This chapter begins by noting the dual challenge of newly developing nations: achieving economic development as late developers, and assuring order in changing societies. The chapter contends that although leaders of developing nations, such as Sun Yat-sen and Chandra Bose, once manifested substantial interest in the Japanese model, there has been little systematic consideration of that approach.

This chapter elaborates on the puzzles in Japanese economic performance and public policy that suggest the need for new analytical paradigms. In the sphere of economic performance, it is puzzling that Japanese growth was distinctively rapid for nearly a century from the late Meiji period until around 1990, slowed down sharply, and then failed to recover, despite massive pump priming and technological strength. Policy puzzles include the slow overall profile of Japan's globalization response, cross-sectoral variance in response profiles, and inconsistencies in governmental responses to specific connected and unconnected firms.

This chapter defines "circles of compensation" as "networks of regular participants . . . in which members have reciprocal benefits and obligations." Such circles have five specific traits: (1) a clearly defined set of members, (2) expansibility, (3) an iterative character, (4) a propensity to allocate resources internally, and (5) a propensity to externalize costs to nonmembers. After specification of the model, the chapter proceeds to illustrate with examples from both Japanese and international experience, including cartels, industry associations, and agricultural cooperatives. The chapter concludes with comments on the geographical distribution of circles, their heuristic value, and methodological comments on case selection, to provide testable hypotheses on the nature of circles of compensation.

This chapter explains the progression of the empirical section of the book, which provides concrete examples of circles of compensation in action, and tests the central hypothesis, which is: Circles of compensation systematically internalize reward and externalize risk, introducing a parochial bias into both policy and corporate behavior that enhances in-group solidarity, and reduces incentives to pursue outside initiatives, thus inhibiting both individual and corporate responsiveness to globalization.

This chapter describes the key institutions of Japanese domestic and international finance, as well as their transformation over the past three decades. It chronicles, in particular, the decline of the long-term credit banks and the keiretsu, together with the implications of these developments for cooperative capitalism across the Japanese political economy. It shows how these developments have impeded innovation and structural adjustment and contributed to stagnant growth. The revision of Japan's Foreign Exchange and Investment Law in late 1980 also influenced domestic incentive structures in critical ways that are described and analyzed.

This chapter shows the central role that the political economy of land has historically played in crowded, high-growth Japan, and how land policy has encouraged expansionary banking behavior and hence high-speed economic growth. It also shows why the same land policies, in interaction with cooperative capitalism in the finance area, have contributed to the rigidity and stagnation of the Japanese political economy.

This chapter describes agricultural policies and institutions, stressing the central role of public–private cooperation, and also explains the structural relationships among agricultural policy, political stability, and leveraged high-speed economic growth. It notes that the agriculture policy is slowly liberalizing, but related circles of compensation nevertheless remain salient, especially at the local level, due to persistent human networks at the grassroots level.

This chapter shows how cooperative capitalism operates in the energy sector to ensure stable price levels and capital investment. The analysis focuses especially on nuclear power and how circles of compensation have promoted nuclear power and worked to assure local acceptance, both before and after the Fukushima nuclear accident of March 2011.

This chapter shows how circles of compensation can impede Japan's globalization by privileging parochial interests (heavily subsidized local airports) at the expense of potentially competitive cosmopolitan interests (Japan's international airlines and largest airports). The result is a situation where neighboring Korea has become the air and sea shipping hub for East Asia, at Japan's expense, due to perverse, inward-looking Japanese transportation policies.

This chapter illustrates the mixed implications of circles of compensation in a rapidly globalizing world, in two parallel dimensions—the "hard" side of communications (telecommunications equipment) and the "soft" side (education and mass media). In the telecommunications sector, the circles have produced an industry focusing on increasingly specialized and arcane applications, largely impractical outside of Japan. In education, there has been a comparable parochial drift. In both areas, Japan is gradually adjusting to long-term global trends, but only slowly, due to the cushioning effect of circles of compensation.

This chapter addresses the impact of domestic circles of compensation on the incentive structure of Japanese firms and policy makers as they confront globalization. It suggests that the circles encourage them to prioritize stability of domestic corporate relationships at the expense of competitive response to international challenge, to the extent that those contrasting pressures come into conflict. The argument is substantiated by evidence from cases of Japanese firms, such as Rakuten and SoftBank, that are not extensively involved with circles of compensation within Japan, yet are proactive and successful abroad.

This chapter documents Japan's difficulties in responding to globalization, principally through comparison with three late-developing political economies with broad similarities to Japan in resource endowment and political structure, which have responded much more smoothly to globalization than has Japan. The chapter then explores where these three countries (Germany, South Korea, and Singapore) provide useful reference points for Japanese policy making.

This chapter returns to the hypothesis that circles of compensation introduce a parochial, stabilizing bias into working-level incentive structures, inhibiting rapid response to globalization. Sector-specific case studies and national-level data generally confirm this hypothesis. Counterfactual foreign and Japanese cases where circles of compensation do not prevail point to a parallel conclusion. The policy implication is that Japan's "third arrow" structural reforms will be difficult to achieve. Given the complexity and possibly perverse macropolitical implications of dismantling embedded circles of compensation, this research suggests broadening the circles through political leadership within Japan and transnational collaboration to enhance innovative capacity. Privatization and "third arrow" Abenomics structural reforms will likely have limited utility, while broadening efforts such as "womanomics" and use of pension-fund investment criteria may be more effective. Another priority should be transnational private-sector, academic, and governmental linkages, with centers of innovation abroad, such as Silicon Valley.