Chapter 8 From a Catching-Up Economy to a Leading-the-Way

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Chapter 8From a Catching-Up Economy to a

Leading-the-Way Innovative Society

Hiroshi ShibuyaJuly 3, 2017

July 3, 2017 Copyright © 2017 Hiroshi Shibuya All Rights Reserved

Transformation toward an Innovative Society: Japan’s Next Challenge 1

• Many Asian countries have succeeded in achieving economic takeoff and have entered into the industrial stage of economic development

• Unless Japan transforms itself from a catching-up industrial economy (the 1940 system) to a leading-the-way innovative society, Japan’s real wage will continue to decline according to the factor price equalization theoremof international economics, and thus will continue to suffer from slow economic growth


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Stagnant Real Wages



• A revolution in the Information Technology (IT) has made the centralized vertical organization (the 1940 system) less effective and the decentralized horizontal organizationmore effective in terms of efficient sharing of information and efficient coordination and cooperation in the production process

• In other words, the IT revolution has made Japan’s 1940 system obsolete

• Japan must transform itself from the 1940 system to a society of decentralized horizontal organizations


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• Japan’s immediate challenge is financial innovation: how to transform financial institutions to perform more effectively their role as financial intermediaries

• Since the 1990 burst of Japan’s bubble economy, financial institutions have focused on the disposal of non-performing bad loans and have avoided taking risks

• As a result, financial institutions have become a major drag on Japan’s economic growth

• Japanese banks must restart the “relationship banking,” helping local companies to grow not only through financing their businesses but also with a value-added consultant service



• Japan must improve its financial technology and skills• Japan holds foreign assets ($7T ) greater than its GDP ($5T),

which means that 1 % improvement in the rate of return on foreign assets will be equivalent to 1.4 % increase in the annual growth rate of GDP!• Japanese financial institutions should improve their

financial investment skills so that 1% increase in the yield of foreign assets can more than offset the negative impact of aging population on the GDP growth• But, in reality, the most of Japanese foreign assets are held

in the form of low-yield USGBs and US bank deposits


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Japan’s Need for Financial Innovation• Margaret Thatcher (Prime Minister of the United Kingdom

from 1979 to 1990) and Ronald Reagan (President of the United States from 1981 to 1989) deregulated their economies, particularly, their financial industries

• Japan should learn an important lesson from the success story of the US and UK economies during the 1980s, 1990s, and 2000s that financial innovation could bring back the economy to a higher potential growth path

• Finance is one of the major industries in which Japan is far behind US and UK


US and UK Economic Growth Rates


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• Great Divergence (European Miracle): Why did Europe in the 17-19th centuries succeed in rapid economic growth, while India and China remained stationary? (see Chart)

• Answer: India had a rigid caste system and China had a rigid bureaucratic system, both of which valued static social order, while Europe was transforming itself into a commercially dynamic society with an increasing number of creative risk-taking individuals called “bourgeoisie”

• Lesson: Japan must transform itself from the bureaucratic 1940 system to a society of creative individuals


Great Divergence (European Miracle): GDP per capita


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Population Growth

Deirdre N. McCloskeyon the Bourgeois Ethic and the Spirit of Capitalism

• Deirdre N. McCloskey, The Bourgeois Virtues: Ethics for an Age of Commerce, University Of Chicago Press, 2007

• Deirdre N. McCloskey, Bourgeois Dignity: Why Economics Can't Explain the Modern World, University Of Chicago Press, 2011

• Deirdre N. McCloskey, Bourgeois Equality: How Ideas, Not Capital or Institutions, Enriched the World, University Of Chicago Press, 2016


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The Implication of a Simple Growth Model

Production Function: Y = Y(L, K) = A 𝐿𝑎 𝐾𝑏

• The long-run potential growth rate is determined by the growth rate of Labor Input (L), Capital Input (K), and Total Factor Productivity (A)

• If L is growing slow or falling, then K and A have to grow faster to achieve a high Y (GDP) growth

• How? By creating more investment opportunities through innovation!


The Implication of Noguchi’s Hypothesisof the 1940 System

• In addition to the theoretical implication of the simple growth model, Noguchi’s hypothesis of “the 1940 system” implies that Japan must transform itself from a catching-up economy (the 1940 system) to a leading-the-way innovative society

•Question: What are the essential elements of an innovative society? What are the necessary and sufficient conditions for a society to successfully generate innovations?


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An Innovative Society Is Comprised of Creative Individuals and Their Cooperation

• Innovation comes from innovative people

• We need a society of creative individuals and their cooperation because it is the actions and interactions of creative individuals that will bring about new innovations

• Then, the next critical questions are:

(1) how to educate creative individuals, and

(2) how to generate cooperation among them


Two Essentials of Innovative Society: Individual Creativity and Group Cooperation

1. Individual creativity

• Creative individuals produce new ideas and innovations

• Individual creativity is not the same as individual interest (utility) maximization

2. Group cooperation

• Group cooperation produce a synergy effect: 1+1 > 2

• Group cooperation is not the same as collectivism (coercion)

3. Individual Creativity + Group Cooperation => Innovative Society


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The Education for Creative Individuals• An innovative society needs an educational system that

can cultivate creative individuals

1. It is an education that respects individual talents, supports divergent thinking, tolerates deviation, and encourages creativity and risk-taking

2. It is a system in which the government does not dictate what students learn or how teachers teach

3. It is a culture that does not rank or judge the success of a school , a teacher, or a student based on only test scores in a few subjects determined by the government


The Importance of Intrinsic Motivation: Autonomy, Competence, and Relatedness

• Deci’s Proposition 1: Intrinsic motivation is at the heart of creativity,innovation, responsibility, healthy behavior, and lasting change

• Deci’s Proposition 2: A combination of autonomy, competence, and relatedness will generate people’s intrinsic motivation (vitality)

• Deci’s Proposition 3: Extrinsic motivation (such as money, competition, ranking, threat, surveillance, and evaluations) will undermine people’s intrinsic motivation

• Therefore, the authentic goal of education (indeed, a company and our society) should be to foster a social environment that encourages autonomy, competence, and relatedness in and among the people, giving rise to their intrinsic motivation

• Edward L. Deci (with Richard Flaste), Why We Do What We Do: Understanding Self-Motivation, Penguin Books, 1995.


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The Culture of Cooperation

• An innovative society needs not only an educational system for creative individuals, but also the culture (meme) of cooperation

• An innovative society must make the best use of synergy effects arising from cooperation among creative individuals

• From an economic point of view, an important place for such cooperation to emerge is the business firm

• Question: How can we promote cooperation among the members of a group, a firm, and an organization?


Homo Sapiens, Cooperation, and Civilization• Harari’s Proposition 1: Homo sapiens have ruled the world because

they alone can cooperate flexibly in large numbers

• How? They can imagine things and produce their common illusions (fictions, myths, social constructs, and imagined realities) that did not really exist in the natural world such as religion, gods, laws, money, and nations, under which they can form an integrated group and cooperate within the group (to compete against other groups?)

• Harari’s Proposition 2: A dramatic increase in the collective power and ostensible success of Homo sapiens went hand in hand with much individual suffering

• Yuval Noah Harari, Sapiens: A Brief History of Humankind, HarperCollins, 2015.

• Yuval Noah Harari, Homo Deus: A Brief History of Tomorrow, HarperCollins, 2017.


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Multi-level Selection:Cooperation and Competition

• A school of evolutionary biology (led by David Sloan Wilson) argues that evolution is based on the multi-level natural selection, which implies:

1. Selfishness beats altruism within groups

2. Altruistic groups beat selfish groups

• Question: Is competition between groups inevitable? It depends on where one draws the line between groups

• Cooperation is more likely to arise among altruisticindividuals than selfish individuals: therefore altruism is an important factor for the emergence of cooperation


Altruism and the Emergence of Cooperation:Hamilton’s Rule (1)


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Altruism and the Emergence of Cooperation:Hamilton’s Rule (2)

• In Hamilton’s original formulation, r (0 < r < 1) represents a genetic relatedness or a genetic distance between the actor (altruist) and the recipient

• But, we can extend the definition of r to a memeticdistance or closeness in human relationship between the actor and the recipient

• Then, we can extend Hamilton’s theory of altruism to a general theory of altruism and the emergence of cooperation beyond the narrowly defined genetic distance


The Cultural Evolution of Ultrasociety

• Question: How did human societies evolve from small groups, integrated by face-to-face cooperation, to huge anonymous societies of today, typically organized as states?

• Answer: Costly institutions that enabled large human groups to function without splitting up evolved as a result of intense competition between societies—primarily warfare.

1. Peter Turchin, Ultrasociety: How 10,000 years of war made human the greatest cooperators on earth, Beresta Books, 2016.

2. Peter Turchina,1, Thomas E. Currieb, Edward A. L. Turnerc, and Sergey Gavriletsd, “War, space, and the evolution of Old World complex societies,” PNAS, published online, Sep. 23, 2013.

http://www.pnas.org/content/110/41/16384.full.pdf


http://www.pnas.org/content/110/41/16384.full.pdf

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Chapter 8 From a Catching-Up Economy to a Leading-the-Way