9. The 1930s and War Economy

(See Handout no.7)

Showa Depression 1930-1932

Japan experienced the deepest economic downturn in modern history during 1930-32. This should not be confused with the banking crisis of 1927 (previous lecture).

There were two causes of this depression.

(1) Internally, the Minsei Party government (July 1929-April 1931, with prime minister Osachi Hamaguchi, finance minister Junnosuke Inoue, and foreign minister Kijuro Shidehara) deliberately adopted a deflationary policy in order to eliminate weak banks and firms and to prepare the nation for the return to the prewar gold parity (fixed exchange rate with real appreciation). The policy of deflation and return to gold was strongly advocated and implemented by finance minister Inoue.

(2) Externally, Black Thursday (Wall Street crash) of October 1929 and the ensuing Great Depression in the world economy had a severe negative impact on the Japanese economy.

Its main consequences on the Japanese economy and society were as follows:

--As before, macroeconomic downturn was felt primarily in falling prices and not so much in output contraction (estimated real growth was positive during this period). As prices fell, manufacturers produced even more to maintain earning and keep factories running. But clearly, this behavior would collectively accelerate the oversupply and the deflation. From 1929 to 1931, WPI fell about 30%, agricultural prices fell 40%, and textile prices fell nearly 50%.

The famous photo of hungry children eating white radish [however, they do not appear on the verge of starvation to me. I think there were worse situations than this in the world].

--Around 1931, rural impoverishment became severe. Moreover in 1934, rural communities were hit by famine. Especially in Tohoku (northeastern) Region of Japan, rural poverty generated many undernourished children and some farmers were forced to sell their daughters for prostitution. This rural disaster caused much anger and popular criticism against the government and big businesses.

--Cartelization and rationalization were promoted under government guidance. Free market seemed to worsen the depression, so agreements on output restriction were adopted. This practice spread to virtually all material industries including cotton yarn, rayon, carbide, paper, cement, sugar, steel, beer, coal and so on.

--Military and right-wing movements emerged. In economic despair, much blame was placed on party governments and their policies. Even ordinary people, who normally hated militarism, were disappointed with the performance of party governments and became more sympathetic to the military and nationalists.

In the 1930s, political and intellectual thinking gradually shifted from economic liberalism toward more economic control under state management. There were many reasons for this, including: (i) influence of Marxism; (ii) apparent success of USSR; (iii) Showa Depression; (iv) the idea that deflation was worsened by excess competition; and (v) disappointment with politicians and political parties. Many considered that the days of the US-style free market economy were over and from now on, state control and industrial monopoly would strengthen the competitiveness of the national economy.

Another aim of the military and right-wing groups was active military expansion. They criticized "Shidehara Diplomacy" which to them seemed too soft on China. Their primary goal was to "defend Japanese interests in Manchuria and Mongolia [more precisely, eastern part of "Inner" Mongolia]).

Seiyukai versus Minsei Party

Seiyukai (full name: Rikken Seiyukai) was established in 1900 by the union of a leading politician (Hirobumi Ito) and a former opposition party who decided to cooperate with the government. Its main policies were (i) fiscal activism with an emphasis on public investment in rural and industrial infrastructure; (ii) acceptance of military buildup and expansion; and (iii) pleasing a narrow voter base (rural landlords and urban rich). It was a party supportive of a big government allocating public money and subsidies. Seiyukai literally means "political friend society."

Minsei Party (full name: Rikken Minsei To) was originally called Kenseikai (1916-), later merged with another party to become Minsei Party in 1927. Its main policies were (i) economic austerity and industrial streamlining (free economy and small government); (ii) return to prewar gold parity; and (iii) international cooperation and peaceful diplomacy especially with the US. Its support base consisted of intellectuals and urban population. Minsei means "people's politics."

@ Minsei Party Seiyukai
Main supporters Intellectuals, urban workers Big businesses, rural landlords
Economic policy Small government, free market principle, eliminate inefficient units through macroeconomic austerity Big government, fiscal activism, public investment for industry and rural development
Foreign policy Cooperate with US, oppose military invasion of China (protect Japanese interests through diplomacy) Supporting military expansion, cooperate with military, if necessary, to undermine Minsei Party
Finance minister & economic policy in the 1930s <Junnosuke Inoue, until Dec. 1931>
Intentionally generate deflation
Return to prewar gold parity
<Korekiyo Takahashi, Dec. 1931-Feb. 1936>
End gold parity and depreciate yen
Fiscal expansion (later, tight budget)
Easy money

Japanese voters did not always vote for the same party but often switched their support from one party to another depending on the issue and situation. Smaller "proletariat parties" also emerged with farmers and workers as the support base.

As noted earlier, Junnosuke Inoue of Minsei Party (finance minister 1929-31) was deeply committed to the policy of deflation and returning to gold. This policy caused severe depression but he never relented or regretted. People became greatly frustrated with his policy. Finally, the government (second Wakatsuki Cabinet) was removed and succeeded by a Seiyukai government (Inukai Cabinet) in December 13, 1931.

As soon as the new Seiyukai government was sworn in, finance minister Korekiyo Takahashi completely reversed Inoue's policies:

--On the very first day of the new government, Takahashi ended the gold standard and the fixed exchange rate, and floated the yen. It immediately depreciated.

--Fiscal expansion financed by government bond issues (called "Spending Policy"). Monetization of fiscal deficit was tried for the first time in Japanese history (BOJ buys up newly-issued government bonds).

--Monetary expansion and low interest rates.

Thanks to this policy turnaround, the Japanese economy began to recover in 1932 and expanded relatively strongly until 1936 (the last year of non-wartime economy). Among major countries, Japan was the first to overcome the global depression of the 1930s. Fiscal and monetary expansion seemed appropriate. But the yen's large depreciation might be considered as the "beggar-thy-neighbor" policy (i.e., a cheaper yen was beneficial to Japanese industries but it imposed costs on other countries through real appreciation of their currencies).

For these achievements, Korekiyo Takahashi is called "Japanese Keynes." He adopted Keynesian policies even before John Maynard Keynes wrote the famous General Theory in 1936 ! Even today, Takahashi's policy is admired while Inoue's policy is generally criticized as stubborn and misguided. But this view is sometimes challenged and continues to be debated. As recently as in 2001, Prof. Junji Banno (Chiba University) wrote that Inoue's deflation policy was pre-requisite for economic expansion of the mid 1930s, because without it efficiency improvement could not have been achieved. His article indirectly criticizes the current Koizumi government's policy of supporting weak firms and banks without painful restructuring (see the box at the end of lecture 8).

Junnosuke Inoue, 1869-1932@iMinsei Party); also see Lec.7 Osachi Hamaguchi, 1870-1931 (Minsei Party)
His policy
Tsuyoshi Inukai, 1855-1932 (Seiyukai) Korekiyo Takahashi (Japanese Keynes?), 1854-1936 (Seiyukai)

Around 1934 when the Japanese economy was firmly on a path to recovery, Takahashi shifted to a tighter budget (which seemed an appropriate decision). But the army and navy demanded more military spending despite fiscal pressure. Takahashi resisted and was assassinated by a military group in the February 26 Incident in 1936 (next section).

Both Inoue and Takahashi previously served as a Bank of Japan governor before becoming a finance minister, but their personalities differed significantly. Inoue was a slim, intellectual graduate from Tokyo University. Takahashi was fat and extremely popular among people (his nickname was "Daruma," a round doll). He did not have much education and had a rough life when he was young.

Political terrorism and invasion of China

From 1931 to 1937, Japanese politics was gradually overtaken by the military. Many incidents occurred, each undermining the basis of party government. Within the army and navy (especially the army), a few ultra-nationalist groups formed with the purposes of rejecting a party-based political system, uniting the nation under the emperor, introducing economic planning, saving the rural poor, and so on. They staged many coups and assassinations. Below is the brief history of this dismal period. Underlined incidents were particularly significant.

1931 March Incident (failed military coup attempt).
Manchurian Incident (Sept. 18 Incident)--a few officers of Kantogun (Japanese army stationed in China), including Kanji Ishihara and Seishiro Itagaki, started military invasion by exploding a railroad track and blaming it on Chinese. Ishihara's idea was that Japan had to take Manchuria (Northeastern China) in order to prepare for a full war against the US. They started the incident without informing the Tokyo government or army headquarters. Foreign minister Shidehara told Kantogun to refrain from further military action but Ishihara's group ignored the order. The Chinese side adopted non-resistance strategy, and Manchuria was soon occupied by the Japanese troops. This incident clearly showed that the party government could no longer restrain the behavior of the military.
October Incident (failed military coup attempt).
1932 Blood Society Incident--Junnosuke Inoue (former finance minister) and Takuma Dan (Mitsui Group) were assassinated.
Establishment of the state of Manchuria (Japanese puppet state).
May 15 Incident--navy officers assassinated prime minister Tsuyoshi Inukai (Seiyukai).
1933 Japan was criticized by the League of Nations over the occupation of Manchuria. In protest, Japan withdrew from the League of Nations.
The period 1933-35 was relatively "quiet" thanks to economic recovery and fewer domestic and international incidents. But this proved to be a temporary calm before the big storm.

1936

February 26 Incident--nationalistic army officers led their troops to stage a military coup on a snowy morning in Tokyo. They wanted to get rid of the current government and start a new regime. Korekiyo Takahashi (finance minister), Makoto Saito (interior minister) and Jotaro Watanabe (education minister) were assassinated. The coup group occupied central Tokyo for four days. The army headquarters first approved their action but later disowned them, because Emperor Showa angrily told the military to put down the rebellion. The coup thus failed, but after this incident the party government was marginalized and the military controlled Japanese politics.
During all these incidents, Seiyukai behaved opportunistically, often supporting the military in order to politically attack its rival, Minsei Party. It was a risky tactic since the goal of the military was to remove all political parties including Seiyukai ! (By contrast, Minsei Party more consistently opposed the military.) Political parties were seriously discredited in the eyes of the public due to (i) inability to oppose the military, (ii) money politics and corruption, and (iii) Seiyukai's self-destructive move to cooperate with the military.

1937

Japan-China War began--on July 7, Japanese and Chinese troops had a skirmish at Marco Polo Bridge near Beijing (Beiping). The incident was minor but Tokyo (Konoe Cabinet) decided to send more troops to China. Thus began a full-scale war with China (until 1945).

After the Japan-China war erupted, political parties were emasculated and later disbanded, the military completely took over Japanese politics, and the entire nation was mobilized to execute the war.

In my view, Japan crossed the point of no return with the Manchurian invasion in 1931. With this incident, Shidehara Diplomacy ended and the military's influence surged. International isolation became unavoidable. Party governments were too weak to stop this trend. While some factions within Seiyukai and Minsei Party tried a few times to merge the two parties to oppose militarism, their attempt did not materialize. Starting with the Manchurian Incident, the period 1931-1945 is sometimes called the "Fifteen-Year War."

The head office of the South Manchuria Railway controlled by Japan (left) and its poster (below).

The poster says "Open up the fertile land of Manchuria: Young Volunteer Army for Cultivating Manchuria and Mongolia"

War economy, 1937-1945

The military leaders thought (hoped) the war with China would be short. But in reality, it lasted for eight years. Without realistic vision or planning, the war front expanded and fighting escalated. Within China, the nationalists and the communists were fighting each other at first but later joined forces to fight the Japanese.

While there were earlier calls for economic planning before the war, the Japanese economy basically remained market-oriented until 1936. But with the outbreak of the Japan-China War in 1937, the economy was completely transformed for war execution. One by one, new measures were introduced to control and mobilize people, enterprises and resources. Most Japanese firms remained privately-owned but were heavily regulated to contribute to the war effort.

Key measures for establishing the war economy included the following:

1937--The Planning Board (kikakuin) was created. This board, directly under the prime minister, was responsible for comprehensive policy design for wartime national resource mobilization. The brightest bureaucrats from various ministries were gathered for this purpose. It basically played the same role as the state planning committee in socialist countries.

1938--The Planning Board issued the Resource Mobilization Plan (first economic plan). Separately, the National Mobilization Law was approved.

1940--Konoe Cabinet's New Regime Movement. This movement was started in response to Japanese invasion of Southeast Asia and German victories in Europe. A strong one-party system was advocated and adopted. Existing political parties were dismantled.

1943--The Military Needs Company Act was adopted. Designated companies were placed under official control (top management, production plan, penalty for non-compliance, etc) but at the same time they were provided with necessary inputs on a priority basis.

In addition, rationing, forced enterprise mergers, and forced factory labor were adopted in increasing intensity.

For economic planners, the primary objective was to maximize military production under limited domestic resources and availability of imports. Key military products were ships and warplanes. Toward the end of the war, airplane production became the only priority. In order to boost heavy industries, consumption was greatly squeezed and light industries were suppressed. The textile industry (previously the leading industry of Japan) was virtually eliminated. The people were forced to live without a new supply of clothes and footwear. Steel products in structures and households were stripped as the metal source for building more airplanes and ships.

RED (Dec.1941): Japan's occupied areas immediately after the Pacific War started. YELLOW (Aug.1942): Japan's maximum military expansion. After this, Japan began to retreat.

In wartime planning, two variables were crucial: (i) foreign exchange reserves; and (ii) energy and raw materials (and the capability to transport them by sea). Until around 1940, the question was how to maximize military output subject to these two constraints. But after 1940, Japan could no longer trade with other countries and the problem shifted to the physical transportation of natural resources from the Japanese colonies and occupied areas to mainland Japan.

Japan considered that resources from the "Yen Bloc" (Korea, Taiwan, Manchuria and the rest of occupied China) were not enough. In July 1941, in order to secure more resources, Japan began to invade Southeast Asia, starting with French Indochina (Vietnam). This angered the US, which imposed oil embargo and asset freeze on Japan. If oil imports from the US were cut off, Japan's oil reserve would last only two years. At this point, Japan began to prepare a war with the US. Diplomatic efforts to maintain peace were tried but failed. With the Pearl Harbor attack in December 1941, Japan started the Pacific War against the US and its allies.

Japanese leaders did not have any clear idea regarding how to fight a war against the US, let alone how to win it. However, they were encouraged by the brilliant victories of Nazi Germany in Europe. To them, totalitarianism of Japan, Germany and the USSR seemed superior to American capitalism and individualism.

Immediately after the outbreak of the Pacific War, Japan invaded a wide area of Southeast Asia but soon began to retreat under allied counter-attacks. Japanese ships and planes were quickly lost while Americans built more and more of them. From late 1944, US aerial bombing (mainly incendiary bombs) destroyed virtually all cities in Japan (except Kyoto). In 1945, the US troops landed in Okinawa, two atomic bombs were dropped in Hiroshima and Nagasaki, and the USSR entered a war against Japan. A few days later, Japan surrendered.

Economically, the main reason for Japan's defeat was that its war economy collapsed due to the lack of inputs and energy. Japan lost virtually all ships and could not transport materials from abroad (including colonies).

Neighborhood groups were organized to put off fire from US bombing. Actually, the bombing was so fierce that this kind of exercise was virtually of no use.

As young males were sent to war fronts, women were trained to defend the homeland. Due to the lack of weapons, they were provided with bamboo swords. Women and high school students were also mobilized to work in military factories.

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The origin of the Japanese system

Many of the characteristics of the post-WW2 Japanese economy originated during the war period (1937-1945). They feature long-term relationship and official intervention such as:

Heavy and chemical industrialization drive
Administrative guidance (gyosei shido)
Subcontracting system
Separation of ownership and management
Lifetime employment system and seniority wage
Enterprise-based trade unions
Financial keiretsu and mainbank system
The Bank of Japan's "window guidance" and "convoy system"
Food control system
Foreign exchange budget and surrender requirement

All of these policies and systems were deliberately adopted by the government in the late 1930s through the early 1940s in order to effectively execute the war. Before that, the Japanese economy was more neoclassical-- characterized by freer entry, short-term contracts and high labor mobility.

These wartime features were largely retained even after WW2 and worked relatively well in the 1950s and 60s when Japan was growing rapidly. However, they are now considered obsolete and to have become barriers to change in the age of IT and globalization. Among the list above, the last one was abolished long ago but most others still remain in the Japanese economy even today in various degrees.

There is a debate among economists regarding the interpretation of the Japanese system.

The majority of Japanese economists argue that Japan should go back to the free market model, because the relational and interventionist system was originally alien to Japan. These may have played a historical role before, but we do not need them any more (some aspects, like priority on job security, could be partially retained, however). Prof. Masahiro Okuno-Fujiwara and Prof. Tetsuji Okazaki (both at Tokyo University) are leading advocates of this view.

But a minority voice says that Japan needed a system based on long-term relations, with or without war. When an economy graduates from the light industry stage (textile, food processing, etc) and moves to heavy industrialization and machinery production, free markets may not be the best choice. Official support and long-term relationship become indispensable for industries with large initial investments, high technology and intra-firm labor market. As Japan began heavy industrialization in the 1920s and 1930s, the free economic system inherited from Meiji was inappropriate and had to change. The war provided a good excuse for this change. But even without the war, Japan had to adopt a new system anyway. Prof. Yonosuke Hara (Tokyo University) presents such a view. He says that the free economy of Meiji was foreign, and the relational and interventionist system is more normal to Japan, dating back to the Edo period.

According to the latter view, implications for today's developing countries are as follows. Light industries and electronics assembly can be promoted by free trade and FDI, but if the country hopes to absorb technology vigorously and have advanced manufacturing capability, certain industrial promotion measures become necessary; Japan, Taiwan and Korea all adopted this method in the past. By contrast, no ASEAN countries seem to have broken through this "glass ceiling" and internalized the industrial power. If latecomer countries are now banned from taking these measures because of WTO, FTAs, World Bank policy matrix and so on, they may remain at a low level of industrialization (contract manufacturing, simple processing, etc) and not get to a higher level of technology.

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<References>

Banno, Junji, Nihon Seijishi: Meiji, Taisho, Senzen Showa (History of Japanese Politics: Meiji, Taisho and Prewar Showa), University of the Air Press, revised 1993.

Iwanami Shoten, Nijukozo, Nihon Keizaishi 6 (The Dual Structure, Japanese Economic History vol. 6), T. Nakamura and K. Odaka, eds, 1989.

Iwanami Shoten, Keikakuka to Minshuka, Nihon Keizaishi 7  (Planning and Democratization,  Japanese Economic History vol. 7), T. Nakamura ed, 1989.

Noguchi, Yukio, 1940 Nen Taisei: Saraba Senji Keizai (The 1940 Regime: Goodbye to the War Economy), Toyo Keizai Shimposha, 1995.

Okazaki, Tetsuji, and Masahiro Okuno, eds, Gendai Nihon Keizai System no Genryu (The Source of the Modern Japanese Economic System), Nihon Keizai Shimbunsha, 1993.

Takafusa Nakamura, Showa Kyoko to Keizai Seisaku (Showa Depression and Economic Policy), Kodansha Gakujutsu Bunko, 1994.