By Eamonn Fingleton
(c) 1995, Eamonn Fingleton

This is an excerpt from Blindside as published in Fortune on March 20, 1995.

No aspect of Japan's remarkable economy has been so consistently underestimated as its employment system. Because the system's three main principles--lifetime employment, company unions, and seniority pay--flout free-market ideals, Westerners consider it self-evidently incapable in the long run of withstanding global competition from the "more efficient" hire-and-fire labor system of the U.S. and Europe. Thus, every time Japan 's economy slows down, influential foreign observers can be counted on to write the system's obituary. Such reports reached a peak during the recession of the early 1990s, when Western publications, led by the Wall Street Journal and the Economist, vied with one another in printing comments from anonymous sources suggesting that lifetime employment was doomed.

The truth is precisely the opposite. Lifetime employment makes more sense now than ever, and the system's continuing strength is a key reason why Japan, with an unemployment rate of just 3% at its peak during the last recession, has been the one major industrial country to buck the global trend of ever-rising rates of structural unemployment.

Why have Western observers constantly been blind-sided on this point? In part, because they misunderstand a not-quite-what-it-seems system that contains several hidden elements of flexibility, as we shall see later. More important, though, is the widely held and mistaken belief that lifetime employment is deeply rooted in Japanese culture. This is pure myth. In fact, in the early days of Japan 's industrialization, employers generally operated by hire-and-fire rules, and as a result suffered many of the same labor problems that we think of as peculiarly Western.

Although absenteeism is virtually unknown in Japan today, a century ago it was so common after payday that employers paid different workers on different days to stagger the disruption of output. In the 1920s, Japan suffered a series of bitter strikes in steel, shipbuilding, and mining, and labor turnover in some industries was as high as 100% a year. As recently as the late 1940s Japanese labor relations were notable for widespread confrontation, chaos, even violence.

The employment system in its present form has existed only since World War II. It was consciously invented as Japan 's answer to a Western labor regime that Japanese business leaders and bureaucrats concluded was inappropriate for an advanced economy. One vital element was the formation of informal employment cartels in many industries. These restrict competition for labor by requiring rival employers to refrain from hiring from each other. This practice immediately explains one of the most puzzling aspects of the present-day system, Japanese workers' apparent lack of interest in changing jobs. The key reason is not loyalty, as Westerners often imagine, but lack of opportunities.

Via the Employment Security Law of 1947, government officials also won case-by-case powers to block employers from advertising for labor and from hiring any worker whose job change required a change of residence. While these comprehensive curbs strengthened the hand of employers in resisting demands for wage increases, they were balanced by a regulation making it illegal for employers to fire workers. Here stands revealed the reason why Japanese employers persistently refuse to break with the lifetime employment system: they provide job security not because they want to but because they have to.

Despite such legal coercion, however, Japan 's employment system offers a host of advantages, many of which are not widely recognized in the West, and only one clear disadvantage--the fact that employers cannot cut labor costs as fast as their Western counterparts when demand turns down.

Consider Japanese corporations' well-deserved reputation for the speed with which they introduce productivity-enhancing new technologies. A big reason is that since Japanese workers enjoy lifetime job guarantees, they see no downside risk in helping employers improve productivity. In fact, they embrace new technology because they know it will enhance their company's future and their own jobs.

One notable example: automation. Japanese workers are delighted for robots to take over dirty, dangerous, and repetitive jobs such as pressing and painting. These machines are often treated as part of the corporate family, to the point where they are named after favorite female singers and movie stars. By contrast, American workers are naturally suspicious of such new labor-saving technology because they know from experience that U.S. employers often use it to cut jobs. It is not surprising, then, that with only half America's work force, Japan has three times as many robots in operation.

If a corporation is to innovate, it must also train its workers to handle ever more sophisticated tasks. Here again the Japanese labor system provides a vital advantage because companies can undertake expensive training programs confident that their enterprise will reap the rewards. By contrast, American employers increasingly consider training a dubious investment, since in the U.S. system trained workers are free to take their skills to rival employers. A recent survey found that U.S. corporations are only one-seventh as likely as their Japanese counterparts to provide new recruits with formal training.

Another major strength of Japan 's labor system is the way it encourages corporations to invest in research and development. The key factor here is that thanks to the no-poaching rule, Japanese companies know that their expensively acquired R&D secrets will not leak to competitors via the job market. Such losses are a major problem for American corporations, particularly in the case of innovative new production techniques that are hard to patent but easy for a rival employer to acquire by headhunting a key employee. And since Japanese corporations can expect to keep more of the rewards from R&D than their American competitors, they naturally do more of it. As of the early 1990s, Japan 's commercial R&D spending was running at about 3% of GDP, vs. just 2.2% for the U.S.

Now consider the high quality of Japanese management, which is rightly considered a major source of Japan 's success. Why are Japanese managers so good? The answer lies mainly in the long-term accountability built into the lifetime employment system. A Japanese executive knows that the decisions he makes today will remain permanently on his record, and he may be asked to account for them many years from now. He cannot simply sweep problems under the carpet.

Japan 's employment system also reinforces the labor peace that has generally prevailed in that country in the postwar era, despite the bizarre (at least to Westerners) ritual of the annual wage negotiation. Each year, in many Japanese industries, demonstrating workers fill the sky with red Marxist banners. Labor leaders use language so fiery they would risk arrest in many countries. Sometimes a mob of slogan-chanting workers will corner a top executive in his office and hold him hostage for hours.

If management still has not gotten the message, a union will have no hesitation in resorting to the ultimate weapon--the strike. But at this point things take a distinctly Japanese turn. A Japanese union's idea of a strike is a one-hour work stoppage timed for the lunch break: workers indignantly put down their tools at noon and don't report back for work until one! If the union has planned things right, the "strike" will not have cost the company a single unit of lost production.

Underneath this theater of the absurd lies a great deal of uncommon common sense. Because the Japanese corporate system has been deliberately arranged to align workers' interests with their employers', a striking Japanese employee generally feels he's striking against his own long-term future. He knows the company will be left weakened and may not have the capital to stay the course in the technology race, which in turn means lower pay raises and less in the kitty for retirement benefits.

What has helped reinforce Japan 's latter-day labor peace is that by the late 1950s workers began to recognize that the old them-and-us divide between management and workers had truly begun to disappear. Because workers had been given lifetime job security, they, more than shareholders, had become the real beneficiaries from an enterprise's existence. Indeed, that stock enemy of American labor, the grasping chief executive officer who is "incentivized" by huge stock options, is unknown in Japan . Top Japanese executives are generally salaried employees like everyone else and do not have stock options--a fact that probably reflects an informal prohibition imposed by the Finance Ministry. Thus, they are under no pressure to make penny-wise, pound-foolish cuts in staffing to manipulate short-term profits. And when they call for pay restraint from the work force, as they do in bad times, they act in the role of the workers' leaders, not the workers' opponents.

Top executives in Japan are also modestly compensated by international standards. On an after-tax basis, a typical Japanese CEO is paid only about ten times the earnings of the most junior staff member and just four times the salary of middle-aged workers. The norm in corporate America is close to 100 times, a gap that Fujitsu Chairman Takuma Yamamoto has characterized as "absurd."

It is sometimes assumed that Japan 's low executive compensation is simply a manifestation of the strong egalitarianism that runs through East Asian culture. In fact, this policy of keeping a tight lid on top salaries is the linchpin of a highly systematized salary structure in which managers and workers are generally paid and promoted according to seniority rather than competence. In the Japanese promotion race, merit becomes a decisive factor only in the case of senior positions that become available toward the middle or end of a manager's career.

This systemization extends beyond individual corporations. Major companies in the same industry typically pay nearly identical salary scales. In the auto industry, for example, the starting salary for graduates recruited in 1993 was $1,700 a month at all five of the biggest companies--Toyota, Honda, Nissan, Mitsubishi, and Mazda. Every Japanese corporation discloses its starting pay rate in public financial reference books, providing a useful signaling system for young graduates as they size up prospective employers.

All this saves Japanese companies the enormous transaction-cost burden of setting salaries on a person-by-person basis. And given the no-poaching rule of Japanese cartels, Japan 's egalitarian salary system is easy to maintain.

The primary rationale of the salary system is to foster teamwork among managers and to eliminate a possible source of friction and jealousy between close colleagues. The system also makes it easy for top management to win workers' cooperation for postings in different departments, a factor that explains not only the speed with which Japanese companies can restructure themselves in a crisis but also the generally high level of communication and cooperation that exists between different departments.

Promotion by seniority rather than competence is to Western eyes one of the strangest aspects of the Japanese employment system. But it has its advantages. One is that it provides a powerful force for cooperation between the generations. Although Westerners argue that competent young people are blocked from realizing their potential in such a system, the truth is generally the opposite. Because senior managers are fully protected against being leapfrogged in the promotion race, they are much more likely than senior managers in the West to mentor their staff.

Perhaps the biggest misconception about Japanese labor economics in the West is that it gives workers a free ride for life. Nothing could be further from the truth. Since seniority pay is, in effect, a form of deferred pay, one of the most persuasive disciplinary tools in the Japanese system is early retirement. Generally, the poorer a person's long-run performance has been, the more likely he is to be asked to take retirement in his 50s or perhaps even in his late 40s. This is a much feared penalty because it means that he misses out on the best earning years of his life.

Officially, early retirees leave voluntarily, but in reality, most do so under threat of coercion. They know that if they resist, their employer has ways of making things uncomfortable. But if they go quietly, they can expect to get a significant termination payment and, more important, vital help in establishing a second career elsewhere. In most cases, large corporations find jobs for their early retirees in closely associated, if less prestigious, companies.

Peer pressure also serves to enforce labor discipline. Workers in a Japanese corporation generally function as part of a clearly identified team, and assignments are given to the team rather than to individuals. Persistent offenders of the team ethic risk ostracism by their peers. This pressure helps explain the apparently irrational behavior of Japanese workers in, say, not claiming their vacation entitlements: an individual worker feels obligated not to claim his rights if this would impair the group's chance of gaining a large salary bonus.

For the worst cases, companies find ways to harass a habitual shirker into resigning. Typically offenders are assigned to the mado giwa zoku--the tribe by the window. This denotes a special dunce's corner in which Japanese companies place certified pariahs. The term's significance derives from the fact that in Japan 's huge open-plan offices, the further away one is from the center of the floor, the less important one's position or section.

The Japanese labor system contains several other hidden checks and balances without which it would not be an effective tool for employers. Corporate Japan 's system of paying large twice-yearly salary bonuses, for instance, is an important shock absorber. In bad times these can be cut or even eliminated, allowing corporations to reduce annual pay levels by as much as 40%.

Another hidden element of flexibility: if a company can convince the authorities that without layoffs its whole future will be jeopardized, it can usually gain exemption from the no-layoff law. Ordinarily this loophole is available only to small employers, which means that companies lower down in the keiretsu system operate with employment practices closer to American-style hire-and-fire. Thus, big employers at the top of the keiretsu can count on their suppliers' labor flexibility as a swing factor in maintaining their group's viability in tough times.

A final nuance of the system is that many corporations maintain a large pool of low-grade, mainly white-collar workers who are specifically denied employment security under a legal loophole providing for "temporary" employment . Although in practice such workers are rarely fired, the fact that they can be affords corporate planners a further insurance policy against bad economic conditions.

Such safety valves apart, Japan 's labor system aims to provide stable long-term employment for virtually all higher-grade workers. It is backed by tough laws requiring employers to pay significant compensation to any permanent staff member who is involuntarily terminated. The strength of these laws can be gauged from the fact that some staffers at Japan Airlines recently were paid as much as $600,000 each to leave.

Perhaps the most ingenious aspect of Japanese labor economics is the extent to which the main elements of it are mutually reinforcing. The lifetime employment system, for instance, bolsters the company union system. Because employees don't expect to be fired, they have no need for industrywide unions and are content to entrust their negotiating power to company unions.

Similarly, the employment cartels' requirement that companies not hire from each other is a hidden support for the lifetime employment system: it protects employers against the loss of their most talented and productive workers. By contrast, in the modern American employment system, where aggressive employers are allowed to hire away their rivals' best people, any company that offers career-long employment security finds its payroll gradually silts up with subpar performers.

The most profound self-reinforcing effect of the Japanese labor system is the way that lifetime employment helps stabilize the economy in times of recession. To an individual employer, the no-firing rule may seem undesirable but, from the nation's point of view, the rule pays off in damping the downswing in the business cycle. In the Western system, by contrast, workers fired in a recession necessarily cut back their consumption, which throws other workers out of a job and thus further burdens the national welfare system. Japanese planners believe, not unreasonably, that workers contribute more to national output if they are in jobs rather than in dole queues.

When we add up all the fine print, a picture emerges of a highly organized and quite self-sustaining employment system-a system that is the antithesis of the cultural hangover it has long been portrayed as in the West. Jobs for life may be on the way out elsewhere in the industrialized world. But in Japan , at least, they are a central part of a labor system
with a bright and stable future.