In the 121 years from 1868 to 1989, Japan had developed from a traditional, feudal society into the world's second largest economy, one of the world's top three trading nations, the world's largest creditor nation, the country with the world's longest life expectancy and the highest per capita GDP (measured at the exchange rate, not PPP), and seemed poised to overtake the U.S. as "Number One."The last decade has not been so kind to Japan. Their stock market collapsed and other asset prices fell sharply, their financial system has been burdened with large amounts of bad debt, and their economy has alternated between anemic growth and recession. Yet as much as the fears of Japanese dominance a decade ago were misplaced, so too is it inappropriate to discount Japanese potential in the decades ahead.
Japan before 1868
Japan has a royal family dating back millennia, and tradition has it that the emperor is directly descended from the goddess of the rising sun. It has remained independent, even though it was heavily influenced by China -- importing, for example, Chan Buddhism, Confucianism, and Chinese characters (hanzi) but then transforming them into something uniquely Japanese, like Zen, bushido, and kanji. They even imported Chinese-style coinage (wado-kaihou) in after 708, though unfortunately the metal content and value of the coinage was debased over time as warlords took advantage of the rights of siegnorage, and the resulting inflation led to the return of a barter system in places and the substitution of Chinese money where available.
After 1185 the Emperor still ruled nominally in Kyoto, but real power was in the hands of generals (shoguns) and local warlords. Japan successfully fought off several invasions by the Mongols who conquered most of Eurasia in the 12-14th Centuries, in part due to lucky weather (the divine wind, or kamikaze). Some of these warlords invaded the Chinese coast from the 1550s through the 1590s. They were called Japanese pirates by the Chinese, though some of their leaders were actually Chinese given Japanese military assistance. They were more like Vikings than pirates, and like the Vikings eventually began to set up their own rule in coastal areas. This conflict interfered with the China trade, which was the trade of silver for Chinese silks, tea, and porcelain, and as a result helped to set off an economic crisis that eventually collapsed China's Ming Dynasty (1368-1644) and led to China being ruled by the Manchus until 1911.
In 1590, Japan's various warlords were unified under Hideyoshi Toyotomi. In 1603, the Tokugawa family established a shogunate that ruled Japan until 1868. In the 1500s, Portuguese traders and Jesuit missionaries threatened to dominate Japan, but were expelled by the Tokugawa shoguns. Thereafter, foreign trade was limited to a small island outside the harbor at Nagasaki (China, too, limited their foreign trade to a small island in the river at Canton, or Guangzhou). The Tokugawa policy that forbid foreign contact was called sakoku, and it was severe. Even foreign sailors who were shipwrecked off the Japanese coast were executed.
Under the Tokugawa shogunate based in Edo (later Tokyo), Japan was a stable, isolated, agricultural (rice-based), reasonably prosperous, and very feudal society. The Tokugawa ruled in the Emperor's name, and power was decentralized to local lords called daimyo. Somewhat reminiscent of the Chinese Confucian class system of shi-gong-nong-shang (scholar-soldier-farmer-trader), Japanese society was divided into the rigid shino-kosho caste system of samurai, peasants, merchants, and even untouchables who were either landless or engaged in trades like butchery.
Trade within Japan grew, however, and the Tokugawa standardized gold and copper coinage to aid in trade. Private paper money was issued, and merchant banks developed that initially enabled safe payment over distances and later made loans to daimyos and peasants. One notable example is the Mitsui exchange, which expanded from Edo to Kyoto and Osaka in the late 1600s. Between 1695-1711 the Tokugawa attempted to earn siegnorage from their control of coinage and again debased the currency, causing an inflation. By 1715, the resulting silver outflow led to a halting of foreign trade. The government changed policy again to the other extreme and a deflation resulted, then by 1736 prices stabilized. Between 1818-1837, two budgetary crises again caused a rapid growth of the money supply and resulted in prices doubling.
In 1854, the Pierce administration sent Commodore Perry and his "black ships" to Japan, and when he sailed into Yokohama harbor he intimidated Japan into signing a treaty opening up Japan to foreign contact and trade. This was seen as a wake-up call for many Japanese, and they blamed their military inferiority on their isolation. In 1868, landless samurai overthrew the Tokugawa under the banner, "revere the emperor, expel the barbarian," and restored power to the 16-year-old Meiji Emperor.
The Meiji Restoration
Under the Meiji Emperor, from 1868-1912, Japan tried to modernize, learn from the West, and develop both its economy and its military. This approach was in stark contrast to the Chinese approach, which continued to retreat from the foreign barbarians into traditional culture, hoping that eventually they would tire or become civilized (Sinocized). The shino-kosho system was dismantled and half the government's budget went to paying off the former daimyo and samurai. With these payments, many of them went into private business, and the resulting business class automatically had the respect of society. Land was redistributed to the farmers. Japanese students went abroad in large numbers to learn about western technology, and by the 1890s Japanese universities had developed to the point where they were attracting the more modern-thinking of the Chinese scholars. The Japanese government invested also heavily in industry, infrastructure, and the military, and many industries were nationalized until a fiscal crisis in 1883 encouraged their privatization. A postal savings system was developed to encourage savings by average Japanese citizens, and the resulting savings eventually allowed for more investment. Japan's modernization, high savings rate, export orientation, capital formation, and rapid industrialization led Japan during the Meiji Restoration to become the world's fastest growing economy at the time.
Japanese government expenditures were originally financed by a small tax base and the creation of new money, but this caused inflation and hampered development. In order to provide for a stable money supply, the Japanese government first adopted a national banking system in 1872 (like the U.S. had from 1863 to 1913), and then in 1882 after a financial crisis adopted instead the European model of a central bank. In 1884 the Bank of Japan became the sole source of money, though it was under the authority of the Ministry of Finance, and it worked with the Yokohama Specie Bank in the management of foreign exchange.
During the Meiji Restoration, Japan became the fastest growing economy in the world. Japan became an exporter to the west in many labor-intensive manufactures, such as textiles, and Japan's military also became more powerful. In 1895, Japan defeated China in a short war that began in part over Korea, and resulted in China giving up Taiwan and Ryuku islands. In 1905, Japan defeated the Russian Empire in a war over influence in Manchuria and Korea, and the defeat caused riots in St. Petersburg and significant political reforms, including the founding of the Russian Duma. In 1910, with secret U.S. agreement, Japan annexed Korea, and Japanese rule resulted in bitter feelings towards the Japanese even today.
Japanese government policy encouraged mergers and cartels, and Japan began to develop into a dual industrial structure. On one hand was the Zaibatsu, huge conglomerates controlled by a single rich family through a series of interlocking directorates, with easy access to the government credit and the Bank of Japan as well as control of the big banks. On the other hand was a private, small-scale, and more competitive industrial sector with risky, poorly-capitalized banks subject to fraud and abuse. Government policy allowed the big firms and banks to essentially control the financial sector and much of the economy.
In 1923, the earth shook under Tokyo in a major earthquake, buildings collapsed and fire spread out. Over 133,000 people died, dwarfing the recent disaster in Kobe. Banks were encouraged by the bank of Japan to lend heavily in order to reconstruct, and in 1927 the extent of the bad debt became public knowledge, causing a run on the Tokyo Watanabe Bank and spilling over to other many banks in a scene foretelling the U.S. financial crises of the Great Depression. As a result of the financial crisis, the government passed a new banking law in 1928 that gave the Ministry of Finance great powers to regulate banking. Banking became extremely concentrated, especially after the government began to mobilize for war.
Japanese politics became less stable and democratic as a result of the rise of military aspirations. Leading politicians in favor of civilian control were often assassinated by young officers, and the Japanese military came to dominate Japan's government. In 1931, Japan took control of Manchuria, the northeast portion of China, and set up a puppet government called Manchuguo under the last Manchu Emperor, who had abdicated as a boy. In 1937, Japan invaded China proper, crossing the Marco Polo Bridge in Beijing into North China and also attacking along the East, moving from Shanghai upriver to the Chinese Republican capital of Nanjing, forcing the Chinese to move their capital upriver to Chongqing, in Sichuan province. In an effort to demoralize the Chinese, the Japanese military went wild in Nanjing once they captured it, and butchered the inhabitants in a two week frenzy. Hundreds of thousands of civilians died. In 1941, Japan entered into World War II, and seized U.S., British, French, and Dutch possessions throughout Asia, in an effort to create what they called the East Asia Coprosperity Sphere. Key to Japanese goals was the Indonesian oil fields, since the U.S. had threatened Japanese oil supplies.
Occupation
Of course, Japan lost the war, Taiwan was returned to China, and Korea was occupied by both Soviet and American forces at the 38th parallel. U.S. forces occupied Japan through 1952, most of the time under the command of General Douglas Macarthur. Macarthur attempted to democratize, decentralize, and demilitarize Japan, but also followed policies emphasizing continuity and redevelopment. A new constitution was written, labor unions were legalized, land was again redistributed, military officials were purged from the government and some were tried for war crimes, minor parties were legalized (even the socialist and communist parties), and the Zaibatsus were broken up. But the Emperor Hirohito remained in power, though he was forced to renounce his divinity, and traditional elites continued to dominate in both business and in politics. Key American advisors to Japan at this time included Deming, who advocated processes of high quality production, and Joseph Dodge, who advocated economic austerity programs and monetary stability.
The Korean War, which began in 1950, had a major effect on the Japanese economy, since the American military provided a big demand boost to the Japanese economy, and American cold war policy tolerated policies promoting exports and restricting imports from the U.S. to bolster an important Asian ally. Still, it took until 1954 for Japanese GDP to recover its prewar levels. In 1955, the leading conservative parties merged to form the Liberal Democratic Party, which dominated Japanese politics through 1993, and through 1973 the Japanese economy grew at an annual rate of about 10 percent per year.