October 2015 newsletter - Masahiko Aoki
01 Oct 2015
Not so long ago, study of the Japanese economic system had little overlap with mainstream economic theory. Many scholars argued that many characteristics that differentiated the Japanese economy from the economies of the U.S. and in Western Europe are explained only by the unique culture of Japan. Also the standard economic theory lacked the tools to understand economies that are somewhat different from market based capitalist economies. Masahiko Aoki was one of the pioneers who filled the gap by seriously applying the standard tools in economics to understand the Japanese economic system. At the same time, Aoki also advanced the economic theory to explain why we observe seemingly different economic systems in different places and times and how an economic system evolves over time.
Masa Aoki was born in Japan in 1938. At the University of Tokyo, he initially studied Marxist economics, which was dominant in Japan back then. He was also a well-known leader of the student movement, which most famously opposed the Japanese government's decision to renew the US-Japan Securities Treaty in 1960. Stimulated by a paper by Kenneth Arrow and Lionel Hurwicz (‘Decentralization and Computation in Resource Allocation’) that he read in the graduate school at the University of Tokyo, Aoki began the study of modern economic theory. He worked with Lionel Hurwicz at University of Minnesota and received his PhD in 1967.
In the same year, Aoki joined Stanford University as an assistant professor in economics. Shortly afterwards he moved to Harvard University and then to Kyoto University, but came back to Stanford in 1984 as the Henri and Tomoye Takahashi Professor of Japanese Studies and Professor of Economics. Aoki spent most of the following 30 years or so on the faculty of Stanford University.
On July 15, 2015, Masahiko Aoki passed away at Stanford Hospital at the age of 77. By then he had become an Emeritus holder of his previous roles and also a Senior Fellow of Stanford Institute of Economic Policy Research (SIEPR) and the Asia Pacific Research Center (APARC) at Freeman Spogli Institute for International Studies (FSI).
Aoki’s early work studied resource allocation in the presence of externalities. He showed that some mechanisms that adjust quantities rather than prices can do better when the first theorem of welfare economics does not hold due to these externalities. The analysis of allocation mechanisms that are different from standard Walrasian markets led Aoki to examine large corporations. Business corporations have hierarchical resource allocation mechanisms different from markets but yet they play essential roles in market economies. Aoki often applied a game-theoretic approach to the working of a corporation. A corporate organization is understood as an equilibrium of a game played by shareholders, creditors, managers, workers, and other stakeholders. Later he would apply a similar game theoretic approach to the entire economic system and beyond.
Understandably, Aoki was especially intrigued by corporations in Japan. Japanese firms use non-price allocation mechanisms not only inside the organizations but also in their transactions with other firms. In the 1980s, Aoki advanced his analysis of the Japanese firm and industrial organization at both Kyoto and Stanford. A result was the book Information, Incentives, and Bargaining in the Japanese Economy (Cambridge U P, 1988). In the Preface, Aoki wrote that in trying to apply the mainstream economics to understand the Japanese economy, ‘I have been compelled to examine critically some textbook
notions about the microstructure of the market economy …… it is necessary to go beyond those … notions in order to arrive at a more complete understanding of the Japanese economy.’
Aoki’s attempt to ‘go beyond’ conventional economic theory to understand an economic system that was different from the market economies of the US and Europe eventually led to establishment of comparative institutional analysis. New institutional economics developed by Douglas North and others stressed the importance of ‘institution’ as the rule of the game in constraining the actions of economic agents and in determining a particular economic outcome. Masahiko Aoki, in collaboration with other economists at Stanford including Avner Greif, Paul Milgrom, Yingyi Qian, and John Roberts, advanced the analysis by defining an ‘institution’ as a shared understanding of all the agents about how the game is played in equilibrium. Thus, the comparative institutional analysis considers how an institution is established, rather than taking the institution given from outside the model. ‘An institution thus conceptualized is essentially endogenous, but appears to be an exogenous constraint to the individual agents.’1 The efforts to build the framework of the comparative institutional analysis culminated in the book Toward a Comparative Institutional Analysis (MIT Press, 2001).
Aoki’s comparative institutional analysis also expanded the scope of institutions to ‘domains’ other than economic, including political and social domains. All of those domains are linked and often exhibit ‘institutional complementarities’ in the sense that a particular institution in one domain increases the benefits of a particular institution in the other domain for all the agents.
Institutional complementarities imply that an institution is robust to small changes in the environment: even when the benefit of a particular institution in one domain declines a little bit, its complementarity with the institutions in the other domains can still make the institution better than any alternatives. Institutional complementarities also imply the possibility of drastic institutional changes if the institutions in sufficiently important domains change. Thus, the comparative institutional analysis can potentially help us understand the rich evolutionary dynamics of institutions in various parts of the world. Indeed this was the theme of Aoki’s most recent paper that he continued to work on even after he was admitted to hospital. The paper contrasted institutional evolutions in China and Japan from the late 19th Century to the early 20th Century.
Masa Aoki made great contributions to economics through his own research, but he also left legacies by building research organizations. He founded the Research Institute of Economy, Trade, and Industry (RIETI) in collaboration with Ministry of Economy, Trade, and Industry of Japan, the Virtual Center for Advanced Studies in Institutions (VCASI) at Tokyo Foundation, and was involved in the establishment of the Center for Industrial Development and Environmental Governance (CIDEG) at Tsinghua University in China. He was the founding editor of the Journal of the Japanese and International Economies, which was the first and still is the top academic journal that focuses on the Japanese economy. He served as the President of International Economic Association from 2008 to 2011 and organized the 16th World Congress at Beijing, China in 2011.
Masa Aoki was an exceptional scholar and institution builder who made important contributions to the field of economics in general and the study of East Asian economies in particular. He is deeply missed.
Takeo Hoshi, Stanford University
1. Aoki, M. (2007) ‘Endogenizing Institutions and Institutional Changes,’ Journal of Institutional Economics, 3, 1-31, p.1.