rates, control who got capital, and keep the financial system sealed off from the world. That let them tilt resources toward the industries they judged should come first — heavy and chemical industry above all — and those industries grew at an extraordinary pace.

Because the occupation authorities knew little about how the bureaucracies that had run the wartime economy actually worked, the technocrats who had supported the wartime system were largely left in place, and they kept their grip on how the economy was run. Noguchi also points out that the occupation forces either worked through interpreters or could talk only to Japanese who spoke fluent English. Interpreters were not necessarily versed in economics, and the Japanese who spoke fluent English at the time were almost all bureaucrats. It was no great trick, then, for the bureaucrats to manage the flow of information and steer the occupation into adopting policies they had written themselves.

Why did the 1940 System suit postwar Japan's high-speed growth so well? In Noguchi's view, the frontier of industrialization worldwide at that time ran through heavy and chemical industry — steel, electrical machinery, shipbuilding, petrochemicals — fields in which large companies could lift productivity by managing everything under one roof. Economic activity in these fields was not easily coordinated through the market; it turned mainly on the division of labor and cooperation inside big companies. Here the 1940 System, which put the individual's duty to the collective above the pursuit of private gain, could do its most.

This also explains why, by the 1970s, Japan and Germany rose quickly and became trade-surplus countries while the United States, holder of the key currency, slid into deficit. The economies of the developed countries were then built around heavy industry, and the vertically integrated production that large corporations led was more efficient. For that kind of production, the mixed systems Japan and Germany adopted, in which the market and state control worked in tandem, released more energy than the wholly market-dependent Anglo-American model.

The 1940 System also helped Japan handle the inflation set off by the oil crisis of the 1970s — though a rising yen absorbed some of the pressure from higher prices as well. In Europe and the United States, labor-management arrangements meant that when prices rose wages had to rise too, trapping those economies in a spiral of inflation and pay increases. The 1940 System instead insisted that "everyone, from the head of the company down to the lowest-ranking employee, unite and struggle for a common goal," which let Japan's unions and company managements stand together and put the survival of the company ahead of a raise. Japan sidestepped the spiral of cost-push inflation.

The 1940 System, in short, was crucial to Japan's postwar recovery and rise. In the 1950s and 1960s, when both resources and capital were scarce, it made sure resources went first, and strategically, to the industrial sectors the state had chosen, helping Japan achieve postwar recovery and industrialization. By the 1970s, facing an external shock like the oil crisis, it again did important work, letting Japan adopt the policies best for the economy as a whole.

And yet fortune leans on misfortune, and misfortune hides inside fortune. In Noguchi's view it was precisely this formidable 1940 System that finally landed Japan in the trap of the bubble economy. The bubble of the 1980s, he argues, had a cause deeper than loose money: the fact that "by the second half of the 1980s, society no longer needed the 1940 System."

In the 1980s the wartime system in finance faced a sharp change in its surroundings. The 1940 System in finance had been possible only by cutting Japan's financial markets off from international ones and closing the door — only in isolation could interest rates be controlled. But as Japan was drawn into an internationalized, liberalized economy, the wartime financial system reached the end of its days.

By then companies could raise money directly in the capital markets. Through direct financing of various kinds — issuing shares at market price, convertible bonds, commercial paper — they could draw funds not only from the domestic market but from markets abroad. Their appetite for capital, moreover, was no longer what it had been during the years of high-speed growth. Having no use for the money, companies simply parked what they had borrowed cheaply in large time deposits, or spent it on financial assets such as trust funds.

Faced with this change in the structure of the economy, the financial machinery should have been rebuilt from the ground up: the bank-centered system of indirect financing needed a soft landing into a system of direct financing. But the weight of history and of vested interests kept the 1940 System in a "death struggle," refusing far too long to leave the stage, and the result was a bubble economy without precedent.

Japan's land prices fanned the flames. In Noguchi's view this was not, as people often say, because land in Japan was scarce, but because urban land was never brought together and put to intensive use — a situation with much to do with the 1940 System. As noted above, the Land Lease Act and the House Lease Act, revised during the war, strengthened the rights of those who rented land and buildings. Owners therefore preferred to let land sit idle rather than lease it out and see it used. Some owners of old houses left them empty until they fell down, because once a place was rented out the tenant could not simply be evicted. Vacancy looked better than a tenant.

On top of that, as technology advanced and work was divided up across the globe, the vertically integrated production at which the 1940 System excelled also reached the end of its days. In the 1990s the internet spread, the cost of communication fell to nearly zero, and small and midsize companies gained real power to process information. Distance constrained economic activity less and less, which made it easier for several companies to divide the work between them through the market, and manufacturing moved from vertical integration to horizontal specialization. In this setting small companies could change policy and decide faster than heavy, lumbering organizations could react to a shifting environment, and many startups grew in a short time into large companies of global scale.

Here, too, Japanese business has been slow to turn and meet the challenges of a changing world. In this sense, Noguchi argues, Japan has never fully stepped out of the shadow of the 1940 System.

Recommended reading: Postwar Japanese Economic History

Cover image: ifeng

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