Valley of Institutional Change: Japanese Political Economy 1990-2005

Why does an extensive reform of a national political-economic system invite temporal, and often substantial, loss of economic output? This paper extends the previous research of transition economies that tackled this question from two new aspects. First, it utilizes recent developments in the studies of institutional change and “Varieties of Capitalism.” Second, by examining Japanese political economy which underwent extensive neoliberal reforms during the 1990s, it analyzes transition between different varieties of capitalism, each composed of complementary institutions. The paper deduces a theoretical model to show that an extensive system change, including a change toward a more efficient system, invites a temporal loss of output. During such a change, institutional complementarities among composing institutions fall apart because speeds of institutional change differ across different types of institutions. The loss of institutional complementarities then results in an output fall during transition. The model is empirically tested against the Japanese Case. Panel data of 65 industries from 1990 to 2005 show that the loss of institutional complementarities during the neoliberal reform resulted in substantial output loss.

Sota Kato joined the Ministry of International Trade and Industry in 1991 after earning a law degree from the University of Tokyo. He served as assistant director for Aircraft and Defense Industries and deputy director for the International Economic Division (MITI) and as a senior fellow at the Research Institute of Economy, Trade, and Industry. He received an MBA (with honors) from Harvard Business School and a PhD in political science from the University of Michigan. Currently he is professor and executive research fellow at the Center for Global Communications at the International University of Japan and at the same time he holds a position as senior research fellow at The Tokyo Foundation.