At the end of World War II, Japan’s economy was in tatters. Some 40 percent of its capital stock was destroyed during the war, and the Japanese standard of living was at pre-World War I levels. Today Japan has the second-largest economy in the world and its growth is the envy of most of the world. From 1952, when the American occupation ended, until 1991, Japan’s real GNP grew at an average rate of 6.8 percent per year. During the period of greatest growth, from 1952 to 1971, real GNP grew at an average annual rate of 9.6 percent. Because of the miracle of compounding, Japan’s GNP in 1991 was over thirteen times its 1952 level. In the United States from 1952 to 1991, by contrast, real GNP grew at an average rate of 2.9 percent, and only tripled over the whole period.

What caused the Japanese “miracle”? Answering that question is difficult. Economists, unlike physicists, cannot conduct controlled experiments in which they change one parameter, leaving all others unchanged, and then look for the effect of the change in this one parameter. Because Japan differs in many ways from other countries—particularly in its culture and its government policies—isolating the effect of any factor is especially difficult. Nevertheless, some major factors seem to be clear-cut causes of Japan’s growth.


Sources of Growth

The most thorough study of the causes of Japan’s twenty-year postwar growth spurt is a Brookings Institution study by Edward F. Denison and William K. Chung. They found that four factors contributed about two percentage points each to the 8.77 percent annual growth rate of national income between 1953 and 1971. The four, in order of importance, were: increases in capital (2.10 percentage points); advances in knowledge and factors not elsewhere classified (1.97); economies of scale (1.94); and increases in labor (1.85). Most of the remaining growth was accounted for by reallocation of resources away from the inefficient agricultural sector.

The major cause of Japan’s large increase in capital was its large increases in investment. Gross private investment, which had been a healthy 17.2 percent of GNP from 1952 to 1954, increased almost continuously throughout the fifties and sixties. By 1970 and 1971 it was a whopping 30.5 percent of GNP. In other words, almost one out of every three yen of Japanese production in 1970 and 1971 was invested in capital. This private investment, in turn, was financed largely by Japanese saving. Gross private saving, half of which was by corporations and half by households, rose steadily from 16.5 percent of GNP between 1952 and 1954 and reached 31.9 percent of GNP in 1970 and 1971. In the United States between 1961 and 1971, by contrast, private saving averaged only 15.8 percent of GNP.

Economist Fumiyo Hayashi of the University of Pennsylvania cautions that comparisons between Japanese and U.S. savings rates are tricky because of the different ways that savings are measured in each country. Measuring savings the same way, he shows, reduces the gap between U.S. and Japanese savings rates. But a large gap still remains.

What accounts for the large Japanese savings rates? Economists are not agreed, but two factors are probably important. The first is low taxes. As Brookings economist Joseph Pechman wrote in 1976, “The fact that the tax burden is unusually low by the standards of other developed countries may alone be a significant factor in the explanation of the high rate of private saving and investment in Japan.” From 1951 to 1970, while Japan’s real GNP was growing at an average of 9 percent per year, total national and local taxes (excluding social security) fell from 22.4 percent of national income to 18.9 percent. This left more money for people to save and invest. Compare Japan’s situation with the United States, where the proportion rose from 28.5 percent to 31.3 percent. Interestingly, Japan’s two decades of greatest postwar growth were also its decades of lowest taxes. During the seventies, as Japan’s taxes rose to 22.8 percent of national income in 1980, real GNP growth declined to only 4.8 percent. Higher taxes weren’t the only reason for this deteriorating performance, of course; oil price increases also contributed.

The second probable cause of high Japanese saving is the incentive that Japan’s tax code gives to savers. Since the early fifties, savers in Japan have been allowed to exempt large amounts of interest income from taxation. Employees who saved part of their wages in an employer-run savings plan paid no taxes on interest on the first x dollars of savings. In 1981, for example, x was $22,600. Interest on postal savings—in Japan the post office offers a limited range of financial services—is treated similarly. In 1981, for example, interest on the first $13,600 was tax free. Those without qualms about lawbreaking could theoretically hold one such account at each post office—there are more than twenty thousand—because postal savings officials tolerate multiple accounts. At one point, according to a study by the Hudson Institute, Japan had twice as many postal savings accounts as people. Also, capital gains from the sale of securities are untaxed.


The Myth of MITI

Early in the fifties, a small consumer-electronics company in Japan asked the Japanese government for permission to buy transistor-manufacturing rights from Western Electric. Permission was necessary because at the time foreign exchange was controlled by the tax and trade ministries. The Ministry of International Trade and Industry (MITI) refused, arguing that the technology wasn’t impressive enough to justify the expenditure. Two years later, the company persuaded MITI to reverse its decision and went on to fame and fortune with the transistor radio. The company’s name: Sony.

In the midfifties MITI exhorted a Japanese industry to develop a prototype “people’s” model of its product so MITI could designate the winning firm as the single producer. In the 1960s MITI tried to force this industry’s many firms to merge into just a few. Both times the companies rebuffed MITI, and today this industry is one of Japan’s finest. Its product: cars.

Many people believe that Japan’s outstanding growth is due in large part to MITI. They believe that MITI has decided what industries the Japanese should invest in, and that MITI persuaded other Japanese government agencies to use their coercive power to get companies to go along. But the evidence goes against this view. Although MITI plans for industry growth, and sometimes gets other agencies to use their powers to carry out the plans, the extent of MITI’s control, and of government control generally, has been greatly exaggerated. Between December 1955 and February 1973, crucial years in Japan’s growth, the government had six different National Economic Plans for economic growth. But without exception actual growth rates exceeded those required to fulfill the plan’s targets. This is evidence that the plans themselves were not responsible. Moreover, had MITI succeeded in preventing Sony from developing the transistor radio, and in coercively limiting the auto industry, two of Japan’s most successful industries would probably have been much less successful.

Between 1953 and 1955 MITI did persuade the government’s Japanese Development Bank to lend money to four industries—electric power, ships, coal, and steel. Some 83 percent of JDB financing over that period went to those four industries. But even with hindsight, what has not been established is whether those were good investments.

The main book cited by those who argue that MITI is responsible for Japan’s growth is MITI and the Japanese Miracle, by U.S. political scientist Chalmers Johnson. But Johnson’s book actually contains little evidence that MITI has helped. Instead, he notes some of the policies, such as tariffs, that MITI persuaded other agencies to implement, and then attributes the large growth to these policies. But tariffs are a particularly unlikely cause of Japan’s growth. Not even the Japanese have been able to repeal the law of comparative advantage. For Japan, as for other countries, tariffs, except in highly unusual circumstances, hinder growth. Most of Johnson’s book is about MITI’s structure and personnel and is not a sustained case for his belief that MITI is the cause of Japan’s extraordinary economic performance.


Other Government Policies

A close look shows that in many ways, government in Japan is less interventionist than governments in most countries. By one reasonable measure—government spending as a percent of GNP—government’s role in Japan is less than in any other major industrialized country. Another way Japan is less interventionist is in antitrust policy. Japan, unlike the United States, has no antitrust restrictions on joint research and development. This allows Japanese companies to avoid duplicating each other’s research.

Japan’s government also allows banks to own stock. America’s Glass-Steagall Act prohibits this. Because Japanese banks own stock and because many bank officers sit on company boards, they can discipline managers. Also, banks in Japan, able to take equity positions in companies, are a source of venture capital.

A further advantage of allowing banks to own stock is that a bank confident of a company’s future can back it when other creditors get scared. Later, if the company performs well, the bank profits because the company’s share price increases. That happened in the case of Toyo Kogyo, the Japanese company that made Mazda autos. When the 1974 oil price increase made its fuel-inefficient Wankel engine uncompetitive, Toyo Kogyo almost went under. Sumitomo Bank, a large stockholder, assured Toyo Kogyo’s creditors and suppliers that it stood behind the firm. Had the U.S. law prevailed in Japan, Sumitomo would have had much less to gain from lending to Toyo Kogyo.

Many economists and others who have written about Japan’s high growth attribute it to a concern with quality production and to Japanese companies’ treatment of their employees. These are certainly important factors in Japan’s growth. But the Japanese government’s only contribution to these factors is that it allowed them. Japan’s growth is stunning evidence, not of the efficacy of government planning, but of the wonders that relatively free people can produce.

About the Author

David R. Henderson is the editor of this encyclopedia. He is a research fellow with Stanford University’s Hoover Institution and an associate professor of economics at the Naval Postgraduate School in Monterey, California. He was formerly a senior economist with the President’s Council of Economic Advisers.

Further Reading

Denison, Edward F., and William K. Chung. How Japan’s Economy Grew So Fast. 1976.

Hayashi, Fumiyo. “Why Is Japan’s Saving Rate So Apparently High?” In NBER Macroeconomics Annual 1986, edited by Stanley Fischer. 1986.

Henderson, David R. “The Myth of MITI.” Fortune. August 8, 1983. 113-16.

Johnson, Chalmers. MITI and the Japanese Miracle. 1982.

Ouchi, William. The M-Form Society. 1984.

Patrick, Hugh, and Henry Rosovsky. Asia’s New Giant: How the Japanese Economy Works. 1976.

Related Links

Agricultural Subsidy Programs

Industrial Policy

Paul Romer on Growth, an EconTalk podcast, August 27, 2007.

Scott Sumner on Growth and Economic Policy, an EconTalk podcast, June 21, 2010.