Veblen's theory of institutional change: an explanation of the deregulation of Japanese financial markets

American Journal of Economics and Sociology, The, July, 1995 by J. Patrick Raines, Charles G. Leathers

I

Introduction

A major development in the last half of the 20th century has been the post-war revival, reconstruction, and growth of the Japanese economy. A search for the source of Japan's economic success discloses a continuing process of institutional adaptation to the western market system that began in the latter half of the 19th century. As Japan emerged as a dominant industrial producer in the world markets after WWII, the highly regulated Japanese financial system lagged behind the West on an institutional basis. In the 1980s, the integration of the Japanese economy into the international market system entered yet another major phase with the implementation of policies aimed at deregulating Japan's financial markets. Deregulation allowed the process of institutional convergence in the financial sector to move faster, a necessary development for Japan to realize the goal of becoming an international financial center rivaling both London and New York.

This paper examines this latest step in the evolutionary process of institutional adaptation of the Japanese economy from the perspective of Thorstein Veblen's analysis of institutional change. Veblen's 1915 essay, "The Opportunity of Japan," has been interpreted as predicting the rise of fascism in Japan (see, for example, Dowd 1966, 100, and Wallace 1940). The focus, however, is on forces described in Veblen's article as impelling longer-run changes in the institutional structure of Japan's economy. More specifically, Veblen theorized that for Japan to fully exploit the industrial potential of borrowed technology, the semi-feudalistic, semi-mercantilistic Japanese economic system would become increasingly integrated into the world business enterprise system.

Veblen's comments on Japan are analyzed within the broader context of his theory of the internal logic and institutional development of the business enterprise system. Rutherford describes Veblen's system of institutional change as a cumulative sequence whereby institutional schemes grow and develop their own internal logic. This logic may promote technological innovation which accommodates prevailing institutions (Rutherford, 1984, 344). Accordingly, attention is focused on two major aspects of institutional change within the Japanese system of business enterprise: first, the increasing importance of the financial sector characterized by evolving financial institutions and financial innovations, and, secondly, the administrative subordination of modern industrial technology to the institutional imperatives of the international business enterprise system. Within this context, Japan's policy of financial deregulation stands as a predictable development.

The paper begins with a brief review of the liberalization of Japanese financial markets. Although this process of deregulation is still in progress, the policies implemented since the 1970s have already resulted in several major changes in the Japanese financial sector and in Japan's position in the world economy.

II

Deregulation of Japanese Financial Markets

The reduction in the extent of regulation and international isolation of Japanese financial markets in the 1980's was a development of potentially large significance for both Japan and the global economy. With huge trade surpluses and a high rate of saving, Japan became the world's largest capital-generating and creditor nation in the 1980s (Ohta 1991, 22). Consequently, any structural changes that occur in Japan's financial system may have significant impacts on the economies of all those countries which either compete with Japan or depend upon Japanese financial institutions for credits.

The structure of the post-WWII Japanese financial system was shaped by both long-standing Japanese practices and directives by the Allied Occupation officials. Given the need to restore stability and provide funding for the regeneration of the Japanese economy, the financial system featured extensive regulations on all private financial institutions, which were in turn protected by the bureaucratic authorities. Competition between the different institutions was strictly limited, interest rates were kept artificially low, and tight controls were imposed on international capital flows.

Under this institutionally segmented, bureaucratically regimented, and internationally isolated system, financial stability was restored and the rapid transformation of the Japanese economy was successfully financed. Household savings deposited at post offices at low controlled interest rates were used to finance public sector corporations. Since open capital markets remained undeveloped in Japan, the business corporate sector was heavily dependent upon indirect financing through commercial bank intermediaries with access to the Bank of Japan. With regulated interest rates often lower than market equilibrium levels, banks rationed the supply of credit among their large corporate clients. Relatively little consumer credit was available, and public sector borrowing was largely through arrangements that avoided selling securities in the open market (OECD 1984, 42).