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Stanford economist Aoki seeks insiders' view of Japan's reform effort
When Japan was dominated by a shogun military commander, he required feudal lords to alternate residence between their castle towns and Edo, now Tokyo. Masa Aoki, the Takahashi Professor of Economics at Stanford, likes to joke that he is returning to that lifestyle.
Last July, Japan's powerful Ministry of International Trade and Industry MITI for short announced that it was tapping the 59-year-old economist to head its research institute. As a result, Aoki will alternate his residence between Stanford and Tokyo, although he spent last quarter in a third locale the London School of Economics. In the shogun era, alternating residences was a system for controlling the shogun's potential rivals, Aoki says, but it also enhanced communication by spreading knowledge of local craft and industrial practices, precisely what Aoki aims to do.
At his first press conference as MITI research director last summer, Aoki said Japan's corporate structure "is getting too fat" and must slim down to head off long-term stagnation of the Japanese economy. Based on a recommendation he made several years ago, the government enacted a law permitting holding companies for the first time in 50 years. Japanese companies now can be broken into subsidiaries controlled by smaller headquarters. It is not like Silicon Valley firms' spin-off culture, Aoki said in a campus interview, but a potentially successful Japanese rendition.
More recently, Aoki has cautioned that Japanese companies need more participation by outsiders in their governing boards to replace the watchdog function that Japan's banks once served. Japan's political and economic institutions formed a highly successful, coherent system in the past, he says. Now that global competition is forcing changes in some parts of that system, other changes must emerge to make the system coherent again.
Born in Japan, educated at the University of Tokyo's School of Economics and at the University of Minnesota, Aoki has advised the World Bank and a number of governments, including China, but he is joining Japan's government at a time of great doubt in that country. A time of great doubt, he hopes, can be converted into a time of great change.
"People think Japan is facing its third major institutional change in the last 150 years or so," he said, referring to the Meiji Restoration in the 19th century and the American Army occupation period from 1945 to 1947. "Lots of politics is involved, so nobody knows how much institutional change we can do now, but the Ministry of International Trade and Industry is quite progressive among the Japanese bureaucracies and they are advocating more deregulation. I wanted to see this from inside the system."
The MITI culture
Aoki is the only academic at MITI. While it is common for Stanford professors to don dark suits and head off to Washington to direct a government agency for a year or two, Japanese agencies are run by insiders. The ministries attract some of the country's brightest college graduates, Aoki said, and then promote some to leadership positions. In this case, Aoki said, he will be more like a chairman of a board than a day-to-day director, so he can continue to teach at Stanford winter and spring quarters while advising ministers and helping set MITI's research agenda. He has organized a conference for March, for example, for Korean, Japanese and Chinese officials to discuss how to bring about institutional changes.
The fact that someone was recruited from the Untied States to head MITI seemed to surprise the Japanese press, who gave prominent attention to his appointment. (To keep this in perspective, Aoki quickly points out that Tiger Woods is much more of a household name in Japan. "When I tell people in Japan that I'm from Stanford, they used to say, 'Oh, yes, that's in the Silicon Valley.' Now they say, 'Oh, Tiger Woods' or 'Chelsea Clinton!' ")
Perhaps the people most excited to see him at MITI, he said, were about 20 Stanford graduates who work there. "They gave me a wonderful party. In general, the young bureaucrats there in their 20s and 30s are really the brightest people and very reform minded, so it's exciting to talk with them."
For years, Aoki and his wife have maintained houses in Kyoto and Stanford, so traveling back and forth is nothing new, he said. What is new is being on the inside of Japanese government.
Aoki is just as enthusiastic about staying "inside the system" at Stanford, where he is among a group of economists who use game theory and other tools to understand why capitalistic economies evolve differently from each other. Since 1990, they have offered the only graduate economics program in the United States that specializes in comparative institutional analysis. Holding up a red coffee mug with CIA printed in white letters, Aoki tells a visitor to his office, "We call it CIA for short like the Culinary Art Institute."
Stanford's CIA reflects renewed attention to institutions in economics. Neoclassical economic theorists have seen markets as the only institutions that mattered to an economy, Aoki says, and the theory predicted that as countries and regions competed, the need for efficiency would force them to evolve similar government and private institutional structures.
That view has been called into question, he says, by the relative success of China compared to Eastern Europe in transitioning from communism to capitalism. China has taken a more gradual approach to reform but its economy is growing faster than those in Eastern Europe that took what he calls the "big bang" approach.
Aoki's reputation is built upon his comparative analyses of Japanese and U.S. industrial structures and on his work for the World Bank on desirable financial systems for transition economies. Government, he says, can play a complementary role to business and enhance markets in developed, developing and transitional economies, but it needs to act in a coherent fashion that takes into account a country's own history.
East Asia's economic problems
The recent currency devaluations in several Asian economies, he says, point to the problems that economically growing countries can have in adapting their institutions to changing circumstances. Korea made great economic strides but failed to develop banks powerful enough to make loan judgments independent from the industrial conglomerates to whom they loaned money. Japan had strong, responsible banks but its "piecemeal" deregulation of securities in the late 1970s undermined the banks' authority by banning them from underwriting securities, a new source of funding for their corporate clients. Foreign investment flooded into both China and Thailand, causing a speculative bubble to develop in both places, but only China's government was able to curb speculation and inflation, by halting central bank loans to local governments.
"People in Europe lump the problems of Japan, Thailand and Korea together as an East Asian crisis," Aoki says, "but the problems are very different in each country." Even the International Monetary Fund in its loan packages, he says, does not seem to recognize that some of the countries with international debt payment problems do not have public fiscal deficits. If governments are not running deficits, Aoki suggests, imposing curbs on government spending may hurt more than help recovery.
Perhaps nothing illustrates the rate of adjustment required of economies today better than the recent history of American and Japanese firms leapfrogging over each other. In his award-winning 1988 book on Japanese firms, Information, Incentives and Bargaining in the Japanese Economy, Aoki wrote about the innovations that permitted Japanese auto makers and other firms to get an edge over their American counterparts in the 1970s. Now the shoe is on the other foot, he says, and the Japanese need to try to catch up with organizational innovations that American firms made in response to Japan's earlier success. The larger question for economists, he said in a 1995 speech when he was president of the Japan Association of Economics and Econometrics, is whether capitalist systems will ultimately become alike or whether they will continue to diverge, leapfrogging over each other as they borrow ideas and adapt them to their local circumstances and culture.
"In the 1950s, Japanese businessmen discovered they had a huge productivity gap with American companies like U.S. Steel and General Motors, so they started to learn American quality control and scientific management methods," he says. "These methods had been designed by engineers and imposed on workers. The Japanese modified it in such a way that quality control was discussed by engineers and workers on the shop floor. In this way, they developed a new type of quality control and a system to reduce costly inventories."
It was a Japanese organizational innovation, but one that resulted from "combining the traditional Japanese cooperative team approach with American scientific management."
Falling behind, American companies then looked at Japanese firms' lean production methods. Instead of controlling inventories within a tightly organized keiretsu, or conglomerate, Aoki says, they focused on designing basic products and writing standards for components, which then could be manufactured by others throughout the world. Using advanced technology in communication and transportation, they downsized the firm and developed a more flexible, modular organization.
"Now is the time when the Japanese should learn from us. There is a way for the Japanese corporate system to evolve by combining some of the innovative ideas and culture you see here with their traditional methods."
The world as a whole gains advantages from not having one capitalistic system with cookie-cutter institutions, Aoki says he believes, yet he concedes there are others who argue forcefully that there will be what he calls "a logical end point with a minimalist state."
In comparative institutional analysis, he said, faculty and graduate students use game theory to look at various institutional innovations as moves on a chess board.
"Adam Smith used the expression of [economics as] the great chess board of human society and I like that very much. He said each piece on the board has its own principles of motion, its own motivations. . . . We try to view each system the Japanese, the American, the Chinese, for example as a different equilibrium of a game. Each system can learn from another system, but you cannot jump from one to another. The outcome of learning is more likely to be a hybrid, like in plant breeding."
The original group includes Professors Paul Milgrom, Avner Greif and Yingyi Qian of the economics department faculty, recently joined by Douglas Bernheim, Marcel Fafchamps and Steve Tadelis. Qian is an assistant professor whom Aoki calls "the best Chinese economist after the Cultural Revolution." Milgrom is well known for his work designing auctions of spectrum licenses for the Federal Communications Commission, and Greif is what Aoki calls a "rising star" in economics because of his work on the institutional arrangements of seafaring traders in the Middle Ages. Using game theory and historical research, Greif was able to show that the individualistic values of Genoese traders and the collectivist beliefs of Maghribi traders constrained their behavior in contracting with overseas agents. Both groups developed institutional arrangements or "rules of the game" that sustained their business success, but they were markedly different rules.
"We are at a point where we can understand why there are different systems of capitalism, but how an institution changes is a very hard problem," Aoki says, fingering his chin. "I know that mutual learning plays a very important role, but I want to understand it better. Putting myself inside Japan where institutional changes are taking place seems like a good way to do that."