In a recent dream, Prime Minister Koizumi found himself on the campaign trail seeking re-election. In this fantasy world, the Liberal Democratic Party was not guaranteed a victory at the polls, a scenario that evidently frightened the Prime Minister. To help guide Mr Koizumi’s dream to a successful conclusion, this paper will attempt to present some ideas that can have a positive impact on Japan’s human resource development system. If included in an equally solvent legislative package designed to reform the Japanese economy and restore it to growth, the combined bill may prove enough to extend Kozumi’s political future. However, as the ideas presented will pay no heed to special interest groups and political bargaining, they may evidently not always appear very realistic. Still, while reality poses some challenges that make ideal solutions impossible, this paper will limit its scope by focusing on the latter. Unfortunately for the Prime Minister, he does not enjoy the same privilege.

The Japanese economy is usually criticised on two levels. First, there is the issue of structural reform. This involves the banking system and the estimated 1 trillion dollar’s worth of bad loans, the political system, the high savings ratio, the ageing society, and similar more or less macro-related problems. Second, a major concern is the perceived conservatism that is embedded within Japanese firms. While much admired until the burst of the bubble, many characteristics of the Japanese HR development system are currently facing heavy criticism. The lifetime employment system is blamed for much of the inflexibility in Japan’s labour market, the seniority system is believed to hinder the development of a dynamic promotion system within Japanese firms, and women remain an underused resource in the labour market. While a major focus of this paper will be on the need for corporate reform, it will be shown that this cannot be successfully implemented without reform also on the macro-level of the economy. Clearly, the Japanese human resource development system can not be studied as a set of independent parts, as the latter need to be considered in relation to each other. However, the incentives system is undoubtedly at the core of the system, and will be described in some detail in order to provide an example of how the system is built up.

Most analysts agree that the high productivity efficiency of firms as Honda and Toyota can not be attributed simply to superior management strategies. "Another possible explanation", writes Stanford Professor Masahiko Aoki, "is that they may be using different methods of organising and co-ordinating productivity". A J-Firm, as Aoki terms a typical Japanese company, has a main focus on the development of people & knowledge. By developing Human Resources, capital resources will come naturally, which leads to a focus on increasing the tacit knowledge of workers. As a natural consequence, Japanese companies desire to create long-term relationships with their employees, thereby establishing the need for an incentive system quite different from that found in the United States.

The Japanese incentive scheme contains three important elements. First, internal promotion is discriminately applied to workers on the basis of merit rating. Second, the wage system combines merit rating and seniority. Finally, a lump sum payment is made to the employee at the time of mandatory separation from the company. All these three elements tend to encourage a long-term relationship between employer and employee, although the importance of for instance the lifetime employment system traditionally has been exaggerated in the West.

Basically, the two fundamental incentive problems faced by both large Western and Japanese business organisations are the moral hazard problem and the adverse selection problem. J-Firms, however, need to promote the development of tacit and contextual skills within the company, and also find it essential to promote productive co-operative behaviour in team production. Japanese workers are often rewarded based on what Joseph Stiglitz has termed a horizontal hierarchy, and, in simplified terms, the salary of workers rises as they climb in the ranking hierarchy. The system, although evidently much more complex in nature than what has been described here, is facing some daunting challenges. It is, therefore, unlikely to remain as it is.

First of all, the Japanese incentive system was created during a period of high economic growth, yet Japan evidently now finds itself in a different economic reality. Growth has been excruciatingly slow during the last decade, and companies thus see the need to establish flexible relationships with their workers. With regard to restructuring, it evidently makes economic sense to lay off senior workers close to mandatory retirement, yet Aoki writes: "Actually doing so, however, may jeopardise the reputation of the firm, which puts it in a serious dilemma". At the same time, especially middle-aged workers are given limited opportunities in terms of employment. Aoki comments that "Japanese firms, particularly large and established ones, have bound themselves to an implicit code of not hiring former employees of other firms, particularly skilled ones". Foreign firms and modern Japanese companies are helping to change this picture, yet the major reason to implement reform has yet to be commented upon.

Masahiko Aoki mentions a very important point when commenting upon the difficulty faced by midcareer workers either forced or willing to switch jobs, yet the contextual skills embedded within a firm may also reduce the ability to change. In America, workers can be laid off and rehired with little or no perceived loss of efficiency, yet Aoki comments upon the different reality that exists in Japan. "But if productivity on the shopfloor depends on the contextual skills that employees have developed over a period of time and that are useful only in specific contexts of the work team or internal organisation", he writes, "a move to sever employees from those contexts, even if temporarily, may reduce the capital value of such skills". This point refers back to the earlier comments concerning the important part played by the Japanese HR system during the period of high growth, yet emphasises that Japanese companies now operate in a different economic environment. According to Aoki, Japanese firms are very efficient in markets where demand is relatively stable, yet may prove less capable in markets where demand fluctuates dramatically. During the period of high economic growth, the market was stable in the sense that it was almost persistently growing. Currently, however, Japanese companies need to adjust to a market that is proving much less predictable, which again calls for changes in the way companies are run.

It is important to emphasis that the Japanese HR system has not failed, and Aoki’s above comments underline this point. Several weaknesses of the incentives structure have already been mentioned, yet companies as Toyota and Honda continue to thrive using human resource development systems that have undergone little or no change since the bubble era. As the two companies continue to be more productive and profitable than basically all their foreign competitors, there is little or no need for them to alter the way they operate. Thus, in terms of government policies, great care should be taken not to implicitly discourage a system that is working splendidly for some. As a consequence, it is fundamentally important that government macroeconomic policies are targeted at unprofitable companies that are in need of organisational reform, but that for various reasons are unable to implement necessary changes.

In a recent article on the Japanese Distribution Sector, Kyoto Professor David Flath discussed the relative absence of American-style large-scale stores in Japan. While many Western observers tend to blame Japanese regulatory policies and other hindrances for the high number of small stores, Professor Flath points to the recent bankruptcies of the Sogo department store chain MyCal supermarket chain to make the argument that Japan is already saturated with large-scale stores. "Actually the fundamental forces that account for Japan’s proliferation of small stores", he comments, "are the relative lack of private cars, smallness of Japanese dwellings, highly developed system of transporting goods by trucks, and geographic centricity of Japan". Still, while this statement may provide some insight into the differences between the Japanese and American distribution sectors, the Japanese version certainly provides an interesting contrast to the country’s highly efficient industrial sector.

Daiei Inc., Japan’s second-largest supermarket chain, is being kept artificially alive despite a debt of close to twenty billion dollars. Concurrently, the retail sector is seeing the entries of Wal-Mart and other foreign competitors as a threat to the existing distribution system. This is exactly where the Japanese government may emit a positive influence on the economy, namely by allowing for competition and eliminating non-performing companies from the market. Professor Richard Katz commented in "Japan; The System that Soured", that the relationship between industry and government becomes difficult to terminate once established. The same can be said for the stakeholder relationship that serves as a foundation for Japanese companies, as some of the latter seem unable to realise that a new economic reality may require a new corporate structure. If a company finds itself in the red, it is either dependent on increasing revenue or on reducing costs, and the former option appears to be formidable task due to the dire economic situation. Thus, in a deflationary economy in the middle of a recession, the inability to reduce one’s headcount constitutes a severe handicap hindering financial recovery. Unfortunately, the Japanese economy is filled with companies unwilling or unable to implement needed reforms, and government policy should be aimed at making sure they do so. This should, however, only be done as part of an effort to create a more dynamic economic system, as the successful heydays of industrial policy are over. There are two fundamental reasons why the Japanese government should not intervene in the economy with more specific policies aimed at reforming the human resource management practices of Japanese firms.

The first argument has been commented upon briefly, mainly that numerous Japanese companies continue to operate with great success with the help of traditional Japanese human resource management practices. As a natural consequence, a creative tax bill aimed at discouraging for example a seniority based pay system would have a negative impact on companies as Toyota and Honda. A holistic approach to the economy should therefore be discouraged simply because it will not be specific enough in its approach, which stems out in another important principle.

The second argument is based on the theory that industrial theory worked well in Japan during the period of high growth, but that government interference in the economy became less successful as the period of catch-up ended. Richard Katz and many other economists have evidently made this argument, but it becomes even truer as the Japanese economy is diversifying. While Honda and Toyota have not been forced to undergo fundamental organisational changes during the last decade, Nissan is a completely different story. None of these companies, however, represent industries that are considered to represent the future of Japan. As the latter appears rather uncertain, bureaucrats can not be entrusted with picking the right fields to develop. Consequently, the focus of the government should be on creating a transparent and open market, in which appropriate human resource management systems are allowed to develop freely.

It is important to keep in mind that both the lifetime employment system and the stakeholder system were developed after World War II, and neither came into existence due to specific government policies. At the moment, however, virtually bankrupt companies are kept alive due to various political interests. As a result, healthy new companies are not able to develop in place of companies that have failed. Solving this problem should be the main focus of the Prime Minister’s new cabinet. Rather than implementing stringent and untargeted policies from above, fundamental inefficiencies of the macroeconomic system should be addressed from below. A more dynamic economy will force failing companies to change, and companies refusing to do so will go under. While making theoretic sense, however, actual implementation will constitute more of a challenge, particularly when considering that the Japanese government is not financially capable of handling the numerous bankruptcies that will come as a result. Therefore, although far from as wide-reaching and effective in their approach, the Prime Minister may be pleased to hear of a few policies that may provide less problematic to implement.

Although currently undergoing major reform, the Japanese tax system is filled with inefficiencies. One much-cited example is the limit of tax-exemption for women, which serves to discourage women from taking higher-paying jobs. While some positive steps have been taken with regard to this issue, more will need to be done. As a substantial part of the Japanese population is set to face retirement within the next few years, the country can not afford the luxury of not using its workforce in an efficient manner. At the same time, efforts should be made to allow for the continued participation of elderly workers in the economy, as there evidently are many that consider the current retirement age as too low and desire to work beyond it.

In addition, recent estimates from METI suggest that Japanese people can help boost the economy simply by taking full advantage of their allotted vacation. While the average salaried worker in Japan is given an average of 18 paid days off holiday a year, only half of these days are actually taken. According to METI, if Japan’s 47 million salaried workers were to take off the remaining nine days, the combined knock-off effect on the economy would be equivalent to 7.5 trillion yen. This would again create employment for an estimated 560,000 workers, and an additional boost would be given by companies hiring extra workers to compensate for the increased vacationing. Evidently, the refusal to take advantage of paid holidays is not unique to Japan, but is also relatively prevalent in for example the United States. Still, while an American employee will refuse to take the allotted number of holidays due to the interest of his career, a Japanese worker will generally feel a great dedication to his employer and fellow workers. This evidently points back to the stakeholder system embedded within Japanese corporations. "Participation is rooted in the expectation that core members will be individually constant in performing the functions expected from them", Robert Ballon writes, "and that they will be collectively supported by the other members". While the work burden of Japanese employees certainly has decreased over the last decade, the Japanese government should consider interfering to ensure that corporations encourage their workers to take advantage of the stipulated number of holidays.

This paper has argued that the Japanese government should not attempt to involve itself on a microeconomic level of the economy. While industrial policy was successful as Japan was catching up with the West, the Japanese economy is currently much more diverse and complex than what was the case thirty years ago. The prime responsibility of the government should be to clean up the financial markets, and to push for improved transparency and reduced corruption. Daiei Inc. is certainly posing a major strain on already troubled Japanese banks, but an even more serious aspect of keeping insolvent companies alive is that more efficient competitors are hindered from growing. Appropriate human resource development systems will need to be stipulated on a corporate level, but the solutions found will certainly differ from company to company. In a sense, reform of the above-described incentives system may prove the most important element. Any company that can motivate its workers through attractive incentives will undoubtedly improve its chances for corporate success, but the appropriate incentives system at an investment bank may differ from what may be beneficial for an automobile manufacturer. The issue is not simply to choose either an American or a Japanese-style human resource development system, and there exist numerous alternatives in addition to hybrids of the two. However, certain tendencies seem clear.

First, Japanese workers currently appear more positively inclined to a performance-based pay structure, which again may encourage companies to compensate workers based on individual achievements. Second, more Japanese women are becoming interested in full-time employment, and companies should take advantage of this largely unused talent pool of educated workers. Finally, although the changes have not been dramatic, the Japanese workforce is becoming increasingly mobile and dynamic. On certain areas, as with regard to labour discrimination and unemployment among mid-career workers, specific government policies may help play a positive role in the economy. It is, however, of fundamental importance that focus is kept on the macroeconomic level, although reform certainly is challenging to implement. "Continuing evolution rather than abrupt revolution", writes Gregory K. Ornatowski, "seems to best characterise the current process of changes in the human resource practices of Japanese companies". If Prime Minister Koizumi ever wakes up from his state of indecisiveness and consensus making, his main priority should be to lay a solid foundation for this evolution to hurry up its pace.