In Chapter 2, we saw that the A-firm relies on economies of specialization. This characteristic has generated two important consequences: the development of well-organized markets external to the firm for standardized jobs; and the emergence of job-control unionism, under which jobs are allocated and paid within the firm according to the well-articulated job-evaluation scheme. Economists have come to call this intrafirm job allocation mechanism the internal labor market. The widely accepted neoclassical notion of the firm has been formulated to reflect such developments. The basic rates of pay for all employees of the firm, including managers, are determined in the external and internal labor markets, and the residual of revenue after all contractual payment is made - that is, the quasi rent in economic terminology - is accruable to the ultimate controller of the firm. This ultimate controller cum residual claimant is identified with the body of stockholders. This body exercises, or should be made to exercise if it does not or is prevented from doing so, ultimate control over the business and affairs of the firm by selecting the board of directors, which is in turn responsible for selecting the executive management responsible for the hierarchical control of the internal labor market.

On the other hand, a reasonable impression for the reader to have gained so far may be that the quasi-permanent employee of the J-firm has achieved a clear status in the firm that does not dissolve in the market mechanism.

Overview

A cooperative game in society N consists of a feasible utility set for the grand coalition N as well as a utility set for each and every coalition (non-empty subset) of N, including the coalitions containing one agent only. Each of those 2n —1 utility sets is viewed, as in the welfarist models of Part I, as a feasible set of cooperative opportunities: If the agents in a given coalition all agree on it, they can enforce any utility distribution in this set. The game model does not describe the course of action they must take to achieve this utility distribution. This must be made clear by each particular microeconomic model generating a cooperative game.

We view the cooperative game model as an extension of the axiomatic bargaining model (Chapter 3). The latter specifies the feasible utility set for the grand coalition TV and for each coalition containing a single agent. Indeed, the disagreement utility of an agent corresponds to his opportunity cost for joining the grand coalition. Thus, the only new ingredients in a cooperative game are the opportunity sets of intermediate coalitions (containing at least two, but not more than n — 1, agents).

A treatise on the Japanese economy can never be complete without a discussion on the role of the government, as many in the West believe that a large share of credit for the economic development of Japan goes to the government. The bureaucracy is viewed as a coherent, farsighted planner, which, in close cooperation with the ruling Liberal Democratic Party (LDP), gives a clear growth-oriented boost to the market economy by means of its promotional and protective industrial policy, indicative economic planning, fiscal incentives, stabilizing monetary policy, and so on. An eloquent exposition of this view may be found in the developmental state theory of Chalmer Johnson, but its variations, sophisticated and vulgarized, are not difficult to find among academics, journalists, politicians, and the general public in the West.

There is, however, an equally powerful opposing view, often held by economists, which may be referred to as the market-supremacy theory. It sees the role of the government as being complementary and sub-ordinate to the workings of the market mechanism. According to this view, although the government has certainly provided a favorable environment, the main impetus to growth has come from the private sector - from active business investment demand, high private saving, and industrious and skilled labor operating in a market-oriented environment. Government intervention has merely accelerated trends already put in motion by private market forces. For example, it is argued that economic planning administered by the government may have helped generate a consensus concerning midterm as well as longterm expectations for firms to make macro-consistent investments.

Many decisions of public concern cannot be left to the market because cooperative opportunities will not be efficiently utilized by decentralized actions of the agents. The most prominent examples include the provision of public goods, pricing of a natural monopoly, as well as all decisions taken by vote. To remedy these market failures, welfare economists have come up with a variety of normative solutions and tried to convince the decision makers of their relevance.

The theoretical foundation of these normative arguments is axiomatic. This point was clearly made in Amartya Sen’s landmark book (Collective Choice and Social Welfare, first published in 1970). Since then the axiomatic literature has considerably expanded its scope and refined its methods: The whole theory of cooperative games has played a central role in the analysis of cost sharing when there are increasing returns to scales; our understanding of voting rules now encompasses the impact of strategic manipulations; several refined measurements of inequality have been constructed and abundantly tested; and so on.

This book describes the recent successes of the axiomatic method in four areas: welfarism (the construction of collective utility functions and inequality measures as well as the axiomatic bargaining approach); cooperative games (the core and the two most popular value operators - Shapley value and nucleolus); public decision making (cost sharing of a public good and pricing of a regulated monopoly, in both the first-best and strategic-second-best perspectives); and voting and social choice (majority voting a la Condorcet and scoring methods a la Borda; the impossibility of aggregating individual preferences into a social preference).

Overview

“Democracy uses, as a method of governing, social summaries of citizens' decisions in elections and legislators' decisions in representative bodies” (Riker [1982], p. 21). Indeed, most public allocative decisions (such as taxes and public expenses) are made by voting. Elections are also used to fill many public offices. These are important examples of pure public goods (all citizens of a given town consume their mayor, with no possibility of exclusion) chosen by voting and precluding side payments.

Ever since the political philosophy of the Enlightenment, the choice of a voting rule has been a major ethical question with far-reaching implications on the behavior of most political institutions. The debate about fairness of various voting methods has been with us since the contributions of de Borda [1781] and Condorcet [1785]. In 1952, Arrow proposed the formal model that framed for three decades a voluminous mathematically oriented literature known as social choice (see Arrow [1963]). It studies the properties of various voting rules from an axiomatic angle. The object of Part IV is to discuss the most important contributions of the social choice approach.

Formally, a voting rule solves the collective decision problem where several individual agents (voters) must jointly choose one among several outcomes (also called candidates), about which their opinions conflict. In this chapter we assume that a finite set N of voters must pick one candidate within a finite set A (we discuss other options in Chapter 10). For simplicity we assume that individual opinions (or preferences) display no ties; they are arbitrary linear orders of A (i.e., complete, transitive, and asymmetric binary relations). This assumption entails no serious loss of generality.

In Chapter 2, I suggested that the internal efficiency of the J-firm, where it exists, may be largely due to the quality of the information structure institutionalized within it. That structure is characterized by rapid intrafirm communications, which are necessary for the coordinated adjustment of constituent operations in reaction to global (market) shocks as well as the decentralized handling of local shocks to minimize their impact on the system as a whole. Undoubtedly the quality of such an information system depends to a great extent on the information-processing capabilities (intellectual skills) of the workers who operate the system. I now turn to the problem of how such human resources can be accumulated and maintained within the firm. This is essentially a question of providing the employee of the J-firm with the incentive to develop the skills, knowledge, expertise, and cooperative attitude needed to effectively operate the horizontal informational structure.

This incentive problem has two aspects: the collective and the individual. The former provides appropriate incentives for firm-specific human resources as a whole, as distinguished from the firm's financial resources. I have already alluded to this aspect in Chapter 2 and will come back to it more fully in Chapter 5. This chapter deals with the latter aspect, that is, the way in which the J-firm provides its individual employees with an appropriate incentive package for competing in the development of skills, knowledge, and expertise useful to the firm, and for cooperating with one another when necessary.

Overview

The egalitarian and classical utilitarian programs, in spite of all their differences, have one common functional feature. Both utilize a collective utility function (CUF) aggregating individual utilities into a single utility index representing the social welfare. Within the feasible utility set, they then select the socially optimum utility vector by maximizing the CUF. This function is the sum of individual utilities for classical utilitarianism and their minimum for egalitarianism (see Chapter 1).

The welfarist axioms considered in this chapter develop this anthropomorphic idea. Society's welfare is described by a collective utility index computed mechanically from individual utilities. Thus, collective choice follows the same rationale as individual choice: “Il faut que les méthodes d'une assemblée délibérante se rapprochent autant qu'il est possible de celles des individus qui la composent” (Condorcet [1785]; the methods of a deliberating assembly must be as close as possible to those of its individual members). In particular, any two vectors of individual utilities can be compared, and those comparisons are transitive.

The primary economic application of CUFs is to the measurement of inequality. Estimating the welfare consequences of the distribution of incomes (or of that of any variable related to individual welfare) is an important task of public economics. Doing this systematically means that we must be able to compare any two income distributions and tell which one yields the highest social welfare. In other words, we must choose a social welfare ordering (SWO). This choice will be guided by additional ethical postulates. The consequences of those postulates on the mathematical form of the SWO is the subject of this chapter.

This book presents a microanalysis of the Japanese economy from the perspectives of information, incentive, and bargaining-game theories. It is not another parable of Japan's economic success.

Many people think that the Japanese economic system does not altogether fit the textbook model of the market economy. Is it because the Japanese economic system is culturally unique? Or is it that the textbook description is too simplistic for analyzing the rich reality of modern market economies of various types? In this book, I have sought to describe and explain the competitive workings of the Japanese microeconomic system in terms familiar to Western economists, although I have tried not to ignore entirely the possible impact of cultural factors.

In pursuing this goal, however, I have been compelled to examine critically some textbook notions about the microstructure of the market economy (e.g., hierarchy as the alternative to the market, the firm as a property of stockholders, market-oriented contracts as the incentive scheme, innovation as a direct application of invention, among others) that have strongly shaped and influenced the economists' approach to industrial organization. Although these notions constitute an appropriate foundation for the analysis of the highly market-oriented Western economy, it is necessary to go beyond those “specific” notions in order to arrive at a more complete understanding of the Japanese economy. At one level, therefore, this book may be regarded as a study of comparative industrial organization.

Overview

The most ambitious task of cooperative game theory is to build a universal solution concept based on widely acceptable equity axioms, picking out of every cooperative game a unique utility distribution, just as the social choice function of Chapter 3 does. Such an object is called a value, or value operator. For more than 30 years, this viewpoint has been tested for TU games. By and large, it proves to be successful. Surely, no single solution concept has emerged that would satisfy everyone's sense of equity for all TU games. All the same, no single social choice function is the universal panacea of axiomatic bargaining (see Part I). However, two prominent values have been discovered and prove useful in a wide range of economic models. These are the Shapley value and the nucleolus, to which most of the discussion of this chapter is devoted.

In a nutshell, the nucleolus applies egalitarianism to TU games, whereas the Shapley value follows from a utilitarian principle. Indeed, the nucleolus minimizes the leximin SWO over long utility vectors in which every coordinate corresponds to a different coalition (see Definition 5.4). The Shapley value, on the other hand, renumerates each agent by averaging his marginal contributions to all coalitions containing him; it is utilitarian inasmuch as classical utilitarianism (Chapter 1) is likewise based upon average utility. Accordingly, the nucleolus tends to be harder to compute than the Shapley value (just as maximizing the leximin SWO is a more involved program than maximizing the utilitarian one).

Overview

In plurality voting it is sometimes rational to cast one's vote for another candidate than one's first-best choice: If I know that my most preferred candidate a will not pass because b and c are both going to get more votes, then I had better help whomever of b, c I like more. In any voting method when a voter realizes that his own vote may influence the final outcome, he thinks twice before casting it. Maybe the naive ballot suggested by his true preferences does not serve his interest best. Rather than passively reporting his opinion about candidates, he acts as a player in the game of election, trying to maximize the returns from his vote.

In real-world elections it is impossible to distinguish a strategically biased report of a voters' preferences from a truthful one. One's opinion is private information de jure, and hence an openly untruthful report is a perfectly legal move.

Several early analysts of voting methods were aware of their strategic aspects, thought of as the nuisance of a dishonest vote; see the quotation by Borda in Straffin [1980] or by Dodgson in Farquharson [1969]. A mathematically rigorous attack of the problem has come only in the last 15 years. The seminal question is this: Can we design a strategyproof voting rule, namely, such that each individual voter would always want to report his opinion truthfully while isolated in the voting booth?

So far I have treated the human resources and the financial resources of the J-firm separately. I have also emphasized the competitive aspect of individual incentives and the possible conflict of interests between different types of stockholders. In this chapter, I deal with the collective interests of quasi-permanent employees and stockholders and analyze the way they interact at the J-firm with the mediation of management. It is assumed that various interests of quasi-permanent employees are aggregated and represented by the enterprise-based union. The possible deviation from share price maximization on behalf of the bank stockholder may be regarded as the agency fee that individual stockholders pay the bank for its monitoring function, although I do not deal with this cost explicitly here. I assume that the body of stockholders is interested in share price maximization.

These two bodies are considered to be integral elements of the J-firm. The efficiency of the decentralized micro-micro information structure of the J-firm as discussed in Chapter 2 depends on the information-processing capabilities of the quasi-permanent employees who participate in it; and information that is generated, processed, and developed within the structure is accumulated and shared among them. They even contribute to a nonnegligible portion of the capital of the J-firm in the form of the accumulated claims for separation payment and future seniority premiums. On the other hand, the body of stockholders contributes an increasing amount of equity capital to the J-firm that is transformed into physical assets that are not readily malleable.

In Section 4.1, we saw that predominant intercorporate stockholdings in Japan have given rise to two types of corporate groups: capital-keiretsu, or subsidiary groups; and former zaibatsu, or financial keiretsu. In this chapter, I focus on the transactional aspects of these two groups. In dealing with the first type, however, I concentrate on a special class of capital-keiretsu characterized by a particular transactional feature, that is, the subcontracting group, which is a stratified, quasi-permanent group of suppliers subcontracting to a major manufacturer.

The bargaining game analysis in Chapter 5 suggested that the coalitional firm tends to limit the size of its employment in order to protect the vested interests of its incumbent employees. I have called this phenomenon the “dilemma of industrial democracy,” because the voice of incumbent employees is enhanced within the firm to the detriment of outsiders' interests. I have argued that this dilemma is manifested in the J-firm in the form of differential employment status (such as that of part-time workers) and have hinted that, to some extent, the increasing hiving off of subsidiaries and reliance on subcontractors by the J-firm may be a similar phenomenon. This may sound like the old dual structure hypothesis: Large Japanese firms exploit their monopsonic positions to make use of smaller subcontracting suppliers as a business cycle buffer.

But the subcontracting group formed by the major contracting firm and its satellite supplier firms is a complex economic institution.

Overview

A voting rule compromises between the voters' conflicting claims by picking a single outcome from each preference profile. In his very influential book, Arrow [1963] proposed a more ambitious goal to the social planner, that of aggregating the preference profile into a complete ordering of outcomes. This ordering is meant to reflect the level of social welfare at any one of the outcomes, including the suboptimal ones. If exogenous constraints prevent the planner from implementing a socially best outcome [i.e., a maximal outcome of the social welfare ordering (SWO)], the social ordering allows him to distinguish the welfare-improving changes of outcomes from those that decrease social welfare.

The thrust of Arrow’s approach is his axiom independence of irrelevant alternatives (AHA). It states that the (social) welfare comparisons within any given subset of outcomes should not depend upon individual preferences outside this subset. Hence, AHA limits the information one may use when comparing two outcomes a and b: The voter’s preferences among these two (who prefers a to b, who prefers b to #, who is indifferent?) should be all that matters to form the social preference about a, b. The bite of the axiom is to reduce the task of defining an ordering of all outcomes to that of solving all pairwise comparisons and to check if those comparisons together form a transitive SWO. But pairwise comparisons are easy to solve.