Industrialization and State-Guided Capitalism: 1868–1945

In the early 1870s, shortly after the Meiji Restoration, Japan's new political leadership faced the problem of Western imperialism. Japan's oligarchs quickly decided to build both a strong economy and a strong military in order to negotiate with Western Europe and the United States on an equal footing. Meiji leaders systematically studied various economic models and decided to adopt a system of government-directed capitalism based on recently unified Germany rather than the Anglo-American capitalist system. Although private markets function in both systems, in government-directed capitalism, particularly in the case of heavy industry and exports, the state plays a larger role in determining what is produced and then allocates capital to private business through state control of the financial system. In government-directed capitalism, free trade is considered harmful much of the time, and politicians and bureaucrats exert more efforts than in the Adam Smith–influenced Anglo-American laissez-faire model to protect domestic industries from foreign competition. Most important, in the Japanese version of state-assisted capitalism, the economy was primarily viewed as existing to serve the interests of the nation and not the individual.

To aid industry, the Meiji government quickly established a national currency and banking system, which in turn greatly facilitated the flow of savings to the private sector. Meiji leaders were highly successful in establishing a modern national communications and transportation infrastructure by building telegraph and railroad lines. The government began such large-scale economic enterprises as coal mining and shipbuilding and later sold them to private interests. Meiji leaders also engaged in activities including educational improvements, export promotion, importation of foreign technology, and encouragement of private business.

Meiji Japan's successes in exporting and industrialization were particularly important because these actions helped to cause even greater economic success in the early 20th century. The Japanese were also fortunate in the early Meiji years in that raw silk, a large peasant industry that had roots in the Tokugawa years, enjoyed high worldwide demand. This demand, partially due to a disastrous European silk blight, subsequently enabled Japan to export massive amounts of silk and thereby raise the money to import equipment and raw materials for heavy industrialization.

By the Meiji emperor's death in 1912, Japan was well on its way to developing heavy industry. Japan's economy grew despite a few setbacks and steadily improved during the Taisho period (1912–1926) and during the first years of the Showa period (1926–1989).

In the early part of the 20th century, World War I was a tremendous boon for the Japanese economy. Exports quadrupled and such important heavy industries as shipbuilding, iron, and steel, although still minor compared with textiles and agriculture, showed steady growth. Despite hard agricultural times and a world depression, the 1920s and 1930s brought continued long-term growth in Japanese manufacturing. In 1935, industrial production became, for the first time, more financially valuable to the economy than agriculture. Although textiles remained a leading export, such other industries as steel, rayon, and shipbuilding made major gains. By 1937, Japan possessed the world's largest merchant marine fleet. In the same year, largely because of the military buildup, total heavy industrial production for the first time surpassed light industry in value.

As the Japanese empire expanded into Manchuria and then China in the 1930s, government bureaucrats and private company employees gained experience, as had been the case earlier in the colonies of Taiwan and Korea, in joint economic planning and even in successful foreign investment. Although Japan incurred a tremendous human and economic cost because of World War II, it is important to understand that this catastrophe could not erase the human know-how in industrial production, management-labor relations, and government and business economic development that had been growing in Japan for decades. This knowledge would prove vitally important as Japan struggled to rebound from the worst disaster in the nation's history.