Q&A WITH MASAHIKO AOKI

Masahiko Aoki, 60, is a Stanford University economist who is known internationally for his work in comparative institutional analysis. One year ago, he was appointed head of Japan's Research Institute of International Trade & Industry, a prominent think tank that drafts policies for the Ministry of International Trade & Industry (MITI). Aoki, who divides his time between Stanford and MITI, explains why Japan is lagging behind the U.S. in information technology [IT] in a recent interview with Business Week Tokyo Correspondent Irene M. Kunii. Here are excerpts of their conversation:

Q: What do you think is wrong with the Japanese corporate model?
A: Japan is facing a critical period of time. Large Japanese companies tend to be closed and centered on the lifetime employment system. There is little information sharing. This was efficient in the 1960s and 70s when we needed a high degree of coordination. But now that the world is changing, these companies need to change as well. For example, they could start by appointing outside members to their board of directors. In the government, bureaucrats who until now have dictated should start to interact more with academics and business people.

Q: Japanese policymakers now look to Silicon Valley as a model for the future. What do you think of this?
A: You have to remember that in the mid-1980s, Silicon Valley was not doing well while Japanese industry was shining. Elsewhere in the U.S., Detroit auto makers and companies like IBM had huge hierarchies with little internal communication. On the other hand, Japanese organizations had introduced their own mechanism of info-sharing. The [Japanese] auto industry founded development teams that helped boost productivity and improved info-feedback. It was a source of innovation at the time.

Facing this challenge and using its IT knowhow, the U.S. created a new model of innovation. In Silicon Valley, there is a loose cluster of startups that are trying to develop new products without coordinating with other firms...what we call decentralized competition. If you combine these products, an interesting system begins to evolve.

Q: Why hasn't it happened in Japan?
A: Japanese companies have become too big. In order to develop products, a company like Toshiba wants to make everything itself, such as the software, the peripherals, and the key devices. In Silicon Valley, companies concentrate on their own areas of specialization. In the end, these best products are combined to make something even better. But it's difficult for Japanese companies to do this because of their size and tendency to keep unprofitable divisions in operation.

Q: Toshiba, which makes everything from electric switches to nuclear power plants, has said it's interested in setting up a holding company to oversee independent division companies. Will this help?
A: Look at General Electric. It's big, but it's based on a divisional system. Each division has to maintain profit levels, and if it doesn't, it's closed down. Sony and Matsushita are trying to emulate the GE model, and even Toshiba will eventually adopt the holding-company sytem and close down unprofitable departments. If profit centers are created, it will help improve productivity.

Q: What are some of Japan's strengths?
A: Software is said to be lacking in Japan, but look at the game software industry and that of "anime" [Japanese animation], which are doing well. Five years from now, Japan will be strong in information appliances, and that's why a company like Microsoft is making alliances with Sony and Matsushita.

Q: Does Japan have a future in the Information Age?
A: In a sense, I'm not that pessimistic. Industry will be to be reorganized, and that will take time. Holding companies have been legalized [this year], but there are still no tax incentives. So we need a consolidated tax scheme to help improve productivity. I've been encouraging MITI officials to speak out on this issue in their dealings with the Ministry of Finance [MOF]. But Japan is now too pessimistic. There seems to be a collective manic depressive syndrome, with the politicians making matters only worse. They are too entrenched and not looking after the interests of the country.

Q: What can be done to encourage more high-tech startups?
A: In Japan we need more innovative intermediaries to take the role of venture capitalists.... Japanese trading houses could play the role of financiers and give assistance to startups to nurture small companies. This would invigorate the economy. The role of MITI is to facilitate this change by pushing for new laws that make change possible.

Q: What do you see as a major hindrance?
A: The strong collusion between politics, bureaucracy, and big business, which is hard to change. The so-called "iron triangle" was started by MITI and then expanded to the rest of government. In the 1960s and 70s, its aim was to nurture industry. There was a shortage of labor, so it was important to overcome a dual structure of labor and wages.... MOF became mediators in drawing up the budget and thus built up their power, while politicians representing interest groups lobbied the MOF officials for a share of the budget. In MITI's case, it set up regulations to protect industry. But export-based companies like Sony didn't need MITI's protection and drifted away. Because they are the most successful, they are now the most heavily taxed and are supporting the least productive sectors like banking and retail.... If Japan continues to do this, what will stop companies like Sony from moving operations overseas?