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Russian re-industrialization dangers – lessons from Japan and USA

September 11, 2019
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Russia’s greatness is in the resilience, endurance and inner strength of her people. They have recovered from many devastating tragedies that have befallen the country, from the Mongol scourge to civil war, and from the fascist invasion of the mid-20th century to the tragic decade that followed the collapse of the Soviet Union.

Because of that terrible decade, Russia finds itself once again having to regroup and rebuild, to get back to the position of technological superiority that had reached its peak, ironically, just before the dissolution of the USSR.

It is well known that Russia successfully accomplished several cycles of re-industrialization and modernization, going back to the ‘Great Reforms of 1861. After the precipitous drop of the First World War and Civil War came the recovery of the New Economic Policy, followed by the jump in industrial output just before and during the Great Patriotic War.

Soviet industrialization resulted in modernization, innovation and the technological leadership of the post-war years. The momentum from this carried the country all the way to the end of the Soviet Union.

Since then, natural resources have been an incredible strategic buffer, even as Russia fell behind in technological leadership. Russia has had the luxury of falling back on raw materials as an engine of economy, to help it weather the worst of this downturn.

Famous Russians such as Yermak Timofeyevich, Konstantin von Kaufman, Mikhail Skobelev and others opened the path to this strategic buffer and the enormous natural resources of the Russian East. Russia should be profoundly grateful to them for having provided the country with such a strategic fallback.

In this context, Russia should be equally grateful for the sacrifices of the Red Army under Marshal Vasilevsky during the Manchurian Strategic Offensive of 1945, especially that of the 16th Army (along with units of the Red Fleet), which returned the oil riches of Sakhalin to Russia – the then unexploited oil riches that had been lost after a harsh and unequal treaty imposed on the country by expansionist Japanese invaders, following the Russo-Japanese war and the military disasters suffered by a decaying Tsarist Russia on the brink of revolution.

But natural resources are merely a safety-net for Russia during difficult times. The emphasis will always have to be on industrialization and technology. The sooner Russia regains its technological prowess, the sooner it can stop being a mere supplier of raw materials and return to its rightful place in the world.

There are other issues facing Russia. Of course, Russian leadership will be well aware of the situation, and will have assessed the risks before choosing the best possible path from among the options available to them. Nevertheless, Russia has to tread very carefully to avoid becoming a junior partner in Eurasia.

Russia needs strategic Eurasian balancing to prevent such an asymmetry from developing with its Eurasian partners. India is one possibility for Eurasian balance, but the Indians are leaning more and more towards the US, partly because of the trade volumes between those two countries.

It is in Russia’s interest to create circumstances for increasing trade with India. This has to be by developing access to the Indian oil and gas market as soon as possible, as well as creating hi-tech cooperation and joint technology development for the longer term.

This is the first part of a three-part series on re-industrialization, Russia developing hi-tech and oil & gas business with India as a Eurasian balance, and bringing together Russia, China and India – the three Eurasian powers.

The series begins with ‘Russian re-industrialization dangers’, a cautionary overview of Japanese re-industrialization and the problems that Japan underwent – from its meteoric rise to the top, to its equally precipitous fall since the 1990s.

Next, ‘Bridges to India’ is about hi-tech possibilities for Russia and India, and the urgency of creating access to the Indian oil and gas market for Russian products.

Finally, ‘Eurasian Triple-Entente’ is about a possible Russia-India-China collaboration, with Russia’s potential as mediator and balancing factor between India and China.

Re-industrialization pitfalls: Japan and the US

There are numerous analyses to understand how developed and developing economies work.

In summary, countries with developed economies, with developed markets and developed industries, can afford to operate in a free market mode. Such market driven systems have very little centralized planning, where the government merely involves itself with rules, procedures and regulatory issues, rather than in setting economic goals.

Countries which are 'catching up' usually operate in some variation of a 'plan-oriented' system, using centralized incubation, entry barriers, and subsidies to help domestic companies defend against foreign competitors, while using international competition to make sure that such domestic products do not fall into low-quality, protected mediocrity.

A plan-oriented system partly explains how Japan recovered so quickly in the decades immediately after the devastation of World War II.

In contrast, most of America is in a free market system, except for one glaring exception – the defense industry. The American military industrial complex is the closest US equivalent to the post-war Japanese plan-oriented system.

It may be valuable for significantly de-industrialized countries in catch-up mode, such as Russia, to examine how and why the Japanese post-war economy succeeded so spectacularly in the beginning, as well as the reasons for its subsequent loss of momentum, stagnation and fall, as a cautionary example of dangers to be avoided.

Japan's recovery in the decades that followed the war, which the Japanese call the 'Great Economic Miracle', was a direct result of close post-war strategic cooperation between Japan's MITI (ministry of trade and industry), MOF (ministry of finance), the central Bank of Japan (BoJ), as well as key corporations and banks.

The Japanese government controlled entrepreneurship and even product development. It set economic goals, targeting specific industries for growth, and as the means to improve Japan's international competitiveness.

The BoJ issued orders to banks on how much they would lend in each quarter and which types of customers they would lend to, via credit controls and diktats they called 'window guidance'. MITI, BoJ and MoF encouraged certain industries and discouraged others, using window guidance as the control mechanism.

The Japanese economy had been on a war-footing since the 1930s. In the 1950s and 1960s, Japan remained on that wartime basis, preserving most of the wartime systems and arrangements, while now producing consumer products.

The cold war also had a huge impact.

Immediately after the Second World War, America focused on creating a US approved model of democracy in Japan. De-industrialization was the prime objective, as cover for American plans to de-militarize Japan – similar to the de-industrialization that was attempted later in Russia, following the collapse of the Soviet Union.

But when the cold war in Europe started percolating into Asia, this began to change, as Japan became a strategically important Asian partner.

Then, when Kim Il Sung invaded the Republic of Korea, US policy towards Japan changed abruptly. Not only was Japanese industry revived to supply munitions and war materiel to US troops in Korea, but Japan became a prized cold war ally.

For the duration of the cold war, Japan's protectionist policies were ignored by the US, as were Japanese funding subsidies and government sponsored predatory international competitive practices.

Japanese fascism, militarism, war crimes and atrocities were swept under the carpet. American media, academia and the political establishment began to portray the Japanese as a harmony-loving, peaceful and industrious people. The Japanese were now shrouded in some vague and concocted spirituality of obscure, propagandized Shinto and pseudo-Buddhist origins.

But by the mid-1980s, once the Japanese stopped being followers in catch-up mode and became world leaders, Japan proved too rigid to adapt, and could not change from their plan-oriented system to the free-market mode that was then required. They soon got bogged down and stalled.

Other countries which were in catch-up mode were able to compete and win using variations of the post-war Japanese model, just as Japan itself had won in previous decades on its own path to the top.

Simultaneously, internal bureaucratic power struggles had disastrous effects on the Japanese economy, when interest rates, bank lending guidelines, and other economic policies became pawns in the in-fighting between the BoJ and MoF.

Ill-advised and short-sighted government borrowing, which have led to Japan now having the highest government debt in the world, was another factor.

Speculation and unsophisticated investment in Japan’s real estate, whose unrealistic valuations were a source of mistaken pride and nationalistic exultation for the Japanese at the time, also contributed to their fragile house of cards, which ultimately came crashing down.

By the 1990s, Mikhail Gorbachev's actions and the collapse of the Soviet Union significantly lessened the importance of Japan as an American cold war ally. Japan's predatory business policies and strategies no longer had to be tolerated by the US. Japan was forced to retreat, under threat of US trade barriers and tariffs, further slowing the Japanese economy.

It can thus be said that Kim Il-Sung of North Korea helped create the post-war Japanese economic miracle, and Mikhail Gorbachev helped destroy it.

Japanese re-industrialization can be characterized by rigidity, inability to react quickly and decisively to adversity, and ultimate failure. In marked contrast is the success of its US counterpart – the American military industrial complex – with its flexible approach and success in quickly adapting to changing realities.

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Source: Expert-online

George Kennan, intellectual father of the cold war and originator of America's 'USSR containment policies', famously said in the 1980s that if the Soviet Union were to vanish, the US military industrial complex would have to remain unchanged until a new adversary was found or created, since destabilizing it would result in a fatal blow to the US economy.

However, the American military industrial complex changed completely, reacting quickly, flexibly and effectively to reconfigure itself into survival mode, when faced with enormous budget cuts following big changes in the 1990s.

The ink had barely dried on Gorbachev's resignation as President of the Soviet Union when the Pentagon sprang into action. Anticipating drastic budget cuts after the fall of the USSR, the Pentagon actively guided and coaxed companies of the military industrial complex to merge, pool resources and position themselves to weather the coming budget storm.

During the now famous 'Last Supper' of 1993, Secretary of Defense Les Aspin, assisted by William Perry, who would succeed Aspin as SecDef in 1994, ordered CEOs of many of the U.S. aerospace defense contractors to merge themselves into three or four companies, to streamline processes and cut costs.

Major defense contractors such as Lockheed and Boeing went on a Pentagon approved shopping frenzy, acquiring many of the smaller defense contractors. In a few years, a defense aerospace industry that had previously had fifty-one principal companies was forced to consolidate into a mere five survivors – Lockheed-Martin, Boeing, Northrop Grumman, Raytheon and Litton.

Similar things happened in various other segments of defense procurement.

In forcing this re-alignment of the US military industrial complex, the Pentagon was taking several risks, since industry consolidation often results in monopolies, with serious adverse effects on innovation, cost-performance, quality and overall cost-effectiveness.

The Pentagon would also lose power in negotiating defense contracts, since there would be far fewer players and fewer sources available to the Pentagon for systems procurement.

But the budget cuts demanded drastic action and risk taking, as a matter of survival.

Besides, hi-tech warfare was changing dramatically. Especially with cyber- and info-wars, it would be more effective for the Pentagon to have its contractors buy and adapt innovations and technologies developed by America's civilian hi-tech world. This brought the US military industrial complex to the well-established and efficient American system of startups, venture funding, IPOs, mergers, acquisitions and high-growth models.

While large players of the old military industrial complex were still needed for expensive items such as warships, combat aircraft and so on, many new hi-tech approaches to war fighting could be developed by smaller companies, with the large companies doing program management and system integration.

This period of austerity, cost cutting and innovative military procurement models allowed the industry to survive, until the 9/11 attacks on the US led to boom years for the military industrial complex.

The anticipation, forecasting and flexibility of this US system have to be studied and lessons incorporated in the structure of any Russian re-industrialization, while avoiding Japan's mistakes.

Above all, bureaucracy and rigidity cannot be allowed, or the process will be doomed to mediocrity and failure.

The best model to understand technology innovation, and how it can create new industries, is America’s Silicon Valley.

Of course, as Aleksandr Svechin said about military strategy – each war has its unique logic and should not be the application of a standardized template. Similarly, in the re-industrialization of Russia, Silicon Valley cannot be a universal template for a Russian system. However, it offers extremely valuable real-world knowledge, in spite of the differences between Russian and American ways.

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